<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q/A
AMENDMENT NO. 1 TO QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 4, 1998
Commission File Number 1-12375
The Learning Company, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 94-2562108
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
One Athenaeum Street
Cambridge, Massachusetts 02142
(Address of Principal Executive Offices)
(617) 494-1200
(Registrant's Telephone Number, Including Area Code)
Indicate by check 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
-------- ---------
As of April 30, 1998, there were 53,509,734 outstanding shares of the
issuer's common stock, par value $.01 per share.
<PAGE>
Restatement of Financial Statements and Changes to Certain Information
The undersigned registrant hereby amends in its entirety Part I of its Quarterly
Report on Form 10-Q for the quarterly period ended April 4, 1998.
In March 1998, The Learning Company, Inc. (the "Company") acquired Mindscape,
Inc. and certain affiliated companies ("Mindscape") for approximately $152
million in a business combination accounted for as a purchase. The Company
allocated $103 million of the purchase price to in-process technology. The
Company believes that the amount recorded as an in-process technology charge at
the date of its acquisition was measured in a manner consistent with appraisal
practices utilized at the time of the acquisition. Subsequent to the
acquisition, in a letter dated September 9, 1998 to the American Institute of
Certified Public Accountants, the Chief Accountant of the Securities and
Exchange Commission (the "SEC") reiterated the views of the staff of the SEC
(the "Staff") on certain appraisal practices employed in the determination of
the fair value of the in-process technology and other intangible assets.
The Company has had discussions with the Staff concerning the application of the
methodology to the valuation of the in-complete technology and other intangible
assets as detailed in the September 9, 1998 letter from the Chief Accountant of
the SEC, and as a result of these discussions, the Company has implemented the
methodology. The Company has restated its previously issued results to reflect
the discussions with the Staff and to apply the appropriate guidance and
policies. The purchase price of Mindscape has been allocated by the Company
based upon the application of the recent guidance and, accordingly, the
financial statements in this Quarterly Report on Form 10-Q/A have been restated.
After applying the appropriate guidance and policy, the allocation of the
Mindscape purchase price was changed for in-process technology from $103,000,000
to $40,000,000; for complete and core technology from $13,000,000 to
$22,000,000; and for brands and trade names from $30,000,000 to $38,000,000,
resulting in a change to goodwill from $9,854,000 to $55,854,000.
The financial statements included in this Quarterly Report on Form 10-Q/A have
also been restated to reflect the acquisition Broderbund Software, Inc. which
occurred on August 31, 1998 and which has been accounted for using the pooling-
of-interests method of accounting. This Form 10-Q/A contains related financial
information and disclosures as of and for the three month period ended April 4,
1998. See Note 2 to the Condensed Consolidated Financial Statements.
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
THE LEARNING COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
------------------- --------------------
(unaudited)
(as restated)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $244,768 $188,956
Accounts receivable (less allowances for returns
of $47,824 and $47,643, respectively) 105,933 161,927
Inventories 45,979 39,382
Other current assets 49,326 35,863
------------------- --------------------
446,006 426,128
Intangible assets, net 221,281 145,848
Other long-term assets 55,630 51,798
------------------- --------------------
$722,917 $623,774
=================== ====================
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities $209,771 $220,192
------------------- --------------------
LONG-TERM OBLIGATIONS:
Long-term debt 287,650 294,356
Accrued and deferred income taxes 45,514 75,167
Other long-term obligations 11,364 8,069
------------------- --------------------
344,528 377,592
------------------- --------------------
STOCKHOLDERS' EQUITY 168,618 25,990
------------------- --------------------
$722,917 $623,774
=================== ====================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE>
THE LEARNING COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------------
1998 1997
--------------- ---------------
(as restated)
<S> <C> <C>
REVENUES $ 179,336 $ 131,196
COSTS AND EXPENSES:
Costs of production 59,402 39,278
Sales and marketing 47,938 32,079
General and administrative 12,600 12,187
Development and software costs 22,821 20,278
Amortization, merger and other charges 97,117 133,013
--------------- ---------------
239,878 236,835
--------------- ---------------
OPERATING LOSS (60,542) (105,639)
INTEREST EXPENSE, net 4,370 3,997
--------------- ---------------
LOSS BEFORE INCOME TAXES (64,912) (109,636)
PROVISION FOR INCOME TAXES: -- 7,527
--------------- ---------------
NET LOSS $ (64,912) $ (117,163)
=============== ===============
NET LOSS PER SHARE - basic and diluted $(.93) $(1.80)
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING-basic and diluted 69,430,000 65,222,000
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE>
THE LEARNING COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------------------
1998 1997
---------------- ----------------
(as restated)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (64,912) $(117,163)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation, amortization and other 59,942 125,718
Provisions for returns and doubtful accounts 12,874 8,449
Provision for income taxes -- 6,563
Charge for incomplete technology 40,000 9,250
Changes in operating assets and liabilities:
Accounts receivable (146) 2,335
Accounts payable and accruals 16,233 1,623
Other (2,381) (5,598)
---------------- ----------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 61,610 31,177
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed assets and other (12,297) (6,049)
Businesses acquired, net of cash acquired (116,972) (8,294)
Acquisition related items (17,970) (11,246)
---------------- ----------------
NET CASH USED FOR INVESTING ACTIVITIES (147,239) (25,589)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments under capital leases and other long-term
debt (266) (207)
Repurchase of Senior Convertible Notes (6,000) (7,000)
Proceeds from issuance of common stock related to exercise
of stock options, net 14,427 1,235
Proceeds from the issuance of special warrants, net 134,346 --
Repurchase of common stock -- (12,453)
Other (2,207) (67)
---------------- ----------------
NET CASH (USED FOR) PROVIDED BY FINANCING ACTIVITIES
140,300 (18,492)
---------------- ----------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (207) (1,769)
---------------- ----------------
EFFECT OF BRODERBUND EXCLUDED PERIOD 1,348 --
---------------- ----------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 55,812 (14,673)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 188,956 259,223
---------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 244,768 $ 244,550
================ ================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
THE LEARNING COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------------------
1998 1997
--------------- -----------------
<S> <C> <C>
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:
Common stock issued to acquire Mindscape $30,000 $ --
Common stock issued to settle note payable to related party -- 3,053
Common stock issued to acquire Living Books -- 7,321
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
6
<PAGE>
THE LEARNING COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts)
(unaudited)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements of The Learning Company, Inc.
("TLC" or the "Company") for the three months ended March 31, 1998 and 1997 are
unaudited and reflect all adjustments, consisting of normal recurring
adjustments, which are, in the opinion of management, necessary for a fair
presentation of the results for the interim periods. These condensed
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements previously filed with the Securities and
Exchange Commission (the "SEC") in the Company's 1997 Annual Report on Forms 10-
K and 10-K/A. The Company filed with the SEC on November 4, 1998 a Current
Report on Form 8-K/A containing supplemental audited consolidated financial
statements for the year ended December 31, 1997 to reflect the Company's
acquisition of Broderbund Software, Inc. ("Broderbund"), which was accounted
for as a pooling-of-interests. The results of operations for the three months
ended March 31, 1998 are not necessarily indicative of the results for the
entire year ending December 31, 1998.
The accompanying condensed consolidated financial statements as of March 31,
1998 have been restated to reflect a change in the original accounting for the
purchase price allocation related to the March 1998 acquisition of Mindscape,
Inc. and certain affiliated companies ("Mindscape", see Note 2). After
discussions with the staff of the SEC (the "Staff"), the Company has revised
the original accounting for the purchase price allocation and the related
amortization of intangibles. The Company has restated its previously issued
results to reflect the discussions with the Staff and to apply the appropriate
guidance and policy as discussed in Note 2 to the Condensed Consolidated
Financial Statements. This has resulted in a reduction in the amount of the
charge for in-process technology from $103,000 to $40,000 and an increase in the
amounts allocated to completed technology and products from $13,000 to $22,000;
to brands and trademarks from $30,000 to $38,000 and to goodwill from $9,854 to
$55,854. Amortization, merger and other charges has decreased for the Three
Months Ended March 31, 1998 from $156,820 to $97,117, and corresponding
changes for the same amounts have been made to the balance of intangible assets
and stockholders' equity. The restatement does not affect previously reported
net cash flows for the periods or for future periods.
On August 31, 1998, the Company acquired Broderbund, a developer and publisher
of consumer software for the home and school pursuant to an agreement dated June
21, 1998. This transaction was accounted for using the pooling-of-interests
method of accounting. The accompanying Condensed Consolidated Financial
Statements of the Company have been restated to include the results and balances
of Broderbund for all periods presented.
The table below details the previously separate results of the Company and
Broderbund and the effect of the restatement as discussed above.
<TABLE>
<CAPTION>
Three Months Ended March 31, 1998
---------------------------------------------------------------------------------
The Learning
Company Broderbund Combined Restated
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 113,602 $65,734 $ 179,336 $179,336
Operating loss (123,894) 1,392 (122,502) (60,542)
Loss before income taxes (129,408) 2,536 (126,872) (64,912)
Net loss (129,408) 2,536 (126,872) (64,912)
Net loss per share-basic and $ (2.45) $ (0.15) $ (1.83) $ (0.93)
diluted
</TABLE>
7
<PAGE>
The first quarter reporting period for 1998 ended on April 4, 1998, and the
first quarter reporting period for 1997 ended on April 5, 1997. The periods
from January 4, 1998 to April 4, 1998 and from January 7, 1997 to April 5, 1997
are referred to as the "First Quarter 1998" and the "First Quarter 1997" or the
"Three Months Ended March 31, 1998" and the "Three Months Ended March 31, 1997",
respectively throughout these financial statements and Form 10-Q/A.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make assumptions regarding items
such as return reserves and allowances, net realizable value of intangible
assets and valuation allowances for deferred tax assets 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. Significant estimates in
these financial statements include: return reserves, inventory reserves,
valuation of deferred tax assets and valuation and useful lives of intangible
assets. Actual results could differ from these estimates.
2. BUSINESS COMBINATIONS
Broderbund
On August 31, 1998, the Company acquired all of the issued and outstanding
common stock of Broderbund in exchange for 16,848,753 shares of common stock of
the Company pursuant to an agreement and plan of merger dated June 21, 1998
whereby each share of common stock of Broderbund was exchanged for 0.80 shares
of the Company's common stock. This acquisition has been accounted for using
the pooling-of-interests method of accounting. The balances as at December 31,
1997 and the results for the Three Months Ended March 30, 1998 and 1997 have
been restated to include the balances and results of Broderbund. The balance
sheet of the Company as at December 31, 1997 has been combined with the balance
sheet of Broderbund as at November 30, 1997. Retained earnings have been
charged with the net income of $682 for the omitted period of December 31, 1997.
Revenues, operating expenses and operating income for the excluded month of
December 1997 were $28,712, $27,974 and $738, respectively. The financial
results for the Three Months Ended March 31, 1998 include the results of the
previously separate businesses for the Three Months Ended March 31, 1998.
Revenues and net loss from the previously separate operations of the Company and
Broderbund are described above in Note 1.
<TABLE>
<CAPTION>
Three Months Ended Combined
March 31, 1997 TLC Broderbund Adjustments Restated
- --------------------------- --------------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Revenues $ 86,881 $44,315 $ -- $ 131,196
Operating loss (102,047) (5,842) 2,250 (105,639)
Net loss (107,318) (3,462) (6,383) (117,163)
Net loss per share (2.20) (0.21) (1.80)
</TABLE>
8
<PAGE>
In order to conform the application of generally accepted accounting principles
between the two separate entities, an adjustment to increase the valuation
allowance for income tax assets of $8,633 was recorded in the Three Months Ended
March 31, 1997. The adjustment increases the valuation allowance for uncertainty
of recoverability of income tax assets of Broderbund as it was determined that
it was more likely than not that some or all of the assets would not be realized
under the combined entity. There were no intercompany transactions between the
two companies other than a termination fee of $18,000 paid by The Learning
Company, a corporation that the Company acquired in 1995 (the "Former Learning
Company"), to Broderbund in December 1995 related to the proposed merger between
the two companies that was terminated. This amount was recorded as other income
by Broderbund and was included in the determination of the purchase price of the
Former Learning Company by the Company. Accordingly, the merger termination fee
was eliminated from the Broderbund net income for the year ended August 31, 1996
and the purchase price of the Former Learning Company was reduced, resulting in
a reduction in amortization of goodwill in the Three Months Ended March 31, 1997
of $2,250.
Mindscape
On March 5, 1998, the Company acquired control of Mindscape, Inc. and certain
affiliated companies ("Mindscape") for a total purchase price of $152,557
payable in cash of $122,557 and the remainder through the issuance of 1,366,743
shares of common stock. This acquisition was accounted for using the purchase
method of accounting.
The purchase price for Mindscape was allocated as follows:
<TABLE>
<CAPTION>
<S> <C>
Purchase price $152,557
Plus: fair value of net liabilities assumed 3,297
--------
Excess to allocate 155,854
Less: excess allocated to
Incomplete technology 40,000
Completed technology and products 22,000
Brands and trade names 38,000
--------
100,000
--------
Goodwill $ 55,854
========
</TABLE>
The Staff has recently issued guidance related to the valuation of in-process
technology as set forth in its letter dated September 9, 1998 from the Chief
Accountant of the SEC to the American Institute of Certified Public Accountants.
The Company has had discussions with the Staff concerning the application of the
methodology to the valuation of the incomplete technology and other intangible
assets and has implemented the methodology. As a result of the application of
the valuation methodology the purchase price was allocated to incomplete
technology, brands and trade names and complete technology and products. Among
the factors considered by the Company to determine the allocation of the
purchase price were an estimation of the stage of completion of development of
each product at the date of acquisition, an estimation of cash flows that would
be achieved by any buyer resulting from the expected revenues generated from
such projects, a discounting of the net cash flows from the products using an
effective industry-based tax rate of 35% (net of any tax benefits from the
acquired assets) and a risk adjusted discount rate (which ranged from 20% to
22%) and an estimation of market royalty rates to value the brands and trade
names. The in-process development consisted of consumer software products in the
games, productivity and education segments. On average the in-process
development projects were approximately 55% complete at the time of acquisition.
The Company expects to complete the majority of the development projects within
the twelve months of the acquisition date and expects to spend approximately
$25,000 to complete the development. The Company expects that it will begin to
receive the benefits of these in-process development projects during 1998. There
were no anticipated material changes from historical pricing, margins or expense
levels in the projects under development. In order to complete the development
on schedule the Company must continue to retain key development personnel. In
the event that these in-process development projects are not
9
<PAGE>
completed or replaced with similar projects the Company may experience lower
future revenues, operating margins and cash flows.
The Company believes that the incomplete products under development had not
reached technical feasibility at the date of the acquisition, have no
alternative future use and additional development is required to ensure their
commercial viability. In order to develop the acquired incomplete technology
into commercially viable products the Company will be required to complete
development of proprietary code, development of the artistic and graphic works
and design of the remaining storyboards.
The remaining identified intangibles, including the value of completed
technology and products and brands and trade names, will be amortized on a
straight-line basis over their estimated useful lives of two and ten years,
respectively. Goodwill resulting from the acquisition is being amortized using
the straight-line method over ten years.
Summarized pro forma combined results of operations for the Three Months Ended
March 31, 1998 and 1997 are shown as if the transaction had occurred at the
beginning of the period presented. Pro forma adjustments relate primarily to
amortization of goodwill and complete technology. These pro forma combined
results of operations include the historical results of Mindscape and do not
reflect any reductions in operating costs derived from consolidation of
functional departments. In addition, the pro forma combined operating loss
includes pro forma amortization of acquired intangible assets resulting from the
acquisition of Mindscape for the Three Months Ended March 31, 1998 and 1997 of
$3,450 and $5,175, respectively.
<TABLE>
<CAPTION>
Mindscape
Three Months Ended The Learning Including Pro Forma Pro Forma
March 31, 1998 Company, Inc. Adjustments Combined
- ---------------------- --------------------------- ------------------------- -------------------------
<S> <C> <C> <C>
Revenues $179,336 $ 9,090 $ 188,426
Operating loss (60,542) (46,824) (107,366)
Net loss (64,912) (47,884) (112,796)
Net loss per share $ ( 0.93) $ (1.44)
</TABLE>
<TABLE>
<CAPTION>
Mindscape
Three Months Ended The Learning Including Pro Forma Pro Forma
March 31, 1997 Company, Inc. Adjustments Combined
- ---------------------- --------------------------- ------------------------- -------------------------
<S> <C> <C> <C>
Revenues $ 131,196 $ 14,144 $ 145,340
Operating loss (105,639) (19,998) (125,367)
Net loss (117,163) (19,998) (137,161)
Net loss per share $ (1.80) $ (1.85)
</TABLE>
3. ISSUANCE OF SPECIAL WARRANTS
On March 12, 1998, the Company's Canadian Subsidiary, SoftKey Software Products
Inc. ("SoftKey"), issued in a private placement in Canada 8,687,500 special
warrants for net proceeds of approximately $134,000. On July 9, 1998 each
special warrant was exchanged into one exchangeable non-voting share of SoftKey
(an "Exchangeable Share") without additional payment. The Exchangeable Shares
are exchangeable at the option of the holder on a one-for-one basis for common
stock of the Company without additional payment.
4. BORROWINGS
On August 7, 1998, the Company amended its revolving line of credit (the "Line")
to provide a maximum availability of $147,500, of which $35,000 is outstanding
at March 31, 1998 and was subsequently repaid. Borrowings under the line are
due July 1, 2000 and bear interest at variable rates. The Line is subject to
certain financial covenants, is secured by a general security interest in
certain operating subsidiaries of the Company and by a pledge of the stock of
certain of its subsidiaries.
10
<PAGE>
5. COMPREHENSIVE LOSS
Effective January 4, 1998, the Company adopted Statement of Financial Accounting
Standard No. 130, "Reporting Comprehensive Income." The Company's comprehensive
loss was as follows:
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------------
1998 1997
------------------ --------------------
<S> <C> <C>
Net loss $(64,912) $(117,163)
Other comprehensive loss (2,760) (1,448)
Total comprehensive loss $(67,672) $(118,611)
================== ====================
</TABLE>
Other comprehensive loss represents losses on foreign currency translation.
6. INVENTORIES
Inventories are stated at the lower of weighted average cost or net realizable
value and include third-party assembly costs, CD-ROM discs, manuals and an
allocation of fixed overhead.
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
---------------- -----------------
<S> <C> <C>
Components $ 1,930 $ 8,333
Finished goods 44,049 31,049
------- -------
$45,979 $39,382
======= =======
</TABLE>
7. COMPUTATION OF EARNINGS PER SHARE
For the year ended December 31, 1997, the Company adopted Statement of
Accounting Standard No. 128 ("FAS 128"), which requires the presentation of
Basic and Dilutive earnings per share, which replaces primary and fully diluted
earnings per share. Basic net loss per share is computed using the weighted
average number of common shares outstanding during the period. Dilutive net
loss per share is computed using the weighted average number of common shares
outstanding during the period, plus the dilutive effect of common stock
equivalents. Common stock equivalents consist of convertible debentures,
preferred stock, stock options and warrants. The dilutive computations do not
included common stock equivalents for the Three Months Ended March 31, 1998 and
1997 as their inclusion would be antidilutive. Dilutive elements would include
the 750,000 shares of Series A Preferred Stock (which is ultimately convertible
into 15,000,000 shares of common stock) issued on December 5, 1997, 8,687,500
special warrants to acquire Exchangeable Shares and employee stock options
totaling 15,996,000 and 12,483,000 at March 31, 1998 and 1997, respectively.
8. EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
In June, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. The statement requires companies to
recognize all derivatives as either assets or liabilities, with the instruments
measured at fair value. The accounting for changes in fair value, gains or
losses, depends on the intended use of the derivative and its resulting
designation. The statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company will adopt SFAS No. 133 by January
1, 2000 and does not expect SFAS No. 133 to have a material impact on its
financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information" which changes the way public companies
report information about operating segments.
11
<PAGE>
SFAS No. 131 which is based on the management approach to segment reporting
establishes requirements to report selected segment information quarterly and to
report entity wide disclosures about products and services major customers and
the material countries in which the entity holds assets and reports revenue.
Management is currently evaluating the effects of this change on its reporting
of segment information. The Company will adopt SFAS No. 131 for its fiscal year
ending December 31, 1998.
9. SUBSEQUENT EVENTS
Proposed Mattel Merger
On December 13, 1998, the Company entered into a merger agreement with Mattel,
Inc. ("Mattel") (the "Merger Agreement") pursuant to which each share of common
stock of the Company will be exchanged for not less than 1.0 nor more than 1.2
shares of Mattel common stock, and the Company will be merged with and into
Mattel. Subject to the minimum and maximum, the exact number of shares of
Mattel common stock to be issued to stockholders of the Company will be
determined by dividing $33.00 by an average of the closing prices of Mattel
common stock on the New York Stock Exchange in accordance with the procedures
set forth in the Merger Agreement (the "Exchange Ratio"). Each share of Series
A Preferred Stock will be converted into the right to receive a number of shares
of Mattel common stock equal to the Exchange Ratio multiplied by twenty (the
rate at which each share of Series A Preferred Stock is convertible into shares
of common stock of the Company). Each exchangeable non-voting share of the
Company's subsidiary, SoftKey Software Products Inc., will become exchangeable
for one share of Mattel common stock multiplied by the Exchange Ratio. The
transaction is expected to be accounted for using the pooling-of-interests
method of accounting. The closing of the transaction is subject to certain
conditions, including regulatory and stockholder approvals of each company.
Sofsource Acquisition
On June 2, 1998, the Company acquired control of Sofsource, Inc. ("Sofsource")
an educational software company, for a total purchase price of $45,000 which was
settled through the issuance of 1,641,138 shares of common stock. This
transaction was accounted for using the purchase method of accounting.
Other 1998 Combinations
On May 14, 1998, the Company acquired PF.Magic, Inc. ("PF Magic"), a virtual
life entertainment software company, in exchange for the issuance of 521,021
shares of common stock. On December 3, 1998, the Company acquired Palladium
Interactive, Inc. ("Palladium"), a genealogy software company, in exchange for
the issuance of 788,754 shares of common stock. Each of these transactions was
accounted for using the pooling-of-interests method of accounting. The
Consolidated Financial Statements for years prior to December 31, 1998 do not
include the results and balances of these companies as they were deemed to be
immaterial to the Consolidated Financial Statements for those periods.
Conversion of Debt to Common Stock
On May 29, 1998, the Company entered into an agreement to issue 3,434,995 shares
of its common stock in exchange for an aggregate principal amount of $96,695 of
its 5 1/2% Senior Convertible Notes due 2000, which were then cancelled. The
holders have agreed to hold substantially all of the common stock received as a
result of the exchange for a period of at least six months from issue date.
Sale of Income Tax Software Business
On July 9, 1998, the Company sold its Canadian income tax software business for
approximately $45,000 in cash. The net gain on sale was not material.
12
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following information should be read in conjunction with the consolidated
financial statements and the notes thereto and in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations in the
Company's audited consolidated financial statements previously filed with the
Securities and Exchange Commission (the "SEC") in The Company's 1997 Annual
Report on Forms 10-K and 10-K/A. The Company filed with the SEC Current
Reports on Form 8-K/A on November 4, 1998 and March 26, 1999 containing
supplemental audited consolidated financial statements for the year ended
December 31, 1997 (the "1997 Supplemental Financial Statements") to reflect the
Company's acquisition of Broderbund Software, Inc. ("Broderbund"), which was
accounted for as a pooling-of-interests. All dollar amounts presented in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations are presented in thousands, except per share amounts. Certain of the
information contained in this Quarterly Report on Form 10-Q which are not
historical facts may include "forward-looking statements" within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). The Company's actual results may differ materially from those set forth
in such forward-looking statements. Certain risks and uncertainties including,
but not limited to, those discussed below in "Factors Affecting Future Operating
Results," as well as in the Company's audited consolidated financial statements
previously filed with SEC in the Company's 1997 Annual Report on Forms 10-K and
10-K/A and in the 1997 Supplemental Financial Statements, as well as other
factors, may also cause actual results to differ materially from those
projected. The Company assumes no obligation to update these forward-looking
statements to reflect actual results or changes in factors or assumptions
affecting such forward-looking statements. The information contained in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations is provided pursuant to applicable regulations of the SEC and is not
intended to serve as a basis for projections of future events.
INTRODUCTION
The Learning Company, Inc. ("TLC" or the "Company") develops and publishes a
broad range of high quality branded consumer software for personal computers
("PCs") that educate and entertain across every age category, from young
children to adults. The Company's primary emphasis is in educational,
productivity and reference software, but it also offers a selection of lifestyle
and entertainment products, both in North America and internationally.
The Company distributes its products through retail channels, including direct
sales to computer electronics stores, office superstores, mass merchandisers,
discount warehouse stores and software specialty stores which control over
23,000 North American storefronts. The Company also sells its products directly
to consumers through the mail, telemarketing and the Internet, and directly to
schools. The Company's international sales are conducted from subsidiaries in
Germany, France, Holland, Ireland, the United Kingdom, Australia and Japan. The
Company also derives revenue from licensing its products to original equipment
manufacturers ("OEMs"), which bundle the Company's products for sale with
computer systems or components and through on-line offerings.
Business Combinations
Proposed Mattel Merger
On December 13, 1998, the Company entered into a merger agreement with Mattel,
Inc. ("Mattel") (the "Merger Agreement") pursuant to which each share of common
stock of the Company will be exchanged for not less than 1.0 nor more than 1.2
shares of Mattel common stock, and the Company will be merged with and into
Mattel. Subject to the minimum and maximum, the exact number of shares of
Mattel common stock to be issued to stockholders of the Company will be
determined by dividing $33.00 by an average of the closing prices of Mattel
common stock on the New York Stock Exchange in accordance with the procedures
set forth in the Merger Agreement (the "Exchange Ratio"). Each share of Series
A Preferred Stock will be converted into the right to receive a number of shares
of Mattel common stock
13
<PAGE>
equal to the Exchange Ratio multiplied by twenty (the rate at which each share
of Series A Preferred Stock is convertible into shares of common stock of the
Company). Each exchangeable non-voting share of the Company's subsidiary,
SoftKey Software Products Inc., will become exchangeable for one share of Mattel
common stock multiplied by the Exchange Ratio. The transaction is expected to be
accounted for using the pooling-of-interests method of accounting. The closing
of the transaction is subject to certain conditions, including regulatory and
stockholder approvals of each company.
Broderbund
On August 31, 1998, the Company acquired Broderbund, a publisher and developer
of consumer software for the home and school market, in exchange for 16,848,753
shares of the Company's common stock pursuant to an agreement and plan of merger
dated June 21, 1998 whereby each share of Broderbund common stock was exchanged
for 0.80 shares of the Company's common stock. This transaction was accounted
for using the pooling-of-interests method of accounting. The accompanying
Consolidated Financial Statements of the Company have been restated to include
the results and balances of Broderbund for all periods presented.
Mindscape
On March 5, 1998, the Company acquired control of Mindscape, Inc., a consumer
software company, and certain affiliated companies ("Mindscape") for a purchase
price of $152,557 payable in cash of $122,557 and the remainder through the
issuance of 1,366,743 shares of common stock. This transaction was accounted
for using the purchase method of accounting.
Sofsource
On June 2, 1998, the Company acquired control of Sofsource, Inc., an educational
software company, for a purchase price of $45,000, which was settled through
the issuance of 1,641,138 shares of common stock. This transaction was accounted
for using the purchase method of accounting.
Other Business Combinations
On May 14, 1998, the Company acquired P.F. Magic, Inc. ("PF Magic"), a virtual
life entertainment software company, in exchange for the issuance of 521,021
shares of common stock. On December 3, 1998, the Company acquired Palladium
Interactive, Inc. ("Palladium"), a genealogy and children's software company, in
exchange for the issuance of 788,754 shares of common stock. Each of these
transactions was accounted for using the pooling-of-interests method of
accounting. The Consolidated Financial Statements for years prior to December
31, 1998 do not include the results and balances of these companies as they were
deemed to be immaterial to the Consolidated Financial Statements for those
periods.
RESULTS OF OPERATIONS
Net Loss. The Company incurred a net loss of $64,912 ($0.93 per share) on
revenues of $179,336 in the First Quarter 1998 as compared to a net loss of
$117,163 ($1.80 per share) on revenues of $131,196 in the First Quarter 1997.
The net loss in the First Quarter 1998 and 1997 is a result of the effect of the
amortization, merger and other charges of $97,117 and $133,013, respectively.
14
<PAGE>
Revenues. Revenues by distribution channel for the First Quarter 1998 as
compared to the First Quarter 1997 and the respective percentage of revenues are
as follows:
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------------------------------------------------
1998 % 1997 %
---------------- ------------ --------------- -------------
<S> <C> <C> <C> <C>
Retail $ 92,486 52% $ 67,575 52%
OEM 9,713 5% 6,496 5%
School 15,423 9% 12,669 10%
Direct response 28,357 16% 18,789 14%
International 25,756 14% 19,306 15%
On line 2,255 1% -- --
Tax software and services 5,346 3% 6,361 4%
---------------- ------------ --------------- -------------
$179,336 100% $131,196 100%
================ ============ =============== =============
</TABLE>
Retail sales increased in dollars and as a percentage of total revenue for the
Three Months Ended March 31, 1998 as compared to the Three Months Ended March
31, 1997 primarily due to growth in the demand for consumer software and the
Company's increased market share. Retail revenues also were higher than the
prior year due to the acquisition of Mindscape and the launch of several new
products which included: Reader Rabbit's Second Grade, Success Builder: Math
Library, CyberPatrol, Compton's Reference Suite, and Compton's 3D Atlas. OEM
sales increased in dollars for the Three Months Ended March 31, 1998 as compared
to the Three Months Ended March 31, 1997 primarily due to additional demand from
PC manufacturers across the industry. International sales increased in dollars
for the Three Months Ended March 31, 1998 as compared to the Three Months Ended
March 31, 1997 primarily as a result of the higher PC sales in Europe and an
extension of a distribution license in Australia. Direct response revenues
increased in dollars for the Three Months Ended March 31, 1998 as compared to
the Three Months Ended March 31, 1997 due to growth in the Company's catalog
based sales to end users. School sales increased in dollars for the Three
Months Ended March 31, 1998 as compared to the Three Months Ended March 31, 1997
as a result of the higher growth in revenues from the acquisitions of Skills
Bank Corporation and Learning Services, Inc. in 1997 and due to the increasing
demand for software in American schools. Revenues from the Tax Division
decreased in dollars and as a percentage of total revenue for the Three Months
Ended March 31, 1998 as compared to the Three Months Ended March 31, 1997 due to
greater competition in the Canadian home tax software market and lower Canadian
dollar exchange rates. The Canadian income tax software business was sold in
July 1998.
Costs and Expenses. The Company's costs and expenses and the respective
percentages of revenues for the First Quarter 1998 as compared to the First
Quarter 1997 are as follows:
<TABLE>
<CAPTION>
Three Months ended March 31,
-------------------------------------------------------------
1998 % 1997 %
------------- ---------- --------------- ---------
<S> <C> <C> <C> <C>
Costs of production $ 59,402 33% $ 39,278 30%
Sales and marketing 47,938 27% 32,079 24%
Development and
Software costs 22,821 13% 20,278 15%
General and
Administrative 12,600 7% 12,187 9%
------------- ---------- --------------- ---------
$142,761 80% $103,822 78%
============= ========== =============== =========
</TABLE>
Costs of production includes the cost of manuals, packaging, diskettes,
duplication, assembly and fulfillment charges. In addition, costs of production
includes royalties paid to third-party developers and inventory obsolescence
reserves. Costs of production as a percentage of revenues increased in the
First Quarter 1998 as compared to the First Quarter 1997 from 30% to 33%. The
increase in costs of production as a percentage of revenues in First Quarter
1998 from First Quarter 1997 was caused by sale of products from the
acquisitions of Mindscape, Broderbund and Creative Wonders that have higher
production costs and royalties plus the higher cost of purchasing third-party
product that is sold through catalog distribution.
15
<PAGE>
Sales and marketing expenses increased to 27% of revenues in the First Quarter
1998 as compared to 24% of revenues in the First Quarter 1997. The increase
relates to higher spending on coupon rebate promotions, retail channel marketing
and trade promotion programs.
Development and software costs decreased to 13% of revenues in the First Quarter
1998 as compared to 15% of revenues in the First Quarter 1997 due to the timing
of product introduction.
General and administrative expenses decreased to 7% of revenues in the First
Quarter 1998 as compared to 9% of revenues in the First Quarter 1997 due to
continued efforts to reduce both fixed costs and employee headcount related to
the combinations of the Company's acquisitions.
The Company reported merger, amortization and other charges in the First Quarter
1998 and the First Quarter 1997 of $97,117 and $133,013, respectively, resulting
primarily from the acquisitions. The charge in the Three Months Ended March 31,
1998 includes $40,000 related to in-process technology write-offs, with the
remainder relating to amortization of goodwill, amortization of acquired
technology related assets and other expenses. The Staff has recently issued
guidance related to the valuation of in-process technology as set forth in its
letter dated September 9, 1998 from the Chief Accountant of the SEC to the
American Institute of Certified Public Accountants. The Company has had
discussions with the Staff concerning the application of the methodology to the
valuation of the incomplete technology and other intangible assets and has
implemented the methodology. As a result of the application of the valuation
methodology the purchase price was allocated to incomplete technology, brands
and trade names and complete technology and products. Among the factors
considered by the Company to determine the allocation of the purchase price
using the methodology were an estimation of the stage of completion of
development of each product at the date of acquisition, an estimation of cash
flows that would be achieved by any buyer resulting from the expected revenues
generated from such projects, a discounting of the net cash flows from the
products using an effective industry-based tax rate of 35% (net of any tax
benefits from the acquired assets) and a risk adjusted discount rate (which
ranged from 20% to 22%) and an estimation of market royalty rates to value the
brands and trade names. The in-process development consisted of consumer
software products in the games, productivity and education segments. On average
the in-process development projects were approximately 55% complete at the time
of acquisition. The Company expects to complete the majority of the development
projects within the twelve months of the acquisition date and expects to spend
approximately $25,000 to complete the development. The Company expects that it
will begin to receive the benefits of these in-process development projects
during 1998. There were no anticipated material changes from historical pricing,
margins or expense levels in the projects under development. In order to
complete the development on schedule the Company must continue to retain key
development personnel. In the event that these in-process development projects
are not completed or replaced with similar projects the Company may experience
lower future revenues, operating margins and cash flows. In order to develop the
acquired incomplete technology into commercially viable products, the Company
will be required to complete development of proprietary code, development of the
artistic and graphic works and design of the remaining storyboards.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased from $188,956 at December 31, 1997 to
$244,768 at March 31, 1998. This increase was attributable to the Company's
Canadian subsidiary, SoftKey Software Products Inc. ("SoftKey"), issuing
8,687,500 special warrants in a private placement for proceeds of approximately
$134,000 offset by the cash paid for the acquisition of Mindscape of
approximately $120,000. Other financing activities generated approximately
$5,954 and investing activities used approximately $27,239 offset by cash
generated from operations of approximately $61,610.
As of May 6, 1998 the Company has outstanding $297,650 principal amount Senior
Convertible Notes ($10,000 is included as current). The Senior Convertible Notes
will be redeemable by the Company on or after November 2, 1998 at declining
redemption prices. Should the Senior Convertible Notes not convert under their
terms into common stock, there can be no assurances that the Company will have
sufficient cash flows from future operations to meet payment requirements under
the debt or be able to re-finance the notes under favorable terms or at all.
16
<PAGE>
On August 7, 1998, the Company amended its revolving line of credit (the "Line")
to provide a maximum availability of $147,500, of which $40,000 is outstanding
at March 31, 1998 and was subsequently repaid. Borrowings under the line are
due July 1, 2000 and bear interest at variable rates. The Line is subject to
certain financial covenants, is secured by a general security interest in
certain operating subsidiaries of the Company and by a pledge of the stock of
certain of its subsidiaries.
The Company, through its wholly owned subsidiary, The Learning Company Funding,
Inc. (a separate special purpose corporation), is party to a receivables
purchase agreement whereby it can sell without recourse undivided interests in
eligible pools of trade accounts receivable on a revolving basis during a five
year period ending September 30, 2002 of up to $100,000, as amended. The
Company acts as servicing agent for the sold receivables in the collection and
administration of the accounts. In addition, the Company has a European
accounts receivable factoring facility where it can sell up to $25,000 of
European accounts receivable on a recourse basis to its banks.
Income generated by the Company's subsidiaries in certain foreign countries
cannot be repatriated to the Company in the United States without payment of
additional taxes since the Company does not currently receive a U.S. tax credit
with respect to income taxes paid by the Company (including its subsidiaries) in
those foreign countries.
At the present time, the Company expects that its cash flows from operations
will be sufficient to finance the Company's operations for at least the next
twelve months. Longer-term cash requirements are dictated by a number of
external factors, which include the Company's ability to launch new and
competitive products, the strength of competition in the consumer software
industry and the growth of the home computer and software markets. In addition,
the Company's Senior Convertible Notes mature November 1, 2000. If not
converted to common stock, the Company may be required to secure alternative
financing sources. There can be no assurance that alternative financing sources
will be available on terms acceptable to the Company in the future or at all.
The Company continuously evaluates products and technologies for acquisitions,
however no estimation of short-term or long-term cash requirements for such
acquisitions can be made at this time.
FUTURE OPERATING RESULTS
The Company operates in a rapidly changing environment that is subject to many
risks and uncertainties. Some of the important risks and uncertainties which
may cause the Company's operating results to differ materially or adversely
are discussed below, in the audited consolidated financial statements previously
filed with the SEC and in the Company's 1997 Annual Report on Forms 10-K and 10-
K/A and in the 1997 Supplemental Financial Statements.
The Company's future operating results are subject to a number of uncertainties,
including its ability to develop and introduce new products, the introduction of
competitive products and general economic conditions. In addition, the Company
competes for retail shelf space and general consumer awareness with a number of
companies that market consumer software, including competitors and potential
competitors that possess significantly greater capital, marketing resources and
brand recognition than the Company. Furthermore, the rapid changes in the market
and the increasing number of new products available to consumers have increased,
and are expected to continue to increase, the degree of consumer acceptance risk
with respect to any specific title that the Company may publish.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE LEARNING COMPANY, INC.
/s/ R. Scott Murray
------------------------------
R. Scott Murray
Executive Vice President and
Chief Financial Officer
(principal financial and accounting
officer)
March 25, 1999
18
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