<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 July 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.
X
Yes ______________ No ___________
As of August 3, 1998, there were 65,522,758 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 July 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 and six month periods
ended July 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>
June 30, December 31,
1998 1997
------------- --------------
(unaudited)
(as restated)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $221,839 $188,956
Accounts receivable (less allowances for returns
of $36,611 and $47,643, respectively) 112,146 161,927
Inventories 43,737 39,382
Other current assets 50,626 35,863
------------- --------------
428,348 426,128
Intangible assets, net 230,328 145,848
Other long-term assets 61,776 51,798
------------- --------------
$720,452 $623,774
============= ==============
LIABILITIES & STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities $206,925 $220,192
------------- --------------
LONG-TERM OBLIGATIONS:
Long-term debt 190,955 294,356
Accrued and deferred income taxes 29,747 75,167
Other long-term obligations 5,668 8,069
------------- --------------
226,370 377,592
------------- --------------
STOCKHOLDERS' EQUITY 287,157 25,990
------------- --------------
$720,452 $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 Six Months Ended
June 30, June 30,
------------------------------------- --------------------------------------
1998 1997 1998 1997
---------------- ---------------- ---------------- -----------------
(as restated) (as restated)
<S> <C> <C> <C> <C>
REVENUES $ 171,983 $ 128,599 $ 351,319 $ 259,795
COSTS AND EXPENSES:
Costs of production 62,626 38,687 122,028 77,965
Sales and marketing 60,756 32,981 108,694 65,060
General and administrative 16,936 11,592 29,536 23,779
Development and software costs 25,041 20,672 47,862 40,950
Amortization, merger and
other charges 63,201 121,645 160,318 254,658
---------------- ---------------- ---------------- -----------------
228,560 225,577 468,438 462,412
---------------- ---------------- ---------------- -----------------
OPERATING LOSS (56,577) (96,978) (117,119) (202,617)
INTEREST INCOME (EXPENSE), net 1,579 (3,560) (2,791) (7,557)
---------------- ---------------- ---------------- -----------------
LOSS BEFORE TAXES (54,998) (100,538) (119,910) (210,174)
PROVISION FOR INCOME TAXES: -- (2,918) -- 4,609
---------------- ---------------- ---------------- -----------------
NET LOSS $ (54,998) $ (97,620) $ (119,910) $ (214,783)
================ ================ ================ =================
NET LOSS PER SHARE-Basic and diluted $(0.72) $(1.49) $(1.65) $(3.28)
WEIGHTED AVERAGE NUMBER
OF BASIC AND DILUTED SHARES OUTSTANDING 75,969,000 65,568,000 72,860,000 65,398,000
</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>
Six Months Ended
June 30,
-----------------------------------
1998 1997
---------------- ----------------
(as restated)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(119,910) $(214,783)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation, amortization and other 107,952 249,613
Provisions for returns and doubtful accounts 38,398 19,020
Charge for incomplete technology 56,924 9,250
Provision for income taxes (626) 6,993
Changes in operating assets and liabilities:
Accounts receivable (19,509) (2,085)
Accounts payable and accruals 660 (13,265)
Other (4,250) (19,691)
---------------- ----------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 59,639 35,052
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed assets and other (19,905) (6,769)
Businesses acquired, net of cash acquired (117,242) (10,127)
Acquisition related items (56,469) (31,245)
---------------- ----------------
NET CASH USED FOR INVESTING ACTIVITIES (193,616) (48,141)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments under capital leases and other long-term (993) (395)
debt
Borrowings under line of credit 5,000 --
Repurchase of Senior Convertible Notes (6,000) (12,000)
Proceeds from issuance of common stock 30,396 1,867
Proceeds from the issuance of special warrants, net 134,346 --
Repurchase of common stock -- (14,574)
Other (2,200) (474)
---------------- ----------------
NET CASH (USED FOR) PROVIDED BY FINANCING ACTIVITIES 160,549 (25,576)
---------------- ----------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (356) (902)
---------------- ----------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 26,216 (39,567)
EFFECT OF BRODERBUND'S EXCLUDED RESULTS 6,667 --
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 188,956 259,223
---------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 221,839 $ 219,656
================ ================
</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>
Six Months Ended
June 30,
--------------------------------
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 acquire Sofsource 45,000 --
Common stock issued to settle earn-out agreements 5,573 --
Common stock issued in exchange for Senior Notes 96,695 --
Common stock issued to settle note payable to related party -- 3,053
Common stock issued to acquire Living Books -- 7,321
The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>
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 and six months ended June 30, 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 and six
months ended June 30, 1998 are not necessarily indicative of the results for the
entire year ending December 31, 1998.
The accompanying condensed consolidated financial statements as of June 30, 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 Six
Months Ended June 30, 1998 from $214,883 to $160,318, 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 for the Three
and Six Months Ended June 30, 1998.
<TABLE>
<CAPTION>
Three Months Ended June 30, 1998
---------------------------------------------------------------------------------
The Learning
Company Broderbund Combined Restated
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $129,251 $ 42,731 $171,983 $171,983
Operating loss (22,636) (30,856) (53,942) (56,577)
Loss before income taxes (24,741) (27,172) (51,913) (54,998)
Net loss (24,741) (27,172) (51,913) (54,998)
Net loss per share $ (.42) $ (.68) $ (.72)
</TABLE>
7
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended June 30, 1998
---------------------------------------------------------------------------------
The Learning
Company Broderbund Combined Restated
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 242,853 $108,466 $ 351,319 $ 351,319
Operating loss (146,530) (29,464) (175,994) (117,119)
Loss before income taxes (154,149) (24,636) (178,785) (119,910)
Net loss (154,149) (24,636) (178,785) (119,910)
Net loss per share $ (2.74) $ (2.45) $ (1.65)
</TABLE>
The second quarter reporting period for 1998 ended on July 4, 1998, and the
second quarter reporting period for 1997 ended on July 6, 1997. The periods
from April 5, 1998 to July 4, 1998 and from April 6, 1997 to July 6, 1997 are
referred to as the "Second Quarter 1998" and the "Second Quarter 1997" or the
"Three Months Ended June 30, 1998" and the "Three Months Ended June 30, 1997",
respectively. The periods from January 4, 1998 to July 4, 1998 and from
January 7, 1997 to July 6, 1997 are referred to as the "Six Months Ended
June 30, 1998" and the "Six Months Ended June 30, 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 and Six Months Ended June 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 Six Months Ended June 30, 1997 include the results of the
previously separate businesses as described below. Revenues and net loss from
the Company and Broderbund for the Six Months Ended June 30, 1998 are described
above in Note 1.
8
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended The Learning Combined
June 30, 1997 Company Broderbund Adjustments Restated
- --------------------------- -------------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Revenues $ 176,186 $83,609 $ -- $ 259,795
Operating loss (199,857) (7,260) 4,500 (202,617)
Net loss (209,873) (3,451) (1,459) (214,783)
Net loss per share $ (4.30) $ (0.21) $ -- $ (3.28)
</TABLE>
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 $5,959 was recorded in the Six Months Ended
June 30, 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 Six Months Ended June 30, 1997 of
$4,500.
Mindscape
- ---------
On March 5, 1998, the Company acquired control of Mindscape, Inc., a consumer
software company, 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.
Summarized pro forma combined results of operations for the Six Months Ended
June 30, 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 Six Months Ended June 30, 1998 and 1997 of
$3,450 and $10,350 respectively.
<TABLE>
<CAPTION>
Mindscape
Six Months Ended The Learning Including Pro Forma Pro Forma
June 30, 1998 Company, Inc. Adjustments Combined
- ---------------------- ------------------ ------------------- --------------
<S> <C> <C> <C>
Revenues $ 351,319 $ 9,090 $ 360,409
Operating loss (117,119) (46,824) (163,943)
Net loss (119,910) (47,884) (167,794)
Net loss per share $ (1.65) $ (2.07)
<CAPTION>
Mindscape
Six Months Ended The Learning Including Pro Forma Pro Forma
June 30, 1997 Company, Inc. Adjustments Combined
- ---------------------- ---------------------- ------------------------ -----------------
<S> <C> <C> <C>
Revenues $ 259,795 $ 33,311 $ 293,106
Operating loss (202,617) (36,430) (239,047)
Net loss (214,783) (34,430) (251,213)
Net loss per share $ (3.28) $ (3.37)
</TABLE>
9
<PAGE>
Sofsource, Inc.
- ---------------
On June 2, 1998, the Company acquired control of Sofsource, Inc. ("Sofsource"),
an educational software publisher, for a total purchase price of $45,000 through
the issuance of 1,641,138 shares of common stock. This acquisition was accounted
for using the purchase method of accounting. Pro forma results for Sofsource
were not material.
The purchase price for the 1998 acquisitions accounted for using the purchase
method of accounting was allocated as follows:
<TABLE>
<CAPTION>
Mindscape Sofsource Total
----------------- ----------------- -----------
<S> <C> <C> <C>
Purchase price $152,557 $45,000 $197,557
Plus: fair value of net liabilities assumed 3,297 2,287 5,584
-------------------------------------------------
Excess to allocate 155,854 47,287 203,141
-------------------------------------------------
Less: excess allocated to
Incomplete technology 40,000 14,924 54,924
Completed technology and products 22,000 -- 22,000
Brands and trade names 38,000 3,322 41,322
-------------------------------------------------
100,000 18,246 118,246
-------------------------------------------------
Goodwill $ 55,854 $29,041 $ 84,895
-------------------------------------------------
</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 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.
10
<PAGE>
PF. Magic, Inc.
- ---------------
On April 30, 1998, the Company acquired PF.Magic, Inc. ("PF.Magic"), a virtual
life software company, in exchange for the issuance of 521,021 shares of common
stock. This transaction was accounted for using the pooling-of-interests method
of accounting. The consolidated financial statements of the Company for the
periods prior to consummation do not include the results and balances of
PF.Magic as it was deemed to be immaterial to the consolidated financial
statements.
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 $40,000 is outstanding
at June 30, 1998 and was subsequently repaid. Borrowings under the line are due
July 1, 2000 and bears 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.
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 June 30, Six Months Ended June 30,
------------------------------- ------------------------------
1998 1997 1998 1997
--------------- --------------- -------------- --------------
<S> <C> <C> <C> <C>
Net loss $(54,998) $ (97,620) $(119,910) $(214,783)
Other comprehensive loss (3,457) (2,520) (6,217) (3,968)
-------- --------- --------- ---------
Total comprehensive loss $(58,455) $(100,140) $(126,127) $(218,751)
======== ========= ========= =========
</TABLE>
Other comprehensive loss includes 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>
June 30, December 31,
1998 1997
--------------- ---------------
<S> <C> <C>
Components $ 2,031 $ 8,333
Finished goods 41,706 31,049
--------------- ---------------
$43,737 $39,382
--------------- ---------------
</TABLE>
11
<PAGE>
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 and Six Months Ended June 30,
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 15,067,000 and 13,214,000 at June 30, 1998 and 1997,
respectively.
8. 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.
9. 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. 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.
10. 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
12
<PAGE>
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.
Sale of Canadian Income Tax Software Business
On July 9, 1998, the Company sold its Canadian income tax software for
approximately $45 million in cash. The net gain on sale was not material.
13
<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 its 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/A 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
the 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 equal to the Exchange Ratio multiplied by twenty (the
rate at which each share of Series A Preferred Stock
14
<PAGE>
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 $54,998 ($0.72 per share) and
$119,910 ($1.65 per share) on revenues of $171,983 and $351,319 in the Second
Quarter 1998 and the Six Months Ended June 30, 1998 as compared to a net loss of
$97,620 ($1.49 per share) and $214,783 ($3.28 per share) on revenues of $128,599
and $259,795 in the Second Quarter 1997 and the Six Months Ended June 30, 1997.
The net loss in the Second Quarter 1998, the Six Months Ended June 30, 1998, the
Second Quarter 1997, and the Six Months Ended June 30, 1997 is a result of the
effect of the amortization, merger and other charges of $63,201, $160,318,
$121,645, $254,658, respectively.
15
<PAGE>
Revenues. Revenues by distribution channel for the Second Quarter 1998 as
compared to the Second Quarter 1997 and the Six Months Ended June 30, 1998 as
compared to the Six Months Ended June 30, 1997 are as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
-------------------------------------- ---------------------------------------
1998 % 1997 % 1998 % 1997 %
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Retail $ 79,285 46% $ 60,340 47% $171,771 49% 127,913 49%
OEM 9,904 6% 7,794 6% 19,617 6% 14,290 6%
School 21,776 13% 17,187 13% 37,199 11% 29,856 11%
Direct response 28,558 17% 18,250 14% 56,915 16% 37,039 14%
On-line 2,140 1% -- --% 4,395 1% -- --%
International 26,922 15% 21,509 17% 52,678 15% 40,814 16%
Tax software and
services 3,398 2% 3,519 3% 8,744 2% 9,883 4%
--------- --------- --------- --------- --------- --------- --------- ---------
$171,983 100% $128,599 100% $351,319 100% $259,795 100%
========= ========= ========= ========= ========= ========= ========= =========
</TABLE>
Sales increased in dollars and as a percentage of total revenue for the Three
and Six Months Ended June 30, 1998 as compared to the Three and Six Months Ended
June 30, 1997 primarily due to growth in the demand for consumer software.
Retail revenues also were higher than the prior year due to the acquisitions of
Mindscape and Sofsource and the launch of several new and upgraded products,
which included: Reader Rabbit's Toddler, Reader Rabbit's Preschool, Reader
Rabbit's Kindergarten, The ClueFinders' 4th Grade Adventures, The Princeton
Review products: Bob Vila's Home Design, Elmo's Reading: Preschool and
Kindergarten, Elmo's Preschool, and Madeline Thinking Games. OEM sales
increased in dollars for the Three and Six Months Ended June 30, 1998 as
compared to the Three and Six Months Ended June 30, 1997 primarily due to
additional demand from PC manufacturers across the industry. International
sales increased in dollars for the Three and Six Months Ended June 30, 1998 as
compared to the Three and Six Months Ended June 30, 1997 primarily as a result
of the higher PC sales in Europe and revenues from the acquisition of Mindscape.
Direct response revenues increased in dollars for the Three and Six Months Ended
June 30, 1998 as compared to the Three and Six Months Ended June 30, 1997 due to
growth in the Company's catalog based sales to end users and due to revenues
from Mindscape. School sales increased in dollars for the Three and Six Months
Ended June 30, 1998 as compared to the Three and Six Months Ended June 30, 1997
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 and Six Months Ended June 30, 1998 as compared to the Three and Six
Months Ended June 30, 1997 due to greater competition in the Canadian home tax
software market and lower Canadian dollar exchange rates. The tax software
business was sold on July 9, 1998 for approximately $45,000 in cash.
Costs and Expenses. The Company's costs and expenses and the respective
percentages of revenues for the Second Quarter 1998 as compared to the Second
Quarter 1997 and the Six Months Ended June 30, 1998 as compared to the Six
Months Ended June 30, 1997 are as follows:
<TABLE>
<CAPTION>
Three Months ended June 30, Six Months Ended June 30,
------------------------------------------------------ ---------------------------------------------------
1998 % 1997 % 1998 % 1997 %
-------------- ---------- -------------- ---------- -------- ----------- -------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Costs of production $ 62,626 36% $ 38,687 30% $122,028 35% $ 77,965 30%
Sales and marketing 60,756 35% 32,981 26% 108,694 31% 65,060 25%
Development and
software costs 25,041 15% 20,672 16% 47,862 14% 40,950 16%
General and
administrative 16,936 10% 11,592 9% 29,536 8% 23,779 9%
-------------- ---------- -------------- ---------- -------- ----------- -------------- ---------
$165,359 96% $103,932 81% $308,120 88% $207,754 80%
============== ========== ============== ========== ======== =========== ============== =========
</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
Second
16
<PAGE>
Quarter 1998 and the Six Months Ended June 30, 1998 as compared to the Second
Quarter 1997 and the Six Months Ended June 30, 1997 from 30% and 30% to 36% and
35%, respectively. The change in costs of production as a percentage of revenues
in Second Quarter 1998 and the Six Months Ended June 30, 1998 from Second
Quarter 1997 and the Six Months Ended June 30, 1997 was caused by sale of
products from the acquisitions of Mindscape, Sofsource, and Creative Wonders
that have higher production costs and royalty rates.
Sales and marketing expenses increased to 35% and 31% of revenues in the Second
Quarter 1998 and the Six Months Ended June 30, 1998 as compared to 26% and 25%
of revenues the Second Quarter 1997 and the Six Months Ended June 30, 1997. The
increase relates to higher spending on coupon rebate promotions, retail channel
marketing and trade promotion programs.
Development and software costs decreased to 15% and 14% of revenues in the
Second Quarter 1998 and the Six Months Ended June 30, 1998 as compared to 16% of
revenues in the Second Quarter 1997 and the Six Months Ended June 30, 1997 due
to the timing of product introduction and the ability of the Company to leverage
its development costs across broader distribution channels.
General and administrative expenses decreased to 10% and 8% of revenues in the
Second Quarter 1998 and the Six Months Ended June 30, 1998 as compared to 9% of
revenues in the Second Quarter 1997 and the Six Months Ended June 30, 1997 due
to continued efforts to reduce both fixed costs and employee headcount related
to the combinations of the Company's acquisitions. In terms of absolute dollars
general and administrative expenses increased in the Second Quarter 1998 and the
Six Months Ended June 30, 1998 as compared to the Second Quarter 1997 and the
Six Months Ended June 30, 1997 due to the costs from the Mindscape and Sofsource
operations.
The Company reported merger, amortization and other charges in the Second
Quarter 1998 and the Six Months Ended June 30, 1998 and the Second Quarter 1997
and the Six Months Ended June 30, 1997 of $63,201, $121,645, $160,318, and
$254,658, resulting primarily from the acquisitions. The charges in the Three
and Six Months Ended June 30, 1998 include $16,924 and $56,924, related to
incomplete 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.
17
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased from $188,956 at December 31, 1997 to
$221,839 at June 30, 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 a further $26,203
and investing activities used a further $73,616 offset by cash generated from
operations of $59,639.
As of July 27, 1998, the Company has outstanding $200,955 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.
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 June 30, 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. Each of these
facilities were fully utilized at June 30, 1998.
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 Company's 1997 Annual Report on Form 10-K and 10-K/A and
in the 1997 Supplemental Financial Statements.
18
<PAGE>
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.
19
<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
20
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