<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
AMENDMENT NO. 3 TO CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of Earliest Event Reported): August 31, 1998
-----------------
THE LEARNING COMPANY, INC.
--------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware
--------------------------------------------------------
(State or Other Jurisdiction of Incorporation)
1-12375 94-2562108
- ------------------------- ------------------------------------
(Commission File Number) (I.R.S. Employer Identification No.)
One Athenaeum Street
Cambridge, MA 02142
- ---------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
(617) 494-1200
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Not Applicable
-------------------------------------------------------------
(Former Name or Former Address, if Changed Since Last Report)
<PAGE>
Item 5 and Item 7 of the Current Report on Form 8-K, as originally filed on
September 10, 1998, and amended on November 4, 1998 and November 10, 1998, of
The Learning Company, Inc. ("TLC" or the "Company") are hereby amended and
restated in their entirety as follows:
Item 5. Other Events
On September 10, 1998, TLC filed with the Securities and Exchange
Commission, as part of a Current Report on Form 8-K, dated August 31, 1998,
certain financial statements relating to the acquisition of Broderbund Software,
Inc. ("Broderbund"). TLC filed Amendment No. 1 to Current Report on Form 8-K/A,
dated November 4, 1998, and Amendment No. 2 to Current Report on Form 8-K/A,
dated November 10, 1998, which included Supplemental Consolidated Financial
Statements of TLC and Unaudited Supplemental Consolidated Financial Information
of TLC to reflect the acquisition of Broderbund which has been accounted for
using the pooling-of-interests method of accounting.
TLC is filing today as Exhibit 99.2 Supplemental Consolidated Financial
Statements of TLC as a result of the following:
In March 1998, 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 determined 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 incomplete technology and other
intangible assets as detailed in the September 9, 1998 letter from the Chief
Accountant, 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 certain of the Company's
financial statements have been restated. After applying the guidance and policy,
the allocation of the Mindscape purchase price was changed for in-process
technology from $103 million to $40 million; for complete and core technology
-2-
<PAGE>
from $13 million to $22 million; and for brands and trade names from
$30 million to $38 million, resulting in a change to goodwill from $9.85 million
to $55.85 million.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
(c) Exhibits.
See Exhibit Index attached hereto.
(d) Supplemental Consolidated Financial Statements of TLC
The supplemental consolidated balance sheets of TLC for the years ended
January 3, 1998 and January 4, 1997 and the related supplemental consolidated
statements of operations, stockholders' equity and cash flows for each of the
three TLC fiscal years in the period ended January 3, 1998 are hereby
incorporated by reference herein and filed as Exhibit 99.2 hereto.
-3-
<PAGE>
SIGNATURE
---------
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 hereunto duly authorized.
Date: March 25, 1999 THE LEARNING COMPANY, INC.
(Registrant)
By: /s/ R. Scott Murray
-----------------------------------
R. Scott Murray
Executive Vice President and
Chief Financial Officer
-4-
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
2.1* Agreement and Plan of Merger dated as of June 21, 1998 by and among
TLC, TLC Merger Corp. and Broderbund.
23.2 Consent of PricewaterhouseCoopers LLP.
99.1* Press Release dated August 31, 1998.
99.2 Supplemental Consolidated Financial Statements of TLC.
___________________________________
* Previously filed.
<PAGE>
Exhibit 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
The Learning Company, Inc. (formerly known as SoftKey International, Inc.) on
Form S-3 (File Nos. 33-73422, 33-63073, 333-00145, 333-02385, 333-03271, 333-
10009, 333-40543, 333-40549, 333-48009, 333-50915, 333-56641, 333-57397, 333-
62171) and Form S-8 (File Nos. 33-75134, 33-92920, 33-92922, 33-61931, 333-
00107, 333-02337, 333-04619, 333-40539, 333-42449, 333-43653, 333-45113, 333-
45115, 333-57335, 333-59123, 333-67045, 333-67047, 333-70705) of our report
dated October 10, 1998, except for Note 12 for which the date is March 24, 1999,
on our audits of the supplemental consolidated balance sheets and financial
statement schedule of valuation and qualifying accounts of The Learning Company,
Inc. as of January 3, 1998 and January 4, 1997 and the related supplemental
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended January 3, 1998, which report is
filed as an exhibit to this Amendment No. 3 to Current Report on Form 8K/A.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 24, 1999
<PAGE>
Exhibit 99.2
THE LEARNING COMPANY, INC.
INDEX TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants............................................... 2
Supplemental Consolidated Balance Sheets as of December 31, 1997 and 1996....... 3
Supplemental Consolidated Statements of Operations for the Years Ended
December 31, 1997, 1996 and 1995........................................... 4
Supplemental Consolidated Statements of Stockholders' Equity (Deficit) for the
Years Ended December 31, 1997, 1996 and 1995............................... 5
Supplemental Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995........................................... 6
Notes to Supplemental Consolidated Financial Statements......................... 8
Supplemental financial Statement Schedule of Valuation and Qualifying Accounts
for the Years Ended December 31, 1997, 1996 and 1995....................... 29
</TABLE>
1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
The Learning Company, Inc.:
We have audited the accompanying supplemental consolidated balance sheets
of The Learning Company, Inc. as of January 3, 1998 and January 4, 1997 and the
related supplemental consolidated statements of operations, stockholders' equity
and cash flows for each of the three fiscal years in the period ended January 3,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
The supplemental consolidated financial statements give retroactive effect
to the merger of The Learning Company, Inc. and Broderbund Software, Inc.
completed on August 31, 1998, which has been accounted for as a pooling-of-
interests as described in Note 2 to the supplemental consolidated financial
statements. Generally accepted accounting principles proscribe giving effect to
a consummated business combination accounted for by the pooling-of-interests
method in financial statements that do not include the date of consummation.
These financial statements do not extend through the date of consummation;
however, they will become the historical consolidated financial statements of
The Learning Company, Inc. after consolidated financial statements covering the
date of consummation of the business combination are issued.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of The Learning
Company, Inc. as of January 3, 1998 and January 4, 1997 and the related
consolidated results of its operations and its cash flows for each of the three
fiscal years in the period ended January 3, 1998 in conformity with generally
accepted accounting principles.
/s/ PricewaterhouseCoopers LLP
-------------------------------
PricewaterhouseCoopers LLP
Boston, Massachusetts
October 10, 1998 except for
Note 12 for which the date is
March 24, 1999
2
<PAGE>
THE LEARNING COMPANY, INC.
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
December 31, December 31,
1997 1996
--------------- --------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and short-term investments $ 188,956 $ 261,013
Accounts receivable, less allowances of $47,643 and
$42,802, respectively 161,927 85,566
Inventories 39,382 19,034
Other current assets 35,863 21,218
--------------- --------------
426,128 386,831
--------------- --------------
Fixed assets and other, net 51,798 30,349
Goodwill and other intangible assets, net 145,848 552,713
--------------- --------------
$ 623,774 $ 969,893
=============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable and accrued expenses $ 101,045 $ 79,314
Other current liabilities 52,851 20,766
Line of credit 35,150 25,000
Merger related accruals 12,533 10,667
Current portion of long-term obligations 10,717 8,083
Purchase price payable 7,896 3,245
--------------- --------------
220,192 147,075
--------------- --------------
LONG-TERM OBLIGATIONS:
Long-term debt 294,356 332,930
Related party debt -- 150,000
Accrued and deferred income taxes 75,167 86,919
Other 8,069 5,078
--------------- --------------
377,592 574,927
--------------- --------------
COMMITMENTS AND CONTINGENCIES (NOTE 7)
STOCKHOLDERS' EQUITY:
Series A Preferred Stock, $.01 par value - Authorized
750,000 shares, issued and outstanding 750,000 shares at
December 31, 1997 (liquidation value of $150,000) 8 --
Common stock, $0.01 par value - Authorized - 120,000,000 shares;
issued and outstanding 65,524,559 and 60,915,781 shares at
December 31, 1997 and 1996, respectively 656 609
Special voting share - Authorized and issued - one share
representing the voting rights of 1,478,929 and 1,551,428
outstanding Exchangeable Shares (for common stock) at
December 31, 1997 and 1996, respectively -- --
Additional paid-in-capital 1,040,463 764,447
Accumulated deficit (997,867) (506,378)
Cumulative translation adjustment (17,270) (10,787)
--------------- --------------
25,990 247,891
--------------- --------------
$ 623,774 $ 969,893
=============== ==============
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements
3
<PAGE>
THE LEARNING COMPANY, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------
1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
REVENUES $ 620,931 $ 529,528 $ 338,636
COSTS AND EXPENSES:
Costs of production 189,219 149,304 114,067
Sales and marketing 156,797 102,071 63,513
General and administrative 48,716 39,806 31,898
Development and software costs 89,987 65,262 35,271
Amortization, merger and
other charges 543,926 503,520 103,267
------------- ------------- -------------
Total operating expenses 1,028,645 859,963 348,016
------------- ------------- -------------
OPERATING LOSS (407,714) (330,435) (9,380)
------------- ------------- -------------
INTEREST INCOME (EXPENSE):
Interest income 6,330 9,280 16,270
Interest expense (22,482) (26,703) (5,315)
------------- ------------- -------------
Total interest income (expense) (16,152) (17,423) 10,955
------------- ------------- -------------
INTEREST (LOSS) BEFORE TAXES (423,866) (347,858) 1,575
PROVISION FOR INCOME TAXES 71,044 28,602 36,742
------------- ------------- -------------
NET LOSS $ (494,910) $ 376,460 $ (35,167)
============= ============= =============
NET LOSS PER SHARE
Basic and Diluted $ (7.48) $ (6.56) $ (0.86)
WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING:
Basic and Diluted 66,183,000 57,346,600 40,876,600
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements
4
<PAGE>
THE LEARNING COMPANY, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Series A
Preferred Common Stock Additional
------------- ---------------------- Paid-In Accumulated
Shares Amount Shares Amount Capital Deficit
------ ------ ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994 -- $ -- 32,396 $ 324 $ 211,554 $ (92,348)
Acquisition of Future Vision -- -- 1,135 11 8,455 (3,608)
Acquisition of tewi -- -- 99 1 3,639 --
Acquisition of The Former
Learning Company -- -- -- -- 43,369 --
Acquisition of Compton's -- -- 5,053 51 86,634 --
Other acquisitions -- -- 748 8 3,205 1,452
Sale of common stock -- -- 2,713 27 73,584 --
Stock issued under exercise
of options and warrants -- -- 2,208 22 38,450 --
Treasury stock retirement -- -- -- -- (1,629) --
Conversion of Exchangeable
Shares to common stock -- -- 2,508 25 (25) --
Unrealized gain on short-term
investment -- -- -- -- -- 29
Translation adjustments -- -- -- -- -- --
Net loss -- -- -- -- -- (35,167)
------ ------ ---------- ---------- ---------- ----------
Balance, December 31, 1995 -- -- 46,860 469 467,236 (129,642)
Acquisition of MECC -- -- 9,214 92 240,670 --
Other acquisitions -- -- 899 9 15,247 --
Conversion of debt to
common stock -- -- 158 2 3,051 --
Stock issued under exercise
of options -- -- 3,319 32 28,661 --
Conversion of Exchangeable
Shares to common stock -- -- 45 -- -- --
Stock issued for settlement of
expenses -- -- 500 5 13,015 --
Unrealized gain on short-term
investment -- -- -- -- -- (276)
Translation adjustments -- -- -- -- -- --
Repurchase of common stock -- -- (80) -- (3,433) --
Net loss -- -- -- -- -- (376,460)
------ ------ ---------- ---------- ---------- ----------
Balance, December 31, 1996 -- -- 60,915 609 764,447 (506,378)
Net income for three months
ended November 30, 1996 of
Broderbund not included in
combination -- -- -- -- -- 8,895
Issuance of Series A Preferred
Stock 750 8 -- -- 202,025 --
Issuance of special warrants -- -- -- -- 57,462 --
Conversion of Exchangeable
Shares to common stock -- -- 73 -- -- --
Stock issued under exercise
of stock options -- -- 1,249 12 11,915 --
Stock issued to settle
earn-outs -- -- 135 2 2,021 --
Other acquisitions -- -- 3,500 33 15,897 (6,193)
Unrealized gain on short-term
investment -- -- -- -- -- 719
Stock issued under employee
stock plan -- -- 52 -- 1,270 --
Repurchase of common stock -- -- (400) -- (14,574) --
Translation adjustments -- -- -- -- -- --
Net loss -- -- -- -- -- (494,910)
------ ------ ---------- ---------- ---------- ----------
Balance, December 31, 1997 750 $ 8 65,524 $ 656 $1,040,463 $(997,867)
====== ====== ========== ========== ========== ==========
<CAPTION>
Cumulative Total
Translation Treasury Stockholders'
Adjustment Stock Equity
------------- ------------- -------------
<S> <C> <C> <C>
Balance, December 31, 1994 (9,651) $ (1,629) $ 108,250
Acquisition of Future Vision -- -- 4,858
Acquisition of tewi -- -- 3,640
Acquisition of The Former
Learning Company -- -- 43,369
Acquisition of Compton's -- -- 86,685
Other acquisitions -- -- 4,665
Sale of common stock -- -- 73,611
Stock issued under exercise
of options and warrants -- -- 38,472
Treasury stock retirement -- 1,629 --
Conversion of Exchangeable
Shares to common stock -- -- --
Unrealized gain on short-term
investment -- -- 29
Translation adjustments 181 -- 181
Net loss -- -- (35,167)
------------- ------------- -------------
Balance, December 31, 1995 (9,470) -- 328,593
Acquisition of MECC -- -- 240,762
Other acquisitions -- -- 15,256
Conversion of debt to
common stock -- -- 3,053
Stock issued under exercise
of options -- -- 28,693
Conversion of Exchangeable
Shares to common stock -- -- --
Stock issued for settlement of
expenses -- -- 13,020
Unrealized gain on short-term
investment -- -- (276)
Translation adjustments (1,317) -- (1,317)
Repurchase of common stock -- -- (3,433)
Net loss -- -- (376,460)
------------- ------------- -------------
Balance, December 31, 1996 (10,787) -- 247,891
Net income for three months
ended November 30, 1996 of
Broderbund not included in
combination -- -- 8,895
Issuance of Series A Preferred
Stock -- -- 202,033
Issuance of special warrants -- -- 57,462
Conversion of Exchangeable
Shares to common stock -- -- --
Stock issued under exercise
of stock options -- -- 11,927
Stock issued to settle
earn-outs -- -- 2,023
Other acquisitions -- -- 9,737
Unrealized gain on short-term
investment -- -- 719
Stock issued under employee
stock plan -- -- 1,270
Repurchase of common stock -- -- (14,574)
Translation adjustments (6,483) -- (6,483)
Net loss -- -- (494,910)
------------- ------------- -------------
Balance, December 31, 1997 $ (17,270) $ -- $ 25,990
============= ============= =============
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements.
5
<PAGE>
THE LEARNING COMPANY, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------
1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(494,910) $(376,460) $ (35,167)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation and amortization 534,612 463,297 32,060
Charge for incomplete technology 32,467 64,697 62,161
Equity in earnings of joint venture -- (217) (3,886)
Provision for returns and doubtful accounts 108,159 64,193 50,002
Provision for income taxes 64,888 (1,334) --
Change in assets and liabilities (net of
acquired assets and liabilities):
Accounts receivable (153,656) (115,570) (73,037)
Inventories (15,911) 2,754 (4,642)
Other current assets 3,376 4,520 8,436
Other long-term assets (8,625) (4,308) 11,990
Accounts payable and accrued expenses 35,684 5,146 25,264
Other long-term obligations (1,629) 9,453 (1,625)
------------- ------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 104,455 116,171 71,556
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Businesses acquired, net of cash on-hand (106,606) 498 (547,889)
Purchases of property and equipment, net (10,872) (8,902) (11,194)
Software development costs (27,299) (12,344) (2,410)
Short-term investments (43,428) (17,702) 33,842
Merger related accruals (53,832) (39,167) (3,324)
Payments to stockholders of The Former
Learning Company -- (25,025) --
------------- ------------- -------------
NET CASH USED FOR INVESTING ACTIVITIES (242,037) (102,642) (530,975)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sale of stock, options and
warrants 12,613 31,581 116,898
Borrowings under line of credit 10,150 25,000 3,150
Payments on term notes -- (4,832) (8,815)
Payments on capital lease obligations (2,676) (1,874) (1,008)
Sale (repurchase) of senior notes (28,000) (18,350) 500,000
Costs incurred to issue series a preferred
stock (10,701) -- --
Repurchase of common stock (14,573) (3,433) --
Proceeds from issue of special warrants 57,462 -- --
Other 1,821 (1,092) --
------------- ------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 26,096 27,000 610,225
------------- ------------- -------------
EFFECT OF EXCHANGE RATE CHANGES ON NET CASH (2,209) (1,321) 181
------------- ------------- -------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (113,695) 39,208 150,987
CASH AND CASH EQUIVALENTS AT BEGINNING OF
PERIOD 219,119 179,911 28,924
EFFECT OF BRODERBUND'S EXCLUDED RESULTS (1,790) -- --
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD 103,634 219,119 179,911
SHORT-TERM INVESTMENTS 85,322 41,894 24,468
------------- ------------- -------------
CASH AND SHORT-TERM INVESTMENTS $ 188,956 $ 261,013 $ 204,379
============= ============= =============
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements
6
<PAGE>
THE LEARNING COMPANY, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ----------- -----------
<S> <C> <C> <C>
SUPPLEMENTAL SCHEDULING OF NON-CASH
INVESTING AND FINANCING ACTIVITIES:
Issuance of Series A Preferred Stock to retire debt $ 202,033 $ -- $ --
Common stock issued to settle earn-out agreements 2,023 -- --
Common stock issued to acquire MECC -- 221,319 --
Increase in APIC due to value of in-the-money employee stock options
acquired in connection with acquisitions 2,969 19,444 43,369
Common stock issued for acquisitions 7,321 15,255 95,292
Conversion of debt to equity -- 3,053 3,471
Common stock issued for settlement of expenses -- 10,132 111
Equipment acquired under capital leases -- 1,262 627
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for:
Interest paid $ 29,914 $ 28,574 $ 563
Income taxes paid 7,684 10,971 24,156
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements
7
<PAGE>
THE LEARNING COMPANY, INC.
Notes to Supplemental Consolidated Financial Statements
(In thousands, except share and per share amounts)
(1) Description Of Business And Summary Of Significant Accounting Policies
The Business
The Learning Company, Inc. ("TLC" or the "Company") develops, publishes and
markets consumer software in the education and reference category and, to a
lesser extent, productivity, lifestyle and entertainment categories. The
Company sells its products in the retail channel through mass merchants,
consumer electronic stores, price clubs, office supply stores, software
specialty stores and distributors; to original equipment manufacturers ("OEMs");
to schools and to end-users through direct response methods. The Company also
develops and distributes income tax software products and offers computerized
processing of income tax returns in Canada. The Company's principal market is
in the United States and Canada. The Company has international operations in
Germany, Ireland, France, Holland, the United Kingdom, Japan and Australia. On
October 24, 1996, SoftKey International Inc. changed its name to The Learning
Company, Inc.
On August 31, 1998, the Company acquired Broderbund Software, Inc.
("Broderbund"), a developer and publisher of consumer software for the home and
school pursuant to an agreement and plan of merger dated June 21, 1998. This
transaction was accounted for using the pooling-of-interests method of
accounting. Generally accepted accounting principles proscribe giving effect to
a consummated business combination accounted for by the pooling-of-interests
method in financial statements that do not include the date of consummation.
These financial statements do not extend through the date of consummation;
however, they will become the historical consolidated financial statements of
the Company after financial statements covering the date of consummation of the
business combination are issued. The accompanying Supplemental Consolidated
Financial Statements of the Company have been restated to include the results
and balances of Broderbund for all periods presented.
The Company's fiscal year is the 52 or 53 weeks ending on or after December
31. For clarity of presentation herein, all references to December 31, 1997
relate to balances as of January 3, 1998, references to December 31, 1996 relate
to balances as of January 4, 1997, the period from January 5, 1997 to January 3,
1998 is referred to as the "Year Ended December 31, 1997", the period from
January 7, 1996 to January 4, 1997 is referred to as the "Year Ended December
31, 1996" and the period from January 1, 1995 to January 6, 1996 is referred to
as the "Year Ended December 31, 1995".
Basis of Presentation
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.
The balance sheets of the Company as of December 31, 1997 and 1996 have
been combined with the balance sheets of Broderbund as at November 30, 1997 and
as at August 31, 1996, respectively. The statements of operations, cash flows,
and stockholders' equity of the Company for the Years Ended December 31, 1997,
1996 and 1995 have been combined with those of Broderbund for the twelve month
period ended November 30, 1997 and the years ended August 31, 1996 and 1995,
respectively. Broderbund's results for the period from September 1, 1996
through November 30, 1996 have been omitted from the supplemental statement of
operations and have been included as a separate line item in the statement of
stockholders' equity. Revenue, operating income and net income of Broderbund
for the period omitted were $61,491, $13,518, and $8,895, respectively.
The accompanying Supplemental Consolidated Financial Statements include the
accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany amounts and transactions have been eliminated.
8
<PAGE>
Certain prior period amounts have been reclassified to conform with the
current year presentation.
Revenue Recognition
Revenues are primarily derived from the sale of software products and from
software licensing and royalty arrangements. The Company recognizes revenue in
accordance with the Statement of Position ("SOP") No. 91-1, Software Revenue
Recognition. The Financial Accounting Standards Board recently issued SOP No.
97-2, Software Revenue Recognition. The most significant changes to SOP No.
91-1, relate to multiple deliverables and "when and if available" products. The
new SOP No. 97-2 is effective for transactions entered into in fiscal years
beginning after December 15, 1997 and has been adopted by the Company for the
fiscal year ending December 31, 1998. The adoption of this new standard has not
had a material effect on the Company's financial statements.
Revenues from the sale of software products are recognized upon shipment,
provided that no significant obligations remain outstanding and collection of
the receivable is probable. Costs related to insignificant post shipment
obligations are accrued when revenue is recognized for the sale of the related
products. Allowances for estimated returns are provided at the time of sale and
allowances for price protection are provided at the time of commitment and
charged against revenues. The Company evaluates the adequacy of allowances for
returns and doubtful accounts primarily based upon its evaluation of historical
and expected sales experience and by channel of distribution. The estimates
determined for reserves for returns and allowances are based upon information
available at the reporting date. To the extent the future market, sell-through
experience, customer mix, channels of distribution, product pricing and general
economic conditions change, the estimated reserves required for returns and
allowances may also change. Revenues from royalty and license arrangements are
recognized as earned based upon performance or product shipments.
Advertising and Marketing Costs
The Company charges direct response advertising costs to sales and
marketing expense as incurred. Direct response costs eligible for
capitalization are not material at December 31, 1997 or 1996. Co-operative
advertising and other channel marketing programs are expensed in the period the
programs are run or over the period of specific contract for services and are
included in sales and marketing expense. The Company offers various coupon
rebate programs to its end-user customers. The Company provides for the
expected cost of the coupon redemption at the time of sale under sales and
marketing expense. The cost is estimated based upon the expected coupon
redemption rate on a product-by-product basis and is adjusted at each reporting
period for actual results. Fees for preferred shelf space are expensed as
incurred as sales and marketing expense.
Investments in Affiliates
Prior to January 1997, the Company and Random House, Inc. (collectively,
the "Partners") participated in a joint venture to publish story-based
multimedia software for children. The joint venture, Living Books, combined
resources of these two publishers and was 50% owned by each. The Company's
contribution to the joint venture consisted of the Living Books product line
existing at the time and the technology and people to produce more Living Books.
Random House, Inc. contributed cash and access to its library of children's
books and authors. The joint venture was responsible for all research and
development, manufacturing and marketing costs associated with the Living Books
products. The Partners each distributed Living Books products through their
respective distribution channels under an affiliated label arrangement. The
Company reported revenues of $1,393, $18,041 and $22,393 during the Years Ended
1997, 1996, and 1995 from distribution of Living Books products as affiliated
label products. Prior to January 1, 1997, the Company reported its share in
earnings of Living Books using the equity method of accounting. The equity
earnings were not material. As of January 1, 1997, the Company purchased Random
House's 50% share in this joint venture (see Note 2 - Business Combinations).
The results of Living Books after this date are reflected in the accompanying
financial statements.
Cash and Short-Term Investments
Cash and equivalents consist of cash in banks and investments in highly
liquid short-term instruments with original maturities of 90 days or less.
Short-term investments consist principally of municipal bonds and U.S.
9
<PAGE>
government agency notes. At year end the Company has approximately $20,000 of
cash on deposit under compensating balances that are not legally restricted with
the Company's bank to provide for credit enhancement under the receivables
purchase agreement.
The Company accounts for investments under Statement of Financial
Accounting Standards No. 115, Accounting for Certain Investments in Debt and
Equity Securities ("SFAS No. 115"). Under SFAS No. 115, investments in equity
and debt securities are classified in three categories and accounted for based
upon the classification. The Company has accounted for investments in debt
securities as "available-for sale" pursuant to SFAS No. 115 and has recorded
such investments at fair value with unrealized gains and losses reported as a
component of stockholders' equity.
Fair Value of Financial Instruments
The carrying amount approximates fair value for each class of financial
instruments which include cash and equivalents, accounts receivable, accounts
payable and accrued liabilities because of the short maturity of these
instruments. The carrying values of short-term investments are based upon quoted
market prices.
<TABLE>
<CAPTION>
December 31,
------------------------
1997 1996
---------- ----------
<S> <C> <C>
Cash and equivalents:
Cash and money market funds $ 98,359 $111,269
Municipal securities 3,200 53,812
Commercial paper 875 1,500
Money Market preferreds 1,200 49,200
Corporate notes -- 3,338
---------- ----------
103,634 219,119
Short-term investments:
Money market preferreds 3,012 2,675
Municipal securities 72,198 22,831
Commercial paper 1,000 --
U.S. Government agencies 7,084 15,884
Corporate equity fund -- 504
Corporate notes 2,028 --
---------- ----------
Cash and short-term
investments $188,956 $261,013
========== ==========
</TABLE>
Accounting for Transfers and Servicing Financial Assets
The Company follows Statement of Financial Accounting Standards No. 125,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities ("FAS 125"). FAS 125 applies a control-oriented, financial-
components approach to financial asset transfer transactions whereby the Company
(1) recognizes the financial and servicing assets it controls and the
liabilities it has incurred, (2) derecognizes financial assets when control has
been surrendered, and (3) derecognizes liabilities once they are extinguished.
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 of up to $75,000 on a revolving
basis during a five year period ending September 30, 2002. The Company acts as
servicing agent for the sold receivables in the collection and administration of
the accounts.
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.
10
<PAGE>
<TABLE>
<CAPTION>
December 31,
----------------------------
1997 1996
------------ ------------
<S> <C> <C>
Components $ 8,333 $ 2,384
Finished goods 31,049 16,650
------------ ------------
$39,382 $19,034
============ ============
</TABLE>
Property and Equipment
Property and equipment are stated at the lower of cost, net of accumulated
depreciation or net realizable value. Depreciation is calculated using
accelerated and straight-line methods over the following useful lives:
Buildings 30-40 years
Computer equipment 3-7 years
Furniture and fixtures 3-7 years
Leasehold improvements Shorter of the life of the
lease or the estimated useful life
Betterments and major renewals are capitalized and included in property,
plant, and equipment accounts while expenditures for maintenance and repairs and
minor renewals are charged to expense. When assets are retired or otherwise
disposed of, the assets and related allowances for depreciation and amortization
are eliminated from the accounts and any resulting gain or loss is reflected in
income.
Goodwill and Intangible Assets
The excess cost over the fair value of net assets acquired, goodwill, is
amortized on a straight-line basis over 2 years, except for the goodwill
associated with the Company's Canadian income tax software business, which is
being amortized on a straight-line basis over its estimated useful life of 40
years (balance of $22,341 at the end of fiscal 1997 and $23,352 at the end of
fiscal 1996). The Canadian income tax software business was sold on July 9,
1998 for $45,000 in cash. The gain on the sale was not material. The cost of
identified intangible assets is generally amortized on a straight-line basis
over their estimated useful lives of 2 to 10 years. Deferred financing costs are
being amortized on a straight-line basis over the term of the related debt
financing.
The carrying value of goodwill and intangible assets is reviewed on a
quarterly and annual basis for the existence of facts or circumstances both
internally and externally that may suggest impairment. To date no such
impairment has occurred. The Company determines whether an impairment has
occurred based on gross expected future cash flows and measures the amount of
the impairment based on the related future estimated discounted cash flows. The
cash flow estimates that are used to determine the amount of an impairment, if
any, contain management's best estimates, using appropriate and customary
assumptions and projections at the time. Goodwill and other intangible assets
have been presented net of accumulated amortization of $920,871 at the end of
fiscal 1997 and $446,658 at the end of fiscal 1996.
<TABLE>
<CAPTION>
Estimated
useful life Net balance
Description in years at December 31,
- ----------- ----------- -----------------------------------
1997 1996
----------------- ----------------
<S> <C> <C> <C>
Goodwill 2 to 40 $ 65,029 $400,029
Acquired technology 2 16,771 128,283
Brands and related
content rights 7 to 10 55,581 10,061
Deferred financing
costs 5 3,828 9,423
Other intangible
assets 3 4,639 4,917
---------- ----------
$145,848 $552,713
========== ==========
</TABLE>
Development and Software Costs
Development and software costs are expensed as incurred. Development costs
for new software products and enhancements to existing software products are
expensed as incurred until technological feasibility has been
11
<PAGE>
established. Capitalized software development costs on a product-by-product
basis are being amortized using the straight-line method over the remaining
estimated economic life of the product, which is generally twelve months
beginning when launched, which approximates the ratio that current gross
revenues for a product bear to the total of current and anticipated future gross
revenues for that product. At December 31, 1997 and 1996, the Company had
capitalized software development costs of $13,665 and $6,140, respectively,
which are included in other current assets. Amortization of software development
costs was $12,052, $9,904 and $2,368 in each of the Years Ended December 31,
1997, 1996 and 1995, respectively.
Income Taxes
Deferred tax liabilities and assets are determined based on the differences
between the financial statement basis and tax basis of assets and liabilities,
using enacted tax rates in effect for the year in which the differences are
expected to reverse. FAS 109 also requires a valuation allowance against net
deferred tax assets if based upon the available evidence it is more likely than
not that some or all of the deferred tax assets will not be realized.
Foreign Currency
The functional currency of each foreign subsidiary is the local currency.
Accordingly, assets and liabilities of foreign subsidiaries are translated to
U.S. dollars at period end exchange rates. Revenues and expenses are translated
using the average rates during the period. The effects of foreign currency
translation adjustments have been accumulated and are included as a separate
component of stockholders' equity (deficit).
Computation of Earnings Per Share
For the year ended December 31, 1997, the Company adopted Statement of
Accounting Standards No. 128 ("FAS 128"), which requires the presentation of
Basic and Dilutive earnings per share, which replaces primary and fully diluted
earnings per share. Earnings per share have been restated for all periods
presented to reflect the adoption of FAS 128. 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 equivalent shares consist of
convertible debentures, preferred stock, stock options and warrants. The
dilutive computations do not include common stock equivalents for the years
ended December 31, 1997, 1996 and 1995 as their inclusion would be antidilutive.
(2) Business Combinations
Broderbund
On August 31, 1998, the Company acquired all of the issued and outstanding
common shares 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 common share of Broderbund was exchanged into 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 1996 and the results for the three years ended December 31, 1997 have been
restated to include the balances and results of Broderbund. Results on a stand-
alone basis were as follows:
<TABLE>
<CAPTION>
Year Ended Combined
December 31, 1997 TLC Broderbund Adjustments Restated
-------------------- -----------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 392,438 $ 228,493 $ -- $ 620,931
Operating loss (393,055) (23,659) 9,000 (407,714)
Net loss (475,667) (11,800) (7,443) (494,910)
Net loss per share (9.59) (0.71) -- (7.48)
Year Ended Combined
December 31, 1996 TLC Broderbund Adjustments Restated
-------------------- -----------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 343,321 $ 186,207 $ -- $ 529,528
Operating income (loss) (381,312) 59,877 (9,000) (330,435)
Net income (loss) (405,451) 36,777 (7,786) (376,460)
Net income (loss) per share (9.94) 2.22 -- (6.56)
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
Year Ended Combined
December 31, 1995 TLC Broderbund Adjustments Restated
-------------------- ----------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 167,042 $ 171,594 $ -- $ 338,636
Operating income (loss) (60,870) 51,490 -- (9,380)
Net income (loss) (65,960) 36,187 (5,394) (35,167)
Net income (loss) per share (2.65) 2.26 -- (0.86)
</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 $16,443, $1,214 and $5,394 was
recorded in each of the Years Ended December 31, 1997, 1996 and 1995,
respectively, and $9,414 was charged to opening retained earnings relating to
years prior to 1995. The adjustments increase 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 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 has been eliminated from the Broderbund
net income for the year ended August 31, 1996 and the purchase price of the
Former Learning Company has been reduced, resulting in a reduction in
amortization of goodwill of $9,000 in each of the Years Ended December 31, 1997
and 1996.
Creative Wonders
On October 23, 1997, the Company acquired control of Creative Wonders,
L.L.C. ("Creative Wonders"), an educational software company that publishes,
among other titles, the Sesame Street line of products. The purchase price was
a total of $37,799 including the value of employee stock options assumed and
estimated transaction costs. The purchase price included cash payments of
$33,883.
Parsons Technology
On August 6, 1997, the Company acquired control of Parsons Technology
("Parsons"). Parsons is a direct-to-consumer marketing organization which
publishes a range of consumer software. The acquisition has been accounted for
under the purchase method. The purchase price was approximately $31,000 in
cash, including transaction costs.
Living Books
On January 1, 1997, the Company acquired the remaining 50% interest in the
Living Books joint venture. The acquisition was accounted for under the
purchase method of accounting and was accomplished by a combination of cash and
restricted stock, with an aggregate purchase price of approximately $18,370,
including transaction costs.
Other 1997 Combinations
On September 19, 1997, the Company acquired Learning Services Inc.
("Learning Services"), a national school software catalog for teachers, in
exchange for the issuance of 709,976 shares of common stock. On September 29,
1997, the Company acquired Skills Bank Corporation ("Skills Bank"), a developer
of educational and remedial software products for adult, adolescent and K to 12
students, in exchange for the issuance of 1,069,286 shares of common stock. On
October 2, 1997, the Company acquired Microsystems Software, Inc.
("Microsystems"), a developer of Internet filtering software, in exchange for
the issuance of 955,819 shares of common stock. On December 30, 1997, the
Company acquired TEC Direct, Inc. ("TEC Direct"), an educational consumer
software catalog, in exchange for the issuance of 429,733 shares of common
stock. Each of these transactions was accounted for using the pooling-of-
interests method of accounting. The Supplemental Consolidated Financial
Statements of the Company for the years prior to December 31, 1997 do not
include the results and balances of these companies as they were deemed to be
immaterial to the Supplemental Consolidated Financial Statements for those
periods.
13
<PAGE>
T/Maker
On August 6, 1996, the Company acquired T/Maker Company ("T/Maker"), a
developer of clip art software. The acquisition has been accounted for under the
purchase method. The purchase price was approximately $19,900 in cash,
including transaction costs. The pre-combination results of T/Maker were not
material.
MECC
On May 17, 1996, the Company acquired Minnesota Educational Computing
Corporation (MECC) ("MECC"), a publisher and developer of high quality
children's educational software sold to consumers and schools, in exchange for
9,214,007 shares of the Company's common stock. The total purchase price was
$284,631, including estimated transaction costs, value of stock options assumed
and deferred income taxes related to certain identifiable intangible assets
acquired. Approximately 1,048,000 MECC employee stock options were converted
into stock options to purchase approximately 1,198,000 shares of TLC common
stock. This transaction was accounted for as a purchase.
Compton's
On December 28, 1995, the Company acquired Compton's New Media, Inc. and
Compton's Learning Company (collectively, "Compton's"), developers and
publishers of multimedia software titles. In and in connection with the
acquisition, the Company issued a total of 5,052,697 shares of the Company's
common stock, which included 587,036 shares of common stock to settle $14,000 of
intercompany debt due to Tribune Company and executed a promissory note for
$3,000 in cancellation of the remaining intercompany debt. The total purchase
price was $104,394, including estimated transaction costs, deferred income taxes
related to certain identifiable intangible assets acquired, settlement of
certain intercompany debt to Tribune Company and the fair value of net
liabilities assumed. The promissory note was repaid in 1996. This transaction
was accounted for as a purchase.
The Learning Company
On December 22, 1995, the Company acquired control of The Learning Company
("The Former Learning Company"), a leading developer of educational software
products for use at home and school. Under the terms of the merger agreement,
the Company acquired, in a two-step business combination, all of the outstanding
shares of The Former Learning Company for total consideration of approximately
$684,066, including the value of stock options assumed, estimated transaction
related costs and deferred income taxes related to certain identifiable
intangible assets acquired. Approximately 1.1 million unvested employee stock
options of The Former Learning Company were converted into options to purchase
3,123,000 shares of the Company's common stock, based on the merger
consideration of $67.50 per share and were vested on or before January 26, 1996.
Approximately $543,163 of the purchase price was settled in cash. This
transaction was accounted for as a purchase.
tewi Verlag GmbH
On July 21, 1995, the Company acquired tewi Verlag GmbH ("tewi"), a
publisher and distributor of CD-ROM software and computer-related books, located
in Munich, Germany. The purchase price was settled by a combination of cash
and issuance of common stock. The Company issued 99,045 shares of common stock
valued at $3,640 and may issue additional shares of common stock to a former
shareholder of tewi pursuant to an earn-out agreement. The Company paid cash
consideration of $12,688 for tewi. The additional shares issuable under the
earn-out agreement have been treated as contingent consideration and will be
recorded if and when certain future conditions are met. During 1997 and 1996,
$498 and $540, respectively, of consideration related to the contingent
consideration was earned and recorded as expense by the Company. This
transaction was accounted for as a purchase.
14
<PAGE>
The purchase price for the 1997 acquisitions has been allocated based on
fair values as follows:
<TABLE>
<CAPTION>
Creative Parsons Living
Wonders Technology Books Total
<S> <C> <C> <C> <C>
Purchase price $ 37,799 $31,000 $18,370 $87,169
Less: fair value of net tangible assets
(liabilities) (7,257) 11,689 4,267 8,699
-------- ------- ------- -------
45,056 19,311 14,103 78,470
Excess allocated to:
Incomplete technology 1,050 10,000 9,250 20,300
Customer list -- 4,600 -- 4,600
Brands and related content rights 44,006 4,711 -- 48,717
-------- ------- ------- -------
Goodwill $ -- $ -- $ 4,853 $ 4,853
======== ======= ======= =======
</TABLE>
The purchase price for the 1996 acquisitions has been allocated based on
fair values as follows:
<TABLE>
<CAPTION>
MECC Others Total
-------- -------- --------
<S> <C> <C> <C>
Purchase Price $284,631 $ 15,681 $300,312
Less: fair value of net tangible assets (liabilities) 13,990 (15,424) (1,434)
-------- -------- --------
270,641 31,105 301,746
Excess to allocated to:
Incomplete technology 56,688 -- 56,688
Completed technology 88,501 285 88,786
Brands and related content rights 894 -- 894
-------- -------- --------
146,083 285 146,368
-------- -------- --------
Goodwill $124,558 $ 30,820 $155,378
======== ======== ========
</TABLE>
The Company primarily used the income approach to determine the fair value
of the identified intangible assets acquired. The debt-free cash flows, net of
provision for operating expenses, were discounted to a net present value. The
value of certain completed technology was based upon comparable fair values in
the open market. The value of software technology and products under development
not considered to have reached technological feasibility and having no future
alternative use was expensed on acquisition.
Unaudited pro forma results of operations for the transactions accounted
for using the purchase method of accounting as though the acquisitions had
occurred at the beginning of the Years Ended December 31, 1996 and 1995 are
below. The pro forma adjustments detailed below include the effect of
amortization of intangible assets and goodwill related to the acquisitions over
their estimated useful lives of two years and the interest expense related to
the issue of the $500,000 of debt for the period prior to 1995 and 1996
acquisitions or issuance, net of any related income tax effects. Pro forma
results for the 1997 acquisitions were immaterial.
15
<PAGE>
<TABLE>
<CAPTION>
The Former
Year Ended Learning Pro forma Pro forma
December 31, 1996 TLC tewi Compton's Company MECC Adjustments Combined
- -------------------- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues $ 529,528 $ -- $ -- $ -- $ 7,800 $ -- $ 537,328
Operating loss (330,435) -- -- -- (9,212) (41,128) (380,775)
Net loss (376,460) -- -- -- (7,021) (34,009) (417,490)
Net loss per share (6.56) -- -- -- -- -- (6.88)
Year Ended
December 31, 1995
- ---------------------
Revenues $ 338,636 $3,720 $ 23,204 $ 60,698 $33,815 $ -- $ 460,073
Operating loss (9,380) (3,589) (13,904) 10,874 6,079 (428,239) (438,159)
Net loss (35,167) (3,643) (9,626) 7,398 5,070 (398,195) (434,163)
Net loss per share (0.86) -- -- -- -- -- (7.93)
</TABLE>
Future Vision Holding, Inc.
On August 31, 1995, the Company acquired all of the issued and outstanding
capital stock of Future Vision Holding, Inc. ("Future Vision"), a multimedia
software company, in exchange for the issuance of 1,088,149 shares of common
stock of the Company. This acquisition has been accounted for using the
pooling-of-interests method of accounting. The Supplemental Consolidated
Financial Statements of the Company for periods prior to December 31, 1995 do
not include results for this acquisition as they were deemed to be immaterial.
Banner Blue Software, Incorporated
On April 28, 1995, the Company acquired Banner Blue Software, Incorporated
("Banner Blue"), a developer of genealogy software, in a transaction accounted
for using the pooling-of-interests method. The Company issued 485,600 shares of
common stock in exchange for all the outstanding stock of Banner Blue. The
results of Banner Blue prior to acquisition were not material.
(3) Fixed Assets and Other
<TABLE>
<CAPTION>
December 31,
------------------------------
1997 1996
----------- ------------
<S> <C> <C>
Buildings, land and leasehold improvements $ 17,288 $ 6,463
Computer equipment 47,356 36,531
Furniture and fixtures 15,432 15,196
----------- ------------
80,076 58,190
Less: accumulated depreciation
and amortization (41,044) (33,509)
----------- ------------
39,032 24,681
Other 12,766 5,668
----------- ------------
$ 51,798 $ 30,349
=========== ============
</TABLE>
Included in computer equipment is equipment under capital lease of $1,952
and $2,207 at December 31, 1997 and 1996, respectively. Depreciation expense
was $9,066, $9,295 and $8,916 in each of the Years Ended December 31, 1997, 1996
and 1995, respectively.
(4) Line of Credit
TLC Multimedia, Inc., a wholly-owned subsidiary of the Company, has a
revolving line of credit (the "Line"), to provide for a maximum availability of
$50,000, of which $35,150 was utilized at December 31, 1997. Borrowings under
the Line become due on July 1, 1999 and bear interest at the prime rate (8 1/2%
at December 31, 1997). The Line is subject to certain financial covenants, is
secured by a general security interest in the assets of The Learning Company,
Inc. and certain other subsidiaries of the Company and by a pledge of the stock
of certain of its subsidiaries. The Line is guaranteed by the Company. On
August 21, 1998, the Company amended its line of credit to increase the total
availability to $147,500.
16
<PAGE>
(5) Long-Term Debt
<TABLE>
<CAPTION>
December 31,
-------------------------------
1997 1996
----------- -----------
<S> <C> <C>
Senior Convertible Notes $ 303,650 $ 331,650
Obligations under capital leases 1,423 2,099
----------- -----------
305,073 333,749
Less: current portion (10,717) (819)
----------- -----------
$ 294,356 $ 332,930
=========== ===========
</TABLE>
At December 31, 1997, the Company had outstanding $303,650 principal amount
5 1/2% Senior Convertible Notes due 2000 (the "Notes"), which are unsecured.
The Notes will be redeemable by the Company on or after November 2, 1998 at
redemption prices of 102.2% on November 2, 1998, 101.1% on November 1, 1999 and
100% on or after November 1, 2000 and are convertible into common stock at a
price of $53 per share. Interest is payable on the Notes semi-annually on May 1
and November 1 each year. The long-term principal portion of the Notes declined
by a total of $38,000 and $18,350 during the Years Ended December 31, 1997 and
1996, respectively. Current portion of long-term debt includes $10,000 of the
Notes as the Company intends to repurchase the amount before December 31, 1998.
On June 8, 1998, the Company repurchased $96,695 of the Notes in exchange for
3,434,995 shares of the Company's common stock.
(6) Related Party Transactions
On December 28, 1995, Tribune Company made an investment in the Company in
the form of $150,000 principal amount 5 1/2% Senior Convertible/Exchangeable
Notes due 2000 (the "Private Notes"). The Private Notes were redeemable by the
Company on or after November 2, 1998 at redemption prices of 102.2% on November
2, 1998, 101.1% on November 1, 1999 and 100% on November 1, 2000 and were
convertible into common stock at a price of $53 per share. The Private Notes
were sold during 1997 in a private transaction to an investor group prior to
issuance by the Company of 750,000 shares of Series A Convertible Participating
Preferred Stock (the "Series A Preferred Stock") and were surrendered by the
investor group for issue of the Series A Preferred Stock. In connection with the
issuance of the Series A Preferred Stock, the Company paid a transaction fee to
the investor group totaling $1,845, of which $1,125 was paid to one of the
investors where a director of the Company is an officer. The loss resulting
from the exchange of the Private Notes for the Series A Preferred Stock, net of
tax benefit, was immaterial.
17
<PAGE>
(7) Commitments and Contingencies
Lease Obligations
The Company leases office facilities and equipment under operating and
capital leases. Rental expense for operating leases was approximately $10,027,
$6,862 and $5,116 and for the Years Ended December 31, 1997, 1996 and 1995,
respectively. Future annual payments under capital and operating leases are as
follows:
<TABLE>
<CAPTION>
Capital Operating
Leases Leases
---------- ------------
<S> <C> <C>
1998 $ 788 $12,851
1999 601 11,209
2000 142 10,021
2001 2 8,570
2002 2 1,747
Thereafter -- 8,602
---------- ------------
1,535 $53,000
============
Less: interest (112)
Less: current portion (717)
----------
$706
==========
</TABLE>
(8) Common and Preferred Stock
Common Stock
The Company has reserved 22,267,847 shares of its common stock for issuance
related to the Exchangeable Shares (described below), employee stock options and
warrants at year end. The Exchangeable Shares are represented by the one share
of Special Voting Stock. In addition, the Company has reserved a total of
20,729,245 shares of its common stock for issuance related to the Notes and the
Preferred Stock at year end.
Exchangeable Shares
On February 4, 1994, the Company completed a three-way business combination
(the "Three-Party Combination") among SoftKey Software Products Inc. ("Former
SoftKey"), WordStar International Incorporated ("WordStar") and Spinnaker
Software Corporation ("Spinnaker"). In connection with the Three-Party
Combination, Former SoftKey stockholders were entitled to elect to receive
shares of the Company's common stock or Exchangeable Non-Voting Shares (the
"Exchangeable Shares") of SoftKey Software Products Inc. ("SoftKey Software"),
the successor by amalgamation to Former SoftKey. The Company also issued a
special voting share (the "Voting Share") which has a number of votes equal to
the number of Exchangeable Shares outstanding. The holder of the Voting Share
is not entitled to dividends and shall vote with the common stockholders as a
single class. The Exchangeable Shares may be exchanged for the Company's common
stock on a one-for-one basis until February 4, 2005, at which time any
outstanding Exchangeable Shares automatically convert to shares of the Company's
common stock. At year end there were 1,478,929 Exchangeable Shares outstanding
and not held by the Company and its subsidiaries.
On November 6, 1997, SoftKey Software issued in a private placement in
Canada 4,072,000 special warrants for net proceeds of $57,462, each of which was
exercisable without additional payment for one Exchangeable Share. On February
23, 1998, each special warrant was exchanged in accordance with their provisions
into one Exchangeable Share without additional payment. On March 12, 1998,
SoftKey Software issued in a private placement in Canada a further 8,687,500
special warrants for net proceeds of approximately $134,000. On July 9, 1998
each special warrant was exchanged in accordance with their provisions into one
Exchangeable Share without additional payment.
18
<PAGE>
Preferred Stock
On December 4, 1997, the Company issued an aggregate of 750,000 shares of
Series A Preferred Stock to an investor group in exchange for the Private
Notes. Each share of the Series A Preferred Stock has an initial liquidation
preference of $200 and is initially convertible into 20 shares of common stock,
or 15,000,000 shares of common stock in the aggregate on an as-converted basis,
subject to adjustment for certain minimum returns on investment. The Series A
Preferred Stock is non-redeemable, bears no dividend, is subject to restrictions
on resale for a period of at least eighteen months and is manditorily
convertible into common stock upon satisfaction of certain conditions.
The Company estimated the extraordinary loss for financial reporting
purposes to be approximately $61,000 as at the date the Company entered into and
announced the agreement on August 25, 1997. The Company also estimated that the
resulting benefit for income tax purposes was approximately $61,000 as at the
date of issuance of the Series A Preferred Stock on December 5, 1997. As a
result, the extraordinary loss, net of tax, was determined to be immaterial.
(9) Stock Options and Warrants
Stock Option Plans
1990 Long-Term Equity Incentive Plan
The Company has a Long-Term Equity Incentive Plan (the "LTIP"). The LTIP
allows for incentive stock options, non-qualified stock options and various
other stock awards. Administration of the LTIP is conducted by the Company's
Compensation Committee of the Board of Directors. The Compensation Committee
determines the amount and type of option or award and terms and conditions and
vesting schedules (generally 3 years) of the award or option. The maximum term
of an option is 10 years. Upon a change of control, as defined, awards and
options then outstanding become fully vested, subject to certain limitations.
On December 4, 1997, the stockholders of the Company approved an amendment
to increase the maximum number of shares of common stock issuable under the LTIP
to 9,000,000 from 7,000,000. On August 31, 1998, the stockholders of the Company
approved an amendment to increase the maximum number of shares of common stock
issuable under the LTIP to 14,000,000 from 9,000,000. The total number of
shares of common stock reserved for issuance under the LTIP at year end was
6,538,716 shares, 2,039,645 of which remained available for grant.
1996 Non-Qualified Stock Option Plan
The Company initiated a non-qualified stock option plan (the "1996 Plan")
that was approved by the Company's Board of Directors on February 5, 1996. The
1996 Plan allows for non-qualified stock options and various other stock awards.
Administration of the 1996 Plan is conducted by the Company's Compensation
Committee of the Board of Directors. The administrator determines the amount
and type of option or award and terms and conditions and vesting schedules
(generally 3 years) of the award or option. The maximum term of an option is 10
years. Upon a change of control, as defined, awards and options then
outstanding become fully vested, subject to certain limitations. The maximum
number of shares issuable under the 1996 Plan is 5,000,000. The total number of
shares of common stock reserved under the 1996 Plan at year end was 4,612,949
shares, 585,183 of which remained available for grant.
1994 Non-Employee Director Stock Option Plan
On April 26, 1994, the Board of Directors approved a non-employee director
stock option plan (the "1994 Non-Employee Director Plan"). The 1994 Non-
Employee Director Plan provides for an initial grant of 20,000 options at fair
market value to be issued to each non-employee director who first became a
director of the Company after February 1, 1994 ("Initial Grants"). During the
Year Ended December 31, 1995, a further 100,000 options were granted to each of
the non-employee directors. During the Year Ended December 31, 1996, a further
26,667 options were granted to each of the non-employee directors. The maximum
number of common shares issuable under the 1994 Non-Employee Director Plan is
500,000, all of which were granted at year end. Options granted to non-employee
directors as Initial Grants were 100% exercisable at the time of grant and
options issued as subsequent grants become exercisable over a three-year period.
All such options are exercisable for a period of 10 years from date of grant.
19
<PAGE>
1996 Non-Employee Director Stock Option Plan
On July 31, 1996, Board of Directors approved the Company's 1996 Non-
Employee Director Option Plan (the "1996 Non-Employee Director Plan"), which was
approved by stockholders on December 4, 1997. Under the 1996 Non-Employee
Director Plan, certain directors who are not officers or employees of the
Company or any affiliate of the Company (the "Non-Employee Directors") are
eligible to receive stock options. The 1996 Non-Employee Director Plan provides
that each Non-Employee Director who became a director after May 16, 1996, but
prior to August 16, 1996 ( the "Effective Date") was entitled to receive a non-
statutory stock option (the "Initial Option") to purchase 50,000 shares of
common stock on the Effective Date. The 1996 Non-Employee Director Plan further
provides that each Non-Employee Director who becomes a director after the
Effective Date is entitled to receive the Initial option to purchase 50,000
shares of common stock on the date that he or she first becomes a member of the
Board of Directors. In addition, the 1996 Non-Employee Director Plan provides
that each Non-Employee Director is entitled to receive a non-statutory option
to purchase 25,000 shares of common stock upon initial appointment to a
committee of the Board of Directors (the "Committee Option"). The Board of
Directors may also grant additional non-statutory options (the "Discretionary
Options") to Non-Employee Directors in its or the Committee's sole discretion.
Initial options, Committee Options and Discretionary Options are exercisable in
eight quarterly installments, with the first of such installments becoming
exercisable three months after the date grant (provided that, for each such
installment, the optionee continues to serve as a director). The total number of
shares of common stock reserved for issuance under the 1996 Non-Employee
Director Plan as of year end was 500,000, 100,000 of which remain available for
grant.
Broderbund Stock Option Plans
Under the Broderbund Employee and Consultant Stock Option Plans (the
"Broderbund Plans"), incentive and non-qualified stock options may be granted to
employees, directors and consultants to purchase a maximum of 5,000,000 common
shares. All options are granted at an amount equal to or greater than the fair
market value of the common stock at the date of grant. Options vest in annual
20% increments from the date of grant, according to the vesting schedule at the
date of grant. The options generally expire ten years from the date of grant. In
connection with the merger with the Company, all of Broderbund options were
converted at the merger exchange ratio of 0.80 per common share into options to
acquire common stock of the Company. None of the terms of the Broderbund
options was changed as a result of the merger.
The following table summarizes the stock option activity under the LTIP,
the 1996 Plan, the Broderbund Plans, the 1996 Non-Employee Director Plan and the
1994 Non-Employee Director Plan:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 December 31, 1995
---------------------------- ----------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ----------- ------------ ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Beginning 12,245,151 $22.35 8,228,569 $17.87 4,033,580 $13.97
Assumed in
acquisitions 716,856 4.78 1,197,852 8.39 3,157,538 8.19
Granted 7,524,973 13.34 8,035,703 22.93 2,974,996 31.84
Exercised (1,240,850) 8.91 (3,319,276) 8.09 (1,704,435) 25.91
Excluded
period 554,400 -- -- -- -- --
Canceled (6,137,075) 19.34 (1,897,697) 21.58 (233,110) 21.52
----------- ----------- ----------- ------------ ----------- -----------
Ending 13,663,455 $17.32 12,245,151 $22.35 8,228,569 $17.87
=========== =========== =========== ============ =========== ===========
</TABLE>
20
<PAGE>
The following table summarizes information about stock options outstanding
at year end:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------------- ---------------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Outstanding Contractual Exercise Exercisable Exercise
Range of Exercise Prices at 12/31/97 Life Price at 12/31/97 Price
- ------------------------ ----------- -------------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C>
$ 0.05 - $ 9.8750 2,623,073 8.39 $ 6.99 896,099 $ 6.19
10.21 - 15.8750 4,304,026 7.74 10.70 3,013,117 10.79
16.0625 - 28.750 4,484,063 7.41 19.47 1,550,061 23.00
30.39 - 41.41 2,195,237 8.92 36.02 477,530 36.26
90 - 95.91 57,056 5.60 92.58 24,960 92.84
- ----------- ---------- ----------- -------------- ---------- ------------- ----------
$0.05 - $95.91 13,663,455 7.94 $17.28 5,961,767 $15.66
=========== ========== =========== ============== ========== ============= ==========
</TABLE>
Options to purchase 5,961,767, 4,631,729 and 2,090,654 shares of common
stock were exercisable at December 31, 1997, 1996 and 1995, respectively.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees", in accounting for its plans. The Company has
adopted the disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123").
Accordingly, no compensation expense has been recognized for the stock option
plans as calculated under SFAS 123. Had compensation cost for the Company's
stock option plans been determined based on the fair value at the grant date for
awards in 1997, 1996 and 1995 consistent with the provisions of SFAS 123, the
Company's net loss and basic and diluted net loss per share would have been
increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ -----------
<S> <C> <C> <C>
Net loss - as reported $ (494,910) $ (376,460) $ (35,167)
Net loss - pro forma (533,378) (405,045) (51,047)
Net loss per share - as reported (7.48) (6.56) (0.86)
Net loss per share - pro forma (8.06) (7.06) (1.26)
</TABLE>
The above compensation cost does not include the fair value of the stock
options assumed in connection with the acquisitions accounted for under the
purchase method of accounting, as the fair value of such options have been
included in the purchase price of the acquired companies.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1997, 1996 and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ -----------
<S> <C> <C> <C>
Dividend yield -- -- --
Expected volatility .7500 .7857 .6827
Risk free interest rate 6.00% 5.47% 5.31%
Expected lives 4 yrs 4 yrs 4 yrs
Weighted average grant-date
fair value of options granted $10.57 $10.79 $15.61
</TABLE>
The effects of applying SFAS 123 in this disclosure are not indicative of
future amounts. Additional grants in future years are anticipated.
21
<PAGE>
On March 13, 1997, in order to continue to provide a competitive employment
environment for staff retention and hiring, the Company instituted an Option
Exchange Program under which certain employees (other than employees who are
directors) with options exercisable at $10.40 per share or higher were given the
opportunity to exchange such options for options with an exercise price of
$10.40 per share. A total of 3,627,020 employee stock options were exchanged
and are included in the cancelled and re-granted employee stock options in the
above table.
1997 Employee Stock Purchase Plan
On December 4, 1997, the Company's stockholders approved the 1997
Employee Stock Purchase Plan, which provides for six offerings, one beginning
every six months commencing December 1, 1997 until and including November 30,
2000, that provides certain eligible employees with the opportunity to purchase
shares of the Company's common stock at a price of 85% of the price listed on
the New York Stock Exchange at various specified purchase dates. A maximum of
1,000,000 shares of common stock has been authorized for issuance under the 1997
Employee Stock Purchase Plan.
Warrants
On November 6, 1997, the Company's Canadian subsidiary, SoftKey Software,
issued in a private placement in Canada 4,072,000 special warrants for net
proceeds of approximately $57,462. Each special warrant was exchanged in
accordance with its provisions into one Exchangeable Share on February 23, 1998.
On March 12, 1998, SoftKey Software issued in a private placement in Canada a
further 8,687,500 special warrants for net proceeds of approximately $134,000.
On July 9, 1998, each special warrant was exchanged in accordance with its
provisions into one Exchangeable Share without additional payment.
On July 31, 1995, the Company announced that it would redeem all of its
2,925,000 publicly traded warrants for $0.10 per warrant on August 31, 1995 in
accordance with the terms and conditions of the warrants. Holders of such
warrants received in exchange for the warrants an aggregate of 289,959 shares of
common stock. The remaining 25,410 warrants were redeemed by the Company.
(10) Amortization, Merger and Other Charges
During the Year Ended December 31, 1997, the Company completed the
acquisition of Creative Wonders, Parson's Technology, and Living Books using the
purchase method of accounting and the acquisitions of Learning Services, Skills
Bank, TEC Direct and Microsystems using the pooling-of-interests method of
accounting. During the year ended December 31, 1996 the Company completed the
acquisitions of T/Maker, MECC and Edusoft S.A. using the purchase method. During
the Year Ended December 31, 1995, the Company completed the acquisitions of The
Former Learning Company, Compton's and tewi using the purchase method of
accounting and Future Vision and Banner Blue using the pooling-of-interest
method of accounting. Amortization, merger and other charges were expensed as
incurred or were recorded when it became probable that the transaction would
occur and the expense could be reasonably estimated. Amortization, merger and
other related charges are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------
1997 1996 1995
-------------- -------------- --------------
<S> <C> <C> <C>
Amortization of goodwill and other intangible assets $455,020 $434,520 $ 32,063
Exit and restructuring costs 54,572 4,260 1,304
Charge for incomplete technology 20,300 56,688 60,483
Provision for earn-outs 5,497 2,917 --
Professional fees and other costs 8,537 5,135 9,417
-------------- -------------- --------------
$543,926 $503,520 $103,267
============== ============== ==============
</TABLE>
The amortization of goodwill and other intangible assets in 1997, 1996 and
1995 represents primarily the amortization of the goodwill and acquired
intangible assets in connection with the acquisitions of Creative Wonders,
Parson's Technology, Living Books, T/Maker, MECC, The Former Learning Company
and Compton's.
22
<PAGE>
Exit and restructuring costs related to charges during the year for
employee severance of $12,130, discontinued products of $23,257, termination of
certain supplier relations of $10,229 and other charges related to the Company's
acquisition strategy and integration of the acquired companies of $8,956. The
charge has increased in the Year Ended December 31, 1997 as compared to the Year
Ended December 31, 1996 due to the change in strategy related to the school
channel and product discontinuation due primarily to the 1997 acquisitions. A
total of 109 employees were terminated in the areas of development, marketing,
operations, sales and administration as part of the integration process. The
plan was consummated during the year. There were no separately identifiable
operations that will not be continued. Employee severance costs in the Year
Ended December 31, 1996 related to termination of employees of the Company in
connection with the acquisitions of The Former Learning Company and MECC and the
related changes in strategy. A total of 108 employees were terminated in the
areas of operations, marketing, sales, technical support and product
development. Employee severance costs in the Year Ended December 31, 1995
related to termination of employees in connection with the acquisitions of
Future Vision and certain severances related to changes in the Company's
operations related to the acquisitions and changes in strategy. A total of 63
employees were terminated in the areas of operations, product development and
administration. Accrued exit and restructuring costs at December 31, 1997 are
not material.
The charge for incomplete technology in the Year Ended December 31, 1997
related to products being developed by Creative Wonders, Parsons Technology, and
Living Books, in the Year Ended December 31, 1996 related to products being
developed by MECC and in the Year Ended December 31, 1995 related to products
being developed by The Former Learning Company and Compton's. In each case the
Company believes the products in development had not reached technological
feasibility at the date of acquisition, had no alternative future use and
additional development would be required to complete the software technology.
The provision for earn-outs related to the amounts earned by the former
owners of certain acquisitions based upon the achievement of certain revenue and
operating goals achieved. These amounts are expected to be paid in common stock
of the Company prior to December 31, 1998.
Professional fees and other costs in the Year Ended December 31, 1997
related to investment banking, legal, accounting fees and other transaction
related costs incurred in connection with the acquisitions of Skills Bank,
Learning Services, TEC Direct and Microsystems. Professional fees and other
transaction related costs in the Year Ended December 31, 1996 relate to
additional legal and accounting costs incurred in connection with the
acquisition of MECC and professional fees incurred in the aborted merger by
Broderbund with the Former Learning Company. Professional fees and other
transaction related costs in the Year Ended December 31, 1995 relate to the
investment banking, legal and accounting costs incurred to such date for the
proposed merger with MECC and the professional fees associated with the
acquisition of Future Vision on August 31, 1995.
At December 31, 1997, the Company had merger related accruals of $12,533.
The accruals consisted of amounts due for legal and accounting fees, employee
severance and lease termination costs related to the acquisitions. The Company
expects to substantially pay the remaining amounts prior to December 31, 1998.
(11) Income Taxes
The Company's net loss for the years ended December 31, 1997, 1996 and 1995
includes amortization, merger and other charges of $543,926, $503,520, and
$103,267, respectively, certain of which are not deductible for income tax
purposes. The Company's income (loss) before income taxes consisted of the
following:
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------
1997 1996 1995
------------ ------------ -----------
<S> <C> <C> <C>
United States $(444,061) $(364,902) $(3,247)
Foreign 20,195 17,044 4,822
------------ ------------ -----------
$(423,866) $(347,858) $ 1,575
============ ============ ===========
</TABLE>
23
<PAGE>
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------
1997 1996 1995
------------- ------------ -----------
<S> <C> <C> <C>
Current income taxes:
Federal $ 46,860 $ 39,169 $ 29,920
State 9,051 9,870 8,289
Foreign 2,233 4,542 488
------------- ------------ -----------
58,144 53,581 38,697
------------- ------------ -----------
Deferred income taxes (benefit):
Federal 14,281 (24,769) (1,669)
State (1,381) (210) (286)
Foreign -- -- --
------------- ------------ -----------
12,900 (24,979) (1,955)
------------- ------------ -----------
$ 71,044 $ 28,603 $ 36,742
============= ============ ===========
</TABLE>
The significant components of deferred income tax expense are primarily
from changes in deferred tax liabilities related to the acquired technology,
depreciation, certain allowances and reserves not currently deductible, and
changes in the deferred tax asset valuation reserve.
The Company's actual tax as compared to the 1997, 1996 and 1995 statutory
tax rate reported on income is as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1997 1996 1995
-------------- -------------- -------------
<S> <C> <C> <C>
Tax provision (benefit) at statutory federal income tax rate (35%) $(148,353) $(121,750) $ 551
State income tax, net of federal benefit 4,869 10,104 6,201
Net foreign earnings taxed at rates different than federal tax rate 1,700 2,319 700
Non deductible amortization, merger and other charges 119,213 181,418 36,110
Effect of change in valuation allowance 77,677 (1,213) 5,394
Utilization of prior year tax benefits -- (41,448) (12,457)
Other 15,933 (828) 243
-------------- -------------- -------------
$ 71,044 $ 28,602 $ 36,742
============== ============== =============
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------
1997 1996
-------------- ------------
<S> <C> <C>
Deferred tax assets:
Net operating losses and credits $ 112,196 $ 49,582
Purchased Technology 10,991 581
Other reserves and accruals 54,527 25,146
-------------- ------------
177,714 75,309
Less: valuation allowance (161,307) (66,945)
-------------- ------------
16,407 8,364
-------------- ------------
Tax liabilities:
Deferred intangible assets (10,552) (58,284)
Deferred foreign taxes -- (3,941)
Other deferred taxes (7,008) (173)
-------------- ------------
(17,560) (62,398)
-------------- ------------
Net deferred tax liability (1,152) (54,034)
Accrued tax liabilities (74,015) (32,885)
-------------- ------------
$ (75,167) $ (86,919)
============== ============
</TABLE>
24
<PAGE>
The valuation allowance relates to uncertainties surrounding the
recoverability of deferred tax assets. In assessing the realizability of
deferred assets, management considers whether it is more likely than not that
some or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during periods in which benefits from net operating loss
carryforwards are available and temporary differences become deductible. The
Company considers the scheduled reversal of deferred tax liabilities, projected
future taxable income, and other matters in making this assessment. As a result
of its evaluation of these factors at December 31, 1997 the Company recorded a
valuation reserve for deferred tax assets of $161,307 (including $16,600 for
items related to additional paid-in-capital in the Year Ended December 31,
1997). At December 31, 1997, the Company had worldwide net operating loss
carryforwards and other tax benefits of approximately $280,400 for income tax
purposes, expiring from the year 2000 through 2012. The Company expects to
reduce its deferred tax liability in proportion to the amortization taken on
certain intangible assets established in the acquisitions. The reduction of the
intangible assets and the deferred tax liability will not impact future cash
flows of the Company. The utilization of tax loss carryforwards is subject to
limitations under Section 382 of the U.S. Internal Revenue Code, the U.S.
consolidated tax return provisions, and foreign country tax regulations.
Accrued income tax liabilities relates to identified federal, state and foreign
accrued income tax liabilities that are not currently due.
(12) 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.
Acquisition of Mindscape and Sofsource
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 transaction was accounted for using the
purchase method of accounting.
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.
25
<PAGE>
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>
At the date of acquisition the Company originally allocated $103,000 of
the purchase price to in-process technology and the remainder to other
intangible assets. 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 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.
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
26
<PAGE>
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.
27
<PAGE>
(13) Geographic Information
The Company operates primarily in one business segment - software for use
with microcomputers. The following table presents information concerning the
Company's United States, and International (including Canada) operations during
the Years Ended December 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
United States International Eliminations Consolidated
------------- --------------- -------------- --------------
<S> <C> <C> <C> <C>
December 31, 1997
Revenues:
Customers $ 506,623 $ 114,308 $ -- $ 620,931
Inter-company 5,360 11,325 (16,685) --
------------- --------------- -------------- --------------
Total $ 511,983 $ 125,633 $ (16,685) $ 620,931
============= =============== ============== ==============
Loss from operations $(438,590) $ 30,876 $ -- $(407,714)
============= =============== ============== ==============
Identifiable assets $ 441,343 $ 182,431 $ -- $ 623,774
============= =============== ============== ==============
December 31, 1996
Revenues:
Customers $ 428,242 $ 101,286 $ -- $ 529,528
Inter-company 2,438 4,643 (7,081) --
------------- --------------- -------------- --------------
Total $ 430,680 $ 105,929 $ (7,081) $ 529,528
============= =============== ============== ==============
Loss from operations $(347,410) $ 16,975 $ -- $(330,435)
============= =============== ============== ==============
Identifiable assets $ 879,610 $ 90,283 $ -- $ 969,893
============= =============== ============== ==============
December 31, 1995
Revenues:
Customers $ 292,951 $ 48,061 $ (2,376) $ 338,636
Inter-company 696 (3,072) 2,376 --
------------- --------------- -------------- --------------
Total $ 293,647 $ 44,989 $ -- $ 338,636
============= =============== ============== ==============
Loss from operations $ (17,705) $ 8,325 $ -- $ (9,380)
============= =============== ============== ==============
Identifiable assets $ 997,311 $ 64,653 $ -- $1,061,964
============= =============== ============== ==============
</TABLE>
The Company conducts a portion of its operations outside the United States.
At December 31, 1997, $21,857 of cash and cash equivalents were subject to
foreign currency fluctuations. Sales and transfers between geographic areas are
generally priced at market less an allowance for marketing costs. No single
customer accounted for greater than 10% of revenues for any of the periods
presented.
28
<PAGE>
Schedule II
-----------
THE LEARNING COMPANY, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(In thousands)
<TABLE>
<CAPTION>
Additions
--------------------------------------------
Charged
Balance at to cost Charged Balance
beginning and to other at end
of period expenses accounts Deductions(1) of period
-------------- ------------ ----------- ---------------- -------------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1997
Allowance for returns and
doubtful accounts $42,802 $83,659 -- $(78,827) $47,643
Year Ended December 31, 1996
Allowance for returns and
doubtful accounts $30,544 $64,193 -- $(51,935) $42,802
Year Ended December 31, 1995
Allowance for returns and
doubtful accounts $20,109 $50,002 -- $(39,567) $30,544
</TABLE>
(1) Deductions relate to credits issued for returns and allowances against
accounts receivable.
29
<PAGE>
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the supplemental
consolidated financial statements and the notes thereto, and the information
included elsewhere herein. All dollar amounts presented in this Management's
Discussion and Analysis of Financial Condition and Results of Operations are
presented in thousands, except share and per share amounts.
General
Business Combinations
On February 4, 1994, the Company completed a three-way business combination
(the "Three-Party Combination") among SoftKey Software Products Inc. ("Former
SoftKey"), WordStar International Incorporated ("WordStar") and Spinnaker
Software Corporation ("Spinnaker"). The Three-Party Combination was accounted
for using the pooling-of-interests method of accounting. On February 4, 1994,
WordStar changed its name to SoftKey International Inc. and on October 24, 1996
changed its name to The Learning Company, Inc. ("TLC" or the "Company").
On August 31, 1998, the Company acquired Broderbund Software, Inc.
("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
common share of Broderbund was exchanged into 0.80 shares of the Company's
common stock. This acquisition has been accounted for using the pooling-of-
interests method of accounting. The accompanying Supplemental Consolidated
Financial Statements of the Company have been restated to include the results
and balances of Broderbund for all periods presented.
On October 23, 1997, the Company acquired control of Creative Wonders,
L.L.C. ("Creative Wonders"), an educational software company that publishes,
among other titles, the Sesame Street line of products. The purchase price was
a total of $37,799 including the value of employee stock options assumed and
estimated transaction costs. The purchase price included cash payments of
$33,883.
On August 6, 1997, the Company acquired control of Parsons Technology, Inc.
("Parsons'). Parsons is a direct-to-consumer marketing organization which
publishes a range of consumer software. The acquisition has been accounted for
under the purchase method. The purchase price was approximately $31,000 in
cash, including transaction costs.
On January 1, 1997, the Company acquired the remaining 50% interest in the
Living Books joint venture. The acquisition was accounted for under the
purchase method of accounting through the payment of cash and the issuance of
restricted stock, with an aggregate purchase price of approximately $18,370,
including transaction costs.
On September 19, 1997, the Company acquired Learning Services Inc.
("Learning Services"), a national school software catalog for teachers, in
exchange for the issuance of 709,976 shares of common stock. On September 29,
1997, the Company acquired Skills Bank Corporation ("Skills Bank"), a developer
of educational and remedial software products for adult, adolescent and K to 12
students, in exchange for the issuance of 1,069,286 shares of common stock. On
October 2, 1997, the Company acquired Microsystems Software, Inc.
("Microsystems"), a developer of Internet filtering software, in exchange for
the issuance of 955,819 shares of common stock. On December 30, 1997, the
Company acquired TEC Direct, Inc. ("TEC Direct"), an educational consumer
software catalog, in exchange for the issuance of 429,733 shares of common
stock. Each of these transactions was accounted for using the pooling-of-
interests method of accounting. The Supplemental Consolidated Financial
Statements of the Company for the years prior to December 31, 1997 do not
include the results and balances of these companies as they were deemed to be
immaterial to the Supplemental Consolidated Financial Statements for those
periods.
On August 6, 1996, the Company acquired T/Maker Company ("T/Maker"), a
developer of clip art software. The acquisition has been accounted for under the
purchase method. The purchase price was approximately $19,900 in cash,
including transaction costs. The pre-combination results of T/Maker were not
material.
30
<PAGE>
On May 17, 1996, the Company acquired Minnesota Educational Computing
Corporation (MECC) ("MECC"), a publisher and developer of high quality
children's educational software sold to consumers and schools, in exchange for
9,214,007 shares of the Company's common stock. The total purchase price was
$284,631, including estimated transaction costs, value of stock options assumed
and deferred income taxes related to certain identifiable intangible assets
acquired. Approximately 1,048,000 MECC employee stock options were converted
into stock options to purchase approximately 1,198,000 shares of TLC common
stock. This transaction was accounted for as a purchase.
On December 28, 1995, the Company acquired Compton's NewMedia, Inc. and
Compton's Learning Company (collectively, "Compton's"), developers and
publishers of multimedia software titles. In and in connection with the
acquisition, the Company issued a total of 5,052,697 shares of the Company's
common stock, which included 587,036 shares of common stock to settle $14,000 of
intercompany debt due to Tribune Company and executed a promissory note for
$3,000 in cancellation of the remaining intercompany debt. The total purchase
price was $104,394, including estimated transaction costs, deferred income taxes
related to certain identifiable intangible assets acquired, settlement of
certain intercompany debt to Tribune Company and the fair value of net
liabilities assumed. The promissory note was repaid in 1996. This transaction
was accounted for as a purchase.
On December 22, 1995, the Company acquired control of The Learning Company
("The Former Learning Company"), a leading developer of educational software
products for use at home and school. Under the terms of the merger agreement,
the Company acquired, in a two-step business combination, all of the outstanding
shares of The Former Learning Company for total consideration of approximately
$684,066, including the value of stock options assumed, estimated transaction
related costs and deferred income taxes related to certain identifiable
intangible assets acquired. Approximately 1.1 million unvested employee stock
options of The Former Learning Company were converted into options to purchase
3,123,000 shares of the Company's common stock, based on the merger
consideration of $67.50 per share and were vested on or before January 26, 1996.
Approximately $543,163 of the purchase price was settled in cash. This
transaction was accounted for as a purchase.
On July 21, 1995, the Company acquired tewi Verlag GmbH ("tewi"), a
publisher and distributor of CD-ROM software and computer-related books, located
in Munich, Germany. The purchase price was settled by a combination of cash
and issuance of common stock. The Company issued 99,045 shares of common stock
valued at $3,640 and may issue additional shares of common stock to a former
shareholder of tewi pursuant to an earn-out agreement. The Company paid cash
consideration of $12,688 for tewi. The additional shares issuable under the
earn-out agreement have been treated as contingent consideration and will be
recorded if and when certain future conditions are met. During 1997 and 1996,
$498 and $540, respectively, of consideration related to the contingent
consideration was earned and recorded as expense by the Company. This
transaction was accounted for as a purchase.
On August 31, 1995, the Company acquired all of the issued and outstanding
capital stock of Future Vision Holding, Inc. ("Future Vision"), a multimedia
software company, in exchange for the issuance of 1,088,149 shares of common
stock of the Company. This acquisition has been accounted for using the
pooling-of-interests method of accounting. The financial statements for periods
prior to the Year Ended December 31, 1995 do not include amounts for this
acquisition as they were deemed to be immaterial to the Supplemental
Consolidated Financial Statements for those periods.
On April 28, 1995, the Company acquired Banner Blue Software, Incorporated
("Banner Blue"), a developer of genealogy software, in a transaction accounted
for using the pooling-of-interests method. The Company issued 485,600 shares of
common stock in exchange for all the outstanding stock of Banner Blue. The
operating results for Banner Blue were not material to the results of the
Company for all periods prior to the acquisition and therefore results for those
periods have not been restated.
Fiscal Periods
On January 27, 1994, the Company changed its fiscal year end to the 52 or
53 weeks ending on or after December 31. For clarity of presentation herein, all
references to the Year Ended December 31, 1997 relate to the period January 5,
1997 to January 3, 1998. All references to the Year Ended December 31, 1996
relate to the period January 7, 1996 to January 4, 1997; all references to the
Year Ended December 31, 1995 relate to the period January 1, 1995 to January 6,
1996. The balance sheets of the Company as of December 31, 1997 and 1996 have
been
31
<PAGE>
combined with the balance sheets of Broderbund as at November 30, 1997
and as at August 31, 1996, respectively. The statements of operations, cash
flows, and stockholders' equity of the Company for the Years Ended December 31,
1997, 1996 and 1995 have been combined with those of Broderbund for the twelve
month period ended November 30, 1997 and the years ended August 31, 1996 and
1995, respectively. Broderbund results for the period from September 1, 1996
through November 30, 1996 have been omitted from the statement of operations and
have been included as a separate line item in the statement of stockholders'
equity. Revenue, operating income and net income for the period omitted were
$61,491, $13,518, and $8,895, respectively.
Period-to-Period Comparisons
A variety of factors may cause period-to-period fluctuations in the
Company's operating results, including the integration of operations resulting
from acquisitions of companies, revenues and expenses related to the
introduction of new products or new versions of existing products, delays in
customer purchases in anticipation of upgrades to existing products, new or
larger competitors in the marketplace, currency fluctuations, dealer and
distributor order patterns and seasonality of buying patterns of customers.
Historical operating results are not indicative of future operating results and
performance. This is particularly true of historical data presented herein,
certain of which reflects the results of TLC prior to its acquisitions of The
Former Learning Company, MECC and Compton's and the other more recent
acquisitions.
Summary of Results
The following table summarizes the audited results of operations of the
Company for the periods shown. Reference is made to the Supplemental
Consolidated Financial Statements included in this report and on which the
following table is based.
<TABLE>
<CAPTION>
Years Ended
December 31,
-----------------------------------------------
1997 1996 1995
------------- -------------- ------------
<S> <C> <C> <C>
Revenues $ 620,931 $ 529,528 $ 338,636
Operating loss (407,714) (330,435) (9,380)
Net loss (494,910) (376,460) (35,167)
Net loss per share (basic and diluted) $(7.48) $(6.56) $(0.86)
</TABLE>
Operating loss includes amortization, merger and other charges of $543,926,
$503,520 and $103,267 in the Years Ended December 31, 1997, 1996 and 1995,
respectively.
Results of Operations - Year Ended December 31, 1997 as compared to Year Ended
December 31, 1996
Revenues
Revenues by distribution channel for the Years Ended December 31, 1997 and
1996 are as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, % of total December 31, % of total
1997 revenues 1996 revenues
--------------- --------------- --------------- -------------
<S> <C> <C> <C> <C>
Distribution Channel
- --------------------
Retail $320,224 51 $318,734 60
OEM 29,634 5 32,244 6
School 60,796 10 30,776 6
Direct response 92,462 15 53,483 10
International 98,072 16 71,570 14
Tax software and services 19,743 3 22,721 4
--------------- --------------- --------------- -------------
$620,931 100 $529,528 100
=============== =============== =============== =============
</TABLE>
32
<PAGE>
Total revenues increased 17% in the Year Ended December 31, 1997 as
compared to the Year Ended December 31, 1996 primarily due to the introduction
of new software products by the Company such as Reader Rabbit's Toddler, Reader
Rabbit's Preschool, Reader Rabbit's Kindergarten and Reader Rabbit's 1st Grade,
The ClueFinders' 3rd Grade Adventures, The Oregon Trail 3rd Edition, The
American Girls Premiere, and Riven: The Sequel to Myst (R). In the Year Ended
December 31, 1997, provision for returns and allowances as a percentage of gross
revenues increased to 15% from 11% in the Year Ended December 31, 1996 as a
result of shorter product shelf life, changing technology and greater
competition. The Company expects returns and allowances as a percentage of
revenues to remain relatively constant in the foreseeable future.
Retail sales during the Year Ended December 31, 1997 grew due to the
introduction of new and upgraded products by the Company. The Company believes
that the increasing availability of PCs at lower prices have contributed to the
increase in retail revenues. OEM sales declined due to lower demand from
hardware manufacturers but this decline was offset by the revenues derived from
the acquisition of Microsystems. School revenues increased primarily as a
result of sales from the acquisitions of Skills Bank and Learning Services and
due to the introduction of new and upgraded school software titles such as The
Oregon Trail 3rd Edition. Direct response sales increased due to the
acquisition of Parsons, which represented $18,846 of the increase, and continued
expansion of the out-bound telesales channel during 1997. The increase in
direct response revenues was partially offset by a decline in solo direct mail
revenues due to the effect of the Internet and a shift in the Company's product
strategy from productivity and reference products to educational products, which
historically have had a lower response rate in the mail. The international
business continued to expand due to the introduction of 631 new localized and
translated titles during the Year Ended December 31, 1997, and due to the effect
of a full year's results of Edusoft in France and Domus in Holland, which were
acquired in August and September of 1996, respectively. In addition, the
Company entered into several international license and distribution transactions
during the Year Ended December 31, 1997 that increased revenues. Revenues from
tax software and services declined due to fluctuations in the Canadian dollar
exchange rates and the timing of delivery of certain products.
The Company expects that its future revenue growth will depend on, among
other things, its ability to introduce new and upgraded products to the
marketplace, the extent of competition, unit pricing trends, the rate of
proliferation of personal computers into the home market and the demand for its
consumer software products along with the Company's respective share in the
consumer software market. Unit pricing will be affected by the extent of
competition in the consumer software industry, which is expected to increase.
In addition, the Company's ability to develop products for new platforms and
introduce titles into new distribution channels will impact future revenues and
growth rates. The consumer software industry has experienced continued
consolidation of formerly independent companies. To the extent that these
companies gain greater market share than the Company, future results will be
affected negatively. During 1997, the Company and many of its competitors began
using rebate coupons as an incentive to consumers to purchase products and
expand revenues. In addition, the Company uses various forms of print and
television media advertising to enhance brand and product awareness. The use of
these methods of channel marketing and advertising is becoming more prevalent
among the larger consumer software companies. To the extent that the Company
competes with companies larger than itself having more financial resources, it
may not be able to adequately match future channel marketing and advertising
programs, which may in turn result in loss of market share and corresponding
revenues and operating profits.
33
<PAGE>
Costs and Expenses
The Company's costs and expenses and the respective percentages of revenues
for the Year Ended December 31, 1997 as compared to the Year Ended December 31,
1996 are as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, % of total December 31, % of total
1997 revenues 1996 revenues
--------------- ------------- ----------------- --------------
<S> <C> <C> <C> <C>
Costs of production $ 189,219 31 $ 149,304 28
Sales and marketing 156,797 25 102,071 19
General and administrative 48,716 8 39,806 8
Development and software costs 89,987 14 65,262 12
Amortization, merger and
other charges 543,926 88 503,520 95
--------------- ------------- ----------------- --------------
$1,028,645 166 $859,963 162
=============== ============= ================= ==============
</TABLE>
Total costs and expenses increased as a percentage of revenues to 166% in
the Year Ended December 31, 1997 as compared with 162% in the Year Ended
December 31, 1996. The increase was primarily due to the increase in cost of
production and sales and marketing as a percent of revenue, partially offset by
a decline in amortization, merger and other charges as a percentage of revenue.
Costs of production includes the cost of manuals, packaging, diskettes and
CD-ROM discs, 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 to 31% in the Year Ended December 31, 1997 as compared to 28% in the
Year Ended December 31, 1996. The increase in costs of production as a
percentage of revenues was caused by a reduction in the retail selling prices of
certain of the Company's products during the year. The Company expects that
costs of production as a percentage of revenues may continue to increase in the
foreseeable future.
Sales and marketing costs increased to 25% of revenues in the Year Ended
December 31, 1997 as compared to 19% of revenues in the Year Ended December 31,
1996. The increase as a percentage of revenues was a result of increased
spending on coupon rebate programs in the retail channel, higher channel
marketing costs and increased spending for print and television media
advertising.
General and administrative costs as a percentage of revenues were constant
between years. The increase in expenses was due to the 1997 acquisitions.
Development and software costs, as a percentage of revenues, increased to
14% in the Year Ended December 31, 1997 as compared to 12% in the Year Ended
December 31, 1996. The increase as a percentage of revenues was due to higher
costs associated with the development of new products. Overall dollars spent
increased in the Year Ended December 31, 1997 as compared to the Year Ended
December 31, 1996 as a result of the higher cost to develop titles in the Reader
Rabbit multi-subject series as well as The ClueFinders' Adventures and Compton's
Interactive Encyclopedia, each of which have a higher proportion of animation,
graphics and online content than products developed in prior years, and as a
result of the development costs associated with completion of Riven: The Sequel
to Myst(R). In addition, the Company has begun to develop MMX, DVD and Internet
Applet platform-based technologies, which are more expensive to develop than
traditional software code. The Company expects that as technologies become more
complex, it will spend an increasing percentage of its revenues on research and
development.
Amortization, merger and other charges decreased as a percentage of
revenues to 88% in the Year Ended December 31, 1997 as compared to 95% in the
Year Ended December 31, 1996. The amortization, merger and other charges
include, among other things, the amortization of goodwill and other acquired
intangible assets from the acquisitions of The Former Learning Company,
Compton's, Creative Wonders, Parsons, Living Books, T/Maker and MECC plus
certain of the European acquisitions. In addition, the amortization, merger and
other charges for the Year Ended December 31, 1997 include certain exit and
restructuring costs related to centralizing certain administrative functions of
the acquisitions and employee severance. The increase in the dollar amount in
amortization of goodwill
34
<PAGE>
and other intangible assets of $20,500 is also due to inclusion of a full year
of amortization of the goodwill and intangible assets resulting from the
acquisitions of MECC and T/Maker whereas the prior year included amortization
from the acquisition date to the end of that year. In addition, the
amortization, merger and other charges includes a charge for incomplete
technology in the Year Ended December 31, 1997 of $1,050 related to the
acquisition of Creative Wonders, $10,000 related to the acquisition of Parsons
Technology and $9,250 related to the acquisition of Living books and in the Year
Ended December 31, 1996 includes a charge for incomplete technology of $56,688
relate to the acquisition of MECC.
Amortization, merger and other charges are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------
1997 1996
--------------- --------------
<S> <C> <C>
Amortization of goodwill and other intangible assets $455,020 $434,520
Exit and restructuring costs 54,572 4,260
Charge for incomplete technology 20,300 56,688
Provision for earn-outs 5,497 2,917
Professional fees and other costs 8,537 5,135
--------------- --------------
$543,926 $503,520
=============== ==============
</TABLE>
The increase in amortization of goodwill and other intangible assets in the
Year Ended December 31, 1997 as compared to the Year Ended December 31, 1996
related primarily to a full year of amortization of goodwill and other
intangible assets resulting from the acquisitions of MECC and T/Maker in 1996
and a full year of amortization of goodwill and other intangible assets
resulting from the European acquisitions of Edusoft and Domus in August and
September of 1996. During 1997, the amortization of the goodwill and other
intangible assets related to the acquisitions of The Former Learning Company and
Compton's was completed.
Exit and restructuring costs related to charges for employee severance,
discontinued products, termination of certain supplier relationships and other
charges related to the acquisitions. The plan was consummated during the year.
The charge increased in the Year Ended December 31, 1997 as compared to the Year
Ended December 31, 1996 as a result of the 1997 acquisitions and related changes
in strategy related to the school channel and discontinued product. The Company
does not expect the annual cost savings or liquidity improvement resulting from
these actions to be material.
The charge for incomplete technology for the Year Ended December 31, 1997
related to products being developed by Creative Wonders, Parsons, and Living
Books and for the Year Ended December 31, 1996 related to products being
developed by MECC, in each case which the Company believes had not yet reached
technological feasibility and had no future alternative use at the date of
acquisition and for which additional development was required to complete the
software technology and products. In order to develop the acquired incomplete
technology into commercially viable products, the Company was required to
complete development of proprietary code, development of the artistic and
graphic works and design of the remaining storyboards. The in-process
development associated with acquisitions completed in fiscal 1996 and 1995 was
generally completed approximately 16 months from the respective acquisition date
in each of the transactions. In order to complete the development of the
incomplete technology, the Company spent approximately $6,000 (incurred in
fiscal 1996 and fiscal 1997) for the acquisitions completed in fiscal 1996 and
$12,000 (incurred in fiscal 1996 and fiscal 1997) for the acquisitions completed
in fiscal 1995. The Company expects to spend approximately $12,000 to be
incurred in fiscal 1997 and fiscal 1998 to complete the development of
incomplete technology for the acquisitions completed in fiscal 1997.
The provision for earn-outs related to additional payments which were
earned by the former owners of certain acquisitions completed in fiscal 1996 and
fiscal 1995. The earn-out requirements are based upon meeting certain financial
and other goals and are recorded when those conditions are met. The amounts due
are payable in shares of the Company's common stock and are due prior to
December 31, 1998.
Professional fees related to the investment banking, legal and accounting
costs for the acquisitions.
Interest Expense
Interest expense decreased to a net expense of $16,152 in the Year Ended
December 31, 1997 as compared to a net expense of $17,423 in the Year Ended
December 31, 1996 as a result of the repurchase of certain of the Senior
Convertible Notes, offset by the interest costs associated with the sale of
certain trade accounts receivable and by borrowings throughout the year under
the bank line of credit.
35
<PAGE>
Results of Operations - Year Ended December 31, 1996 as compared to Year Ended
December 31, 1995
Revenues
Revenues by distribution channel for the Years Ended December 31, 1996 and
1995 are as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, % of total December 31, % of total
1996 revenues 1995 revenues
--------------- ---------------- ----------------- ---------------
<S> <C> <C> <C> <C>
Distribution Channel
- --------------------
Retail $318,734 60 $215,640 64
OEM 32,244 6 27,119 8
School 30,776 6 11,534 3
Direct response 53,483 10 33,346 10
International 71,570 14 31,544 9
Tax software and services 22,721 4 19,453 6
--------------- ---------------- ----------------- ---------------
$529,528 100 $338,636 100
=============== ================ ================= ===============
</TABLE>
Total revenues increased 56% in the Year Ended December 31, 1996 as
compared to the Year Ended December 31, 1995 due to several factors, including
the effect of revenues from the acquisitions of The Former Learning Company,
Compton's and MECC of approximately $130,000 and the remainder due to an
increase in sales of new and upgraded products launched by the Company during
the year. Retail revenues increased by approximately $103,094 as a result of
the acquisitions of The Former Learning Company, Compton's and MECC plus a
general increase in sales of consumer software products through retailers such
as Wal-Mart, Office Depot, Kmart and OfficeMax and sales from new and upgraded
products. International sales increased primarily as a result of the
acquisition of Edusoft in 1996, a full year of sales from tewi which was
acquired in July 1995 and an increase in the number of translated foreign
language versions of the Company's products available for sale in the
international markets. Original equipment manufacturer ("OEM") revenues
increased due to the availability of new product offerings for this channel and
an increased demand for multi-language titles. Direct response revenues
increased on a dollar basis but decreased as a percentage of revenues due to the
overall increase in revenues resulting from product sales of the acquired
companies, which did not formerly participate in the direct response channel.
Direct response revenues also increased as a result of the introduction of an
outbound telephone sales program during 1996. School revenues increased by
approximately $19,242 as a result of the acquisitions of The Former Learning
Company and MECC. Revenues from tax software and services increased for the
Year Ended December 31, 1996 as compared to the Year Ended December 31, 1995 as
a result of earlier delivery of product to the Company's customers.
Costs and Expenses
The Company's costs and expenses and the respective percentages of revenues
for the Year Ended December 31, 1996 as compared to the Year Ended December 31,
1995 are as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, % of total December 31, % of total
1996 revenues 1995 revenues
--------------- ------------- ----------------- ---------------
<S> <C> <C> <C> <C>
Costs of production $149,304 28 $114,067 34
Sales and marketing 102,071 19 63,513 19
General and administrative 39,806 8 31,898 10
Development and software costs 65,262 12 35,271 10
Amortization, merger
and other charges 503,520 95 103,267 30
-------- --- -------- ---
$859,963 162 $348,016 103
======== === ======== ===
</TABLE>
Total costs and expenses increased as a percentage of revenues to 162% in
the Year Ended December 31, 1996, as compared with 103% in the Year Ended
December 31, 1995. This increase as a percentage of revenues was
36
<PAGE>
caused primarily by the charges for incomplete technology and the amortization
of goodwill and acquired technology resulting from the acquisitions of The
Former Learning Company, Compton's, T/Maker, and MECC, and was partially offset
by the reduction in general and administrative costs and costs of production as
a percentage of revenues as a result of the integration and centralization of
the operations of the acquired companies.
Costs of production includes the cost of manuals, packaging, diskettes and
CD-ROM discs, 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,
decreased to 28% in the Year Ended December 31, 1996 as compared to 34% in the
Year Ended December 31, 1995. The decrease in costs of production as a
percentage of revenues was caused by reduced costs of manufacturing product due
to increased unit volumes, changes in the production components and the impact
from The Former Learning Company and MECC having historically higher gross
margin selling products than the Company prior to their acquisitions. In
addition, during 1996 the Company experienced an increase in revenues in the
OEM, school and direct response channels, all of which typically experience
higher gross margins than the Company's traditional retail box product sales
channel. As well, the Company has seen an increase in sales of its Value line
of products, which, due to the nature of the low cost packaging in a jewel case,
also generates higher gross margins.
Sales and marketing expenses remained constant at 19% of revenues in the
Year Ended December 31, 1996 and the Year Ended December 31, 1995. The
percentage decrease was a result of the Company reducing both fixed costs and
employee headcount of its combined operations following the acquisitions in late
1995 and May 1996.
General and administrative expenses decreased to 8% of revenues in the Year
Ended December 31, 1996 as compared to 10% in the Year Ended December 31, 1995.
This is primarily the result of a general reduction in overhead costs and
employee headcount following the acquisitions in 1995 and 1996.
Development and software costs increased to 12% of revenues for the Year
Ended December 31, 1996 as compared to 10% in the Year Ended December 31, 1995.
The increase is a result of a higher proportion of internally developed products
from The Former Learning Company, Compton's and MECC than developed by the
Company prior to these acquisitions.
Amortization, merger and other charges increased to 95% of revenues in the
Year Ended December 31, 1996 as compared to 30% in the Year Ended December 31,
1995. The increase results from the amortization of the goodwill and other
intangible assets arising on the acquisitions of The Former Learning Company,
Banner Blue and Compton's for a full year in the Year Ended December 31, 1996
and from the amortization of goodwill and other intangible assets and the charge
for incomplete technology arising from the acquisition of MECC and T/Maker in
1996.
Amortization, merger and other charges are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------
1996 1995
--------------- ----------------
<S> <C> <C>
Amortization of goodwill and other intangible assets $434,520 $32,063
Charge for incomplete technology 56,688 60,483
Employee severance costs 4,260 1,304
Provision for earn-outs 2,917 --
Professional fees and other costs 5,135 6,784
Provision for litigation -- 2,633
-------- --------
$503,520 $103,267
======== ========
</TABLE>
The increase in amortization of goodwill and other intangible assets in the
Year Ended December 31, 1996 as compared to the Year Ended December 31, 1995
relates primarily to the amortization resulting from the acquisitions of MECC
and T/Maker in 1996 and a full year of amortization of goodwill arising from The
Former Learning Company, Banner Blue and Compton's, which were acquired in 1995.
Goodwill and other intangible assets are primarily being amortized on a
straight-line basis over two to ten years.
The charge for incomplete technology for the Year Ended December 31, 1996
relates to products being developed by MECC and for the Year Ended December 31,
1995 for products being developed by The Former Learning
37
<PAGE>
Company and Compton's which the Company believes had not yet reached
technological feasibility at the date of acquisition and for which additional
development was required to complete the software technology and products.
Employee severance costs in each year related to severance paid to
employees of the Company terminated in connection with the acquisitions.
The provision for earn-outs relates to additional payments which may be
earned by the former owners of certain international companies purchased in 1996
and 1995. The earn-out requirements are based upon meeting certain financial
and other goals and will be recorded when those conditions are met.
Professional fees and other costs decreased in the Year Ended December 31,
1996 as compared to the Year Ended December 31, 1995 due to decreased charges
related to the investment banking, legal and accounting costs.
Interest Income (Expense)
Interest income (expense) increased to a net expense of $17,423 in the Year
Ended December 31, 1996 as compared to interest income of $10,955 in 1995 as a
result of increased interest expense arising from the Senior Convertible Notes
issued by the Company in 1995.
Liquidity and Capital Resources
Cash and short-term investments decreased from $261,013 at December 31,
1996 to $188,956 at December 31, 1997. This decrease was attributable to the
repurchase of $28,000 of 5-1/2% Senior Convertible Notes due 2000 (the "Senior
Convertible Notes") and repurchase of common stock of $14,573 offset by cash
generated from operations of $104,455. The Company also paid $33,500 during
the year to acquire control of Creative Wonders, $31,000 to acquire Parsons and
$18,370 to acquire Living Books, all of which were offset by the net proceeds of
$57,462 from the issue of the special warrants in Canada. Included as a use of
cash from operating activities is $25,115 of interest related to the Senior
Convertible Notes and the 5-1/2% Senior Convertible/Exchangeable Notes due 2000
formerly held by Tribune Company (the "Private Notes").
On August 1, 1996, the Company announced that its Board of Directors
authorized the repurchase by the Company over the next twelve months of up to
$50,000 principal amount of its Senior Convertible Notes from time to time in
the open market and privately negotiated transactions. Any purchases would
depend on price, market conditions and other factors. During the Year Ended
December 31, 1997, the Company repurchased $28,000 of Senior Convertible Notes.
As of September 24, 1998, the Company has outstanding $190,955 long-term
principal amount Senior Convertible Notes. The Senior Convertible Notes will be
redeemable by the Company on or after November 2, 1998 at declining redemption
prices and are due on November 2, 2000. 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 refinance the notes under favorable
terms or at all.
On December 5, 1997, the Company issued an aggregate of 750,000 shares of
Series A Convertible Participating Preferred Stock (the "Preferred Stock") to an
investor group. The Preferred Stock was issued in exchange for $150,000
principal amount of the Private Notes, which the investor group purchased from
Tribune Company in a private transaction. Each share of the Preferred Stock has
an initial liquidation preference of $200 and is initially convertible into 20
shares of common stock, subject to adjustment. The Preferred Stock is non-
redeemable, bears no dividend, is subject to restrictions on resale for a period
of at least eighteen months and is manditorily convertible into common stock
upon satisfaction of certain conditions. The retirement of the Private Notes
will reduce the Company's future annual interest expense by $8,250.
On November 6, 1997, the Company's Canadian subsidiary, SoftKey Software
Products Inc. ("SoftKey"), issued 4,072,000 special warrants in a private
placement in Canada for net proceeds of $57,462 . Each special warrant is
exercisable without additional payment for one exchangeable non-voting share of
SoftKey (an "Exchangeable Share"). The Exchangeable Shares are exchangeable at
the option of the holder on a one-for-one basis for common stock of the Company.
The proceeds of the private placement were used to acquire a 100% equity
interest in Creative Wonders for $33,500, and the remainder was used for general
corporate purposes.
38
<PAGE>
The Company has in place a revolving line of credit (the "Line") with Fleet
Bank, as agent for a bank syndicate, to provide for a maximum availability of
$147,500, as amended on August 7, 1998, of which $35,000 was outstanding at
December 31, 1997. Borrowings under the Line become due on July 1, 1999 and
bear interest at the prime rate (8 1/2% at December 31, 1997). 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 Line is guaranteed by the Company.
In addition, the Company has a European accounts receivable factoring facility
under which it can sell up to $25,000 of European accounts receivable on a
recourse basis to its banks.
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 up to $100,000 on a
revolving basis during a five year period ending September 30, 2002. The
Company acts as servicing agent for the sold receivables in the collection and
administration of the accounts.
On October 23, 1997, the Company acquired control of Creative Wonders for a
total purchase price of approximately $37,799, which included $33,883 of cash
($33,500 of which had been paid at year end), the value of employee stock
options assumed by the Company and estimated transaction costs.
On August 6, 1997, the Company acquired control of Parsons Technology
("Parsons'). Parsons is a leading direct-to-consumer marketing organization and
has an experienced product development group. The acquisition has been
accounted for under the purchase method. The purchase price was approximately
$31,000 in cash, including transaction costs.
On January 1, 1997, the Company acquired the remaining 50% interest in the
Living Books joint venture. The acquisition was accounted for under the
purchase method of accounting and was accomplished by a combination of cash and
restricted stock, with an aggregate purchase price of approximately $18,370,
including transaction costs.
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.
The Company conducts portions of its business in currencies other than U.S.
dollar. The Company does not expect that it will incur any significant risk of
currency translation loss due to fluctuations in those other currencies as the
amounts are not material.
The Company has expensed all costs incurred in connection with Year 2000
system conversions. The amounts incurred and expected to be incurred are not
material.
In the Year Ended December 31, 1997, revenues derived for the school and
international channels increased by $56,522, each of which has a slower customer
collection cycle and also requires a higher level of inventory on-hand due to
the higher number of title offerings and smaller production size requirements.
In addition, in the Year Ended December 31, 1997, the Company completed a number
of acquisitions, some of which involve catalog operations. Such operations,
relative to the Company's operations, require a greater number of software title
offerings and also have a slower accounts receivable collection pattern.
Management believes these changes in channel mix have caused an increase in the
accounts receivable aging and a decrease in inventory turnover as compared to
the prior year. The Company expects that as revenues derived from these
channels and from catalogs represent a greater proportion of its overall
business, accounts receivable aging may increase and inventory turns may
decrease correspondingly.
At the present time, the Company expects that its cash and short-term
investments and 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
39
<PAGE>
computer market. In addition, the Company's remaining long-term portion of the
Senior Convertible Notes totaling $190,955, mature in November 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.
40
