##### Table of Contents



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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549


FORM 10-K


|                                                                                             
|---------------------------------------------------------------------------------------------
|                                                                                             
|[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE
SECURITIES EXCHANGE ACT OF 1934      
|For the Fiscal Year Ended: December 31, 2002                                                 
|OR                                                                                           
|[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 0-25520

CENTERSPAN COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)


|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Oregon                                                         |  | 93-1040330                          
|(State or other jurisdiction of incorporation
or organization) |  | (I.R.S. Employer Identification No.)
|                                                               |  |                                     
|7175 NW Evergreen Parkway #400
Hillsboro, Oregon               |  | 97124-5839                          
|(Address of principal executive offices)                       |  | (Zip Code)                          

Registrants telephone number, including area code: 503-615-3200

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

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





Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes [X] No [  ]


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

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [  ] No [X]

The aggregate market value of the voting and non-voting common equity held by
non-affiliates, computed by reference to the last sales price ($4.60) as
reported by the Nasdaq National Market System, as of the last business day of
the Registrants most recently completed second fiscal quarter (June 28, 2002),
was $29,688,317

The number of shares outstanding of the Registrants common stock as of March
21, 2003 was 10,926,915 shares.



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Documents Incorporated by Reference


The Registrant will incorporate into Part III of Form 10-K, by reference,
portions of its Proxy Statement for its 2003 Annual Meeting of Shareholders.




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TABLE OF CONTENTS



|                                                                           |                                                                                               |  |  |  |  |  |  | 
|-------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART 1                                                                    
|                                                                           | Item 1. Business                                                                             
|                                                                           | Item 2. Properties                                                                           
|                                                                           | Item 3. Legal Proceedings                                                                    
|                                                                           | Item 4. Submission of Matters to a Vote of Security Holders                                  
|PART II                                                                   
|                                                                           | Item 5. Market for the Registrants Common Equity and Related Shareholder Matters            
|                                                                           | Item 6. Selected Financial Data                                                              
|                                                                           | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                                                           | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                          
|                                                                           | Item 8. Financial Statements and Supplementary Financial Data                                
|                                                                           | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 
|PART III                                                                  
|                                                                           | Item 10. Directors and Executive Officers of the Registrant                                  
|                                                                           | Item 11. Executive Compensation                                                              
|                                                                           | Item 12. Security Ownership of Certain Beneficial Owners and Management                      
|                                                                           | Item 13. Certain Relationships and Related Transactions                                      
|PART IV                                                                   
|                                                                           | Item 14. Controls and Procedures                                                             
|                                                                           | Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                     
|SIGNATURES                                                                
|CERTIFICATION PURSUANT TO SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
|EXHIBIT 10.23                                                             
|EXHIBIT 23                                                                
|EXHIBIT 99.1                                                              



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CENTERSPAN COMMUNICATIONS CORPORATION
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS

|               |  |                                                                                       |  |     
|-------------- |  | ------------------------------------------------------------------------------------- |  | ----
|               |  |                                                                                       |  | Page
|               |  |                                                                                       |  |     
|               |  | PART I                                                                                |  |     
|Item 1.        |  | Business                                                                              |  | 2   
|Item 2.        |  | Properties                                                                            |  | 5   
|Item 3.        |  | Legal Proceedings                                                                     |  | 5   
|Item 4.        |  | Submission of Matters to a Vote of Security Holders                                   |  | 5   
|               |  | PART II                                                                               |  |     
|Item 5.        |  | Market for Registrants Common Equity and Related Stockholder
Matters                 |  | 6   
|Item 6.        |  | Selected Financial Data                                                               |  | 7   
|Item 7.        |  | Managements Discussion and Analysis of Financial Condition
and Results of Operations |  | 8   
|Item 7A.       |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 20  
|Item 8.        |  | Consolidated Financial Statements and Supplementary Data                              |  | 21  
|Item 9.        |  | Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure  |  | 37  
|               |  | PART III                                                                              |  |     
|Item 10.       |  | Directors and Executive Officers of the Registrant                                    |  | 38  
|Item 11.       |  | Executive Compensation                                                                |  | 38  
|Item 12.       |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 38  
|Item 13.       |  | Certain Relationships and Related Transactions                                        |  | 41  
|               |  | PART IV                                                                               |  |     
|Item 14.       |  | Controls and Procedures                                                               |  | 42  
|Item 15.       |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                       |  | 42  
|Signatures     |  |                                                                                       |  | 45  
|Certifications |  |                                                                                       |  | 46  

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PART I

This Annual Report on Form 10-K contains forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. The Act
provides a safe harbor for forward-looking statements to encourage companies
to provide prospective information about themselves so long as they identify
these statements as forward-looking and provide meaningful cautionary
statements identifying important factors that could cause actual results to
differ from the projected results. Words such as anticipates, expects,
intends, plans, believes, seeks, estimates, and similar expressions
identify forward-looking statements. However, the absence of these words does
not mean the statement is not forward-looking. All statements other than
statements of historical fact that we make in this Annual Report on Form 10-K
are forward-looking. In particular, these forward-looking statements include
statements regarding: the adequacy of funds to meet our current or future cash
needs; the development and launch of content distribution solutions and
services such as C-StarOne; future revenue and revenue sources and models; the
renegotiation of our agreement with Sony Music Entertainment; the outcome of
pending litigation; upcoming research and engineering expenses; selling,
general and administrative expenses; and capital expenditures.

We cannot guarantee any of the forward-looking statements, which are subject to
risks, uncertainties and assumptions that are difficult to predict. Actual
results may differ materially from those we forecast in forward-looking
statements due to a variety of factors, including those set forth in the
Factors That May Affect Forward-Looking Statements section of this Annual
Report on Form 10-K. We do not intend to update any forward-looking statements
due to new information, future events or otherwise. If we do update or correct
one or more forward-looking statements, investors and others should not
conclude that we will make additional updates or corrections with respect to
other forward-looking statements.




Item 1. Business

Overview

CenterSpan Communications Corporation is a venture stage company that develops
and markets secure software-based Internet and intranet content delivery
solutions for media and communications service providers and corporate
customers. C-StarOne is a low-cost, content delivery solutions designed for
delivering large files such as digital audio, video, executables, and data
files. Value-added services complementary to C-StarOne delivery include
content preparation, publishing, security, and data analysis.

C-StarOne competes in the Content Distribution Network (CDN) market space.
Targeted market segments include video game developers and on-line retailers,
telecom companies, Multiple Service Operators (MSOs) and Internet Service
Providers (ISPs), and media service providers like movie studios, music labels,
publishers, distributors and portals. Integration with customer web sites for
file delivery began in the fourth quarter of 2002.

The market for CenterSpans C-StarOne services is characterized by rapidly
changing technology, evolving industry standards, and changing customer needs.
We believe that our future success will depend, in part, upon our ability to
enhance our current offerings on a timely and cost-effective basis, and to
respond to changing customer needs and technological developments. An inability
to generate demand for our services, whether as a result of competition,
technological change or other factors, could have a material adverse effect on
our financial condition, results of operations and liquidity.

CenterSpan continued to experience operating losses during the year ended
December 31, 2002 and we have never generated significant revenues from our
software-based content delivery operations. We expect that significant ongoing
expenditures will be necessary to successfully implement our business plan and
develop and market our content delivery solutions. Execution of our plans and
our ability to continue as a going concern depend upon our acquiring
substantial additional financing. Managements plans include efforts to obtain
additional capital through bridge loans and the sale of equity securities. We

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have raised operating funds in the past by selling shares of our common stock.
We may not be able to raise additional funding. If we are unable to obtain
adequate additional financing or generate sufficient cash flow from operations,
management will likely be required to further curtail our operations and we
will likely cease operations.

Background

CenterSpan was originally incorporated in 1990 as ThrustMaster, Inc., an Oregon
corporation. ThrustMaster designed and built video game controllers and other
peripheral hardware for gaming. In 1999, we sold our hardware business for
$15 million in cash and changed our name to CenterSpan Communications
Corporation.

Following the sale of our hardware business, we began developing and marketing
peer-to-peer Internet communication, collaboration and distribution solutions.
Due to lack of commercial adoption of our internet communication, collaboration
and distribution solutions, we discontinued distribution efforts in the fourth
quarter of 2000 and no longer promote or market those products.

Digital Distribution Solutions

In the third quarter of 2000, we began developing a distributed file network
utilizing digital rights management technology code-named C-Star. In December
2000, we purchased certain assets of Scour, Inc. for $5.8 million in cash and
333,333 shares of our common stock. We began beta testing of the new Scour,
which incorporated our C-Star technology, in March 2001. Scour is a showcase
music and video distribution network, which provides digital content free to
the end user. Scour was the first application of C-Star and represents a
secure and legal digital distribution channel that integrates distribution
technology with digital rights management support. In April 2002, we changed
the name to C-StarOne and began marketing it as a digital distribution
service.

In February 2002, we entered into an agreement with Sony Music Entertainment.
Under the terms of the agreement, Sony makes recordings available from its
catalog of music performances for us to distribute digitally via C-StarOne to
various C-StarOne service provider customers and their subscribers in the
United States and Canada. In exchange, we paid cash and issued stock and
warrants to Sony. The total value of the stock, warrants and cash was $3.7
million and is being amortized over the three-year term of the agreement. We
paid an initial content fee of $500,000 in February 2002 upon execution of the
agreement. Under the terms of the agreement, a second content fee payment of
$500,000 was due September 1, 2002. In addition, quarterly advance royalty
payments of $250,000 each are payable for four quarters beginning on September
1, 2002. Neither the second content fee payment due September 1, 2002, nor
advance royalty payments due September 1, 2002, December 1, 2002 and March 1,
2003 have been made. We are currently in negotiations with Sony seeking to
restructure or modify this agreement.

Product Development and Technology

To enable faster downloads and to deliver a better streaming experience for end
users, C-StarOne uses advanced distributed networking technologies that
deliver digital content more efficiently and more cost-effectively than
traditional central server-based Content Delivery Networking (CDN) systems.
Using C-StarOne provides service providers a cost effective option for scaling
their offerings to fit a variety of business models, including pay-per-use,
downloadable or streaming content. To safeguard copyrights and protect digital
files from tampering and viruses, C-StarOne includes market-leading Tiered
Security. Customers can deliver fast, top quality rich media without
provisioning bandwidth or incurring additional infrastructure costs.
C-StarOnes advanced networking infrastructure uses our Intelligent Caching
technology to guarantee that end-users obtain the fastest downloads and
highest-quality streams. C-StarOnes Tiered Security provides the highest
level of security available in the commercial market for video and audio
content. The security layers of C-StarOne were designed to accommodate
multiple Digital Rights Management (DRM) licensing services.

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Research and Engineering

Amounts incurred for research and engineering in 2002 primarily relate to costs
for the continued development of C-StarOne. During the third quarter of 2002,
we decided to market C-StarOne as a service only, rather than as a service and
a product. Accordingly, software development costs incurred for significant
improvements or enhancements from that point forward are accounted for as
software developed for internal use in accordance with Statement of Position
98-1, Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. Accordingly, $402,000 of research and engineering costs were
capitalized in 2002. There were no software development costs capitalized in
2001 or 2000.

Sales, Distribution and Marketing

We use a direct sales group and marketing partnerships to sell C-StarOne CDN
services. Our target customers include companies that offer rich media via the
Internet through VOD (Video on Demand), video game software developers and
retailers, media and entertainment companies offering audio and video via the
Internet, internet service providers (ISPs) and eLearning companies. These
segments must offer rich media at sufficient quality and profit margins while
safeguarding the content they offer. C-StarOne addresses those needs.

We intend to charge for our C-StarOne service in a number of ways: customer
set-up fees, volume of content delivered, Digital Rights Management, license
management as well as content hosting, traffic reporting, content encoding and
other value added services. We have signed agreements with eight customers and
recognized $6,600 of revenue in the first quarter of 2003. Revenue is
recognized when services are completed and invoiced.

The agreement with Sony Music Entertainment provides us with certain musical
and other content. We intend to resell the Sony music content to our
C-StarOne customers to provide added value. Currently, we are discussing
modifications to this agreement with Sony that we believe will be mutually
beneficial and will expand the scope of content available for potential
C-StarOne service provider customers. See Digital Distribution Solutions
above.

Competition

The CDN market is highly competitive. Many of our competitors may have greater
resources and experience than we do. Though there has been some consolidation
in the market, we expect competition to continue to be significant in the
future. Our principal competitors include CDN service and product vendors, such
as Akamai, Digital Island (recently purchased by Cable & Wireless) and
Speedera. Smaller companies focused on rich media include Kontiki and
BlueFalcon, Internet music distributors that use digital download, peer-to-peer
or streaming technologies, such as MP3.com, Liquid Audio, Press Play, Real
Networks, music labels and movie studios, in-house providers, as well as
providers of digital entertainment services such as MusicNet, Listen.com and
RioPort. Some of our competitors may have advantages over us, including:



| |  |  | Longer operating histories;                                                          
| | - |  | -------------------------------------------------------------------------------------
|
| |  |  | Larger customer bases;                                                               
|
| |  |  | Substantially greater financial, technical, sales and marketing resources;           
|
| |  |  | Greater name recognition; and                                                        
|
| |  |  | The ability to provide solutions for static and rich content more easily than we can.

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Intellectual Property

Some of the intellectual property rights used in the development of our
technology, but that we no longer use, are licensed from another company.
These licenses were expensed as research and development in prior years and
expire August 21, 2005. We have applied for registration of the names
CenterSpan, Scour Exchange, Scour, C-Star and C-StarOne. We rely on
patent, trademark and copyright law, trade secret protection and
confidentiality agreements with our employees, strategic partners and others to
protect our proprietary rights. In October 2001, we filed applications for two
additional patents to protect multi-source peer streaming technology developed
internally. We also have applications filed for 12 provisional and utility
patents surrounding internally developed and purchased digital media
distribution technologies. Although we believe that our technology, processes
and trademarks do not infringe on the rights of others, third parties may
assert infringement or other related claims against us in the future. Any
infringement claim or related litigation against us, or any challenge to the
validity of our own intellectual property rights, or the expense and effort of
defending those claims, could materially and adversely affect our business,
financial condition and results of operations.

Employees

As of December 31, 2002, we had a total of thirty-seven full-time employees.
At times, we supplement our workforce with temporary contract workers. None of
our employees are represented by a labor union. We have not experienced any
work stoppages and consider our relations with our employees to be good. A
reduction of force was made in February 2003 to reduce the number of employees
to seventeen. Only key personnel were retained.




Item 2. Properties

We maintain our headquarters facility in Hillsboro, Oregon, in approximately
22,000 square feet of space under a lease expiring in September 2003. We
maintain our Los Angeles office in approximately 4,300 square feet of space
under a lease expiring in April 2005. We believe our facilities are adequate
for our immediately foreseeable needs and that suitable additional or
alternative space will be available on commercially reasonable terms if needed.

In addition, we lease space for the storage of certain of our servers and
related technology infrastructure under a three-year lease, which expires
January 2005. We can terminate this lease anytime after January 2003 without
penalty with a 30-day written notice to the lessor.




Item 3. Legal Proceedings

CenterSpan, its Chief Executive Officer and its former President and Chief
Operating Officer were named as defendants in a lawsuit filed on August 22,
2002 in the Circuit Court of Oregon for Multnomah County, Case No. 0208-08460,
by two former, non-executive employees. The former employees allege
intentional and reckless misrepresentation with respect to their offers of
employment and subsequent terminations and seek damages of $1.0 million each
for economic loss and $2.0 million each for emotional distress and injury to
reputation. We intend to vigorously defend this action. We cannot predict the
outcome of this suit. A negative outcome could have a material adverse effect
on our financial condition and business.




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

No matters were submitted to a vote of security holders during the quarter
ended December 31, 2002.

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PART II




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

Our common stock is traded on the Nasdaq National Market under the symbol CSCC.
The high and low sales prices for the two years in the period ended December
31, 2002 were as follows:

|          |  |      |       |     |  |   |       | 
|--------- |  | ---- | ----- | --- |  | - | ----- | 
|2001      |  | High |       | Low
|          |  |      |       |    
|Quarter 1 |  | $    | 20.31 |     |  | $ | 11.00 | 
|Quarter 2 |  |      | 17.71 |     |  |   | 9.02  | 
|Quarter 3 |  |      | 13.64 |     |  |   | 5.15  | 
|Quarter 4 |  |      | 11.72 |     |  |   | 6.00  | 

|          |  |      |       |     |  |   |      | 
|--------- |  | ---- | ----- | --- |  | - | ---- | 
|2002      |  | High |       | Low
|          |  |      |       |    
|Quarter 1 |  | $    | 11.00 |     |  | $ | 6.75 | 
|Quarter 2 |  |      | 7.13  |     |  |   | 4.18 | 
|Quarter 3 |  |      | 5.00  |     |  |   | 2.01 | 
|Quarter 4 |  |      | 4.10  |     |  |   | 1.16 | 

The approximate number of beneficial shareholders and shareholders of record at
March 21, 2003 were 3,000 and 95, respectively. There were no cash dividends
declared or paid in 2002 or 2001. We do not anticipate declaring cash
dividends in the foreseeable future.

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Item 6. Selected Financial Data

The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and the notes thereto.
On July 26, 1999, our Board of Directors approved the sale of our hardware
business assets. We have presented the hardware business as a discontinued
operation in the selected consolidated financial data presented below.

|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |     |       |       |  
|------------------------------------------------------------------------------------------------------------- | ------------------------------- | ------------------------ | ----------------- | ----- | ----------------------- | ------ | ------- | ----- | ------ | ----- | ------- | ----- | ------ | ----- | ------- | ----- | ----- | ----- | ------ | --- | ----- | ----- | -
|                                                                                                              |                                 |                          |                   |       | Year Ended December 31,
|                                                                                                              |                                 |                          |                   |       |                        
|IN THOUSANDS (except per share amounts)                                                                       |                                 | 2002                     |                   | 2001  |                         | 2000   |         | 1999  |        | 1998 
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |      
|Consolidated Statement of Operations Data                                                                     |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|Revenues                                                                                                      |                                 | $                        |                  |       |                         | $      | 51      |       |        | $     | 1       |       |        | $     | 787     |       |       | $     |       |    
|Cost of goods sold                                                                                            |                                 |                          |                  |       |                         |        |        |       |        |       |        |       |        |       | 569     |       |       |       |       |    
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|                                                                                                              | Gross profit                    |                          |                   |      |                         |        |         | 51    |        |       |         | 1     |        |       |         | 218   |       |       |        |    |      
|Operating expenses:                                                                                           |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|                                                                                                              | Operations and customer service |                          |                   | 1,156 |                         |        |         | 829   |        |       |         |      |        |       |         |      |       |       |        |    |      
|                                                                                                              | Research and engineering        |                          |                   | 4,107 |                         |        |         | 7,035 |        |       |         | 4,692 |        |       |         | 3,242 |       |       |        | 152 |      
|                                                                                                              | Marketing and sales             |                          |                   | 4,457 |                         |        |         | 6,195 |        |       |         | 1,985 |        |       |         | 1,179 |       |       |        |    |      
|                                                                                                              | General and administrative      |                          |                   | 3,439 |                         |        |         | 4,009 |        |       |         | 3,242 |        |       |         | 1,274 |       |       |        | 914 |      
|                                                                                                              | Depreciation and amortization   |                          |                   | 3,907 |                         |        |         | 3,856 |        |       |         | 445   |        |       |         | 61    |       |       |        | 31  |      
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|                                                                                                              |                                 | Total operating expenses |                   |       | 17,066                  |        |         |       | 21,924 |       |         |       | 10,364 |       |         |       | 5,756 |       |        |     | 1,097 |      
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|Loss from operations                                                                                          |                                 |                          | (17,066           | )     |                         |        | (21,873 | )     |        |       | (10,363 | )     |        |       | (5,538  | )     |       |       | (1,097 | )  
|Interest income                                                                                               |                                 |                          | 76                |       |                         |        | 399     |       |        |       | 895     |       |        |       | 417     |       |       |       | 64     |    
|Interest expense                                                                                              |                                 |                          | (9                | )     |                         |        | (62     | )     |        |       |        |       |        |       |        |       |       |       |       |    
|Loss from beneficial conversion feature                                                                       |                                 |                          |                  |       |                         |        |        |       |        |       |        |       |        |       | (987    | )     |       |       |       |    
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|Loss from continuing operations before income
taxes                                                           |                                 |                          | (16,999           | )     |                         |        | (21,536 | )     |        |       | (9,468  | )     |        |       | (6,108  | )     |       |       | (1,033 | )  
|Benefit from (provision for) income taxes                                                                     |                                 |                          | 164               |       |                         |        |        |       |        |       |        |       |        |       | (4,532  | )     |       |       |       |    
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|Loss from continuing operations                                                                               |                                 |                          | (16,835           | )     |                         |        | (21,536 | )     |        |       | (9,468  | )     |        |       | (10,640 | )     |       |       | (1,033 | )  
|Income (loss) from discontinued operations, net
of tax provision (benefit) of $0, $0, $0,
$(5,792) and $1,615 |                                 |                          |                  |       |                         |        |        |       |        |       |        |       |        |       | (5,207  | )     |       |       | (8,023 | )  
|Gain on disposal of discontinued operations, net                                                              |                                 |                          |                  |       |                         |        | 674     |       |        |       |        |       |        |       | 6       |       |       |       |       |    
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|Net loss                                                                                                      |                                 | $                        | (16,835           | )     |                         | $      | (20,862 | )     |        | $     | (9,468  | )     |        | $     | (15,841 | )     |       | $     | (9,056 | )  
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|Loss per share from continuing operations:                                                                    |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|                                                                                                              |                                 |                          | Basic and diluted |       | $                       | (1.65  | )       |       | $      | (2.59 | )       |       | $      | (1.52 | )       |       | $     | (2.11 | )      |     | $     | (0.24 | )
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|Income (loss) per share from discontinued
operations:                                                         |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|                                                                                                              |                                 |                          | Basic and diluted |       | $                       |       |         |       | $      | 0.08  |         |       | $      |      |         |       | $     | (1.03 | )      |     | $     | (1.83 | )
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|Net loss per share:                                                                                           |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|                                                                                                              |                                 |                          | Basic and diluted |       | $                       | (1.65  | )       |       | $      | (2.51 | )       |       | $      | (1.52 | )       |       | $     | (3.14 | )      |     | $     | (2.07 | )
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|Shares used in per share calculations:                                                                        |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    
|                                                                                                              |                                 |                          | Basic and diluted |       |                         | 10,190 |         |       |        | 8,309 |         |       |        | 6,231 |         |       |       | 5,038 |        |     |       | 4,380 |  
|                                                                                                              |                                 |                          |                   |       |                         |        |         |       |        |       |         |       |        |       |         |       |       |       |        |    

|                                |  |      |       |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|------------------------------- |  | ---- | ----- | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ |  |  | - | ------ | 
|December 31,                    |  | 2002 |       | 2001 |  | 2000 |        | 1999 |  | 1998
|                                |  |      |       |      |  |      |        |      |  |     
|Consolidated Balance Sheet Data |  |      |       |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|Working capital                 |  | $    | 1,513 |      |  | $    | 4,615  |      |  | $    | 6,998  |  |  | $ | 15,535 |  |  | $ | 10,685 | 
|Total assets                    |  |      | 8,727 |      |  |      | 11,308 |      |  |      | 20,855 |  |  |   | 19,357 |  |  |   | 25,954 | 
|Total liabilities               |  |      | 1,864 |      |  |      | 1,379  |      |  |      | 3,165  |  |  |   | 3,397  |  |  |   | 14,401 | 
|Shareholders equity            |  |      | 6,863 |      |  |      | 9,929  |      |  |      | 17,690 |  |  |   | 15,960 |  |  |   | 11,553 | 

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

General

Managements Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with our consolidated financial
statements and notes thereto.

Continuing Operations

We are a venture stage company. Our operations consist of our software
business, which began in mid-1998.

CenterSpan continued to experience operating losses during the year ended
December 31, 2002, and in the first three months of 2003, and we have never
generated sufficient revenues from our software-based content delivery
operations to offset expenses. We expect to continue to incur losses through
2003. CenterSpan expects to incur approximately $1.0 million per quarter of
operating expenses and expects that significant ongoing expenditures will be
necessary to successfully implement our business plan and develop and market
our products.

There is substantial doubt about our ability to continue as a going concern.
Execution of our plans and our ability to continue as a going concern depend
upon our acquiring substantial additional financing, which we may be unable to
do. Managements plans include efforts to obtain additional capital, through
bridge loans and the sale of equity securities. We cannot predict on what terms
any such financing might be available, but any such financing could involve
issuance of equity below current market prices and could result in significant
dilution to existing shareholders.

CenterSpan has raised operating funds in the past by selling our shares of our
common stock. We may not be able to raise additional funding. If we are
unable to obtain adequate additional financing or generate sufficient cash flow
from operations, management will likely be required to further curtail our
operations, and we will likely cease operations.

In the third quarter of 2000, we began developing a distributed file network
utilizing digital rights management technology, code-named C-Star. In
December 2000, we purchased certain assets of Scour, Inc. We began beta
testing of the new version of Scour, which incorporated our C-Star
technology, in March 2001. Scour is a showcase music and video distribution
network, which provides digital content free to the end user. Scour was the
first application of C-Star and represents a secure and legal digital
distribution channel that integrates distribution technology with digital
rights management support. In July 2001, we began marketing C-Star as a
digital distribution service. In April 2002, we introduced a new version of
our content delivery network service named C-StarOne. In the second and third
quarters of 2002, we entered into three customer agreements to provide
C-StarOne services and, during the fourth quarter of 2002, we entered into
five additional customer agreements. Integration with customer web sites for
file delivery began in the fourth quarter of 2002 and $6,600 of revenue
generated from these agreements was recorded in January 2003.

In February 2002, we entered into an agreement with Sony Music. Under the
terms of the agreement, Sony makes recordings available from its catalog of
music performances for us to distribute digitally via C-StarOne to various
C-StarOne service provider customers and their subscribers in the United
States and Canada. In exchange, we paid cash and issued stock and warrants to
Sony. The total value of the common stock, warrants and cash was $3.7 million
and is being amortized over the three-year term of the agreement. We paid an
initial content fee of $500,000 in February 2002 upon execution of the
agreement. Under the terms of the agreement, a second content fee payment of
$500,000 was due September 1, 2002. In addition, quarterly advance royalty
payments of $250,000 each are payable for four quarters beginning September 1,
2002. The second content fee and the first three quarterly advance royalty
payments are due and payable to Sony. These payments, totaling $1.25 million,
have not been made as we are currently in negotiations with Sony seeking to
restructure or modify this agreement. If we

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are unable to successfully restructure or modify this agreement and these
payment obligations, our financial condition and business may be materially
harmed and we may be forced to cease operations.

We use a direct sales group and marketing partnerships to sell C-StarOne
content delivery network services. Although we have signed several customer
service agreements, obtaining delivery contracts with major providers of
digital media is crucial to our success.

Critical Accounting Policies

The preparation of our financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses. Significant estimates used by management primarily relate to the
estimated lives of intangible assets. Our estimates are based on historical
experience and on various other assumptions that we believe are reasonable
under the circumstances. These estimates and assumptions form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. See Note 2 to our consolidated
financial statements, Summary of Significant Accounting Policies, for
additional information.

Our critical accounting policies include the following:



| |  |  | Accounting for intangible assets;                      
| | - |  | -------------------------------------------------------
|
| |  |  | Revenue recognition; and                               
|
| |  |  | Research and development costs and purchased technology

The following is a summary of these policies:

Intangible Assets

Intangible assets primarily consist of a trade name purchased during 2000 from
Scour, Inc., content distribution rights purchased from Sony in the first
quarter of 2002 and capitalized research and engineering costs related to
software developed for internal use. We review identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. We determine impairment
based on a comparison of the carrying amount of the assets to the estimated
fair value of the assets, which is determined based on the discounted cash flow
method or current market prices for similar assets when available. In
accordance with Statement of Financial Accounting Standards (SFAS) No. 142
Goodwill and Other Intangible Assets, which was adopted in January 2002,
intangible assets with estimable useful lives are amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. If we change the estimates used
in the assessment of recoverability for intangible assets, such as our
estimates of anticipated future revenues or of the life of the associated
technologies, we may determine that our intangible assets have a lower net
realizable value. This, in turn, would increase our reported operating
expenses, and increase our net loss, but have no effect on our cash flows. The
balance of our intangible assets at December 31, 2002 totaled $3.5 million,
which is being amortized over the remaining lives of the related assets of one
to two years. As mentioned under Continuing Operations above, we are seeking
to restructure or modify our agreement with Sony. Depending on the outcome of
the renegotiations with Sony, the remaining value of the related intangible
asset could be impaired. The amount of the potential impairment is not known
at this time, but it could have a materially adverse effect on our financial
condition and business.

Revenue Recognition

In compliance with the Securities and Exchange Commission (SEC) Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, and
SFAS No. 48, Revenue Recognition When Right of Return Exists, we recognize
revenue when the earnings process is complete. The earnings process is
considered complete when persuasive evidence of an arrangement between the
customer and us exists, when delivery and acceptance has occurred or services
have been rendered, when pricing is fixed or

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determinable, when any right of return lapses or is reasonably estimable, and
when collectibility is reasonably assured. We consider differing market
conditions such as the relative financial condition of our customers. These
conditions do not impact the method by which we recognize revenues, although
such conditions may affect the allowance for returns or receivables.

Research and Development and Purchased Technology

During the third quarter of 2002, we decided to focus on C-StarOne as a
service, rather than as a service and a product. Accordingly, software
development costs incurred for significant improvements or enhancements from
that point forward are accounted for as software developed for internal use in
accordance with SOP 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use. We follow SFAS No. 2, Accounting for
Research and Development Costs, for all other research and development costs
and, therefore, charge them to expense as incurred. Capitalized software costs
totaled $402,000 at December 31, 2002. Such costs are amortized over a
24-month period and are evaluated for impairment in accordance with SFAS No.
144 on an annual basis, or more frequently if circumstances indicate a possible
impairment.

The costs of intangibles that are purchased from others for use in research and
development activities and that have alternative future uses are capitalized.
Those intangibles purchased for research that do not have an alternative future
use in other research projects or otherwise are expensed as incurred. At
December 31, 2002, we did not have any capitalized purchased technology.

Results of Continuing Operations

Year Ended December 31, 2002 Compared to 2001

Revenues

We did not recognize any revenue in 2002. We recognized revenue of $51,000 in
2001 related to advertising placed on the Scour.com website by third parties.
We recognized $6,600 of revenue from a currently signed C-StarOne service
customer in January 2003.

Operations and Customer Service

Operations and customer service expenses consist of salaries and related
expenses for providing customer service and support and for maintaining and
running our data center, which houses our servers and networking capabilities.
Operations and customer service expense was $1.2 million in 2002 compared to
$829,000 in 2001. The increase is primarily the result of a $155,000 increase
in salaries and related expenses due to an increase in headcount during the
first three quarters of 2002 compared to 2001 and a $152,000 increase in
maintenance and infrastructure costs related to our data center for C-StarOne.
We reduced the number of our Operations and Customer Service employees in the
fourth quarter of 2002. At December 31, 2002, we had six remaining employees
in the operations and customer service department compared to seven at December
31, 2001. Following our reduction in force in February 2003, we had five
employees in the operations and customer service department.

Research and Engineering

Research and engineering expenses consist primarily of salaries and related
expenses, consultant fees and the cost of purchased technology used in product
development. Research and engineering expense was $4.1 million in 2002
compared to $7.0 million in 2001. Amounts incurred for research and
engineering in 2002 primarily relate to costs for the continued development of
C-StarOne. As noted previously, during the third quarter of 2002, we decided
to focus on C-StarOne as a service, rather than as a service and a product.
Accordingly, $402,000 of software development costs incurred in the third and
fourth quarters of 2002 for significant improvements or enhancements were
capitalized as software developed for internal use in accordance with SOP 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use.

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In addition to the capitalization of software costs discussed above, the
decrease in 2002 compared to 2001 is due to a $1.2 million decrease in payroll
and contract labor and recruiting expenses due to reductions in staffing in the
third and fourth quarters of 2002, a $750,000 charge in the third quarter of
2001 for technology purchased from Supertracks.com, Inc., an impairment charge
of $580,000 in the first quarter of 2001 related to technology purchased from
Scour, Inc. in December 2000 and a $339,000 decrease in development expenses
due to a shift from development to implementation of C-StarOne during 2002.
At December 31, 2002, we had 17 research and engineering employees compared to
35 at December 31, 2001. Following our reduction in force in February 2003, we
had seven employees in the research and engineering department.

Marketing and Sales

Marketing and sales expenses consist of salaries and related expenses for
personnel engaged in direct sales, partner development, consultant fees,
advertising and promotional materials. Marketing and sales expenditures in
2002 were primarily for the promotion of C-StarOne and our Scour website.
Marketing and sales expense was $4.5 million in 2002 compared to $6.2 million
in 2001. The decrease in 2002 is a result of a $2.5 million charge in 2001
related to the impairment of certain intangible assets, $519,000 in
non-employee stock option expense in 2001 for services and a $272,000 reduction
in creative design costs in 2001, partially offset by a $493,000 charge in 2002
related to the impairment of certain intangible assets a $770,000 increase in
cost in 2002 to promote C-StarOne through our Scour website and a $277,000
increase in costs related to increased headcount and other costs to increase
our sales department in the first half of 2002 to promote and sell C-StarOne
services. Our marketing and sales expense decreased in the third and fourth
quarters of 2002 compared to the first two quarters of 2002 due to a reduction
in advertising expense and the number of employees. At December 31, 2002, we
had eight employees in our marketing and sales department compared to 15 at
December 31, 2001. Following our reduction in force in February 2003, we had
one employee in the marketing and sales department.

General and Administrative

General and administrative expenses consist of salaries and related expenses
for executive, accounting and administrative personnel, professional services
and general corporate expenses. General and administrative expenses were $3.4
million in 2002 compared to $4.0 million in 2001. The decrease in 2002
compared to 2001 is due to a decrease of $486,000 in accounting, legal and
public relations fees due to fewer equity and other business transactions
during 2002; a decrease of $225,000 related to expenses associated with a
settlement with Ingram Micro, Inc. in 2001; and a decrease of $215,000 in
salaries and related expenses due to lower headcount (net of increased director
and officer salaries), partially offset by an increase of $114,000 in Directors
and Officers insurance premiums and public filing fees in 2002, and $86,000 for
costs related to the line of credit that was not used. We had seven employees
in our general and administrative department at December 31, 2002 compared to
eleven at December 31, 2001. Following our reduction in force in February 2003,
we had four employees in the general and administrative department.

Depreciation and Amortization

Depreciation and amortization includes the depreciation on our fixed assets and
amortization of our identifiable intangible assets. Depreciation and
amortization remained relatively constant at $3.9 million in 2002 and 2001.
Decreases due to a write-off of $3.1 million in 2001 and $493,000 in 2002 of
intangible assets related to the customer list we acquired from Scour were
offset by the addition of $3.7 million of intangible assets in 2002 related to
our Sony agreement and $402,000 of capitalized software costs in the second
half of 2002.

Interest Income

Interest income decreased to $76,000 in 2002 from $399,000 in 2001 as a result
of lower cash balances in 2002 compared to 2001 as well as lower interest rates
in 2002.

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Interest Expense

Interest expense of $9,000 in 2002 and $62,000 in 2001 was related to the
purchase of certain information systems software utilizing a capital lease in
the amount of $675,000. This lease was paid off during the second quarter of
2002. In addition, we utilized a capital lease in the amount of $77,000 in the
fourth quarter of 2002 for the purchase of certain information systems
hardware.

Gain from Disposal of Discontinued Operations

The gain from disposal of discontinued operations of $674,000 in 2001 resulted
from the release of $2.4 million of restricted cash from escrow and final
settlement with Guillemot Corporation SA, to which we sold assets of our
discontinued hardware game controller business in October 1999.

Provision for Income Taxes

A valuation allowance has been recorded for the full amount of deferred tax
assets due to the uncertainty regarding the utilization of our net operating
loss carryforwards. We have federal, state and foreign net operating loss
carryforwards of $54.3 million, $69.8 million and $6.6 million, respectively,
which expire through the end of 2022. As the result of the Job Creation and Worker
Assistance Act of 2002, we recorded a tax refund of $164,000 in 2002 from a tax
credit carryback to 1996 and 1997, which was received in February 2003.

Year Ended December 31, 2001 Compared to 2000

Revenues

Total revenues were $51,000 in 2001 compared to $1,000 in 2000. The revenue
generated in 2001 related to advertising placed on the Scour.com website by
third parties. The revenue generated in 2000 related to Socket, our Internet
communication product, which we are no longer marketing.

Operations and Customer Service

Operations and customer service expense was $829,000 in 2001 compared to $0 in
2000. We had no operations related to our C-StarOne data and service center
in 2000.

Research and Engineering

Research and engineering expense was $7.0 million in 2001 compared to $4.7
million in 2000. Amounts incurred for research and engineering in 2001
primarily related to the development and beta launch of the new Scour in March
2001 and development of the C-StarOne technology. The increase in 2001
compared to 2000 was primarily due to a $2.0 million increase in salaries,
contract labor and related costs for developing the C-StarOne technology; the
purchase of $750,000 of technology from Supertracks.com, Inc. in August 2001,
which was expensed because the product into which the technology is being
incorporated had not yet achieved technological feasibility and the technology
had no alternative future use; the impairment of $580,000 of technology in
2001, which was purchased from Scour, Inc. in December 2000; and $250,000
related to recruiting, relocation and travel in 2001. We determined that the
$580,000 impairment charge was necessary because we are utilizing the
C-StarOne technology that we developed internally rather than the technology
purchased from Scour. The technology purchased from Scour is not expected to
produce future cash flows.

Research and engineering expense in 2000 included a $1.3 million charge related
to the value of a warrant issued to Intel in exchange for the ability to
sublicense its Launch & Connect technology. This technology is no longer being
utilized, nor are we attempting to sublicense the technology.

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Marketing and Sales

Marketing and sales expense was $6.2 million in 2001 compared to $2.0 million
in 2000. Marketing and sales expenditures in 2001 primarily focused on
developing customers and markets for the new Scour and our C-StarOne
services. The increase in 2001 was primarily due to $2.5 million for the
impairment in the fourth quarter of 2001 of the customer list we acquired from
Scour, Inc., $1.2 million related to the establishment of our Digital Media and
Entertainment Group, which is responsible for building long-term business
relationships with content providers, and $519,000 related to value of
non-employee stock options issued in exchange for services.

General and Administrative

General and administrative expense was $4.0 million in 2001 compared to $3.2
million in 2000. The increase in 2001 compared to 2000 was primarily due to a
$584,000 increase in legal and related expenses for defending against legal
claims and obtaining and protecting patents and trademarks and a $240,000
increase in 2001 related to Directors and Officers insurance premiums and
public relations expenses.

Depreciation and Amortization

Depreciation and amortization was $3.9 million in 2001 compared to $445,000 in
2000. The increase in 2001 compared to 2000 primarily relates to $2.6 million
of amortization expense in 2001 related to the purchase, in the fourth quarter
of 2000, of certain intangible assets of Scour, Inc and an $800,000 increase in
depreciation expense related to equipment acquired to support the operations of
C-StarOne and Scour.

Interest Income

Interest income decreased to $399,000 in 2001 from $895,000 in 2000 as a result
of lower interest rates in 2001 compared to 2000 and higher cash balances in
the first half of 2000. The higher cash balances in the first half of 2000
resulted primarily from the sale of debt and equity securities in private
placements during 1999 and the sale of our hardware business in October 1999
for $15.0 million.

Liquidity and Capital Resources

At December 31, 2002, we had $1.5 million of working capital and a current
ratio of 1.8 to 1. Included in working capital is $163,000 of restricted cash
related to letters-of-credit for deposits on an office lease . We have
financed our activities since the disposition of our hardware business in
October 1999 primarily with a combination of proceeds from the sale of our
hardware business and proceeds from the sale of equity securities.

We must obtain substantial additional financing to continue our operations. We
may not be able to obtain such financing. Based on current estimates, we
anticipate utilizing $1.0 million of cash per quarter to fund our operations
during the first half of 2003. This amount is less than the amount utilized in
the fourth quarter of 2002 as we reduced the number of employees from 35 to 17
in February 2003 and made a concerted effort to reduce operating costs to
conserve cash. Given our cash and cash equivalents available, we anticipate
that we will not have sufficient cash to fund our operations at projected
levels past March 31, 2003. If we do not obtain additional financing, we may
be forced to cease operations.

In February 2002, we sold 662,667 units to a total of twelve accredited
investors for $6.00 per unit for total proceeds to us of $4.0 million. Each
unit consisted of one share of our common stock and a warrant to purchase one
share of our common stock for $10.67 per share.

In March 2002, we sold 333,333 units to a total of six accredited investors for
$6.00 per unit for total proceeds to us of $2.0 million. Each unit consists of
one share of our common stock and a warrant to purchase one share of our common
stock for $10.67 per share.

In March 2002, we also arranged a stand-by line of credit in the amount of $1.0
million upon which we could have drawn between July 1, 2002 and December 31,
2002. In exchange for this commitment, we

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issued a three-year warrant to purchase 20,000 shares of our common stock at
$7.20 per share. Due to certain economic factors affecting the lender,
CenterSpan did not draw on this line of credit and the credit line has since
been terminated.

In June 2002, we executed a stand-by stock purchase agreement with an investor.
Pursuant to this agreement, the investor purchased 833,333 shares of our
common stock at a price of $6.00 per share on August 22, 2002, for total
proceeds to us of $5.0 million. As compensation for entering into this
agreement, on June 10, 2002, we issued the investor a three-year warrant to
purchase 100,000 shares of our common stock at $10.67 per share and in
connection with the purchase on August 22, 2002, we issued an additional
three-year warrant for 733,333 shares of our common stock at $10.67 per share.
In connection with the execution of the stand-by stock purchase agreement, we
issued a three-year warrant to purchase 10,000 shares of our common stock at
$10.67 per share as a finders fee. In addition, a three-year warrant
exercisable for 73,333 shares of our common stock was issued as a finders fee
in connection with the stock sale pursuant to the stand-by stock purchase
agreement in August 2002.

In April 2002, we sold a total of 22,000 units for $6.00 per unit to certain
directors and employees for total proceeds to us of $132,000. Each unit
consists of one share of our common stock and a warrant to purchase one share
of our common stock for $10.67 per share.

Cash decreased $2.9 million in 2002 compared to December 31, 2001, primarily as
a result of using $12.4 million for operating activities and $1.3 million for
investing activities. This decrease was partially offset by net proceeds of
$10.8 million from financing activities.

Taxes receivable of $164,000 at December 31, 2002 relate to a refund of federal
income taxes due to a change in the tax law that allows operating losses to be
carried back for five years, as opposed to three years.

Accounts payable increased $1.1 million to $1.6 million at December 31, 2002
from $551,000 at December 31, 2001, primarily as a result of the accrual of
payments due to Sony Music Entertainment. A content fee payment of $500,000
was due September 1, 2002 and advance royalty payments of $250,000 were due on
each of September 1, 2002, December 1, 2002 and March 1, 2003. An additional
advance royalty payment of $250,000 is due June 1, 2003 under the existing
terms of the agreement with Sony Music Entertainment. We paid an initial
content fee of $500,000 in February 2002 upon execution of the agreement;
however, we have not paid the other amounts due under the agreement. We are in
negotiations with Sony seeking to restructure or modify the agreement. If we
are unable successfully to renegotiate the agreement, Sony could terminate the
agreement, accelerate the due date for remaining payments under the agreement
and revoke our right under the agreement to integrate Sonys content into our
services. This or the collection by Sony of past due amounts would have a
material adverse affect on our financial condition and could force us to cease
operating.

Other assets increased $817,000 to $3.4 million at December 31, 2002 from $2.6
million at December 31, 2001, primarily as a result of the capitalization of
$3.7 million for the content distribution rights purchased from Sony in the
first quarter of 2002, offset by amortization. The $3.7 million of capitalized
content distribution rights are being amortized over a 36-month period, the
original life of the agreement with Sony.

We spent $349,000 on capital expenditures in 2002 and capitalized $402,000 of
software development costs in the third quarter of 2002. Anticipated capital
expenditures for 2003 will primarily be for additional hardware required to
support growth of our Network Operations Center. The dollar amount of these
expenditures will be dependent on the success of C-StarOne deployment and
growth in content to deliver.

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New Accounting Pronouncements

In July 2002, the FASB approved SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. SFAS No. 146 addresses the financial
accounting and reporting for obligations associated with an exit activity,
including restructuring, or with a disposal of long-lived assets. Exit
activities include, but are not limited to, eliminating or reducing product
lines, terminating employees and contracts and relocating plant facilities or
personnel. SFAS No. 146 specifies that a company will record a liability for a
cost associated with an exit or disposal activity only when that liability is
incurred and can be measured at fair value. Therefore, commitment to an exit
plan or a plan of disposal expresses only managements intended future actions
and, therefore, does not meet the requirement for recognizing a liability and
the related expense. SFAS No. 146 is effective prospectively for exit or
disposal activities initiated after December 31, 2002, with earlier adoption
encouraged. The Company does not anticipate that the adoption of SFAS No. 146
will have a material effect on its financial position or results of operations.

In November 2002, the FASB issued FASB Interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees of
Indebtedness of Others. FIN No. 45 requires that upon issuance of a
guarantee, a guarantor must recognize a liability for the fair value of an
obligation assumed under the guarantee. FIN No. 45 also requires additional
disclosures by a guarantor in its financial statements about the obligations
associated with guarantees issued. The initial recognition and measurement
provisions of FIN No. 45 are effective for financial statements issued after
December 15, 2002. The Company does not expect this interpretation to have a
material impact on its consolidated financial statements and results of
operations.

In December 2002, the FASB issued SFAB No. 148, accounting for Stock-Based
Compensation  Transition and Disclosure, and amendment of FASB Statement No.
123. This statement amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements
of Statement No. 123 to require prominent disclosure in both annual and interim
financial statements. Certain of the disclosure modifications are required for
fiscal years ending after December 15, 2002 and are included in the notes to
these consolidated financial statements.

Factors That May Affect Forward-Looking Statements

You should carefully consider the following factors that may affect our
business, future operating results and financial condition, as well as other
information included in this Annual Report. The risks and uncertainties
described below are not the only ones we face. Additional risks and
uncertainties not presently known to us or that we currently deem immaterial
also may impair our business operations. If any of the following risks
actually occur, our business, financial condition and operating results could
be materially adversely affected.

If we are unable to obtain additional financing, we will likely cease
operations.

During the fiscal year ended December 31, 2002, we incurred net losses of
approximately $16.8 million and we have not generated significant revenues from
our software-based content delivery operations. We expect to continue to incur
losses for the foreseeable future, as the costs of developing and marketing our
content delivery solutions is expected to continue to exceed revenue from such
operations. To continue operations, we will need to raise significant
additional capital. If we are unable to obtain sufficient financing,
management will likely be required to further curtail our operations and we
will likely cease operations.

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We have incurred substantial losses from continuing operations in our business
in 2002, 2001 and 2000 and continued losses may deplete our capital resources.

We have derived insignificant revenues from our business and have incurred
substantial losses from continuing operations of $16.8 million in 2002, $21.5
million in 2001 and $9.5 million in 2000, and in every quarter since we began
our current technology operations. We cannot predict when, if ever, we will
achieve profitability. In addition, to effectively market, sell and implement
our peer-to-peer digital distribution solution we may need to increase staffing
and organizational expenses, marketing costs, capital expenditures and other
expenses. As a result, we expect to incur significant operating losses on a
quarterly and annual basis for the foreseeable future. Continued losses would
further impair our capital resources, which in turn may require that we raise
additional capital or curtail or cease our business activities.

If our solutions are not adopted by potential customers, we may not achieve or
maintain profitability.

We began our current technology business in mid-1998. Accordingly, we have a
limited operating history with which you can evaluate our current business and
prospects. Our business is new and will not be successful unless potential
customers adopt wide usage of our technology and revenues are generated from
our digital distribution solution service. We derived insignificant revenues in
2001 from our internet communication, collaboration and distribution
solutions and are no longer developing or promoting them. We have not launched
a Scour subscription service and may continue to operate Scour as a free beta
service to showcase C-StarOne. We have only signed eight customer agreements
for C-StarOne services to date. In addition, our prospects must be considered
in light of the risks and uncertainties encountered by early stage companies in
new and rapidly evolving markets such as the Internet digital distribution
markets.

If we are unable to renegotiate our agreement with Sony Music Entertainment,
Sony could invoke its termination rights due to our nonpayment, which could
materially adversely affect our financial condition and could force us to cease
operations.

Under the terms of our agreement with Sony, a content fee payment of $500,000
was due to Sony on September 1, 2002. In addition, quarterly advance minimum
royalty payments of $250,000 each are payable for four quarters beginning
September 1, 2002. Neither the content fee payment, nor the advance royalty
payments due September 1, 2002, December 1, 2002 and March 1, 2003 have been
made. We are seeking to restructure or modify the agreement with Sony. If we
are unable to successfully renegotiate the agreement, Sony could terminate the
agreement, accelerate the due date for remaining payments under the agreement
and revoke our right under the agreement to integrate Sonys content into our
services. If we cannot integrate Sonys content into our C-StarOne CDN
Services, we may not be able to generate revenue from customers wishing to
offer a consumer entertainment service. The collection of past due amounts
under the agreement would have a material adverse affect on our financial
condition and could force us to cease operating. In addition, the remaining
value of the intangible asset related to our purchase of content distribution
rights from Sony may be impaired if we are unable to successfully renegotiate
the Sony agreement. The amount of any impairment is not known at this time,
but it could have a material adverse affect on our financial condition.

If we are not successful in selling our C-StarOne digital distribution
solutions to several large customers, we may not be able to generate
significant revenue, which could lead to continued operating losses.

Our revenue expectations include significant transaction-based service provider
revenues to be received from customers of C-StarOne digital distribution
solutions. If we are not successful in selling C-StarOne digital distribution
solutions to several large customers, we may not be able to generate
significant revenue, which could lead to continued operating losses.

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If we fail to secure access to additional popular music and video files, we may
not be able to generate significant revenue from selling C-StarOne digital
distribution services, which could lead to continued operating losses.

Our revenue model for 2003 is based in large part on digital distribution
service fees from C-StarOne. In February 2002, we entered into a digital music
distribution agreement with Sony Music, which allows us to digitally distribute
their catalog. If we fail to secure access to additional popular music and
video files from other major music labels or movie studios, we may not be able
to generate significant C-StarOne CDN Services revenue from customers wishing
to offer a consumer entertainment service. The customer agreements signed to
date did not produce any revenues in 2002 and it is uncertain that these
agreements will provide significant revenues in the future.

If we fail to attract a significant number of subscribers to Scour, we may not
achieve anticipated revenues, which could lead to continued operating losses.

Part of our strategy in building out the C-StarOne network is to attract
consumers to actively use the Scour showcase service and act as hosts for
digital files. The larger the network of digital hosts, the stronger the value
of the C-StarOne CDN Services network. If we fail to attract a significant
number of subscribers to Scour, we may not be able to achieve anticipated
C-StarOne CDN Services revenue.

If consumers are able to get music and video files for free, we may not be able
to achieve anticipated revenue, which could lead to continued operating losses.

In March 2001, the largest Internet file sharing network, Napster, was ordered
by a federal court to block the exchange of copyrighted music identified by the
music labels. Our revenue expectations include significant C-StarOne CDN
Services revenue from customers operating subscription based entertainment
services. Third-party surveys of Napster and other free peer-to-peer exchange
users indicate a willingness to pay for digital music files on a subscription
basis by a majority of users if the files are not available for free. The
record industry and the motion picture industry continue to attack several
forms of illegal exchange of copyrighted files. However, if innovative software
providers are able to develop alternative technologies for free file sharing,
it may be difficult for our customers to attract and retain paying subscribers
to subscription entertainment services, which would adversely affect our
customers payments to us for our services.

If we are unable to successfully develop new capabilities for C-StarOne CDN
Services, we may not be able to generate anticipated revenues, which could lead
to continued operating losses.

We believe that the C-StarOne search and peer-to-peer file distribution
technology, which is the basis of C-StarOne CDN Services and Scour, can be
applied in vertical markets outside of media and entertainment. We are
pursuing a service provider, transaction-based licensing strategy to generate
revenue from the use of the C-StarOne digital distribution channel. If we are
unable to develop new service capabilities for C-StarOne CDN Services, our
services may not be adopted in other markets and we may not achieve anticipated
revenues or profitability.

If we are not able to compete effectively, we may not be able to generate
anticipated technology and service revenues, which could lead to continued
operating losses.

The CDN market is highly competitive. Many of our competitors may have greater
resources and experience than we do. Though there has been some consolidation
in the market, we expect competition to continue to be significant in the
future. Our principal competitors include CDN service and product vendors, such
as Akamai, Digital Island (recently purchased by Cable & Wireless), and
Speedera. Smaller companies focused on rich media include Kontiki and
BlueFalcon, Internet music distributors that use digital download, peer-to-peer
or streaming technologies, such as MP3.com, Napster, Liquid Audio, Press Play,
Real Networks, music labels and movie studios, as well as providers of digital
entertainment

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services such as MusicNet, Listen.com and RioPort. Some of our competitors may
have advantages over us, including:



| |  |  | Longer operating histories;                                               
| | - |  | --------------------------------------------------------------------------
|
| |  |  | Larger installed customer bases;                                          
|
| |  |  | Substantially greater financial, technical, sales and marketing resources;
|
| |  |  | Greater name recognition; and                                             
|
| |  |  | The ability to more easily provide solutions for static and rich content. 

Our current and potential competitors may establish cooperative relationships
among themselves or with third parties that would increase their ability to
compete with us. In addition, competitors may be able to adapt more quickly
than we can to new or emerging technologies and changes in customer needs, or
to devote more resources to promoting and selling their products and
technologies. If we fail to adapt to market demands and to compete
successfully with existing and new competitors, our ability to generate service
revenues will suffer.

If we lose key personnel, we may not be able to continue our operations or to
timely deploy our C-StarOne technology and services, which may delay or
decrease anticipated revenues and lead to continued operating losses.

Our success depends largely upon the continued services of our executive
officers and other key management and development personnel. The loss of the
services of one or more of our executive officers, engineering personnel, or
other key employees could have a material adverse effect on our ability to
continue to operate our business and to timely deploy services and technology
based on C-StarOne, which may delay or decrease anticipated revenues and
profitability. Our employees are employed on an at will basis and could
terminate their employment with us at any time. We do not maintain key person
life insurance policies on any of our employees. Mr. Mark B. Conan resigned
as CenterSpans Vice President of Finance, Administration and Chief Financial
Officer effective December 31, 2002 to pursue other interests. Mr. Conan
agreed to provide transition assistance for a period of three months under a
part-time employment arrangement. In February 2003, Mr. Andrew Mallinger
resigned as Vice President of Product Management and Marketing and Mr. Alfred
Lee resigned as Vice President of Engineering. We do not plan on replacing
those positions until further capital is raised.

If we are not able to attract and retain qualified personnel, we may not be
able to timely market, sell and deploy services based on C-StarOne, which may
delay or decrease anticipated revenues and lead to continued operating losses.

Our future success also depends on our ability to attract and retain highly
qualified personnel to market, sell and deploy services based on C-StarOne.
We may not be successful in attracting or retaining qualified personnel which
could have a materially adverse effect on our ability to timely deploy
services, which may delay or decrease anticipated revenues and profitability.
We attempt to hire engineers with high levels of experience in marketing,
selling, designing and developing software in time-pressured environments.
There are a limited number of qualified personnel in our geographic location,
resulting in intense competition for their services.

An adverse outcome of existing litigation against us and certain officers could
harm our financial condition and business.

In August 2002, we and our Chief Executive Officer and our then President and
Chief Operating Officer were named as defendants in a lawsuit filed by two
former, non-executive officer employees. The former employees allege
intentional and reckless misrepresentation with respect to their offers of
employment and subsequent terminations and seek damages of $1.0 million each
for economic loss and $2.0 million each for emotional distress and injury to
reputation. We intend to vigorously defend this action. However, we cannot
predict the outcome of this suit. We have not accrued for any potential
liability related to this

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lawsuit. However, a negative outcome could have a material adverse effect on
our financial condition and business.

We may not be able to establish partnerships to sell services based on
C-StarOne in new vertical markets, which may delay or decrease revenues.

We do not currently have adequate marketing and sales personnel to sell
services based on C-StarOne in vertical markets outside of media and
entertainment. Rather than hire significant additional personnel, we are
employing a business development strategy of partnering with market leaders in
product sales and system integrators to sell into specific vertical markets,
such as enterprise communications and storage, eLearning and digital media
distribution for medical applications. We may not be able to establish
partnerships with market leaders in product sales or system integrators in some
or any vertical markets, which may delay or decrease expected revenues.

If we are unable to protect our intellectual property, competitors could obtain
access to proprietary information, which could have a material adverse impact
on future revenues.

We regard elements of C-StarOne as proprietary and are attempting to protect
them by relying on patent, trademark, service mark, trade dress, copyright, and
trade secret laws and restrictions, as well as confidentiality procedures and
contractual provisions. Protecting our intellectual property may be time
consuming and expensive. In addition, despite our efforts, we may be unable to
prevent third parties from infringing upon or misappropriating our intellectual
property. Any infringement or misappropriation could have a material adverse
effect on our subscription and licensing revenues. New patent applications may
not provide us with any competitive advantages, or may be challenged by third
parties. Effective trademark, copyright, and trade secret protection may not be
available in every country in which our technology is used. In addition, our
competitors may independently develop similar technologies that may
substantially limit the value of our intellectual property.

Others may bring intellectual property infringement claims against us, which
could require significant resources to defend and could lead to restrictions on
our current operations.

In addition to the technology we have developed internally, we have acquired or
licensed technologies from other companies. Our internally developed
technology, or the technology we acquired or licensed, may infringe on a third
partys intellectual property rights and third parties may bring claims against
us alleging infringement of their intellectual property rights. Any
infringement or claim of infringement could have a material adverse effect on
our business, resulting in suspension of revenue generating activities or the
payment of cash.

In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. We are not currently
involved in any intellectual property litigation. However, we may be a party
to litigation in the future to protect our intellectual property or as a result
of an alleged infringement of others intellectual property. These potential
claims and any resulting litigation could subject us to significant liability
for damages and invalidation of our proprietary rights. Any litigation
involving intellectual property, regardless of its success, likely would be
time-consuming and expensive to defend and would divert management time and
attention.

Any potential intellectual property litigation could also force us to do one or
more of the following:



| |  |  | Cease selling, incorporating, or using technology, products or
services that incorporate the challenged intellectual property;                                                              
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Obtain a license to sell or use the relevant technology from the
holder of the infringed intellectual property right, which license may
not be available on reasonable terms, or at all; and
|
| |  |  | Redesign those technologies, products or services that incorporate
the technology at issue.                                                                                                 

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Technology defects could inhibit our ability to attract customers or cause
losses of customers, which would adversely affect our revenues.

Our technology may contain undetected errors, or bugs, when first introduced
or as new versions or enhancements are released. Despite our internal testing,
these errors may be discovered only after our technology has been installed and
used by customers. These undetected errors may relate to components supplied to
us. Our technology under development is complex as a result of factors
including:



| |  |  | Advanced functionality;                                                                                              
| | - |  | ---------------------------------------------------------------------------------------------------------------------
|
| |  |  | The diverse operating environments in which the technology may be deployed; and                                      
|
| |  |  | The multiple versions of our technology that will need to be
supported for diverse operating platforms and standards.

The complexity of the technology we have under development and in operation
increases the likelihood that it may contain errors when introduced. Problems
encountered by customers could have a materially adverse affect our ability to
attract and retain potential customers of C-StarOne CDN Services.

The market price for our common stock, like other technology stocks, may
continue to be volatile, and decreases could adversely affect us.

The market price of CenterSpans common stock could decline due to the impact
of any of the following factors:



| |  |  | Variations in our actual and anticipated operating results;           
| | - |  | ----------------------------------------------------------------------
|
| |  |  | Changes in our earnings estimates by analysts; and                    
|
| |  |  | Our failure to meet investors and analysts performance expectations.

In addition, for many companies in the technology sector, continued price and
volume volatility in the stock market has affected their stock prices. General
stock market trends may continue to be negative for this sector and this may
adversely affect the market price of our common stock even though our business
prospects may be good.

If the market price of our common stock decreases, it may become more difficult
for us to raise needed additional capital through the sale of equity securities
and may result in increased dilution to our existing shareholders.




Item 7A. Quantitative and Qualitative Disclosures About Market 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
available funds for investment. We do not use, nor do we plan to use,
derivative financial instruments in our investment portfolio. We plan to
ensure the safety and preservation of our invested principal funds by limiting
default risk, market risk and reinvestment risk. We plan to mitigate default
risk by investing in high-credit, quality securities.

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Item 8. Financial Statements and Supplementary Financial Data

Independent Auditors Report

The Board of Directors
CenterSpan Communications Corporation

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

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

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
CenterSpan Communications Corporation and subsidiaries as of December 31,
2002 and 2001, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2002 in conformity
with accounting principles generally accepted in the United States of
America.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 of Notes to
Consolidated Financial Statements, the Company has suffered recurring losses
from continuing operations, has limited cash on hand, and has yet to generate
sustainable revenue streams. These matters raise substantial doubt about its
ability to continue as a going concern. Managements plans in regard to these
matters are also described in Note 2. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.

/s/ KPMG LLP

Portland, Oregon
February 11, 2003

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CenterSpan Communications Corporation
Consolidated Balance Sheets
(In thousands, except share amounts)

|                                         |                                                                                                                  |                                      |                                            |                   |   |              |       |         |   |        |       | 
|---------------------------------------- | ---------------------------------------------------------------------------------------------------------------- | ------------------------------------ | ------------------------------------------ | ----------------- | - | ------------ | ----- | ------- | - | ------ | ----- | 
|                                         |                                                                                                                  |                                      |                                            |                   |   | December 31,
|                                         |                                                                                                                  |                                      |                                            |                   |   |             
|                                         |                                                                                                                  |                                      |                                            |                   |   | 2002         |       | 2001   
|                                         |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|                                         |                                                                                                                  |                                      |                                            | ASSETS            |   |              |       |         |   |        |       | 
|Current assets:                          |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|                                         | Cash and cash equivalents                                                                                        |                                      | $                                          | 2,424             |   |              | $     | 5,276   |  
|                                         | Restricted cash                                                                                                  |                                      |                                            | 163               |   |              |       | 562     |  
|                                         | Income taxes receivable                                                                                          |                                      |                                            | 164               |   |              |       |        |  
|                                         | Prepaid expenses and other                                                                                       |                                      |                                            | 577               |   |              |       | 156     |  
|                                         |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|                                         |                                                                                                                  |                                      | Total current assets                       |                   |   | 3,328        |       |         |   | 5,994  |      
|Plant and equipment, net                 |                                                                                                                  |                                      | 1,945                                      |                   |   |              | 2,677 |        
|Other assets, net                        |                                                                                                                  |                                      | 3,454                                      |                   |   |              | 2,637 |        
|                                         |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|                                         |                                                                                                                  |                                      | Total assets                               |                   | $ | 8,727        |       |         | $ | 11,308 |      
|                                         |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|                                         |                                                                                                                  | LIABILITIES AND SHAREHOLDERS EQUITY |                                            |                   |   |              |       |         |   |       
|Current liabilities:                     |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|                                         | Capital lease obligation                                                                                         |                                      | $                                          | 24                |   |              | $     | 225     |  
|                                         | Accounts payable                                                                                                 |                                      |                                            | 1,642             |   |              |       | 551     |  
|                                         | Accrued liabilities                                                                                              |                                      |                                            | 149               |   |              |       | 603     |  
|                                         |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|                                         |                                                                                                                  |                                      | Total current liabilities                  |                   |   | 1,815        |       |         |   | 1,379  |      
|Long-term portion of capital lease       |                                                                                                                  |                                      | 49                                         |                   |   |              |      |        
|                                         |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|                                         |                                                                                                                  |                                      |                                            | Total liabilities |   |              | 1,864 |         |   |        | 1,379 | 
|                                         |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|Commitments & contingencies (See Note 7) |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|Shareholders equity:                    |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|                                         | Preferred stock, no par value, 5,000,000 shares
authorized; none issued or outstanding                           |                                      |                                            |                  |   |              |       |        |  
|                                         | Common stock, no par value, 25,000,000 shares
authorized; 10,926,915 and 8,786,925 shares
issued and outstanding |                                      |                                            | 61,897            |   |              |       | 52,572  |  
|                                         | Common stock warrants                                                                                            |                                      |                                            | 12,121            |   |              |       | 7,677   |  
|                                         | Accumulated deficit                                                                                              |                                      |                                            | (67,155           | ) |              |       | (50,320 | )
|                                         |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|                                         |                                                                                                                  |                                      | Total shareholders equity                 |                   |   | 6,863        |       |         |   | 9,929  |      
|                                         |                                                                                                                  |                                      |                                            |                   |   |              |       |        
|                                         |                                                                                                                  |                                      | Total liabilities and shareholders equity |                   | $ | 8,727        |       |         | $ | 11,308 |      
|                                         |                                                                                                                  |                                      |                                            |                   |   |              |       |        

The accompanying notes are an
integral part of these consolidated financial statements

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CenterSpan Communications Corporation
Consolidated Statements of Operations
(In thousands, except per share amounts)

|                                                              |                          |                                 |         |                         |       |      |         |        |       |   |         |        |       | 
|------------------------------------------------------------- | ------------------------ | ------------------------------- | ------- | ----------------------- | ----- | ---- | ------- | ------ | ----- | - | ------- | ------ | ----- | 
|                                                              |                          |                                 |         | Year Ended December 31,
|                                                              |                          |                                 |         |                        
|                                                              |                          |                                 |         | 2002                    |       | 2001 |         | 2000  
|                                                              |                          |                                 |         |                         |       |      |         |       
|Revenue                                                       |                          | $                               |        |                         |       | $    | 51      |        |       | $ | 1       |       
|Operating expenses:                                           |                          |                                 |         |                         |       |      |         |        |       |   |         |       
|                                                              |                          | Operations and customer service |         |                         | 1,156 |      |         |        | 829   |   |         |        |      | 
|                                                              |                          | Research and engineering        |         |                         | 4,107 |      |         |        | 7,035 |   |         |        | 4,692 | 
|                                                              |                          | Marketing and sales             |         |                         | 4,457 |      |         |        | 6,195 |   |         |        | 1,985 | 
|                                                              |                          | General and administration      |         |                         | 3,439 |      |         |        | 4,009 |   |         |        | 3,242 | 
|                                                              |                          | Depreciation and amortization   |         |                         | 3,907 |      |         |        | 3,856 |   |         |        | 445   | 
|                                                              |                          |                                 |         |                         |       |      |         |        |       |   |         |       
|                                                              | Total operating expenses |                                 |         | 17,066                  |       |      |         | 21,924 |       |   |         | 10,364 |      
|                                                              |                          |                                 |         |                         |       |      |         |        |       |   |         |       
|Loss from operations                                          |                          |                                 | (17,066 | )                       |       |      | (21,873 | )      |       |   | (10,363 | )     
|Interest income                                               |                          |                                 | 76      |                         |       |      | 399     |        |       |   | 895     |       
|Interest expense                                              |                          |                                 | (9      | )                       |       |      | (62     | )      |       |   |        |       
|                                                              |                          |                                 |         |                         |       |      |         |        |       |   |         |       
|Loss from continuing operations before taxes                  |                          |                                 | (16,999 | )                       |       |      | (21,536 | )      |       |   | (9,468  | )     
|Benefit from income taxes                                     |                          |                                 | 164     |                         |       |      |        |        |       |   |        |       
|                                                              |                          |                                 |         |                         |       |      |         |        |       |   |         |       
|Loss before gain from disposal of discontinued operations     |                          |                                 | (16,835 | )                       |       |      | (21,536 | )      |       |   | (9,468  | )     
|Gain from disposal of discontinued operations                 |                          |                                 |        |                         |       |      | 674     |        |       |   |        |       
|                                                              |                          |                                 |         |                         |       |      |         |        |       |   |         |       
|Net loss                                                      |                          | $                               | (16,835 | )                       |       | $    | (20,862 | )      |       | $ | (9,468  | )     
|                                                              |                          |                                 |         |                         |       |      |         |        |       |   |         |       
|Basic and diluted loss per share from continuing
operations   |                          | $                               | (1.65   | )                       |       | $    | (2.59   | )      |       | $ | (1.52   | )     
|                                                              |                          |                                 |         |                         |       |      |         |        |       |   |         |       
|Basic and diluted gain per share from discontinued
operations |                          | $                               |        |                         |       | $    | 0.08    |        |       | $ |        |       
|                                                              |                          |                                 |         |                         |       |      |         |        |       |   |         |       
|Basic and diluted net loss per share                          |                          | $                               | (1.65   | )                       |       | $    | (2.51   | )      |       | $ | (1.52   | )     
|                                                              |                          |                                 |         |                         |       |      |         |        |       |   |         |       
|Shares used for per share calculations                        |                          |                                 | 10,190  |                         |       |      | 8,309   |        |       |   | 6,231   |       
|                                                              |                          |                                 |         |                         |       |      |         |        |       |   |         |       

The accompanying notes are an
integral part of these consolidated financial statements

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CenterSpan Communications Corporation
Consolidated Statements of Cash Flows
(in thousands)

|                                                                                  |                                                         |                                           |         |                         |         |      |         |        |         |   |        |        |        |  
|--------------------------------------------------------------------------------- | ------------------------------------------------------- | ----------------------------------------- | ------- | ----------------------- | ------- | ---- | ------- | ------ | ------- | - | ------ | ------ | ------ | -
|                                                                                  |                                                         |                                           |         | Year Ended December 31,
|                                                                                  |                                                         |                                           |         |                        
|                                                                                  |                                                         |                                           |         | 2002                    |         | 2001 |         | 2000  
|                                                                                  |                                                         |                                           |         |                         |         |      |         |       
|Cash flows from Operating Activities:                                             |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|Net loss                                                                          |                                                         | $                                         | (16,835 | )                       |         | $    | (20,862 | )      |         | $ | (9,468 | )     
|Adjustments to reconcile net loss to net cash flows used in
operating activities: |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|                                                                                  | Gain from disposal of discontinued operations           |                                           |         |                        |         |      |         | (674   | )       |   |        |       |       
|                                                                                  | Amortization                                            |                                           |         | 2,347                   |         |      |         | 2,599  |         |   |        |       |       
|                                                                                  | Impairment of intangibles                               |                                           |         | 493                     |         |      |         | 3,058  |         |   |        |       |       
|                                                                                  | Depreciation                                            |                                           |         | 1,560                   |         |      |         | 1,253  |         |   |        | 445    |       
|                                                                                  | Net loss on retirement of assets                        |                                           |         |                        |         |      |         |       |         |   |        | 13     |       
|                                                                                  | Stock options issued for services provided              |                                           |         |                        |         |      |         | 519    |         |   |        |       |       
|                                                                                  | Equity instruments issued for technology                |                                           |         |                        |         |      |         | 750    |         |   |        | 1,300  |       
|                                                                                  | Equity instruments issued for line of credit            |                                           |         | 86                      |         |      |         |       |         |   |        |       |       
|Changes in operating assets and liabilities:                                      |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|                                                                                  | Restricted cash                                         |                                           |         | 399                     |         |      |         | 1,858  |         |   |        | (138   | )     
|                                                                                  | Accounts receivable                                     |                                           |         |                        |         |      |         |       |         |   |        | 4      |       
|                                                                                  | Income taxes receivable                                 |                                           |         | (164                    | )       |      |         |       |         |   |        |       |       
|                                                                                  | Prepaid expenses and other assets                       |                                           |         | (421                    | )       |      |         | (124   | )       |   |        | 150    |       
|                                                                                  | Accounts payable and accrued liabilities                |                                           |         | 137                     |         |      |         | (1,319 | )       |   |        | (232   | )     
|                                                                                  |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|                                                                                  |                                                         | Net cash used in operating activities     |         |                         | (12,398 | )    |         |        | (12,942 | ) |        |        | (7,926 | )
|                                                                                  |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|Cash flows from investing activities:                                             |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|                                                                                  | Payments for purchase of plant and equipment            |                                           |         | (349                    | )       |      |         | (865   | )       |   |        | (2,467 | )     
|                                                                                  | Capitalization of software development costs            |                                           |         | (402                    | )       |      |         |       |         |   |        |       |       
|                                                                                  | Purchase of intangibles                                 |                                           |         | (500                    | )       |      |         |       |         |   |        | (4,771 | )     
|                                                                                  |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|                                                                                  |                                                         | Net cash used in investing activities     |         |                         | (1,251  | )    |         |        | (865    | ) |        |        | (7,238 | )
|                                                                                  |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|Cash flows from financing activities:                                             |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|                                                                                  | Payments on capital lease obligation                    |                                           |         | (229                    | )       |      |         | (450   | )       |   |        |       |       
|                                                                                  | Proceeds from issuance of common stock and warrants     |                                           |         | 11,026                  |         |      |         | 11,832 |         |   |        | 6,398  |       
|                                                                                  |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|                                                                                  |                                                         | Net cash provided by financing activities |         |                         | 10,797  |      |         |        | 11,382  |   |        |        | 6,398  |  
|                                                                                  |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|Decrease in cash and cash equivalents                                             |                                                         |                                           | (2,852  | )                       |         |      | (2,425  | )      |         |   | (8,766 | )     
|Cash and cash equivalents:                                                        |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|                                                                                  | Beginning of year                                       |                                           |         | 5,276                   |         |      |         | 7,701  |         |   |        | 16,467 |       
|                                                                                  |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|                                                                                  | End of year                                             |                                           | $       | 2,424                   |         |      | $       | 5,276  |         |   | $      | 7,701  |       
|                                                                                  |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|Cash paid during the year for:                                                    |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|                                                                                  | Interest                                                |                                           | $       | 9                       |         |      | $       | 60     |         |   | $      |       |       
|Supplemental cash flow information:                                               |                                                         |                                           |         |                         |         |      |         |        |         |   |        |       
|                                                                                  | Stock issued in connection with purchase of assets      |                                           | $       |                        |         |      | $       |       |         |   | $      | 3,500  |       
|                                                                                  | Assets purchased with capital lease                     |                                           |         | 77                      |         |      |         | 675    |         |   |        |       |       
|                                                                                  | Purchase of technology with equity instruments          |                                           |         |                        |         |      |         | 750    |         |   |        | 1,300  |       
|                                                                                  | Purchase of goods and services with equity instruments  |                                           |         |                        |         |      |         | 519    |         |   |        |       |       
|                                                                                  | Accrued purchase of intangibles                         |                                           |         | 500                     |         |      |         |       |         |   |        |       |       
|                                                                                  | Purchase of distribution rights with equity instruments |                                           |         | 2,657                   |         |      |         |       |         |   |        |       |       
|                                                                                  | Equity instrument issued for standby commitment         |                                           |         | 555                     |         |      |         |       |         |   |        |       |       

The accompanying notes are an
integral part of these consolidated financial statements

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CenterSpan Communications Corporation
Consolidated Statements of Changes in Shareholders Equity
(In thousands)

|                                                       |  |              |        |        |  |             |        |              |  |        |        |   |  |   |         |   |  |   |         |  
|------------------------------------------------------ |  | ------------ | ------ | ------ |  | ----------- | ------ | ------------ |  | ------ | ------ | - |  | - | ------- | - |  | - | ------- | -
|                                                       |  | Common Stock |        | Common |  |             |        |              |  | Total 
|                                                       |  |              |        | Stock  |  | Accumulated |        | Shareholder
|                                                       |  | Shares       |        | Amount |  | Warrants    |        | Deficit      |  | Equity
|                                                       |  |              |        |        |  |             |        |              |  |       
|Balance at December 31, 1999                           |  |              | 5,950  |        |  | $           | 31,736 |              |  | $      | 3,530  |   |  | $ | (19,306 | ) |  | $ | 15,960  |  
|Exercise of stock options                              |  |              | 240    |        |  |             | 1,398  |              |  |        |       |   |  |   |        |   |  |   | 1,398   |  
|Exercise of warrants                                   |  |              | 66     |        |  |             | 684    |              |  |        |       |   |  |   | (684    | ) |  |   |        |  
|Warrant issued in exchange
for technology              |  |              |       |        |  |             |       |              |  |        | 1,300  |   |  |   |        |   |  |   | 1,300   |  
|Common stock issued in
exchange for specific
assets    |  |              | 333    |        |  |             | 3,500  |              |  |        |       |   |  |   |        |   |  |   | 3,500   |  
|Common stock issued in
private placement               |  |              | 714    |        |  |             | 5,000  |              |  |        |       |   |  |   |        |   |  |   | 5,000   |  
|Net loss                                               |  |              |       |        |  |             |       |              |  |        |       |   |  |   | (9,468  | ) |  |   | (9,468  | )
|                                                       |  |              |        |        |  |             |        |              |  |        |        |   |  |   |         |   |  |   |         |  
|Balance at December 31, 2000                           |  |              | 7,303  |        |  |             | 42,318 |              |  |        | 4,830  |   |  |   | (29,458 | ) |  |   | 17,690  |  
|Exercise of stock options                              |  |              | 80     |        |  |             | 592    |              |  |        |       |   |  |   |        |   |  |   | 592     |  
|Exercise of warrants                                   |  |              | 53     |        |  |             | 279    |              |  |        | (279   | ) |  |   |        |   |  |   |        |  
|Common stock and warrants
issued in private
placements |  |              | 1,284  |        |  |             | 8,114  |              |  |        | 3,126  |   |  |   |        |   |  |   | 11,240  |  
|Stock option issued in
exchange for services           |  |              |       |        |  |             | 519    |              |  |        |       |   |  |   |        |   |  |   | 519     |  
|Common stock issued in
exchange for technology         |  |              | 67     |        |  |             | 750    |              |  |        |       |   |  |   |        |   |  |   | 750     |  
|Net loss                                               |  |              |       |        |  |             |       |              |  |        |       |   |  |   | (20,862 | ) |  |   | (20,862 | )
|                                                       |  |              |        |        |  |             |        |              |  |        |        |   |  |   |         |   |  |   |         |  
|Balance at December 31, 2001                           |  |              | 8,787  |        |  |             | 52,572 |              |  |        | 7,677  |   |  |   | (50,320 | ) |  |   | 9,929   |  
|Exercise of stock options                              |  |              | 5      |        |  |             | 26     |              |  |        |       |   |  |   |        |   |  |   | 26      |  
|Common stock and warrants
issued in private
placements |  |              | 1,851  |        |  |             | 8,067  |              |  |        | 2,933  |   |  |   |        |   |  |   | 11,000  |  
|Common stock issued in
exchange for intangibles        |  |              | 284    |        |  |             | 1,701  |              |  |        | 956    |   |  |   |        |   |  |   | 2,657   |  
|Common stock warrants
issued for standby
commitment    |  |              |       |        |  |             | (469   | )            |  |        | 469    |   |  |   |        |   |  |   |        |  
|Common stock warrant issued
for prepaid expense        |  |              |       |        |  |             |       |              |  |        | 86     |   |  |   |         |   |  |   | 86      |  
|Net loss                                               |  |              |       |        |  |             |       |              |  |        |       |   |  |   | (16,835 | ) |  |   | (16,835 | )
|                                                       |  |              |        |        |  |             |        |              |  |        |        |   |  |   |         |   |  |   |         |  
|Balance at December 31, 2002                           |  |              | 10,927 |        |  | $           | 61,897 |              |  | $      | 12,121 |   |  | $ | (67,155 | ) |  | $ | 6,863   |  
|                                                       |  |              |        |        |  |             |        |              |  |        |        |   |  |   |         |   |  |   |         |  

The accompanying notes are an
integral part of these consolidated financial statements

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CENTERSPAN COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. The Company

CenterSpan Communications Corporation (CenterSpan or the Company) was
originally incorporated in 1990 as ThrustMaster, Inc., an Oregon Corporation.
The Company changed its name to CenterSpan Communications Corporation in
October 1999.

CenterSpan currently develops and markets secure Internet content delivery
solutions for media and communications service providers and the enterprise.
C-StarOne, the Companys current offering, is a suite of modular content
delivery solutions for delivering digital audio, video and data files.
Components of C-StarOne enable content preparation, publishing, security,
delivery and analytics for media and entertainment, communications service
providers and large corporate customers.

The Companys C-StarOne services suite is targeted at the Content Distribution
Network (CDN) market serving communications service providers such as telecom
companies, Multiple Service Operators (MSOs) and Internet Service Providers
(ISPs), and media service providers like movie studios, music labels,
publishers, distributors and portals.

The market for CenterSpans C-StarOne services is characterized by rapidly
changing technology, evolving industry standards, and changing customer needs.
CenterSpan believes that its future success will depend, in part, upon its
ability to enhance its current offerings on a timely and cost-effective basis,
and to respond to changing customer needs and technological developments. An
inability of CenterSpan to generate demand for its services, whether as a
result of competition, technological change or other factors, could have a
material adverse affect on the Companys financial condition, results of
operations and liquidity.

The consolidated financial statements include the accounts of CenterSpan
Communications Corporation, an Oregon corporation, and its wholly-owned
subsidiary, CSCC Corporation. Former subsidiaries, ThrustMaster (Europe)
Limited, and ThrustMaster (Deutschland) GmbH, are no longer active. All
inter-company transactions have been eliminated.

NOTE 2. Significant Accounting Policies

The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. As shown in the accompanying
consolidated financial statements for the years ending December 31, 2002, 2001,
and 2000, the Company has incurred losses from continuing operations of $16.8
million, $21.5 million, and $9.5 million, respectively, has limited cash on
hand, and has yet to generate significant revenue streams.

During fiscal 2002, the Company has taken a number of steps to improve its
financial condition including issuance of common stock under private placement
agreements and reductions in work force. Management is pursuing strategies
both to raise additional capital and establish sustainable revenue streams.

There is no assurance the Company will be able to obtain adequate working
capital or generate sufficient revenues in the amounts needed to sustain its
operations. The above matters raise substantial doubt about the Companys
ability to continue as a going concern. The financial statements do not
include any adjustments relating to the recoverability and classification of
asset carrying amounts or the amount and classification of liabilities that
might result should the Company be unable to continue as a going concern.

Cash and Cash Equivalents.Cash equivalents consist of highly liquid debt
instruments purchased with an original maturity of three months or less.

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Restricted Cash.Restricted cash of $163,000 relates to letters-of-credit for
deposit on an office lease.

Fair Value of Financial Instruments.CenterSpans financial instruments
consist of accounts payable and capital lease obligations. For the periods
presented, the fair value of CenterSpans accounts payable and capital leases
is equal to its carrying value.

Plant and Equipment.Plant and equipment are stated at cost and are
depreciated using the straight-line method over the estimated useful lives (two
to seven years). Capitalized leases are amortized using the same method over
the shorter of the estimated useful lives or the lease term. Replacements and
improvements that extend the useful lives are capitalized. Maintenance and
repairs and routine replacements are expensed as incurred. Upon disposal, costs
and related accumulated depreciation of the assets are removed from the
accounts and resulting gains and losses are reflected in operations.

Other Assets.Other assets primarily consist of intangible assets including a
customer list and a trade name purchased during 2000 from Scour, Inc., content
distribution rights purchased from Sony in the first quarter of 2002 and
capitalized research and engineering costs related to software developed for
internal use. The Company reviews identifiable intangible assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable. The Company determines impairment based on
a comparison of the carrying amount of the assets to the estimated fair value
of the assets, which is determined based on the discounted cash flow method or
current market prices for similar assets when available. In accordance with
Statement of Financial Accounting Standards (SFAS) No. 142 Goodwill and Other
Intangible Assets, which was adopted in January 2002, intangible assets with
estimable useful lives are amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. The Companys intangible assets are being amortized over
the remaining lives of the related assets of one to two years.

Income Taxes. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial reporting
and tax bases of assets and liabilities and operating loss and tax credit carry
forwards. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
tax assets and liabilities of a change in tax rates is recognized in income in
the period of change. The Company has recorded a valuation allowance for its
entire deferred tax asset balance since it is uncertain whether it will be able
to recognize the related tax benefits as a result of continuing losses.

Revenue Recognition.In compliance with the Securities and Exchange Commission
(SEC) Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in
Financial Statements, and SFAS No. 48, Revenue Recognition When Right of
Return Exists, the Company recognizes revenue when the earnings process is
complete. The earnings process is considered complete when persuasive evidence
of an arrangement between the customer and the Company exists, when delivery
and acceptance has occurred or services have been rendered, when pricing is
fixed or determinable, when any right of return lapses or is reasonably
estimable, and when collectibility is reasonably assured. We consider
differing market conditions such as the relative financial condition of our
customers. These conditions do not impact the method by which we recognize
revenues, although such conditions may affect the allowance for uncollectible
receivables.

Software Development Costs, Research and Engineering Expense and Purchased
Intangibles.Software development costs incurred for significant improvements
or enhancements for software developed for internal use is capitalized in
accordance with SOP 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use. The Company follows SFAS No. 2,
Accounting for Research and Development Costs, for software development costs
and, therefore, charges them to expense as incurred. Capitalized software
development costs, which are included in property, plant and equipment, totaled
$402,000 at December 31, 2002. Such costs are amortized over a 24-month period
and are evaluated for

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impairment in accordance with SFAS No. 144 on an annual basis, or more
frequently if circumstances warrant.

The costs of intangibles that are purchased from others for use in research and
development activities and that have alternative future uses are capitalized.
Those intangibles purchased for research that do not have an alternative future
use in other research projects or otherwise are expensed as incurred. At
December 31, 2002, we did not have any capitalized purchased technology.

Advertising.Advertising costs, which include direct advertising, cooperative
advertising and marketing development funds, are expensed as incurred and
totaled $795,000, $23,000 and $462,000 in 2002, 2001 and 2000, respectively.

Stock Based Compensation.CenterSpan accounts for stock-based employee
compensation arrangements in accordance with provisions of Accounting
Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees and complies with the disclosure provisions of SFAS No. 123,
Accounting for Stock-Based Compensation. Under APB No. 25, compensation
expense is based on the difference, if any, on the date of grant between the
exercise price of the instrument granted and the fair value of the underlying
stock. Non-employee stock-based compensation is determined in accordance with
SFAS No. 123, utilizing the Black Scholes valuation methodology. Stock-based
compensation is amortized over the vesting period of the related securities.
The Company accounts for stock and stock options issued to non-employees in
accordance with the provisions of Emerging Issues Task Force Consensus on Issue
No. 96-18, Accounting for Equity Instruments that are Issued to Other than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services.

If the Company had accounted for its stock-based compensation plans in
accordance with SFAS No. 123, the Companys net loss and net loss per share
would approximate the pro forma disclosures below (in thousands except per
share data):

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|                                                                                                                             |             |   |                         |         |      |   |         |         |   |   |         |         |  
|---------------------------------------------------------------------------------------------------------------------------- | ----------- | - | ----------------------- | ------- | ---- | - | ------- | ------- | - | - | ------- | ------- | -
|                                                                                                                             |             |   | Year Ended December 31,
|                                                                                                                             |             |   |                        
|                                                                                                                             |             |   | 2002                    |         | 2001 |   | 2000   
|                                                                                                                             |             |   |                         |         |      |   |        
|Net loss as reported                                                                                                         |             | $ | (16,835                 | )       |      | $ | (20,862 | )       |   | $ | (9,468  | )      
|Deduct: Total stock-based employee
compensation expense determined
under fair value based method, for
all awards, net of tax |             |   | (4,539                  | )       |      |   | (8,764  | )       |   |   | (4,675  | )      
|                                                                                                                             |             |   |                         |         |      |   |         |         |   |   |         |        
|Pro forma net loss                                                                                                           |             | $ | (21,374                 | )       |      | $ | (29,626 | )       |   | $ | (14,143 | )      
|                                                                                                                             |             |   |                         |         |      |   |         |         |   |   |         |        
|Loss from continuing operations:                                                                                             |             |   |                         |         |      |   |         |         |   |   |         |        
|                                                                                                                             | As reported |   | $                       | (16,835 | )    |   | $       | (21,536 | ) |   | $       | (9,468  | )
|                                                                                                                             | Pro forma   |   |                         | (21,374 | )    |   |         | (30,300 | ) |   |         | (14,143 | )
|Basic and diluted loss per share
from continuing operations:                                                                 |             |   |                         |         |      |   |         |         |   |   |         |        
|                                                                                                                             | As reported |   |                         | (1.65   | )    |   |         | (2.59   | ) |   |         | (1.52   | )
|                                                                                                                             | Pro forma   |   |                         | (2.10   | )    |   |         | (3.65   | ) |   |         | (2.27   | )
|Gain from discontinued operations:                                                                                           |             |   |                         |         |      |   |         |         |   |   |         |        
|                                                                                                                             | As reported |   |                         |        |      |   |         | 674     |   |   |         |        |  
|                                                                                                                             | Pro forma   |   |                         |        |      |   |         | 674     |   |   |         |        |  
|Basic and diluted loss per share
from discontinued operations:                                                               |             |   |                         |         |      |   |         |         |   |   |         |        
|                                                                                                                             | As reported |   |                         |        |      |   |         | 0.08    |   |   |         |        |  
|                                                                                                                             | Pro forma   |   |                         |        |      |   |         | 0.08    |   |   |         |        |  
|Net loss:                                                                                                                    |             |   |                         |         |      |   |         |         |   |   |         |        
|                                                                                                                             | As reported |   |                         | (16,835 | )    |   |         | (20,862 | ) |   |         | (9,468  | )
|                                                                                                                             | Pro forma   |   |                         | (21,374 | )    |   |         | (29,626 | ) |   |         | (14,143 | )
|Basic and diluted net loss per share:                                                                                        |             |   |                         |         |      |   |         |         |   |   |         |        
|                                                                                                                             | As reported |   |                         | (1.65   | )    |   |         | (2.51   | ) |   |         | (1.52   | )
|                                                                                                                             | Pro forma   |   |                         | (2.10   | )    |   |         | (3.57   | ) |   |         | (2.27   | )

The effect of applying SFAS No. 123 in this pro forma disclosure is not
indicative of future amounts.

Earnings Per Share Data.Basic earnings per common share is computed using the
weighted average number of shares of common stock outstanding for the period.
Diluted earnings per common share is computed using the weighted average number
of shares of common stock and dilutive common equivalent shares outstanding
during the year. Common equivalent shares from stock options and other common
stock equivalents are excluded from the computation when their effect is
antidilutive.

Shares used for basic and diluted earnings per share (EPS) are the same for
all periods presented since CenterSpan was in a loss position. Potentially
dilutive securities that were not included in the diluted net loss per share
calculations because they would be antidilutive were as follows (in thousands):

|               |       |  |                         |       |      |  |       |       |  |  |       |       | 
|-------------- | ----- |  | ----------------------- | ----- | ---- |  | ----- | ----- |  |  | ----- | ----- | 
|               |       |  | Year Ended December 31,
|               |       |  |                        
|               |       |  | 2002                    |       | 2001 |  | 2000 
|               |       |  |                         |       |      |  |      
|Stock options  |       |  | 4,012                   |       |      |  | 3,673 |       |  |  | 2,143 |      
|Stock warrants |       |  | 3,330                   |       |      |  | 1,185 |       |  |  | 599   |      
|               |       |  |                         |       |      |  |       |       |  |  |       |      
|               | Total |  |                         | 7,342 |      |  |       | 4,858 |  |  |       | 2,742 | 
|               |       |  |                         |       |      |  |       |       |  |  |       |      

Comprehensive Income (Loss).CenterSpan has adopted the accounting treatment
prescribed by SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130
establishes standards for reporting comprehensive income (loss) and its
components in financial statements. Comprehensive income (loss), as defined,
includes all changes in equity during a period from non-owner sources.
Comprehensive loss was the same as the net loss for 2002, 2001 and 2000.

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Use of Estimates.The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Significant estimates used by management primarily
relate to the estimated lives of intangible assets and the fair value of such
assets.

Reclassifications.Certain reclassifications, none of which affected operating
or net loss, have been made to conform to the current year presentation.

NOTE 3. Discontinued Operations: Disposal of Hardware Business Assets

In October 1999, Guillemot Corporation S.A. (Guillemot) purchased certain
CenterSpan assets for a total price of $15.0 million, of which $2.25 million
was retained in escrow and was to be released to CenterSpan pursuant to a
schedule provided in the parties escrow agreement. In June 2000, CenterSpan
filed a lawsuit for breach of contract against Guillemot. CenterSpan alleged
that Guillemot breached the terms of the escrow agreement by prohibiting the
scheduled release of escrow funds to CenterSpan. In March 2001, CenterSpan and
Guillemot entered into a settlement agreement and mutual release under which
CenterSpan received approximately $1.4 million of restricted cash from escrow.
Guillemot received approximately $1.0 million from escrow, consisting of
amounts collected on their behalf of approximately $318,000 and downward
purchase price adjustments of approximately $682,000. No amounts remained in
escrow at December 31, 2002 or 2001. The purchase price adjustments made
pursuant to the asset purchase agreement mainly related to uncollected accounts
receivable. In connection with the release of the restricted cash and final
settlement with Guillemot, CenterSpan recognized a gain on disposal of
discontinued operations in 2001 of $674,000.

NOTE 4. Plant and Equipment

Plant and equipment consisted of the following at December 31 (in thousands):

|                                                |  |      |        |      |  |   |        |  
|----------------------------------------------- |  | ---- | ------ | ---- |  | - | ------ | -
|                                                |  | 2002 |        | 2001
|                                                |  |      |        |     
|Computers and other equipment                   |  | $    | 4,638  |      |  | $ | 4,232  |  
|Capitalized software costs                      |  |      | 402    |      |  |   |       |  
|Tooling                                         |  |      | 3      |      |  |   | 3      |  
|Furniture and fixtures                          |  |      | 480    |      |  |   | 538    |  
|Leasehold improvements                          |  |      | 174    |      |  |   | 165    |  
|                                                |  |      |        |      |  |   |        |  
|                                                |  |      | 5,697  |      |  |   | 4,938  |  
|Less: Accumulated depreciation and amortization |  |      | (3,752 | )    |  |   | (2,261 | )
|                                                |  |      |        |      |  |   |        |  
|                                                |  | $    | 1,945  |      |  | $ | 2,677  |  
|                                                |  |      |        |      |  |   |        |  

NOTE 5. Other Assets

Other assets consisted of the following at December 31 (in thousands):

|                                 |  |      |        |      |  |   |       |  
|-------------------------------- |  | ---- | ------ | ---- |  | - | ----- | -
|                                 |  | 2002 |        | 2001
|                                 |  |      |        |     
|Sony content distribution rights |  | $    | 3,657  |      |  | $ |      |  
|Scour, Inc. customer list        |  |      |       |      |  |   | 1,000 |  
|Scour, Inc. trade name           |  |      | 2,438  |      |  |   | 2,438 |  
|Other                            |  |      | 23     |      |  |   | 23    |  
|                                 |  |      |        |      |  |   |       |  
|                                 |  |      | 6,118  |      |  |   | 3,461 |  
|Less: Accumulated amortization   |  |      | (2,664 | )    |  |   | (824  | )
|                                 |  |      |        |      |  |   |       |  
|                                 |  | $    | 3,454  |      |  | $ | 2,637 |  
|                                 |  |      |        |      |  |   |       |  

The Company reviews long-lived assets and identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. The Company determines
impairment based on a comparison of the carrying amount of the assets to the

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estimated fair value of the assets, which is determined based on the discounted
cash flow method or current market prices for similar assets when available.
Based on these analyses, the Company recorded impairment charges totaling $2.5
million in 2001 and $493,000 in 2002 related to the customer list acquired from
Scour, Inc. and $579,000 in 2001 related to purchased technology.

NOTE 6. Accrued Liabilities

Accrued liabilities consisted of the following at December 31 (in thousands):

|                  |  |      |     |      |  |   |     | 
|----------------- |  | ---- | --- | ---- |  | - | --- | 
|                  |  | 2002 |     | 2001
|                  |  |      |     |     
|Accrued bonuses   |  | $    |    |      |  | $ | 397 | 
|Accrued vacation  |  |      | 112 |      |  |   | 163 | 
|Other liabilities |  |      | 37  |      |  |   | 43  | 
|                  |  |      |     |      |  |   |     | 
|                  |  | $    | 149 |      |  | $ | 603 | 
|                  |  |      |     |      |  |   |     | 

NOTE 7. Commitments, Contingencies and Factors That Could Affect Future
Results

Commitments

In February 2002, CenterSpan entered into an agreement with Sony Music, a group
of Sony Music Entertainment, Inc., wherein Sony provides CenterSpan with
certain musical content for it to distribute digitally via its C-StarOne
content delivery network to various C-StarOne service provider customers and
their subscribers in the U.S. and Canada. In exchange, CenterSpan issued to
Sony 283,556 shares of its common stock valued at $1.7 million and a warrant to
purchase 189,037 shares of its common stock at an exercise price of $8.11 per
share. In addition, CenterSpan agreed to pay an initial content fee of
$500,000 in connection with the execution of the agreement and an additional
content fee of $500,000 on September 1, 2002, as well as quarterly advance
minimum service fees of $250,000 each for four quarters beginning September 1,
2002. CenterSpan has not made the $500,000 payment due September 1, 2002 nor
the $250,000 payments which were due on each of September 1, 2002, December 1,
2002 and March 1, 2003. CenterSpan and Sony are currently renegotiating this
agreement. Depending on the outcome of the renegotiations with Sony, the
remaining value of the related intangible asset may be impaired. The amount of
the impairment is not known at this time, but it could have a material adverse
affect on our financial condition and business. (See also Note 9).

CenterSpan leases facilities and equipment under non-cancelable operating
leases. Certain of the facility leases contain escalation clauses. CenterSpan
also leases certain equipment under a capital lease. The following is a
schedule by year, through expiration of the leases, of future minimum lease
payments required under these leases as of December 31, 2002:

|                                               |  |              |     |                 |  |   |       | 
|---------------------------------------------- |  | ------------ | --- | --------------- |  | - | ----- | 
|                                               |  | CapitalLease |     | OperatingLeases
|For the year ending December 31,               |  |              |    
|2003                                           |  | $            | 29  |                 |  | $ | 584   | 
|2004                                           |  |              | 29  |                 |  |   | 411   | 
|2005                                           |  |              | 24  |                 |  |   | 102   | 
|                                               |  |              |     |                 |  |   |       | 
|Total minimum lease payments                   |  |              | 82  |                 |  | $ | 1,097 | 
|                                               |  |              |     |                 |  |   |       | 
|Less amounts representing interest             |  |              | (9  | )               |  |   |       | 
|                                               |  |              |     |                 |  |   |       | 
|Present value of future minimum lease payments |  |              | 73  |                 |  |   |       | 
|Less current portion                           |  |              | (24 | )               |  |   |       | 
|                                               |  |              |     |                 |  |   |       | 
|Present value of minimum lease payments        |  | $            | 49  |                 |  |   |       | 
|                                               |  |              |     |                 |  |   |       | 

Under the agreements for the lease of its office facilities, CenterSpan is
obligated to the lessors for its share of certain expenses related to the use,
operation, maintenance and insurance of the properties. These expenses,
payable monthly in addition to the base rent, are not included in the amounts
shown above. Rental expense totaled $468,000, $441,000 and $222,000 for the
years ended December 31, 2002, 2001 and 2000, respectively.

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The Company has entered into arrangements with its two executive officers
providing for severance payments in the event they are terminated without
cause, or terminated as a result of a change in control.

NOTE 8. Legal Proceedings

In August 2002, the Company, its Chief Executive Officer and its President and
Chief Operating Officer were named as defendants in a lawsuit filed by two
former, non-executive officer employees. The former employees allege
intentional and reckless misrepresentation with respect to their offers of
employment and subsequent terminations and seek damages of $1.0 million each
for economic loss and $2.0 million each for emotional distress and injury to
reputation. The Company intends to vigorously defend this action. The Company
cannot predict the outcome of this suit. The Company has not accrued for any
potential liability related to this lawsuit. However, a negative outcome could
have a material adverse effect on its financial condition.

NOTE 9. Changes in Equity

In June 2002, CenterSpan entered into a definitive stand-by stock purchase
agreement with an accredited investor who is also a related party. Under the
terms of the agreement, the investor unconditionally agreed to purchase up to
833,333 shares of CenterSpans common stock at a price of $6.00 per share, upon
the Companys request at any time from July 2002 through December 2002,
representing total maximum proceeds to the Company of $5.0 million. As
compensation for entering into this agreement, on June 10, 2002, the Company
issued to the investor a three-year warrant to purchase 100,000 shares of
CenterSpans common stock at $10.67 per share. The warrant issued to the
investor was valued using the Black-Scholes model using the following
assumptions: expected dividends, 0%; risk-free interest rate, 3.6%; volatility,
92.7%; and contractual life, 3 years. The relative fair value of the warrant
was $447,000 and was shown as a reduction to common stock.

In connection with this agreement, the Company issued a warrant to purchase
10,000 shares of CenterSpans common stock at $10.67 per share as a finders
fee. This warrant was valued using the Black-Scholes model using the following
assumptions: expected dividends, 0%; risk-free interest rate, 3.6%; volatility,
93%; and contractual life, 3 years. The fair value of the warrant was $22,000.

In August 2002, CenterSpan sold 833,333 shares of its common stock for $6.00
per share for total proceeds of $5.0 million to one accredited investor who is
also a related party pursuant to the stand-by stock purchase agreement
discussed above. In connection with this issuance, CenterSpan issued a warrant
exercisable for 733,333 shares of its common stock at $10.67 per share. The
warrant was valued using the Black-Scholes model using the following
assumptions: expected dividends, 0%; risk-free interest rate, 3.0%; volatility,
93.6%; and contractual life, 3 years. The relative fair value of the warrants
was $585,000. In addition, a warrant exercisable for 73,333 shares of
CenterSpans common stock was issued as a finders fee in connection with this
stock sale. This warrant was also valued using the Black-Scholes model using
the following assumptions: expected dividends, 0%; risk-free interest rate,
3.0%; volatility, 93.6%; and contractual life, 3 years. The fair value of the
warrant was $59,000.

In April 2002, CenterSpan sold a total of 22,000 units for $6.00 per unit to
certain directors and employees for total proceeds to the Company of $132,000.
Each unit consists of one share of common stock and a warrant to purchase one
share of common stock for $10.67 per share. The price per unit reflected a
discount of approximately 25% from the February 2002 trailing 10-day
volume-weighted average price of the Companys common stock, with a premium of
approximately 35% for the attached warrant. The warrants are immediately
exercisable and expire March 31, 2005. The warrants were valued using the
Black-Scholes model using the following assumptions: expected dividends, 0%;
risk-free interest rate, 3.6%; volatility, 92.7%; and contractual life, 3
years. The relative fair value of the warrants was $49,000.

In March 2002, CenterSpan sold 333,333 units of the Company to a total of six
accredited investors for $6.00 per unit for total proceeds to the Company of
$2.0 million. Each unit consisted of one share of the Companys common stock
and a warrant to purchase one share of the Companys common stock for

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$10.67 per share. The warrants are immediately exercisable and expire March
2005. The warrants were valued using the Black-Scholes model using the
following assumptions: expected dividends, 0%; risk-free interest rate, 3.6%;
volatility, 92.7%; and contractual life, 3 years. The relative fair value of
the warrants was $765,000.

In March 2002, CenterSpan issued a warrant to a related party to purchase
20,000 shares of the Companys common stock at $7.20 per share in connection
with a line of credit commitment. The line of credit commitment expired
unused. The warrant was valued using the Black-Scholes model using the
following assumptions: expected dividends, 0%; risk-free interest rate, 3.6%;
volatility, 92.7%; and contractual life, 3 years. The fair value of the
warrant was $86,000.

In February 2002, CenterSpan entered into an agreement with Sony Music
Entertainment (see Note 7). In exchange, CenterSpan issued to Sony 283,556
shares of its common stock and a warrant to purchase 189,037 shares of its
common stock at an exercise price of $8.11 per share. The 283,556 shares of
common stock issued to Sony were valued at $1.7 million, representing a
discount of approximately 25% from the trailing 10-day volume-weighted average
price of the Companys common stock. The warrant to purchase 189,037 shares of
CenterSpans common stock has an exercise price of $8.11 per share and was
valued using the Black-Scholes model using the following assumptions: expected
dividends, 0%; risk-free interest rate, 3.6%; volatility, 92.7%; and
contractual life, 3 years. The fair value of the warrant was $956,000.

In February 2002, CenterSpan sold 662,667 units of the Company to a total of
twelve accredited investors for $6.00 per unit for total proceeds to the
Company of $4.0 million. Each unit consisted of one share of the Companys
common stock and a warrant to purchase one share of the Companys common stock
for $10.67 per share. The warrants are immediately exercisable and expire
February 2005. The warrants were valued using the Black-Scholes model using
the following assumptions: expected dividends, 0%; risk-free interest rate,
3.6%; volatility, 92.7%; and contractual life, 3 years. The relative fair
value of the warrants was $1.5 million.

In August 2001, CenterSpan purchased certain assets from Supertracks.com, Inc.
for total consideration of 66,905 shares of the Companys common stock with a
total value of $750,000 on the date of purchase. The $750,000 was recorded as
research and engineering expense as the technology was being used in a product
then under development and for which no alternative use exists.

In June 2001, CenterSpan sold 569,177 units, each consisting of one share of
its common stock and a warrant to purchase one share of its common stock for an
exercise price of $18.68 per share, to nine accredited investors for $11.21 per
unit (the 30-day trailing volume weighted average price of the Companys common
stock) for proceeds to the Company of $6.4 million. In conjunction with this
issuance, warrants covering an additional 21,008 shares of the Companys common
stock were issued to the investors and certain finders with an exercise price
of $18.68 per share. The warrants are immediately exercisable and expire in
June 2004. The warrants were valued using the Black-Scholes model using the
following assumptions: expected dividends, 0%; risk-free interest rate, 4.4%;
volatility, 90%; and contractual life, 3 years. The relative fair value of the
569,177 warrants was $2.0 million.

In December 2000 and February 2001, CenterSpan sold an aggregate of 1,428,572
shares of its common stock to an accredited investor for $7.00 per share for
total proceeds of $10.0 million. In conjunction with this issuance, the
Company issued warrants exercisable for an aggregate of 170,000 shares of its
common stock to five designees of the investors financial consultant. The
warrants are immediately exercisable at a price of $9.063 per share and expire
in December 2005. The warrants were valued using the Black-Scholes model using
the following assumptions: expected dividends, 0%; risk-free interest rate,
5.9%; volatility, 90%; and contractual life, 5 years. The relative fair value
of the 170,000 warrants issued was $1.0 million.

In December 2000, CenterSpan issued 333,333 shares of its common stock in
connection with the purchase of the assets of Scour, Inc. The shares were
valued at $10.50 per share.

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In April 2000, CenterSpan issued a warrant to purchase 125,000 shares of its
common stock at $13.41 per share, which represented a 15% discount to an
average of the preceding 10-day closing stock price, to Intel Corp. in exchange
for certain technology. The warrant vested immediately and is exercisable until
April 21, 2005. The warrant was valued using the Black-Scholes model using the
following assumptions: expected dividends, 0%; risk-free interest rate, 5.9%;
volatility, 83%; and contractual life, 5 years. The fair value of the warrant
was $1.3 million.

NOTE 10. Warrants

All warrants are immediately exercisable for shares of the Companys common
stock. The following table summarizes warrant transactions:

|            |  |                |           |           |  |          |   |              |  |                |   |           |  |         |           |          |  |         |          |          |  |   |       |  |  |  |  | 
|----------- |  | -------------- | --------- | --------- |  | -------- | - | ------------ |  | -------------- | - | --------- |  | ------- | --------- | -------- |  | ------- | -------- | -------- |  | - | ----- |  |  |  |  | 
|            |  |                |           |           |  |          |   |              |  |                |   |           |  | Warrant |           |          |  |         |          | Weighted |  |   |       | 
|            |  |                |           |           |  |          |   |              |  | Shares         |   | Shares    |  |         |           |          |  | Average |          |          |  |  
|            |  |                |           |           |  | Warrant  |   | Acquired     |  | Outstanding at |   |           |  |         |           | Exercise |  |         |          |         
|            |  | Shares Subject |           | Shares    |  | Upon     |   | December 31, |  | Expiration     |   | Price     |  |         |           |         
|Date Issued |  | to Warrant     |           | Cancelled |  | Exercise |   | 2002         |  | Date           |   | Per Share |  |         |           |         
|            |  |                |           |           |  |          |   |              |  |                |   |           |  |         |           |         
|08/09/99    |  |                | 200,000   |           |  |          |  |              |  |                |  |           |  |         | 200,000   |          |  |         | 08/09/04 |          |  | $ | 18.09 | 
|08/30/99    |  |                | 30,000    |           |  |          |  |              |  |                |  |           |  |         | 30,000    |          |  |         | 08/30/04 |          |  |   | 18.26 | 
|01/28/99    |  |                | 35,377    |           |  |          |  |              |  |                |  |           |  |         | 35,377    |          |  |         | 01/28/04 |          |  |   | 20.00 | 
|01/28/99    |  |                | 35,377    |           |  |          |  |              |  |                |  |           |  |         | 35,377    |          |  |         | 01/28/04 |          |  |   | 22.40 | 
|04/21/00    |  |                | 125,000   |           |  |          |  |              |  |                |  |           |  |         | 125,000   |          |  |         | 04/21/05 |          |  |   | 13.41 | 
|12/18/00    |  |                | 85,000    |           |  |          |  |              |  |                |  |           |  |         | 85,000    |          |  |         | 12/18/05 |          |  |   | 9.06  | 
|02/23/01    |  |                | 85,000    |           |  |          |  |              |  |                |  |           |  |         | 85,000    |          |  |         | 12/18/05 |          |  |   | 9.06  | 
|06/20/01    |  |                | 501,452   |           |  |          |  |              |  |                |  |           |  |         | 501,452   |          |  |         | 06/20/04 |          |  |   | 18.68 | 
|06/22/01    |  |                | 88,733    |           |  |          |  |              |  |                |  |           |  |         | 88,733    |          |  |         | 06/20/04 |          |  |   | 18.68 | 
|02/08/02    |  |                | 662,667   |           |  |          |  |              |  |                |  |           |  |         | 662,667   |          |  |         | 02/08/05 |          |  |   | 10.67 | 
|02/27/02    |  |                | 189,037   |           |  |          |  |              |  |                |  |           |  |         | 189,037   |          |  |         | 02/27/05 |          |  |   | 8.11  | 
|03/28/02    |  |                | 333,333   |           |  |          |  |              |  |                |  |           |  |         | 333,333   |          |  |         | 03/27/05 |          |  |   | 10.67 | 
|03/29/02    |  |                | 20,000    |           |  |          |  |              |  |                |  |           |  |         | 20,000    |          |  |         | 03/28/05 |          |  |   | 7.20  | 
|04/01/02    |  |                | 22,000    |           |  |          |  |              |  |                |  |           |  |         | 22,000    |          |  |         | 03/31/05 |          |  |   | 10.67 | 
|06/10/02    |  |                | 110,000   |           |  |          |  |              |  |                |  |           |  |         | 110,000   |          |  |         | 06/10/05 |          |  |   | 10.67 | 
|08/22/02    |  |                | 806,666   |           |  |          |  |              |  |                |  |           |  |         | 806,666   |          |  |         | 08/22/05 |          |  |   | 10.67 | 
|            |  |                |           |           |  |          |   |              |  |                |   |           |  |         |           |          |  |         |          |          |  |   |       | 
|            |  |                | 3,329,642 |           |  |          |   |              |  |                |   |           |  |         | 3,329,642 |          |  |         |          |          |  | $ | 12.64 | 
|            |  |                |           |           |  |          |   |              |  |                |   |           |  |         |           |          |  |         |          |          |  |   |       | 

NOTE 11. Stock Option Plans

Options
CenterSpan has adopted a stock option plan for employees and directors (as
amended, the 1998 Plan) and has reserved 4,850,000 shares of common stock for
issuance thereunder. The 1998 Plan provides for incentive stock options and
nonqualified options to be granted. CenterSpan previously made grants under
the 1994 Stock Option Plan, the 1994 Directors Stock Option Plan, and a
nonqualified plan adopted in 1990, under which a total of 1.2 million shares
had been reserved. In May 1998, any ungranted options and any future
forfeitures under the 1994 and 1990 option plans were transferred to the 1998
Stock Option Plan. At December 31, 2002, CenterSpan had 3,638,324 shares of
its common stock reserved for issuance under the 1998 Plan and all previous
plans combined.

CenterSpan has also issued options covering 400,000 shares of common stock
outside of the 1998 Plan, for which it had 387,500 shares of common stock
reserved for issuance at December 31, 2002.

During 2000, the Board of Directors adopted the 2000 Nonqualified Stock Option
Plan (the 2000 Nonqualified Plan) and approved the reservation of 900,000
shares of the Companys common stock for issuance thereunder. At December 31,
2002, 796,628 shares of the Companys common stock remained reserved for
issuance.

During 2001, the Board of Directors adopted a non-employee stock option plan
and reserved 500,000 shares of the Companys common stock for issuance
thereunder. At December 31, 2002, 490,000 shares of the Companys common stock
remained reserved for issuance.

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Except for the 2000 Nonqualified Plan, the stock option plans generally require
the price of options to be at the estimated fair market value of the stock at
the date of grant. Options have a maximum duration of ten years (five years
under certain circumstances) and may be exercised in varying amounts over the
vesting periods. The following table summarizes all stock option transactions
in the last three fiscal years (in thousands, except per share amounts):

|                            |                                                        |  |               |            |            |  |           |           |   |   |          |       | 
|--------------------------- | ------------------------------------------------------ |  | ------------- | ---------- | ---------- |  | --------- | --------- | - | - | -------- | ----- | 
|                            |                                                        |  |               |            |            |  |           |           |   |   | Weighted
|                            |                                                        |  |               |            |            |  |           |           |   |   | Average 
|                            |                                                        |  | Shares        |            | Shares     |  | Exercise 
|                            |                                                        |  | Available for |            | Subject to |  | Price    
|                            |                                                        |  | Grant         |            | Options    |  | Per Share
|                            |                                                        |  |               |            |            |  |          
|Balances, December 31, 1999 |                                                        |  | 419,249       |            |            |  | 1,182,188 |           |   | $ | 10.01    |      
|                            | Additional shares reserved                             |  |               | 1,425,000  |            |  |           |          |   |   |          |      | 
|                            | Options granted                                        |  |               | (1,410,675 | )          |  |           | 1,410,675 |   |   |          | 13.38 | 
|                            | Options cancelled                                      |  |               | 210,500    |            |  |           | (210,500  | ) |   |          | 16.50 | 
|                            | Options exercised                                      |  |               |           |            |  |           | (239,400  | ) |   |          | 5.91  | 
|                            |                                                        |  |               |            |            |  |           |           |   |   |          |      
|Balances, December 31, 2000 |                                                        |  | 644,074       |            |            |  | 2,142,963 |           |   |   | 11.99    |      
|                            | Additional shares reserved                             |  |               | 1,873,000  |            |  |           |          |   |   |          |      | 
|                            | Options granted                                        |  |               | (2,125,000 | )          |  |           | 2,125,000 |   |   |          | 11.16 | 
|                            | Options cancelled                                      |  |               | 514,668    |            |  |           | (514,668  | ) |   |          | 13.93 | 
|                            | Options exercised                                      |  |               |           |            |  |           | (79,984   | ) |   |          | 7.41  | 
|                            |                                                        |  |               |            |            |  |           |           |   |   |          |      
|Balances, December 31, 2001 |                                                        |  | 906,742       |            |            |  | 3,673,311 |           |   |   | 11.31    |      
|                            | Additional shares reserved                             |  |               | 750,000    |            |  |           |          |   |   |          |      | 
|                            | Options granted                                        |  |               | (1,345,233 | )          |  |           | 1,345,233 |   |   |          | 3.34  | 
|                            | Options cancelled under shareholder approved plans     |  |               | 988,558    |            |  |           | (988,558  | ) |   |          | 10.69 | 
|                            | Options cancelled under non-shareholder approved plans |  |               |           |            |  |           | (12,500   | ) |   |          | 23.88 | 
|                            | Options exercised                                      |  |               |           |            |  |           | (5,101    | ) |   |          | 5.13  | 
|                            |                                                        |  |               |            |            |  |           |           |   |   |          |      
|Balances, December 31, 2002 |                                                        |  | 1,300,067     |            |            |  | 4,012,385 |           |   | $ | 8.76     |      
|                            |                                                        |  |               |            |            |  |           |           |   |   |          |      

The following table summarizes information about stock options outstanding at
December 31, 2002:

|                    |  |                     |  |              |  |          |           |             |          |          |           |       |         |  |          |           |  |  |   |       | 
|------------------- |  | ------------------- |  | ------------ |  | -------- | --------- | ----------- | -------- | -------- | --------- | ----- | ------- |  | -------- | --------- |  |  | - | ----- | 
|Options Outstanding |  | Options Exercisable
|                    |  |                    
|                    |  |                     |  |              |  |          | Weighted  |             |          |          |           |       |         |  |          |           |  |  |  
|                    |  |                     |  |              |  |          | Average   |             | Weighted |          |           |       |         |  | Weighted
|                    |  |                     |  |              |  |          | Remaining |             | Average  |          | Number of |       | Average
|Range of            |  | Number              |  | Contractual  |  | Exercise |           | Shares      |          | Exercise
|Exercise Prices     |  | Outstanding         |  | Life (years) |  | Price    |           | Exercisable |          | Price   
|                    |  |                     |  |              |  |          |           |             |          |         
|$1.99
- $5.45       |  |                     |  | 1,729,192    |  |          |           | 8.8         |          |          | $         | 3.22  |         |  |          | 402,193   |  |  | $ | 3.77  | 
|6.00 - 9.88         |  |                     |  | 547,683      |  |          |           | 8.1         |          |          |           | 8.03  |         |  |          | 351,480   |  |  |   | 7.92  | 
|10.50 - 13.69       |  |                     |  | 1,139,052    |  |          |           | 8.1         |          |          |           | 12.69 |         |  |          | 536,236   |  |  |   | 12.79 | 
|14.25 - 18.00       |  |                     |  | 462,208      |  |          |           | 7.4         |          |          |           | 16.10 |         |  |          | 331,562   |  |  |   | 15.96 | 
|23.88 - 26.00       |  |                     |  | 134,250      |  |          |           | 7.1         |          |          |           | 24.34 |         |  |          | 100,000   |  |  |   | 24.22 | 
|                    |  |                     |  |              |  |          |           |             |          |          |           |       |         |  |          |           |  |  |   |      
|$1.99 - $26.00      |  |                     |  | 4,012,385    |  |          |           | 8.3         |          |          | $         | 8.76  |         |  |          | 1,721,471 |  |  | $ | 10.96 | 
|                    |  |                     |  |              |  |          |           |             |          |          |           |       |         |  |          |           |  |  |   |      

At December 31, 2001 and 2000, 790,074 and 475,284 options, respectively, were
exercisable at weighted average exercise prices of $9.68 per share and $7.74
per share, respectively.

SFAS No. 123

The Company applies APB opinion No. 25 and related interpretations in
accounting for its stock based compensation plans. However, in accordance with
SFAS No. 123, pro forma disclosures as if the Company adopted the fair value
method requirements under SFAS No. 123 for all awards subsequent to January 1,
1995, are presented below.

Using the Black-Scholes methodology, the total value of options granted during
2002, 2001 and 2000 was $2.8 million, $14.5 million and $10.4 million,
respectively. The weighted average per share fair value of options granted
during 2002, 2001 and 2000 was $2.07, $7.03 and $7.81, respectively. The fair
value of each option granted during the years ended 2002, 2001 and 2000 was
estimated on the date of grant using the Black-Scholes option pricing model
with the following assumptions:

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|                        |  |                         |            |      |  |      |          |   |  |  |          |  
|----------------------- |  | ----------------------- | ---------- | ---- |  | ---- | -------- | - |  |  | -------- | -
|                        |  | Year Ended December 31,
|                        |  |                        
|                        |  | 2002                    |            | 2001 |  | 2000
|                        |  |                         |            |      |  |     
|Risk-free interest rate |  |                         | 1.9% - 4.4 | %    |  |      | 2.8%-4.8 | % |  |  | 5.2%-6.8 | %
|Expected dividend yield |  |                         | 0          | %    |  |      | 0        | % |  |  | 0        | %
|Expected lives (years)  |  |                         | 5          |      |  |      | 5        |   |  |  | 5        |  
|Volatility              |  |                         | 96         | %    |  |      | 93       | % |  |  | 89       | %

NOTE 12. Income Taxes

The provision for income taxes differs from the amount of income taxes
determined by applying the statutory federal income tax rate to income from
continuing operations due to the following:

|                                         |  |                         |       |      |  |      |       |    |  |  |       |   
|---------------------------------------- |  | ----------------------- | ----- | ---- |  | ---- | ----- | -- |  |  | ----- | --
|                                         |  | Year Ended December 31,
|                                         |  |                        
|                                         |  | 2002                    |       | 2001 |  | 2000
|                                         |  |                         |       |      |  |     
|Statutory federal income tax rate        |  |                         | (34.0 | )%   |  |      | (34.0 | )% |  |  | (34.0 | )%
|State taxes, net of federal income taxes |  |                         | (4.2  | )    |  |      | (4.5  | )  |  |  | (4.4  | ) 
|Change in valuation allowance            |  |                         | 41.4  |      |  |      | 41.7  |    |  |  | 38.4  |   
|Carryback of tax credit                  |  |                         | (1.0  | )    |  |      |      |    |  |  |      |   
|Other, net                               |  |                         | (3.2  | )    |  |      | (3.2  | )  |  |  |      |   
|                                         |  |                         |       |      |  |      |       |    |  |  |       |   
|Effective tax rate                       |  |                         | (1.0  | )%   |  |      |      | %  |  |  |      | % 
|                                         |  |                         |       |      |  |      |       |    |  |  |       |   

Deferred tax assets (liabilities) are comprised of the following components (in
thousands):

|                          |                                                  |   |              |        |      |   |         |        | 
|------------------------- | ------------------------------------------------ | - | ------------ | ------ | ---- | - | ------- | ------ | 
|                          |                                                  |   | December 31,
|                          |                                                  |   |             
|                          |                                                  |   | 2002         |        | 2001
|                          |                                                  |   |              |        |     
|Deferred tax assets:      |                                                  |   |              |        |      |   |         |       
|                          | Expenses and allowances not currently deductible |   | $            | 3,804  |      |   | $       | 122    | 
|                          | Net operating loss carryforwards                 |   |              | 22,971 |      |   |         | 20,034 | 
|                          | Credit carryforwards                             |   |              | 987    |      |   |         | 739    | 
|                          |                                                  |   |              |        |      |   |         |       
|Net deferred income taxes |                                                  |   | 27,762       |        |      |   | 20,895  |       
|Valuation allowance       |                                                  |   | (27,762      | )      |      |   | (20,895 | )     
|                          |                                                  |   |              |        |      |   |         |       
|                          |                                                  | $ |             |        |      | $ |        |       
|                          |                                                  |   |              |        |      |   |         |       

The net change in total valuation allowance for the years ended December 31,
2002, 2001 and 2000 was an increase of $6.9 million, $8.7 million and $3.8
million, respectively.

The Company has established a valuation allowance for its deferred tax assets.
Such a valuation allowance is recorded when it is more likely than not that
some portion of the deferred tax assets will not be realized. The portion of
the valuation allowance for deferred tax assets for which subsequently
recognized tax benefits will be applied directly to contributed capital is $3.5
million as of December 31, 2002. This amount is attributable to differences
between financial and tax reporting of employee stock option transactions.

The Company has federal, state, and foreign net operating loss carryforwards
of $54.3 million, $69.8 million and $6.6 million,
respectively, which expire through the end of 2002. The Company has research and
experimentation credits of $987,000 that expire through 2022.

Section 382 of the Internal Revenue Code requires the utilization of net
operating losses be limited when there is a change of more than fifty percent
in ownership of the Company. Such a change occurred in conjunction with the
sale of common stock in December of 2000. Accordingly, the utilization of the
net operating loss carryforwards generated from periods prior to this change is
limited.

As the result of the Job Creation and Worker Assistance Act of 2002, we
recorded a tax refund of $164,000 in 2002 from a tax credit carryback to 1996
and 1997 which was received in February 2003.

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NOTE 13. 401(k) Plan

The Company has a 401(k) Plan covering substantially all employees meeting
minimum service requirements. The 401(k) Plan allows the Company to make
discretionary matching contributions. The Company provided discretionary
contributions of $57,000, $41,000, and $36,000 for the years ended December 31,
2002, 2001, and 2000, respectively.

NOTE 14. Quarterly Financial Data (Unaudited)

Selected unaudited quarterly financial data for each of the eight quarters in
the two-year period ended December 31, 2002 is as follows:

|                                                                          |  |             |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------- |  | ----------- | ------ | ----------- |  | ----------- | ------ | ----------- |  | - | ------ | - |  | - | ------ | -
|In thousands, except per share data                                       |  | 1st Quarter |        | 2nd Quarter |  | 3rd Quarter |        | 4th Quarter
|                                                                          |  |             |        |             |  |             |        |            
|2001                                                                      |  |             |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|Revenue                                                                   |  | $           | 12     |             |  | $           |       |             |  | $ | 39     |   |  | $ |       |  
|Loss from continuing operations                                           |  |             | (4,494 | )           |  |             | (4,931 | )           |  |   | (5,648 | ) |  |   | (6,463 | )
|Gain on disposal of discontinued operations                               |  |             | 604    |             |  |             |       |             |  |   |       |   |  |   | 70     |  
|Net loss                                                                  |  |             | (3,890 | )           |  |             | (4,931 | )           |  |   | (5,648 | ) |  |   | (6,393 | )
|Basic and diluted loss per share from
continuing operations               |  |             | (0.59  | )           |  |             | (0.61  | )           |  |   | (0.65  | ) |  |   | (0.74  | )
|Basic and diluted gain per share from
disposal of discontinued operations |  |             | 0.08   |             |  |             |       |             |  |   |       |   |  |   | 0.01   |  
|Basic and diluted net loss per share                                      |  |             | (0.51  | )           |  |             | (0.61  | )           |  |   | (0.65  | ) |  |   | (0.73  | )

|                                     |  |             |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|------------------------------------ |  | ----------- | ------ | ----------- |  | ----------- | ------ | ----------- |  | - | ------ | - |  | - | ------ | -
|                                     |  | 1st Quarter |        | 2nd Quarter |  | 3rd Quarter |        | 4th Quarter
|                                     |  |             |        |             |  |             |        |            
|2002                                 |  |             |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|Revenue                              |  | $           |       |             |  | $           |       |             |  | $ |       |   |  | $ |       |  
|Gross profit                         |  |             |       |             |  |             |       |             |  |   |       |   |  |   |       |  
|Net loss                             |  |             | (4,096 | )           |  |             | (5,633 | )           |  |   | (3,560 | ) |  |   | (3,546 | )
|Basic and diluted net loss per share |  |             | (0.44  | )           |  |             | (0.56  | )           |  |   | (0.34  | ) |  |   | (0.33  | )

In the fourth quarter of 2001 and 2002, the Company recorded an impairment
charge of $2.5 million and $493,000, respectively, related to a customer list,
as discussed in Note 5.

NOTE 15. Subsequent Events

Reduction in Force

In February 2003, the Company announced a reduction in force in order to reduce
its quarterly cash burn rate to approximately $1.0 million. In addition, Mr.
Andrew Mallinger resigned as Vice President of Product Management and Marketing
and Mr. Alfred Lee resigned as Vice President of Engineering. Following this
reduction and these resignations, the Company had seventeen employees.




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

None.

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##### Table of Contents






PART III




Item 10. Directors and Executive Officers of the Registrant

The information required by this item will be included in CenterSpans Proxy
Statement for its 2003 Annual Meeting of Shareholders and is incorporated
herein by reference.




Item 11. Executive Compensation

The information required by this item will be included in CenterSpans Proxy
Statement for its 2003 Annual Meeting of Shareholders and is incorporated
herein by reference.




Item 12. Security Ownership of Certain Beneficial Owners and Management

The additional information required by this item will be included in
CenterSpans Proxy Statement for its 2003 Annual Meeting of Shareholders and is
incorporated herein by reference.

Disclosure Regarding CenterSpans Equity Compensation Plans

CenterSpan maintains the 1998 Stock Option Plan (1998 Plan), the 2000
Nonqualified Stock Option Plan (the 2000 Plan) and the 2001 Non-Employee
Option Plan (the 2001 Plan) pursuant to which CenterSpan may make equity
awards to eligible persons. Additionally, certain awards granted under the 1990
Nonqualified Stock Option Plan (the 1990 Plan) and the Directors
Nonqualified Stock Option Plan (the 1994 Directors Plan) remain outstanding
and CenterSpan has awarded options to certain of its directors and officers
outside of the plans. The 1990 Plan, the 1994 Directors Plan and the 1998
Plan have been approved by CenterSpans shareholders. The 2000 Plan, the 2001
Plan and the options granted outside of the plans were not approved by
CenterSpans shareholders. The material terms of those plans, options are
described below.

The following table summarizes information about CenterSpans common stock that
may be issued upon exercise of outstanding equity awards made as of December
31, 2002 under and outside of CenterSpans existing equity compensation plans:

|                                                       |  |                         |           |                   |  |                                 |       |  |  |                      |           |    
|------------------------------------------------------ |  | ----------------------- | --------- | ----------------- |  | ------------------------------- | ----- |  |  | -------------------- | --------- | ---
|                                                       |  |                         |           |                   |  |                                 |       |  |  | Number of securities
|                                                       |  | Number of securities to |           | Weighted average  |  | remaining available for future 
|                                                       |  | be issued upon          |           | exercise price of |  | issuance under equity          
|                                                       |  | exercise of outstanding |           | outstanding       |  | compensation plans             
|                                                       |  | options, warrants and   |           | options, warrants |  | (excluding securities reflected
|Plan Category                                          |  | rights                  |           | and rights        |  | in the first column)           
|                                                       |  |                         |           |                   |  |                                
|Equity compensation plans approved by shareholders     |  |                         | 3,038,870 | (1)               |  | $                               | 8.06  |  |  |                      | 599,454   | (3)
|Equity compensation
plans not approved
by shareholders |  |                         | 973,515   | (2)               |  |                                 | 10.93 |  |  |                      | 700,613   | (4)
|                                                       |  |                         |           |                   |  |                                 |       |  |  |                      |           |    
|Total                                                  |  |                         | 4,012,385 |                   |  | $                               | 8.76  |  |  |                      | 1,300,067 |    
|                                                       |  |                         |           |                   |  |                                 |       |  |  |                      |           |    



|(1) |  | Comprised of 32,960 shares issuable under our 1990 Plan, 20,600
shares issuable under our 1994 Directors Plan and 2,985,310 shares
issuable under our 1998 Plan.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Comprised of 586,015 shares issuable under our 2000 Plan and 387,500
share subject to options issued to employees outside any of our equity
compensation plans   
|   
|(3) |  | All shares are available under our 1998 Plan.                                                                                                                    
|   
|(4) |  | Comprised of 210,613 shares available under our 2000 Plan and
490,000 shares available under our 2001 Plan.                                                      

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2000 Nonqualified Stock Option Plan and 2001 Non-Employee Option Plan

CenterSpans Board of Directors adopted the 2000 Nonqualified Stock Option Plan
in 2000 and adopted the 2001 Non-Employee Option Plan in 2001. Neither the 2000
Plan, nor the 2001 Plan have been approved by CenterSpans shareholders. The
2000 Plan and the 2001 Plan are sometimes referred to collectively in this
section as the Plans.

Shares Available

The 2000 Plan reserved up to 900,000 shares of CenterSpans Common Stock for
issuance pursuant to options granted thereunder. The 2001 Plan reserves up to
500,000 shares of CenterSpans Common Stock for issuance pursuant to options
granted thereunder. Both Plans permit grants of non-statutory stock options
(NSOs). If an option granted under either Plan expires, terminates or is
cancelled, the shares subject to such option again become available for
issuance under the applicable Plan.

Eligibility

All employees, officers and directors of CenterSpan and its subsidiaries are
eligible to participate in the 2000 Plan. Non-employee consultants, agents,
independent contractors and advisors who provide services to CenterSpan or its
subsidiaries are also eligible to participate. In any given three-year period
beginning October 1 to the following third September 30, CenterSpans officers
and directors may not receive options involving more than an aggregate of 49%
of the shares of Common Stock subject to the total aggregate number of options
granted during any single three-year period.

Non-employee service providers, suppliers, consultants, advisors and
independent contractors who provide bona-fide, non-capital raising services to
CenterSpan or a related company are eligible to participate in the 2001 Plan.

Administration

The Compensation Committee of the Board of Directors administers the 2000 Plan
and the 2001 Plan. The Compensation Committee may designate, from time to time,
the individuals to whom options are granted under the Plans, the option price,
the number of shares subject to each option, the period of each option and the
times at which options vest and may be exercised. The Compensation Committee
has the full and exclusive power to interpret the 2000 Plan and the 2001 Plan
and may, subject to the provisions of the each of the Plans, establish the
rules for their operation. The Plans may only be amended, modified or
terminated by the Board.

Term of Plan

Neither the 2000 Plan, nor the 2001 Plan has an expiration date, but the Board
of Directors may suspend or terminate either of the Plans at any time.

Stock Options

Options granted under either of the Plans generally continue in effect for the
period fixed by the Compensation Committee. If no term is fixed, options shall
be exercisable for ten years from the date of grant. No monetary consideration
is paid to CenterSpan upon the granting of options. Options are exercisable in
accordance with the terms of an option agreement entered into at the time of
grant. Except as otherwise determined by the Compensation Committee, options
granted under the 2001 Plan are nontransferable and options granted under the
2000 Plan are nontransferable except on death. The Compensation Committee shall
establish whether an option will continue to be exercisable if an optionee
ceases to be employed by or in the service of CenterSpan or a related company.
If the Compensation Committee does not so establish, the vested options shall
be exercisable after termination of employment or service on the earliest of
(i) the options expiration date; (ii) within 12 months following termination
of employment or service by reason of death or disability; or (iii) 90 days
following termination for any other reason. Notwithstanding the foregoing,
under the 2001 Plan, if the optionees service terminates for cause, the option
expires upon notice of such termination. The purchase price for each share
purchased pursuant to exercise of options under the 2000 Plan must be paid in
cash or by check or in other forms of consideration permitted by the
Compensation Committee. The purchase price for each share purchased

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##### Table of Contents



pursuant to exercise of options under the 2001 Plan may also be paid in shares
of Common Stock valued at fair market value that have been owned by the
optionee for at least six months (or any shorter period necessary to avoid a
charge to CenterSpans earnings for financial reporting purposes). Upon the
exercise of an option, the number of shares subject to the option and the
number of shares available under the relevant Plan for future option grants are
reduced by the number of shares with respect to which the option is exercised,
less any shares surrendered in payment or withheld to satisfy withholding
obligations.

Changes in Capital Structure

Both Plans provide that if the outstanding Common Stock of CenterSpan is
increased or decreased or changed into or exchanged for a different number or
kind of shares or other securities of CenterSpan or of another corporation due
to any recapitalization, merger, consolidation, stock split or certain other
transactions, appropriate adjustment will be made by the Compensation Committee
in the number and kind of shares available for awards under each of the Plans
and the number and kind of securities that are subject to the Plans and to any
outstanding option.

Amendments

The Board of Directors may at any time amend, suspend or terminate either of
the Plans in such respect as it shall deem advisable; provided that shareholder
approval must be obtained if required by law.

Tax Consequences

No income is realized by the grantee under federal income tax law until a stock
option is exercised. All of the stock options granted under the 2000 Plan and
the 2001 Plan are NSOs. At the time of exercise of an NSO, the optionee will
realize ordinary compensation income, and CenterSpan will generally be entitled
to a deduction, in the amount by which the market value of the shares subject
to the option at the time of exercise exceeds the exercise price. CenterSpans
deduction is conditioned upon withholding income taxes on the income amount.
Upon the sale of shares acquired upon exercise of an NSO, the excess of the
amount realized from the sale over the market value of the shares on the date
of exercise will be taxable to the optionee.

Section 162(m) of the Code limits to $1,000,000 per person the amount that
CenterSpan may deduct for compensation paid to any of its most highly
compensated officers in any year after 1993. Because neither of the Plans were
approved by CenterSpans shareholders, compensation received through the
exercise of options granted under the 2000 Plan or the 2001 Plans subject to
the $1,000,000 deduction limit.

Other Non-Shareholder Approved Equity Arrangements

On February 23, 2001, we issued nonqualified stock options to three of our
officers to purchase 125,000 shares each of our common stock at an exercise
price of $13.438 per share. These options were not awarded pursuant to any of
our equity compensation plans. Because each option was issued as an inducement
essential to the officers entering into employment with CenterSpan,
shareholder approval of the options was not required. One quarter of the
shares subject to each option vested and became exercisable on the first
anniversary of the grant and an additional 1/48 of the shares vest monthly
thereafter. One of the optionees resigned on February 7, 2003, the second
optionee resigned on February 14, 2003 and the third optionee resigned on
February 28, 2003. At the time of their resignations, 59,896, 59,896 and
62,500 shares, respectively, were vested under each option. The options will
terminate and no longer be exercisable on May 8, 2003, May 15, 2003 and May 29,
2003, respectively if not exercised prior to that date. Except as permitted by
the Compensation Committee the options are nontransferable except on death. The
options provide for the payment of the exercise price in cash, by check or any
other method permitted by the Compensation Committee.

On February 3, 2000, we issued a stock option to Steven Frison to purchase
125,000 shares of our common stock at an exercise price of $23.875 per share.
The option incorporates the terms and conditions of our 1998 Plan. When the
grant was made, the 1998 Plan limited one-time grants to newly hired
individuals to 100,000 shares. Therefore, the portion of the option granted to
purchase 25,000 shares in excess of the 100,000 share limitation was awarded
outside of any of our equity compensation

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##### Table of Contents



plans. Because the option was issued as an inducement essential to Mr.
Frisons entering into employment with CenterSpan, shareholder approval of the
option was not required. Pursuant to its terms, one-quarter of the shares
subject to the option vest and become exercisable on each of the first four
anniversaries of the grant date. Mr. Frison resigned on November 15, 2002. At
that time, 75,000 shares were vested under the option. The option terminated
unexercised on February 15, 2003. The option is nontransferable except on
death. Payment of the exercise price must be made in cash or by check.




Item 13. Certain Relationships and Related Transactions

The information required by this item will be included in CenterSpans Proxy
Statement for its 2003 Annual Meeting of Shareholders and is incorporated
herein by reference.

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##### Table of Contents






PART IV




Item 14. Controls and Procedures

Disclosure Controls and Procedures

Within the 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and acting Chief Financial Officer, of
the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-15b under the Securities Exchange Act of 1934.
Based on their review of our disclosure controls and procedures, the Chief
Executive Officer and acting Chief Financial Officer concluded that our
disclosure controls and procedures are effective in timely alerting him to
material information relating to us that is required to be included in our
periodic SEC filings.

Internal Controls and Procedures

There were no significant changes in internal controls or in other factors that
could significantly affect these controls subsequent to the date of their
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.

Our Chief Executive Officer and acting Chief Financial Officer does not expect
that our disclosure controls or our internal controls will prevent all error
and all fraud. A control system, no matter how well conceived and operated,
can provide only reasonable, not absolute, assurance that the objectives of the
system are met. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
mistake or error. Additionally, controls can be circumvented by individual
acts or some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based
partly on certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions.




Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

Financial Statements and Schedules

The Consolidated Financial Statements, together with the report thereon of KPMG
LLP, are included on the pages indicated below:

|                                                                                                     |  |      |    | 
|---------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                                                                                     |  | Page
|                                                                                                     |  |     
|Independent Auditors Report                                                                         |  |      | 21 | 
|Consolidated Balance Sheets as of December 31, 2002 and 2001                                         |  |      | 22 | 
|Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000           |  |      | 23 | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000           |  |      | 24 | 
|Consolidated Statements of Shareholders Equity for the years ended December 31, 2002, 2001 and 2000 |  |      | 25 | 
|Notes to Consolidated Financial Statements                                                           |  |      | 26 | 

There are no schedules required to be
filed herewith.

Reports on Form 8-K

CenterSpan filed one report on Form 8-K during the quarter ended December 31,
2002 regarding the resignation of CenterSpans Chief Financial Officer on
December 31, 2002.

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Exhibits
The following exhibits are filed herewith and this list is intended to
constitute the exhibit index:

|            |  | 
|----------- |  | 
|Exhibit No. |  | 
|            |  | 

|2.1(1)    |  | Asset Purchase Agreement dated December 18, 2000 between CenterSpan and Scour, Inc.                                                                                                               
|--------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|          |  |                                                                                                                                                                                                   
|2.2(2)    |  | Asset Purchase Agreement between CenterSpan and Supertracks.com, Inc. dated August
3, 2001                                                                                                        
|          |  |                                                                                                                                                                                                   
|3.1(12)   |  | Articles of Incorporation, as amended                                                                                                                                                             
|          |  |                                                                                                                                                                                                   
|3.2(3)    |  | Amended and Restated Bylaws                                                                                                                                                                       
|          |  |                                                                                                                                                                                                   
|10.1(12)* |  | 1998 Stock Option Plan, as amended                                                                                                                                                                
|          |  |                                                                                                                                                                                                   
|10.2(4)*  |  | 2000 Nonqualified Stock Option Plan                                                                                                                                                               
|          |  |                                                                                                                                                                                                   
|10.3(5)*  |  | Directors Nonqualified Stock Option Plan, dated July 19, 1994, as amended                                                                                                                        
|          |  |                                                                                                                                                                                                   
|10.4(14)* |  | 2001 Non-Employee Option Plan                                                                                                                                                                     
|          |  |                                                                                                                                                                                                   
|10.5(3)   |  | Leases, dated March 13, 1996, between Pacific Realty Associates, L.P. and the
Company, as amended                                                                                                 
|          |  |                                                                                                                                                                                                   
|10.6(6)*  |  | Form of Change-in-Control Agreement for all officers of CenterSpan Communications
Corporation                                                                                                     
|          |  |                                                                                                                                                                                                   
|10.7(7)   |  | Software Development and License Agreement dated August 9, 1999 between Intel
Corporation and the Company, as amended (confidential treatment requested for
portions of this exhibit              
|          |  |                                                                                                                                                                                                   
|10.8(8)   |  | Settlement Agreement and Mutual Release dated March 27, 2001 between CenterSpan
Communications Corporation and Guillemot Corporation, S.A.                                                        
|          |  |                                                                                                                                                                                                   
|10.9(9)+  |  | Form of Unit Purchase Agreement dated June 20, 2001                                                                                                                                               
|          |  |                                                                                                                                                                                                   
|10.10(9)+ |  | Form of Common Stock Purchase Warrant dated June 20, 2001                                                                                                                                         
|          |  |                                                                                                                                                                                                   
|10.11(9)  |  | License Agreement dated April 12, 2001 and Term License Lease Schedule between
Oracle Corporation and CenterSpan Communications Corporation. [DELETE?]                                            
|          |  |                                                                                                                                                                                                   
|10.12(10) |  | Securities Purchase Agreement dated as of January 28, 1999 among the Company and
the Purchasers party thereto                                                                                     
|          |  |                                                                                                                                                                                                   
|10.13(10) |  | Form of Callable Warrant                                                                                                                                                                          
|          |  |                                                                                                                                                                                                   
|10.14(10) |  | Registration Rights Agreement dated as of January 28, 1999 among the Company and
the Purchasers party thereto                                                                                     
|          |  |                                                                                                                                                                                                   
|10.15(5)  |  | Common Stock Purchase Agreement, dated as of August 6, 1999, between the Company
and Peter R. Kellogg                                                                                             
|          |  |                                                                                                                                                                                                   
|10.16(5)  |  | Form of Warrant issued to Lucas Capital Management                                                                                                                                                
|          |  |                                                                                                                                                                                                   
|10.17(12) |  | Content Integration Agreement dated as of February 27, 2002 between CenterSpan and
Sony Music, a group of Sony Entertainment, Inc. (confidential treatment requested
for portions of this exhibit)
|          |  |                                                                                                                                                                                                   
|10.18(11) |  | Common Stock Purchase Agreement dated December 18, 2000                                                                                                                                           

43



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##### Table of Contents



|            |  | 
|----------- |  | 
|Exhibit No. |  | 
|            |  | 

|10.19(11)  | Form of Common Stock Purchase Warrant dated December 18, 2000
|---------- | -------------------------------------------------------------
|           |                                                              
|10.20(13)  |                                                              
|           |                                                              
|10.21(13)  |                                                              
|           |                                                              
|10.22(13)  |                                                              
|           |                                                              
|10.23      |                                                              
|           |                                                              
|10.24(14)* |                                                              
|           |                                                              
|10.25(14)* |                                                              
|           |                                                              
|10.26(14)* |                                                              
|           |                                                              
|10.27(14)* |                                                              
|           |                                                              
|21(4)      |                                                              
|           |                                                              
|23         |                                                              
|           |                                                              
|24         |                                                              
|           |                                                              
|99.1       |                                                              



|* | Management compensatory plan                                                                                                                                                                                                                                                            
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|+ | A Schedule attached to this exhibit identifies all other documents not
required to be filed as exhibits because such other documents are
substantially identical to this exhibit. The schedule also sets forth
material details by which the omitted documents differ from this exhibit.
| 
|  | (1)                                                                                                                                                                                                                                                                                     
| 
|  | (2)                                                                                                                                                                                                                                                                                     
| 
|  | (3)                                                                                                                                                                                                                                                                                     
| 
|  | (4)                                                                                                                                                                                                                                                                                     
| 
|  | (5)                                                                                                                                                                                                                                                                                     
| 
|  | (6)                                                                                                                                                                                                                                                                                     
| 
|  | (7)                                                                                                                                                                                                                                                                                     
| 
|  | (8)                                                                                                                                                                                                                                                                                     
| 
|  | (9)                                                                                                                                                                                                                                                                                     
| 
|  | (10)                                                                                                                                                                                                                                                                                    
| 
|  | (11)                                                                                                                                                                                                                                                                                    
| 
|  | (12)                                                                                                                                                                                                                                                                                    
| 
|  | (13)                                                                                                                                                                                                                                                                                    
| 
|  | (14)                                                                                                                                                                                                                                                                                    

44



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, hereunto duly authorized.

|                     |    |                                                                                                                    
|-------------------- | -- | -------------------------------------------------------------------------------------------------------------------
|Date: March 28, 2003 |    | CENTERSPAN COMMUNICATIONS CORPORATION                                                                              
|                     |    |                                                                                                                    
|                     | By | /s/ Frank G. Hausmann, Jr.                                                                                         
|                     |    | Frank G. Hausmann, Jr.,
President, Chief Executive Officer, Chairman of
the Boardand acting Chief Financial Officer

POWER OF ATTORNEY

Each person whose signature appears below constitutes and appoints Frank G.
Hausmann, Jr. as his true and lawful attorney-in-fact and agent with full power
of substitution and resubstitution, for him, and in his name, place and stead,
in any and all capacities to sign any and all amendments to this Annual Report
on Form 10-K, and to file the same, with all exhibits thereto, and all other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorney-in-fact and agent full power and authority to do
and perform each and every act and thing requisite and necessary to be done, as
fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that said attorney-in-fact and agent or his
substitute may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 28, 2003:

|                                                   |  |                                                                                                                                                                         
|-------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Signature                                          |  | Title                                                                                                                                                                   
|                                                   |  |                                                                                                                                                                         
|/s/ Frank G. Hausmann, Jr.

Frank G. Hausmann, Jr. |  | President, Chief Executive Officer, (Principal
Executive Officer), acting Chief Financial Officer
(Principal Financial and Accounting Officer)
and Chairman of the Board
|                                                   |  |                                                                                                                                                                         
|/s/ David Billstrom                                |  | Director                                                                                                                                                                
|                                                   |  |                                                                                                                                                                         
|David Billstrom                                    |  |                                                                                                                                                                         
|                                                   |  |                                                                                                                                                                         
|/s/ Merrill A. McPeak                              |  | Director                                                                                                                                                                
|                                                   |  |                                                                                                                                                                         
|Merrill A. McPeak                                  |  |                                                                                                                                                                         
|                                                   |  |                                                                                                                                                                         
|/s/ G. Gerald Pratt                                |  | Director                                                                                                                                                                
|                                                   |  |                                                                                                                                                                         
|G. Gerald Pratt                                    |  |                                                                                                                                                                         
|                                                   |  |                                                                                                                                                                         
|/s/ Frederick M. Stevens                           |  | Director                                                                                                                                                                
|                                                   |  |                                                                                                                                                                         
|Frederick M. Stevens                               |  |                                                                                                                                                                         

45



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##### Table of Contents






CERTIFICATION PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002

I, Frank G. Hausmann, Jr., certify that:



|1. |  | I have reviewed this annual report on Form 10-K of CenterSpan
Communications Corporation;                                                                                                                                                                                                                               
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;                   
|  
|4. |  | The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:                                                                                                



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



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



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



|6. |  | The registrants other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: March 28, 2003

/s/ Frank G. Hausmann, Jr.
Chief Executive Officer and acting Chief Financial Officer

46