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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K
                                  ANNUAL REPORT
                               -------------------

[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
      ACT OF 1934 (Fee Required) For the fiscal year ended December 31, 1997 or

[ ]   TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE EXCHANGE ACT
      OF 1934 (No Fee Required)

                         Commission File Number 0-28330

                              LEGACY SOFTWARE, INC.
             (Exact name of registrant as specified in its charter)

                 Delaware                             95-456-1156
    (State or other jurisdiction of         (IRS Employer Identification No.)
      information or organization)


            5340 Alla Road
         Los Angeles, California                              90066
  Address of principal executive offices)                   (Zip Code)


       Registrant's telephone number, including area code: (310) 823-2423
                                -----------------
        Securities registered pursuant to Section 12(b) of the Act: None

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


                                                       Name of exchange on
       Title of each class                              which registered
  Common Stock, $.0001 par value                      NASDAQ SmallCap Market

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

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

     As of March 27, 1998, there were 2,655,002 shares of the registrant's
Common Stock outstanding. The aggregate market value (based on the average bid
and asked prices of the Common Stock on the NASDAQ Small Cap Market) of the
voting stock held by non-affiliates of the registrant on March 27, 1998 was
$1,825,314.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the registrant's definitive proxy statement for the
registrant's Annual Meeting of Stockholders which is scheduled for May 28, 1998
have been incorporated by reference into Part III of this Report

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                                     PART I


     Except for historical information contained herein, the statements in this
report (including without limitation, statements indicating that the registrant
"expects" "estimates" "anticipates" or "believes" and all other statements
concerning future financial results, product offerings or other events that have
not yet occurred) are forward-looking statements that are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995,
Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A
of the Securities Act of 1933, as amended. Forward-looking statements involve
known and unknown factors, risks and uncertainties which may cause the
registrant's actual results in future periods to differ materially from
forecasted results. Those factors, risks and uncertainties include, but are not
limited to: the registrant's ability to ( i) restructure its outstanding
indebtedness by reaching agreement with creditors to convert a sufficient amount
of such indebtedness into Common Stock or Preferred Stock of the registrant so
that the remainder of such indebtedness can be paid as it comes due, and (ii) to
effect a business combination or strategic alliance with another company, in
order to continue operating as a going concern; the positioning of the
registrant's products in the registrant's market segments; the registrant's
ability to effectively manage its various businesses in a rapidly changing
environment; the timing of new product introductions; retail sell-through of the
registrant's products; the continued emergence of the Internet, resulting in new
competition and changing consumer demands; the registrant's ability to adapt and
expand its product offerings in light of changes to and developments in personal
computer platforms and the Internet environment; growth rates of the
registrant's market segments; variations in the cost of, and demand for,
customer service and technical support; price pressures and the competitive
environment in the consumer software and edutainment industry; the possibility
of programming errors or other "bugs" in the registrant's software games and
Internet technology; the registrant's ability to establish itself successfully
as a software developer, publisher and distributor ; the emergence of
competition from new and existing software gaming and Internet companies; the
timing and consumer acceptance of new product releases and services (including
current users' willingness to upgrade from older versions of the registrant's
products); the consummation of possible acquisitions; and the registrant's
ability to integrate acquired operations into its existing business and manage
growth. Additional information on these and other risk factors are included
under "Risk Factors" and elsewhere in this Form 10-K.

     As of December 31, 1997, the Company had (i) never achieved operating
profits, (ii) had negative working capital of $672,039 and cash on hand of
$14,464, (iii) total short term indebtedness of $783,619, and long term
indebtedness of $161,882, (iv) ceased development of new titles pending the
generation of additional working capital or the implementation of subcontractor
relationships on terms that permit payments to be made by the Company when it
has cash available to make such payments, (v) curtailed its internet gaming
services, (vi) closed one of its business offices, (vii) significantly reduced
marketing and public relations efforts, and (viii) reduced its total number of
employees to four. Revenues from the Company's Emergency Room and derivatives
thereof are continuing to decrease, and revenues from the D.A. Pursuit of
Justice title have been lower than expected. These conditions raise substantial
doubt about the Company's ability to continue as a going concern. On February
28, 1998, the Company was notified by The Nasdaq National Market, Inc.
("NASDAQ") that the Company is not in compliance with NASDAQ's net tangible
assets/market capitalization/net income and



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minimum bid price requirements, and that absent compliance, the Company's Common
Stock will be delisted from the NASDAQ SmallCap Exchange.

     The Company believes that should it not be able to obtain funding to
supply its near-term cash requirements, there is substantial doubt about the
Company's ability to continue operations.

     The Company has pursued various funding alternatives, but has not been able
to obtain either the debt or equity financing it requires. On March 25, 1998,
the Company signed a non-binding letter of intent (the "Letter of Intent") with
Black Tusk Medical, Inc. ("BTI"), a Nevada corporation engaged in the business
of marketing and distribution of software titles. Pursuant to the Letter of
Intent, BTI advanced the Company $30,000 toward two proposed joint ventures for
the development and publication of high production value educational software,
and will purchase 260,000 shares of the Company's Common Stock for $130,000
within five days following execution of a definitive Merger Agreement. If the
Merger is consummated, the foregoing 260,000 shares would become authorized but
unissued shares of Common Stock and the shareholders of BTI would receive
1,922,588 shares of the Company's Common Stock, at a valuation of $0.40 per
share. As a result, following the merger, the shareholders of BTI will hold
approximately 42% of the total outstanding shares of the Company.

     The Company believes that it will be able to complete the Merger, and its
prospects for obtaining additional financing will improve as a result thereof.
However, the Company has not been able to identify other viable financing
alternatives at the present time, and there can be no assurance that the
transactions contemplated by the Letter of Intent ultimately will be effected on
terms acceptable to the Company, or at all.

     However should this transition not be successful the Company could face
short term liquidity requirements that could significantly deplete its current
cash resources. If this occurs the Company believes that liquidity requirements
can be satisfied by ceasing costs associated with development of future titles,
significantly curtailing its Internet gaming services, finding new affiliate
arrangements for future titles and seeking additional financing.

     Additionally, although the Company believes that its operating plan and
efforts will be adequate to meet its fiscal 1998 working capital needs there can
be no assurance that the Company may not experience liquidity problems caused by
adverse market conditions or other unfavorable events.


ITEM 1.  BUSINESS.


GENERAL

     Legacy Software, Inc. ("Legacy" or the "Company") was organized in
California in 1989 as a successor to a partnership formed in 1986, and was
reincorporated in Delaware in 1996. The principal offices of the Company are
located at 5340 Alla Road, Los Angeles, California 90066, and its telephone
number is 310/823-2423.



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     The Company develops mind stimulating CD-ROM and Internet games which
entertain as well as educate. Since its incorporation, the Company has created
several best selling "edutainment" software titles, including Children's Writing
and Publishing Center (published by The Learning Company), Mickey's Crossword
Puzzle Maker (Walt Disney), Mutanoid Math Challenge, Mutanoid Word Challenge and
Magic Bear's Masterpiece (published by Legacy). An edutainment product combines
entertainment and education content for home and educational use and makes
learning an integral part of playing a game. In 1995, the Company introduced its
first title in the Company's RealPlay(TM) (formerly Career Sim(TM)) series,
Emergency Room, marketed by its then co-development partner International
Business Machines Corporation ("IBM"). In 1997, the Company introduced a second
title in the Company's RealPlay series D.A. Pursuit of Justice(TM) and Emergency
Room Intern(TM), a Win95 enhanced version of Emergency Room(TM) featuring 50 new
cases both of which are distributed through a marketing and distribution
agreement with Alpha Software Corporation ("Alpha Soft"). See "Management's
Discussion and Analysis of Financial Condition and Results of Operations".

     In addition to CD-ROM development, in 1997 the Company created an Internet
game and information service, the Passport2(TM) Network. Passport2 enables users
to compete with one another via the Internet. This Internet service is based on
proprietary Win95 client server technology developed by On The Toes of Giants, a
California corporation ("OTTOG"), substantially all of the assets of which
Legacy acquired in August, 1996.

INITIAL PUBLIC OFFERING

     In May, 1996, the Company completed an initial public offering of 1,150,000
shares of its common stock, $.0001 par value per share ("Common Stock"). Net
proceeds to the Company were $5,198,048 after deducting all offering-related
expenses. During 1996 and 1997, the Company used the majority of such proceeds
for the development of additional RealPlay(TM) titles, including the first three
episodes of the D.A. Pursuit of Justice title, the Emergency Room Intern title
and the Best of Emergency Room title, all of which were released in by the
Company in 1997 , development of three additional episodes of the District
Attorney title, the launching of Passport2, the Company's internet gaming
technology, repayment of certain outstanding indebtedness and for working
capital purposes.

ACQUISITION OF RESEARCH AND DEVELOPMENT

     In August, 1996, the Company acquired substantially all of the assets,
properties and rights of OTTOG, pursuant to an Asset Purchase Agreement, dated
August 19, 1996, which consisted primarily of purchased research and
development. The consideration for the purchased assets consisted of 33,334
newly-issued shares of the Company's Common Stock and the assumption by the
Company of certain liabilities of OTTOG. The transaction was valued as of August
30, 1996, the closing date, based on the last sales price of $7.00 per share of
the Common Stock on the NASDAQ SmallCap Market on such date, and the aggregate
purchase price of the transaction, $233,338, was recorded as an expense of
product development. The Company has developed and operates a separate
Internet-oriented business unit based upon the purchased research and
development. See



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"Risk Factors--Management of Growth; Uncertainties Relating to Acquisitions and
New Businesses."

PRIOR BUSINESS AFFILIATIONS

     In February of 1997 the Company signed a letter of intent to acquire
certain assets and liabilities of Educorp Multimedia, Inc. ("Educorp"), a
California-based multimedia software publisher, and its wholly-owned
subsidiaries Educorp Direct, Inc. and High Text Interactive, Inc. The total
proposed consideration of $1,800,000 was to be payable in shares of Common
Stock. The actual number of shares was to be based on the average closing price
of the stock for the 30 days following the closing of this transaction, subject
to a minimum of 425,000 shares. The negotiation for the acquisition of Educorp
was terminated on June 30, 1997.

     On June 27, 1997 the Company signed a non-binding letter of intent to
acquire all of the outstanding stock of Canyon Interactive, LLC ("Canyon"), a
California limited liability company. The total proposed consideration was to be
$750,000 in cash and $1,000,000 payable in shares of the Company's Common Stock.
The actual number of shares was to be determined based on the price of the
Company's Common Stock from June 27, 1997 until the consummation of the
transaction. On September 29, 1997 the Company and Canyon mutually agreed to
terminate negotiations.

PENDING BUSINESS AFFILIATION

     In January, 1998, the Company signed a non-binding Letter of Intent with
Black Tusk Medical, Inc. , a Nevada corporation ("BTI") to joint venture the
development and publishing of high production value educational software. BTI as
a part of a $3.5 million financing program will make an equity investment in the
Company. The Letter of Intent was superseded by a revised Letter of Intent dated
March 25, 1998. Pursuant to the revised Letter of Intent BTI and Legacy will
pursue joint venture programs for the development and distribution of up to four
product-oriented joint ventures, including new titles in the Company's
RealPlay(TM) series--Emergency Room and D.A. Pursuit of Justice. To date BTI has
advanced the Company $30,000 toward two of the proposed joint ventures.
Utilizing the joint venture vehicle the Company and BTI intend to obtain funding
from third parties to produce, market and distribute the Company's titles in the
retail, OEM, educational and professional markets worldwide. The Company and BTI
will share in any revenue received from each joint venture after the initial
funding to the third party investors has been repaid. Additionally, BTI will
purchase 260,000 shares of the Company's Common Stock for $130,000 within five
days following execution of a definitive Merger Agreement. If the Merger is
consummated, the foregoing 260,000 shares would become authorized but unissued
shares of Common Stock and the shareholders of BTI would receive 1,922,588
shares of the Company's Common Stock, at a valuation of $0.40 per share. As a
result, following the merger, the shareholders of BTI would hold approximately
42% of the outstanding shares of the Company. However, there can be no assurance
that the transactions contemplated by the Letter of Intent ultimately will be
effected on terms acceptable to the Company, or at all. See "Risk
Factors--Management of Growth; Uncertainties Relating to Acquisitions and New
Businesses; Management's Discussion and Analysis of Financial Condition and
Results of Operations"

MARKETING AND DISTRIBUTION AND CORPORATE SERVICES AGREEMENTS

     On July 31, 1997, the Company and Alpha Soft Corporation ("Alpha Soft")
entered into a Distribution Agreement for D.A. Pursuit of Justice cases 1
through 3 and the Emergency Room Intern titles. Under the terms of the Agreement
Alpha Soft will produce, market and distribute the titles and the Company will
receive a royalty on each sale.


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     On June 5, 1997, the Company entered into an Information Provider
Commission Agreement with AT & T WorldNet Service ("WorldNet") whereby customers
of WorldNet are offered the opportunity to participate in Passport2Network
interactive games. The Passport2Network pays WorldNet a percentage of
advertising revenue.

     On October 14, 1997, the Company signed an Information Provider Commission
Agreement with The New York Times Electronic Media Company ("Times on Line")
whereby subscribers of the Times On Line Bridge and Chess columns have the
opportunity to participate in Passport2Network interactive games under terms
similar to the WorldNet agreement.

     On January 8, 1998, the Company signed an Information Provider Commission
Agreement with Earthlink Networks, Inc. whereby subscribers have the opportunity
to participate in Passport2Network interactive games under terms similar to the
WorldNet agreement.

PRODUCTS AND SERVICES

CD-ROM TITLES

     Emergency Room, an interactive game which the Company co-developed with
IBM, is the first RealPlay(TM) title designed to give teenagers and adults a
realistic experience of a particular career. In this game, the player begins as
a medical student who can work his or her way up the ranks to become the
attending physician by successfully completing 400 different medical cases. The
player examines, diagnoses and treats patients whose problems range from simple
broken bones to gunshot wounds. From October, 1995, to Summer, 1997, IBM
distributed over 160,000 units of this DOS-based title through the consumer
retail channel. In addition, from September 1997 through December , 1997, Alpha
Soft has distributed over 45,000 units of Emergency Room Intern. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".

     The Company and IBM entered into a Development and Licensing Agreement,
(the "DA License Agreement") on November 16, 1995. The D.A. Pursuit of Justice
title is the Company's second RealPlay(TM) title. In the fourth quarter of 1996
the Company and IBM mutually agreed to terminate the DA License Agreement with
respect to the D.A. Pursuit of Justice title. As consideration for the
termination and for acquisition of IBM's rights under the DA License Agreement,
the Company was obligated to pay IBM an aggregate sum of $400,000, which sum
represents the total amount of milestone payments made by IBM to the Company
under the DA License Agreement. The final termination agreement, effective
January 3, 1997, provides for payment to IBM based upon a fixed percentage of
royalty payments received, or net revenue generated if the Company distributes
the software directly, with payment in full required by December 15, 1997. In
the event that the Company breaches its obligation to pay IBM the aggregate sum
of $400,000 by December 15, 1997, as royalties and final payment, the total
amount due IBM will be increased by interest at the annual rate of 10% and
continuing on the unpaid balance until paid in full. The Company recorded a
$400,000 current liability at December 31, 1996 to account for the payments
under the termination agreement which effectively increased the capitalized
software development costs related to the D.A. Pursuit of Justice title. On
December 15, 1997 the Company was unable to make the payment to IBM. The Company
and IBM have reached an agreement in principal whereby the Company will pay
$25,000 to IBM and IBM will receive a royalty on revenues generated from the ER
Intern. ER Deluxe and DA Pursuit of Justice titles up to a total of an
additional $175,000 plus interest at 10 percent. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations".

     Developed as a six-part series, D.A. Pursuit of Justice builds on the
public's fascination for high profile criminal cases and explores what it is
like to be a district attorney. Similar to Emergency Room, the game is developed
around an underlying database of accurate information relating to a



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specific career. While it is not necessary to be a lawyer or doctor in order to
be successful at these games, thinking like one while playing certainly helps.
The game includes cutting edge technology and production values, such as
full-motion video and 16 bit color.

PRODUCT RELEASES

     During 1997 the Company released the following products:

     D.A. Pursuit of Justice, The Sunset Boulevard Deuce, The Gatsby Diamond
Jewelry Theft and The Rat Tattoo Murder were released in Summer , 1997.
Individual episodes were distributed by the Company through direct mail and the
Internet. The three episodes combined in a series were distributed by Alpha
Soft in retail stores beginning in September, 1997.

     The Best of Emergency Room, an abbreviated version of the original DOS
title consisting of 50 of the original 400 cases contained in Emergency Room,
was released and distributed by the Company in Summer, 1997.

     Emergency Room Intern, the Windows 95 enhanced version of Emergency Room
containing 50 new cases, was released and distributed by Alpha Soft in Fall,
1997.

     In 1998 the Company, financed through a series of joint ventures with BTI,
plans to release three more episodes of D.A. Pursuit of Justice, The Orange
Grove Teenage Arson, The Beverly Hills Burglary and The Murder at the Bordeaux
Motel, and Emergency Room Deluxe, a Win95 version of the original Emergency Room
featuring new 3-D hospital graphics and containing one hundred cases from
Emergency Room. It has not yet been determined how the new products will be
distributed.

THE PASSPORT2 NETWORK

     Passport2 is a distributed software technology that allows
client/server-based games to be played across the Internet with usage and
billing information tracked at a central location. Passport2's categories of
games and activities include: Passport2Compete; Passport2Learn; and
Passport2Participate. The Company launched its family multiplayer network in
November, 1996 and currently has the following five games actively on the
network: bridge, chess, backgammon, Intelligentsia (trivia) and Spell- O- rama.
In 1997 and 1998 the Company negotiated information provider agreements with AT
& T WorldNet Service., The New York Times Electronic Media Company and Earthlink
Networks, Inc. whereby customers of each company are offered the opportunity to
participate in Passport2Network interactive games. The Passport2Network pays
each company a percentage of advertising revenue. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and "Risk
Factors--Management of Growth; Uncertainties Relating to Acquisitions and New
Businesses" and "--Rapidly Changing Technologies and Markets".

INTERACTIVE SERVICES DIVISION

     In December, 1997 the Company launched an Interactive Services Division
for the purpose of marrying its interactive design expertise and high production
values with corporate sales and



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marketing goals. The primary mission is to bring the fullest range of
interactive solutions to business clients in the communications, advertising,
educational and entertainment industries.

     On January 15, 1998, the Company signed a Certificate of Authorship and
Services Agreement with Addison Wesley Longman, Inc. ("AWL") to develop and
provide an interactive sales demonstration for the AWL Waterford Early Reading
Program, Levels 1 and 2.

     On March 10, 1998, the Company signed a Certificate of Authorship and
Services Agreement with Polar Vision, Inc. to develop CD-ROM Website and printed
materials for Polar Vision's product lines.

RESEARCH AND DEVELOPMENT

     The Company's research and development program consists primarily of
activity relating to the early development stages of game titles and the
development of new product concepts. The Company has developed a unique,
flexible and effective product development approach which integrates the
expertise of various disciplines as well as market research in all stages of
development. There are four phases in the Company's development process which
consist of the concept phase, prototype phase, production phase and the quality
assurance phase. The Company's research and development expenses for a
particular period will consist of all costs incurred on projects, both CD-ROM
and Internet, for which technological feasibility has not yet been attained. In
accordance with Statement of Financial Accounting Standards No. 86, the Company
determines technological feasibility based upon the completion of a detailed
program design, after which time development expenses for a particular project
will be capitalized. Product development expenses are presented in the Company's
financial statements net of co-funded development expenses and primarily include
personnel expenses associated with both creative developers and programmers, and
costs associated with external video production for use in the Company's
software titles. For the years ended December 3l, 1997, 1996, and 1995 net
product development expenses were $619,507, $1,664,478, and $72,951,
respectively. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations".

COMPETITION

     Each of the computer software development, Internet technology and software
retail distribution industries is intensely competitive. The Company's
competitors in each industry range from small companies with limited resources
to large, more established companies which have significantly greater assets and
greater financial, technical and personnel resources than those of the Company.
The Company expects competition to continue and increase in each of these market
segments.

COMPANY STRATEGY


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     Legacy's objective is to establish itself as a leading developer of
edutainment, infotainment, and simulation software products. To achieve this
objective, the Company has identified the following factors as critical to its
success: interactive design and development capability, product branding,
distribution partnerships, financial model and Internet strategy.

     Interactive Design and Development Capability. Legacy continues to maintain
its software development capability through its management of production joint
ventures with BTI, as well as through projects in its Interactive Services
division. Legacy employees remain responsible for interactive and conceptual
design of its various CD-ROM products; however, most of the graphic production
and programming is done currently by outside contractors, under the supervision
of Legacy management.

     During 1998, the Company expects to complete the remaining three episodes
of D.A. Pursuit of Justice, complete Emergency Room Deluxe, and begin
development of ER Code Blue, although there can be no assurance that the
products will be completed as planned. The Company is also prepared to create
DVD versions of its products as the market for that medium evolves. The Company
believes that the Emergency Room and D.A. Pursuit of Justice series have the
potential to become "evergreen" products which, if successfully marketed, may be
developed into new versions and cases in the future.

     Product Branding. Legacy is attempting to build awareness of its company
name ("Legacy"), its product names ("Emergency Room" and "D.A. Pursuit of
Justice"), and its product series name ("RealPlay"). Until recently, however,
Legacy has been unable to successfully exploit many branding opportunities. As a
developer, Legacy's trademarks were less visible on the retail box as compared
to the publisher's trademarks. Through participation in distribution and
affiliate label relationships as negotiated by the BTI Production Joint
Ventures, the Company believes that its brands will become more recognizable to
consumers in the future.

     Distribution Partnerships. Currently Legacy distributes its retail products
through other companies, specifically Alpha Soft. While this approach provides
the Company's products with access to the retail channel, it has disadvantages.
First, as mentioned previously, it is more difficult for the Company to build
its own product and company branding in such a relationship. Second, Legacy is
not able to fund sufficient consumer marketing to "pull" products off the
shelves of retailers.

     In 1998 the Company anticipates entering a series of production joint
ventures ("PJV") with BTI. A PJV is similar to a cinema production joint
venture; it has investors and a lead team of managers (directors, producers, and
accounting personnel) working with a contracted development team (Legacy) on a
project funded by outside investors. Legacy anticipates that each of its new
1998 products will be part of a unique PJV, with a team dedicated to the
development and success of the particular project. There are a number of
advantages to this approach to software development and distribution, including
the fact that Legacy can share the risks/costs of product development with its
PJV partners. In addition, the cost of the product development and marketing is
off-balance sheet, enabling the Company to preserve its liquidity for other
activities. Other participants in the PJVs will include companies with access to
different distribution channels. The current assumption is that the products
will be distributed in the retail channel through an affiliated label
relationship, with the PJV



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assuming responsibility for packaging, manufacturing and marketing costs. In
addition, the PJV for each product will also exploit sales in alternative
markets, such as K-12 schools, colleges and professional segments. Unique
versions of Emergency Room and D.A. Pursuit of Justice, including alternative
packaging and pricing will be made available for continuing education for adults
in both legal and medical fields.

     Financial Model. Legacy has participated in a number of different types of
financial models for the development and distribution of its RealPlay software.
With IBM, Legacy co-funded the development of Emergency Room, and IBM
manufactured, published, and distributed the title in the retail channel. With
Alpha Soft, Legacy has funded the development of Emergency Room Intern and
D.A. Pursuit of Justice, and Alpha Soft manufactures, publishes and distributes
the titles in the retail channel.

     Internet Strategy. The acquisition of OTTOG in August, 1996 provided the
Company with the opportunity to develop an internet gaming network with the goal
of providing superior family entertainment and educational content on-line. The
Company introduced the Passport2Network in November, 1996. The Network
currently contains five games: bridge, chess, backgammon, Intelligentsia, and
Spell-o-rama. In 1997 and 1998, the Company negotiated information provider
agreements with AT&T WorldNet Service, The New York Times Electronic Media
Company and EarthLink Networks, Inc., whereby customers of each company are
offered the opportunity to participate in Passport2 games. In exchange, the
Passport2Network pays each Company a percentage of advertising revenue.

SEASONALITY; SHELF LIFE, QUARTERLY FLUCTUATIONS IN REVENUE AND OPERATING RESULTS

     The Software Marketplace - Estimates indicate that the entire interactive
software market, all areas, will be approximately $8 billion in 1998; of that,
the consumer software market (i.e., retail sales of non-utility, interactive
units) is approximately $5.5 billion. The edutainment marketplace is expected to
round-out at approximately $1.8 billion in 1998 and it is growing at an annually
compounding rate of 17%. This slice of the market is expected to represent about
27% of the total marketplace.

     The Company believes that the growth of multimedia computers containing
CD-ROM drives, the introduction of DVD technology and the increasing interest in
on-line services through the World Wide Web on the Internet will result in
increased demand for consumer and school software utilizing the graphic sound
and data capabilities of such hardware technology. See "Risk
Factors--Competition".

     Fourth quarter holiday sales represent a significant amount of sales that
can be expected in the retail channel from an edutainment software product.
Typically, sales are highest during the fourth quarter, decline in the first
quarter and are lowest in the second and third quarters. This seasonal pattern
is due primarily to the increased demand for the Company's products during the
calendar year-end holiday selling season. Other fluctuations in retail sales are
related to the school market, which generally purchases most products at the
beginning of the school year in September or in late spring, when software
budgets must be expended. The Company believes that potential OEM or



<PAGE>   11

hardware and software bundling opportunities exist year-around. The average
entertainment title has a product life span of approximately 18 months. The
average educational title has a product life span of approximately three years.
The Company believes that the shelf life of the RealPlay(TM) titles will be
longer than the typical entertainment title because of the sophisticated and
educational content of such products. See "Risk Factors--Significant Quarterly
Fluctuations in Revenue and Operating Results and Related Factors" and
"--Seasonality".

     The Company's quarterly operating results have fluctuated significantly in
the past, and are likely to fluctuate significantly in the future, based on a
number of factors. In addition to the seasonal factors discussed above, the
Company's quarterly operating results can be affected significantly by the
number and timing of new product releases by the Company, the Company's ability
to recognize revenue in accordance with SFAS 48, expenditures and a variety of
non-recurring events, such as acquisitions.

PROPRIETARY RIGHTS

     The Company regards its technology as proprietary and relies primarily on a
combination of trademark, copyright, trade secret laws, employee and third-party
non-disclosure agreements and other methods to protect its proprietary rights.
The source code for the Company's proprietary software is protected both as a
trade secret and as an unpublished and unregistered copyrighted work.

     Products in the market and under development contain proprietary software
which is comprised of the manager routines and system code for such products. In
addition, since the release of Emergency Room the Company has made improvements
in the software manager routines and system code for use in its products
currently under development and products contemplated at a future date. The
Company has registered trademarks in the United States for both its Company name
and certain of its product names and has pending trademarks and copyrights for
certain additional product names. The Company believes that trademarks and
copyrights are important and significant to the Company's success, as are other
factors such as the knowledge, ability and experience of the Company's personnel
and the Company's research and development program.

     Legacy's tools, techniques and processes support the full range of
interactivity and high resolution graphics that today's CD-ROM customer expects.
For example, the D.A. Pursuit of Justice title contains advanced technology
including full-screen, full motion video with 16 bit color. The Company believes
that the video and graphics quality of the game are comparable to or better than
the current best selling CD-ROM titles.

     The technology in which the Company has proprietary rights is embodied in
its software. This includes (i) the Emergency Room title software, (ii) the
improved software which the Company is using in its current products and its
off-line tools for translating data and (iii) the software being utilized for
the development of the Company's Internet game server network. A competitor
could independently develop software which produces the same results as the
Company's software without copying the Company's software and without violating
the Company's proprietary rights.



<PAGE>   12

EMPLOYEES

     As of March 27, 1998 the Company had four full-time employees. Operating
under joint venture relationships with BTI, the Company will contract to manage
employees for each joint venture but will not directly hire individuals on the
Company's staff. Competition for highly specialized employees with technical,
management, marketing, sales, product development and other specialized training
is intense, and there can be no assurance that the Company will be successful in
attracting or retaining such personnel in the joint ventures. The Company's
employees are not covered by a collective bargaining agreement and the Company
has experienced no work stoppages. The Company believes that its relationship
with its employees is good.


ITEM 2.  PROPERTIES

     In February 1998, the Company terminated its lease for the facility at 5340
Alla Road, Los Angeles, CA and negotiated a month-to-month lease for a smaller
portion of space at a reduced rental rate in the same building, and in March
1998 the Company terminated its lease for office property located in Oakhurst,
CA. The Company believes that the new space is adequate and suitable for its
needs.


ITEM 3.  LEGAL PROCEEDINGS

     On August 18, 1997, the U.S. Securities and Exchange Commission ("SEC")
issued a subpoenas deces tecum to the Custodian of Records of the Company and
other parties. The subpoenas were issued in connection with the SEC's formal
investigation entitled In the Matter of Reynolds Kendrick Stratton, Inc., File
No. LA-752 (the "Investigation"). The Investigation appears to center around
activities of JB Oxford Holdings, Inc., a broker-dealer, which is the successor
to Reynolds Kendrick Stratton, Inc., and was the underwriter of the Company's
initial public offering. The SEC has indicated that it expects to take the
testimony of the Company and other parties at some point in the future. The
Company has no reason to conclude that it is a target of the Investigation.

     The Company is not currently involved in any litigation that is expected to
have a material adverse effect on the Company's business or financial position.
There can be no assurance, however, that third parties will not assert
infringement or other claims against the Company in the future which, regardless
of the outcome, could have an adverse impact on the Company as a result of
defense costs, diversion of management resources and other factors.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.

ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT



<PAGE>   13

     The executive officers of the Company, as well as the ages as of March
27, 1998, are listed below, followed by brief accounts of their business
experience and certain other information.

<TABLE>
<CAPTION>
     Name                    Age                 Position
     ----                    ---                 --------
<S>                           <C>     <C>
Ariella J. Lehrer, Ph.D.      45      Chairwoman of the Board,
                                      President, Chief Executive Officer
                                      and Director
William E. Sliney             59      Vice President of Finance, Chief
                                      Financial Officer, Secretary,
                                      Treasurer and Director
</TABLE>


     Ariella J. Lehrer, Ph.D., has served as the Company's Chairwoman of the
Board of Directors, President and Chief Executive Officer since August, 1989.
Dr. Lehrer received a Master of Arts in Child Development from Pacific Oaks
College in 1976, a Ph.D. in Cognitive Psychology from Claremont Graduate School
in 1983 and completed a post-doctorate at the University of California, Los
Angeles in 1984. Prior to joining the Company, Dr. Lehrer headed Lehrer
Associates, a consulting company whose clients included The Learning Company,
Walt Disney Software, Commodore International, Ltd., International Business
Machines, Inc. and SoftKat, Inc. From 1986 to 1989, Dr. Lehrer served on the
California Educational Technology Commission. Dr. Lehrer is a member of the
Board of Fellows of the Claremont Graduate School's Center for Organizational
and Social Psychology and of the Board of Governors of Otis College of Art and
Design.

     William E. Sliney has served as the Company's Chief Financial Officer since
October, 1995. In November, 1995, Mr. Sliney also became the Company's Vice
President of Finance, Treasurer and a director and in January 1998 Mr. Sliney
became Secretary. From September, 1994 until October, 1995, Mr. Sliney was an
independent consultant. Prior to that, Mr. Sliney was Chief Executive Officer of
Gump's from May, 1993 to August, 1994, and Vice President and Chief Financial
Officer of Highland Superstores, Inc. from January to May, 1993. From 1987 to
1992, Mr. Sliney was President, Chief Financial and Administrative Officer and a
director of Phoenix Service Corporation. Mr. Sliney graduated from Northeastern
University in 1961 with a Bachelor of Science in Business Administration and
from the University of California, Los Angeles, in 1963 with a Master of
Business Administration


                                     PART II


ITEM 5.  MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.

MARKET INFORMATION FOR COMMON STOCK

     Legacy's common stock, $.0001 par value per share ("Common Stock"), is
traded on the NASDAQ SmallCap Market under the symbol LGCY. After the Company
began public trading on May 14, 1996, and until December 31, 1997, the Common
Stock was traded in the over-the-counter



<PAGE>   14

market and was quoted on the NASDAQ SmallCap Market under the symbol LGCY. Prior
to May 14, 1996, there was no public trading market for the Common Stock. The
following table sets forth for each period indicated the high and low bids for
the Common Stock as reported by the NASDAQ SmallCap Market. Price CALENDAR YEAR
1997 High Low


<TABLE>
<CAPTION>
                                                       Price
                                                       -----
CALENDAR YEAR 1997                          High                  Low
                                            ----                  ---
<S>                                         <C>                  <C>
   First Quarter.....................       $4 1/2               $1 7/8
   Second Quarter....................        4                    1 3/4
   Third Quarter.....................        3 1/2                1
   Fourth Quarter....................        2 9/16                 1/4
</TABLE>

<TABLE>
<CAPTION>

CALENDAR YEAR 1996                          High                  Low
                                            ----                  ---
<S>                                         <C>                  <C>
   First Quarter.....................        N/A                  N/A
   Second Quarter....................       $10 1/2              $7
   Third Quarter.....................        9 5/8                5 1/2
   Fourth Quarter....................        7 3/8                2
</TABLE>

HOLDERS

     As of March 27, 1998, there were 2,655,003 shares of the Common Stock
outstanding, representing approximately 800 beneficial holders.

TRANSFER AGENT AND REGISTRAR

     Chase Mellon Shareholder Services, 400 S. Hope Street, 4th Floor, Los
Angeles, California 90071-2806, is the Transfer Agent and Registrar for the
Common Stock.

DIVIDENDS

     The Company has not paid any cash dividends on its capital stock to date.
The Company currently anticipates that it will retain all future earnings, if
any, for use in its business and does not anticipate paying any cash dividends
on its capital stock in the foreseeable future. In addition, the payment of cash
dividends may be limited by financing agreements entered into by the Company in
the future.


ITEM 6.  SELECTED FINANCIAL DATA

                         SELECTED FINANCIAL INFORMATION

     The statement of operations data set forth below with respect to the years
ended December 31, 1997, 1996, 1995, 1994, and 1993, and the balance sheet data
at December 31, 1995 and 1994, are derived from, and are qualified by reference
to, the audited financial statements included elsewhere in this document or in
the Company's Registration Statement on Form S-1. The balance sheet set forth
below with respect to the balance sheet data at December 31, 1993, is derived
from unaudited financial information prepared on the same basis as the audited
financial statements. In the opinion of management all unaudited financial
information includes all adjustments, consisting of normal recurring accruals,
necessary to present fairly the information presented. The information presented
below should be read in



<PAGE>   15

conjunction with and is qualified by "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Company's financial
statements, the related notes thereto and other financial information included
herein.


<TABLE>
<CAPTION>
                                                      Year Ended December 31,
                                   ----------------------------------------------------------------------
                                    1997            1996            1995           1994            1993
                                   ------          ------          ------         ------          ------
<S>                             <C>            <C>            <C>            <C>            <C>
Statement of Operations Data:
Revenue:
   Royalties                    $   411,465    $   768,716    $     9,179    $    16,809    $    34,819
   Software sales                    85,723         13,501         36,399         69,856        421,715
   Consulting                          --           12,125          6,000        100,000           --
                                -----------------------------------------------------------------------
      Total                     $   497,188    $   794,342    $    51,578    $   186,665    $   456,534

Costs end expenses:
   Cost of royalties                211,308         76,507         13,939           --
   Cost of software sales            98,881          9,745         31,528         46,783        177,661
   Product development (1)          619,516      1,664,478         72,951        196,595         81,959
   General and administrative     1,351,127      1,585,084        336,457        133,644        124,634
   Selling                          267,376         91,995         21,216          9,829         31,467
                                -----------------------------------------------------------------------
      Total                       2,548,208      3,427,809        476,091        386,851        415,721

Income (Loss) from operations    (2,051,020)    (2,633,467)      (424,513)      (200,186)        40,813
Interest expense                    123,571        459,315        267,005         51,707         41,775
Interest income                     (19,492)      (108,240)
                                -----------------------------------------------------------------------
Net loss                        $(2,155,099)   $(2,984,542)   $  (691,518)   $  (251,893)   $      (962)
                                =======================================================================
Net loss per common share       $     (0.84)   $     (1.59)   $     (0.87)   $     (0.32)   $      --
Dividends per share                       0              0              0              0              0
Weighted average common stock
  outstanding                     2,574,633      1,871,904        798,200        798,200        798,200

</TABLE>

<TABLE>
<CAPTION>
                                                      Year Ended December 31,
                                -----------------------------------------------------------------------
                                      1997          1996            1995           1994            1993
                                     ------        ------          ------         ------          ------
<S>                              <C>            <C>           <C>            <C>            <C>
Balance Sheet Data:
Cash and cash equivalents        $    14,464    $ 1,804,779   $   365,190    $    20,750    $     3,389
Working capital (deficiency)        (672,039)     1,155,017      (162,097)      (186,013)        16,631
Total assets                       1,614,932      3,680,507       710,890         96,492        191,601
Long-term debt (including
  current portions)                  465,501        461,802     1,338,084        626,431        485,673
Stockholders' equity (deficit)       552,388      2,505,481      (834,590)      (674,895)      (423,002)

</TABLE>
----------

(1)  Product development expenses for the years ended December 31, 1997, 1996,
1995, 1994 and 1993 are net of co-funding development expenses of $0, $173,000,
$261,140, $338,058 and $141,162 respectively.



<PAGE>   16

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

     Except for historical information contained herein, the statements in this
report (including without limitation, statements indicating that the Company
"expects" "estimates" "anticipates" or "believes" and all other statements
concerning future financial results, product offerings or other events that have
not yet occurred) are forward-looking statements that are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995,
Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A
of the Securities Act of 1933, as amended. Forward-looking statements involve
known and unknown factors, risks and uncertainties which may cause the Company's
actual results in future periods to differ materially from forecasted results.
Those factors, risks and uncertainties include, but are not limited to: the
registrant's ability to ( i) restructure its outstanding indebtedness by
reaching agreement with creditors to convert a sufficient amount of such
indebtedness into Common Stock or Preferred Stock of the registrant so that the
remainder of such indebtedness can be paid as it comes due, and (ii) to effect a
business combination or strategic alliance with another company, in order to
continue operating as a going concern; the positioning of the Company's products
in the Company's market segments; the Company's ability to effectively manage
its various businesses in a rapidly changing environment; the timing of new
product introductions; retail sell-through of the Company's products; the
continued emergence of the Internet, resulting in new competition and changing
consumer demands; the Company's ability to adapt and expand its product
offerings in light of changes to and developments in personal computer platforms
and the Internet environment; growth rates of the Company's market segments;
variations in the cost of, and demand for, customer service and technical
support; price pressures and the competitive environment in the consumer
software and edutainment industry; the possibility of programming errors or
other "bugs" in the Company's software games and Internet technology; the
Company's ability to establish itself successfully as a software developer,
publisher and distributor; the emergence of competition from new and existing
software gaming and Internet companies; the timing and consumer acceptance of
new product releases and services (including current users' willingness to
upgrade from older versions of the Company's products); the consummation of
possible acquisitions; and the Company's ability to integrate acquired
operations into its existing business and manage growth. Additional information
on these and other risk factors are included under "Risk Factors" and elsewhere
in this Form 10-K.

GENERAL

     The Company was organized in California in 1989, as a successor to a
partnership formed in 1986 and was reincorporated in Delaware in March, 1996.
The Company completed an initial public



<PAGE>   17

offering of 1,150,000 shares of its common stock, par value $.0001 per share
("Common Stock"), in May of 1996. The Company develops edutainment CD-ROM
computer software. An edutainment product combines entertainment and education
content for home and educational use, in which learning is an integral part of
playing a game. The Emergency Room title, the Company's first RealPlay(TM)
(formerly Career Sim(TM)) series title, is a multimedia computer simulation
designed to provide a realistic and involving experience of what it is like to
be an emergency room doctor. The second title in the Company's RealPlay(TM)
series, D.A. Pursuit of Justice, is a multimedia computer simulation designed to
provide a realistic and involving experience of what it is like to be a district
attorney. The first three episodes were released in 1997. In addition the
Company released The Best of Emergency Room consisting of 50 of the original
Emergency Room cases in DOS and Emergency Room Intern consisting of 50 new cases
in a DOS/Win95 enhanced CD-ROM. The Company also operates Passport2, its
Internet gaming technology, with five interactive games currently operational,
whereby users are able to complete with one another via the Internet. See "Risk
Factors--Management of Growth; Uncertainties Relating to Acquisitions and New
Businesses" and "--Competition"

     In 1996 and for six months of 1997 IBM marketed the Emergency Room title
which the Company co-developed with IBM. Due to the Company's inability to
reasonably estimate returns on the Emergency Room title, the Company did not
recognize royalty revenue on this product on the accrual basis of accounting
until the fourth quarter of 1996 when the amount of returns could be reasonably
estimated in accordance with Statement of Financial Accounting Standards No. 48
("SFAS 48").

     The Company and IBM entered into a Development and Licensing Agreement (the
"DA License Agreement") on November 16, 1995. The D.A. Pursuit of Justice title
is the Company's second RealPlay(TM) title. In the fourth quarter of 1996 the
Company and IBM mutually agreed to terminate the DA License Agreement with
respect to the D.A. Pursuit of Justice title. As consideration for the
termination and for acquisition of IBM's rights under the DA License Agreement,
the Company was obligated to pay IBM an aggregate sum of $400,000, which sum
represents the total amount of milestone payments made by IBM to the Company
under the DA License Agreement. The final termination agreement, effective
January 3, 1997, provides for payment to IBM based upon a fixed percentage of
royalty payments received, or net revenue generated if the Company distributes
the software directly, with payment in full required by December 15, 1997. In
the event that the Company breaches its obligation to pay IBM the aggregate sum
of $400,000 by December 15, 1997, as royalties and final payment, the total
amount due IBM will be increased by interest at an annual rate of 10% and
continuing on the unpaid balance until paid in full. The Company recorded a
$400,000 current liability at December 31, 1996 to account for the payments
under the termination agreement which effectively increased the capitalized
software development costs related to the D.A. Pursuit of Justice title. On
December 15, 1997 the Company was unable to make the payment to IBM. The Company
and IBM have reached an agreement in principal whereby the Company will pay
$25,000 to IBM and IBM will receive a royalty on revenues generated from the ER
Intern, ER Deluxe and DA Pursuit of Justice titles up to total of an additional
$175,000 plus interest at 10 percent .

ACQUISITIONS


<PAGE>   18
     In August of 1996, the Company acquired substantially all of the assets,
properties and rights of On The Toes of Giants, Inc., a California corporation
("OTTOG"), pursuant to an Asset Purchase Agreement, dated August 19, 1996, which
assets consisted primarily of purchased research and development. The
consideration for the purchased assets consisted of Common Stock of the Company
and the assumption by the Company of certain liabilities of OTTOG. The
transaction was valued as of August 30, 1996, the closing date, when the Common
Stock had a market value of $7.00 per share (based on the August 30, 1996
closing market price of the Common Stock on the NASDAQ SmallCap Market), and the
total fair market value of the transaction, $233,338, was recorded as an expense
of product development. The Company has developed and operated a separate
Internet-oriented business unit, Passport2, based upon the purchased research
and development. Currently the Company operates five fully functional Internet
interactive games. During the first quarter of 1997 the Company began to reduce
expenditures related to Passport2 in a general company-wide plan to reduce
payroll and overhead expenses. Due to the relatively young and extremely
competitive nature of the Internet gaming industry, there can be no assurance
that the Company will be able to generate future positive net operating cash
flow from the operation of its Internet division.

     In February of 1997, the Company signed a letter of intent to acquire
certain assets and liabilities of Educorp Multimedia, Inc. ("Educorp"), a
California-based multimedia software publisher, and its wholly-owned
subsidiaries Educorp Direct, Inc. and High Text Interactive, Inc. The total
proposed consideration of $1,800,000 was to be payable in shares of Common
Stock. The actual number of shares was to be based on the average closing price
of the stock for the 30 days following the closing of the transaction, subject
to a minimum of 425,000 shares. The negotiation for the acquisition of Educorp
was terminated on June 30, 1997.

     On June 27, 1997, the Company signed a non-binding letter of intent to
acquire all of the outstanding stock of Canyon Interactive, LLC ("Canyon"), a
California limited liability company. The total proposed consideration was to be
$750,000 in cash and $1,000,000 payable in shares of the Company's Common Stock.
The actual number of shares was to be determined based on the price of the
Company's Common Stock from June 27, 1997 until consummation of the transaction.
On September 29, 1997 the Company and Canyon mutually agreed to terminate
negotiations.

     In January, 1998, the Company signed a non-binding Letter of Intent with
Black Tusk Medical, Inc. , a Nevada corporation ("BTI") to joint venture the
development and publishing of high production value educational software. BTI as
a part of a $3.5 million financing program will make an equity investment in the
Company. The Letter of Intent was superseded by a revised Letter of Intent dated
March 25, 1998. Pursuant to the revised Letter of Intent BTI and Legacy will
pursue joint venture programs for the development and distribution of up to four
product-oriented joint ventures, including new titles in the Company's
RealPlay(TM) series - Emergency Room and D.A. Pursuit of Justice. To date BTI
has advanced the Company $30,000 toward two of the proposed joint ventures.
Utilizing the joint venture vehicle the Company and BTI intend to obtain funding
from third parties to produce, market and distribute the Company's titles in the
retail, OEM, educational and professional markets worldwide. The Company and BTI
will share in any revenue received from each joint venture after the initial
funding to the third party investors has been repaid. Additionally, BTI will
purchase 260,000 shares of the Company's Common Stock for $130,000 within five
days following execution of a definitive Merger Agreement. If the Merger is
consummated, the foregoing 260,000 shares would become authorized but unissued
shares of Common Stock and the shareholders of BTI would receive 1,922,588
shares of the Company's Common Stock, at a valuation of $0.40 per share. As a
result, following the merger, the shareholders of BTI would hold approximately
42% of the outstanding shares of the Company. However, there can be no assurance
that the transactions contemplated by the Letter of Intent ultimately will be
effected on terms acceptable to the Company, or at all. See "Risk
Factors--Management of Growth; Uncertainties Relating to Acquisitions and New
Businesses; Management's Discussion and Analysis of Financial Condition and
Results of Operations"


<PAGE>   19

     Although the Company believes that the acquisition of the assets of OTTOG
and the proposed transactions with BTI are in the best interests of the Company
and its stockholders, there are significant risks associated with these
transactions. The acquisition of the assets of OTTOG initially expanded the
Company's size, operations, financial resources and personnel. The Company's
ability to integrate and organize new businesses and successfully manage growth
require significant expansion in its operational, financial and management
systems. There is no assurance that the Company will be able to address these
requirements in a satisfactory manner, and the failure to do so could have a
material adverse effect on the Company's results of operations, financial
condition and business.

RESULTS OF OPERATIONS

FOR THE YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED
DECEMBER 31, 1996.

     For the twelve months ended December 31, 1997 revenue decreased by $297,154
from $794,342 for the twelve months ended December 31, 1996 to $497,188 for the
twelve months ended December 31, 1996. This decrease was primarily due to a
decrease in royalty revenue related to sales of the Emergency Room title by IBM
in the twelve months ended December 31, 1997 compared to the twelve months ended
December 31, 1996, partially offset by increases in royalty revenue of $343,447
related to sales of the D.A. Pursuit of Justice and Emergency Room Intern titles
by Alpha Soft during the six months ended December 31, 1997. As disclosed in the
Company's Annual Report on Form 10K for 1996, in accordance with SFAS 48 the
Company was able to reasonably estimate the returns and recognize royalty
revenue during the fourth quarter of 1996. Software sales increased from $13,501
for the twelve months ended December 31, 1996 to $85,723 for the twelve months
ended December 31, 1997 primarily from sales of the Best of Emergency Room title
which began shipping in June, 1997 and individual cases of the D.A. Pursuit of
Justice title which began shipping in July, 1997 both directly marketed by the
Company.

     For the twelve month period ended December 31, 1997 cost of royalties was
$211,308 compared to $76,507 for the twelve months ended December 31, 1996. The
increase is the result of amortization of the capitalized product development
costs of $134,279 during the year ended December 31, 1997 from sales of the D.A.
Pursuit of Justice and Emergency Room Intern titles by Alpha Soft. The cost of
software sales increased from $9,745 in the twelve-month period ended December
31, 1996 to $98,881 in the twelve-month period ended December 31, 1997 as a
result of sales of the Best of Emergency Room title and individual cases of the
D.A. Pursuit of Justice in the twelve months ended December 31, 1997 compared to
sales of older Company software products in 1996, as the Best of Emergency Room
and the D.A. Pursuit of Justice titles were not available in 1996.

     Product development expenses, which are net of co-development expenses, for
the twelve months ended December 31, 1997 decreased by $1,044,962, or 63%, to
$619,516 compared to $1,664,478 for the twelve months ended December 31, 1996.
The decrease was primarily due to completion of the D.A. Pursuit of Justice,
Emergency Room Intern and the Best of Emergency Room titles in July 1997 and the
Company cessation of development of future products at that time.



<PAGE>   20
 General and administrative expense decreased from $1,585,084 for the twelve
months ended December 31, 1996 to $1,351,127, a decrease of $233,957, or 15%,
for the twelve months ended December 31, 1997. This decrease is due to the
Company in June 1997 implementing cost reduction programs by ceasing all costs
associated with development of new titles; significantly curtailing its Internet
gaming services; closing one business office; significantly reducing marketing
and public relations efforts; reducing the total Company staff to four personnel
and implementing other operating cost reductions.

     Selling expenses for the twelve months ended December 31, 1997 increased by
$175,381 to $267,376 from $91,995 for the twelve months ended December 31, 1996.
The increase is primarily related to the increases in company public relations
efforts and promotional expenses related to the Passport2Network and promotion
of The Best of Emergency Room, D.A. Pursuit of Justice and Emergency Room Intern
titles which were incurred during the first six months of 1997 compared to the
prior year when primarily all selling costs were incurred by IBM.

     Interest expense decreased from $459,315 for the twelve months ended
December 31, 1996 to $123,571 for the twelve months ended December 31, 1997,
resulting primarily from that certain convertible note in the original principal
amount of $1,000,000 payable to EBC Trust Corporation that was retired in May of
1996. Interest income decreased to $19,942 for the twelve months ended December
31, 1997 compared to $108,240 for the twelve months ended December 31, 1996, due
to use of the proceeds of the initial public offering in Company operations
during 1997.

     As of December 31, 1997, the Company has federal and state net operating
loss carryforwards of approximately $5,533,000 and $2,696,000, respectively,
available to offset taxable income through the year 2012. The Company's net
deferred tax assets of approximately $2,253,000 and $1,290,500 as of December
31, 1997 and 1996, respectively, consist primarily of net operating losses. The
Company has established a valuation allowance equal to the net deferred tax
asset for each period, as the Company could not conclude, based upon prior
recurring operating losses, that it was more likely than not that the Company
will generate sufficient taxable income before 2012 to utilize all of the
Company's deferred tax assets.

FOR THE YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED
DECEMBER 31, 1995

     For the twelve months ended December 31, 1996, total revenues increased by
1,440%, from $51,578 to $794,342. This $742,764 increase is due primarily to an
increase in royalty revenue related to the Emergency Room title, and is
augmented by a $6,125 increase in consulting revenue. Due to the Company's
inability to reasonably estimate returns on its early sales of the Emergency
Room title, the Company did not recognize any royalty revenue on this product on
the accrual basis of accounting until the fourth quarter of 1996 when the amount
of future returns could be reasonably estimated in accordance with Statement of
Financial Accounting Standards No. 48 (SFAS 48). During the fourth quarter of
1996 the Company recognized $747,995 of royalty revenue, net of estimated
returns, from the Emergency Room title that related to IBM's sales. Of the
royalty revenue recognized, $312,787, $93,670, $267,592 and $73,946 relate to
sales from the fourth quarter of 1995, and the first, second and third quarters
of 1996, respectively. No royalty revenue related to the Emergency Room title
was recognized in the Statement of Operations for the year ended December



<PAGE>   21

31, 1995. Royalty revenue of $20,721 and $9,179 recognized during the twelve
months ended December 31, 1996 and 1995, respectively, related to other titles.
The increases in royalty revenue and consulting revenue are partially offset by
a decrease in software sales of $22,898, as unit sales of the Company's
self-developed software titles, Mutanoid Math Challenge and Mutanoid Word
Challenge, continued to decrease due to the introduction of competing software
titles designed to better take advantage of the new personal computer hardware
available in the marketplace.

     Total cost of revenues for 1996 increased by $40,785 or 90%, as compared to
1995. This increase is due mostly to an increase in cost of royalties from
$13,939 to $76,507, and is offset slightly by a decrease in cost of software
sales of $21,783. The increase in cost of royalties is due to the amortization
of capitalized software development costs associated with the development of the
Emergency Room title. During 1995 the Company capitalized $90,446 of software
development costs related to the Emergency Room title, of which $13,939 and
$76,507 was amortized into operations for the years ended December 31, 1995 and
1996, respectively. During 1996 the Company capitalized $1,260,478 of software
development costs associated with the District Attorney title, none of which was
amortized into operations during the year ended December 31, 1996 as the title
was not ready for general release. Cost of software sales which consist of
product packaging and documentation costs, decreased by $21,783 or 69% during
the twelve months ended December 31, 1996 due to a decline in sales of the
Company's self-developed software titles during the twelve months ended December
31, 1996, as compared to 1995. The cost of consulting revenue was negligible for
1995 and 1996 and therefore has not been separately disclosed.

     Product development expenses, which are net of co-funded development
expenses and primarily include personnel expenses and costs associated with
external video production for use in the Company's software titles, increased by
$1,591,527 from 1995 to 1996. This increase is due to the Company capitalizing
all product development expenses incurred during the twelve months ended
December 31, 1995 as technological feasibility had been attained for the
Emergency Room title in January of 1995. Technological feasibility was attained
for the District Attorney title during May, 1996, prior to which all product
development expenses were properly expensed. Also during the twelve months ended
December 31, 1996, the $233,338 fair market value of acquiring the assets of
OTTOG, which consisted primarily of purchased research and development, was
included in product development expenses. In addition, the Company began
development of several new titles during the twelve months ending December 31,
1996, including ER Code Blue, Emergency Room Intern, Animal Hospital and Junior
Astronaut, and also began development of its Internet gaming technology, which
had not yet attained technological feasibility. Due mostly to the termination of
various co-development arrangements, the Company indefinitely halted the
development of the ER Code Blue and Junior Astronaut titles at the end of 1996
and development of the Animal Doctor title was halted indefinitely during early
1997.

     General and administrative expenses, which consist primarily of personnel
expenses, professional expenses and other overhead costs, increased by 371%,
from $336,457 to $1,585,084. This $1,248,627 increase is almost entirely due to
the increase in the Company's overhead structure resulting from an increase in
the number of employees, including the hiring of a Chief Financial Officer, a
Vice President of Business Development, a Controller and an Internet Marketing
Director. The increase is also related to an increase in expenses incurred as a
result of the relocation of the Company's headquarters, including an increase in
rent expense. The general growth of the



<PAGE>   22

Company's overhead structure is a direct result of the increase in the number of
titles under development from 1995 to 1996. The increase is also related to
personnel and organizational changes, and increases in professional fees that
are a direct result of the initial public offering, and will continue to be
required of a publicly traded company. During 1995 and 1996, the Company entered
into employment agreements with key members of management. If these agreements
had been in place throughout 1995, total general and administrative expenses
would have been $88,250 higher for the year ended December 31, 1995.

     Selling expenses, which primarily include freight and miscellaneous
advertising, increased by $70,779 or 334% from 1995 to 1996. The increase in
selling expenses is primarily due to general product and company image public
relations efforts, promotional expenses related to the Passport2 Internet gaming
technology, and miscellaneous expenditures associated with the D.A. Pursuit of
Justice title. The increase is directly related to the increase in the number of
titles under development from 1995 to 1996.

     Interest expense increased from $267,005 to $459,315. This $192,310
increase relates primarily to the interest expense and the amortization of the
original issue discount and loan costs incurred relating to that certain
convertible note in the original principal amount of $1,000,000 payable to EBC
Trust Corporation (the "Convertible Note") obtained by the Company on November
21, 1995 and retired during May, 1996. The Company also had interest income of
$108,240 during the period primarily as a result of interest earned on the net
proceeds of the initial public offering.

LIQUIDITY AND CAPITAL RESOURCES

     The Company had $1,747,858 in cash outflows from operating activities for
the twelve months ended December 31, 1997 compared to cash outflows of
$1,913,500 for the twelve months ended December 31, 1996. The increase in net
outflows of $165,642 between 1997 and 1996 operating cash flow primarily
resulted from the following: a decrease in the net loss from operations after
adjustments for non-cash items of $607,136. This has been offset by an increase
in deferred revenue of $2,622, an increase in accounts receivable of $159,967,
an increase of accrued interest of $80,000 and a decrease in other receivables
of $104,872. This has been offset by a decrease in accounts payable and accrued
expenses of $163,563; an increase in inventory of $22,320 and a decrease in
development expense co-funding recognized of $4,908. The total net outflows from
operating activities decreased primarily due to actions whereby the Company has
implemented cost reduction programs by ceasing all costs associated with
development of new titles; significantly curtailing its Internet gaming
services; closing one business office; significantly reducing marketing and
public relations efforts; reducing the total Company staff to four
administrative personnel and implementing other operating cost reductions.


     Investing activities in the twelve months ended December 31, 1997 consisted
of a note receivable of $50,000, purchases of computer equipment and
construction of leasehold improvements totaling $5,238 and the capitalization of
product development costs related to the District Attorney and Emergency Room
Intern titles totaling $204,372. These outflows were offset by proceeds from the
disposition of property and equipment in the amount of $7,438. In the twelve
months ended December 31, 1996 investing activities consisted of purchases of
computer equipment



<PAGE>   23

and construction of leasehold improvements totaling $385,829 and additional
product development costs for the District Attorney title of $1,260,478.

     The Company has cash inflows of $209,715 from financing activities for the
twelve months ended December 31, 1997 compared to inflows of $4,994,646 for the
twelve months ended December 31, 1996 . Financing activities for the twelve
months ended December 31, 1997 included payments of notes payable of $71,301 and
payments under a line of credit of $35,250 which was offset by proceeds of a
note payable of $75,000, the exercise of warrants for common stock of $162,500
and the issuance of stock to employees of $23,526. Net cash received by the
Company from the successful completion of an initial public offering during the
year ended December 31, 1996 consisted of receipt of $5,355,589 representing net
proceeds of the Company's initial public offering less $300,000 used to retire
the note payable to EBC Trust Corporation and an increase of $8,184 on the
Company's line of credit.

     In the six months ended December 31, 1997 the Company failed to make a
principal payment on an unsecured note Payable to a related party. The monthly
payment, in the amount of $10,000, was due in accordance with the terms of the
original Note dated February 1, 1991, as amended, which provides for monthly
payments of principal and interest commencing on July 1, 1997.

     On January 3, 1997, the Company and IBM executed a final termination
agreement with respect to the District Attorney Developing and Licensing
Agreement dated November 16, 1995. As consideration for the termination and for
the acquisition of IBM's rights under the agreement, the Company was obligated
to pay IBM no later than December 15, 1997 the aggregate sum of $400,000,
representing the total amount of milestone payments made by IBM to the Company
under the DA Licensing Agreement. The Company was not able to make the payment
on December 15, 1997 and in accordance with the terms of the Agreement, accrued
interest at the rate of 10 percent from January 1, 1996 to December 31, 1997.
The Company and IBM have reached an agreement in principal whereby the Company
will pay $25,000 to IBM and IBM will receive a royalty on revenues generated
from the ER Intern, ER Deluxe and DA Pursuit of Justice titles up to a total of
an additional $175,000 plus interest at 10 percent.

     The Company's ability to achieve positive cash flow over the next twelve
months depends on a variety of factors including the ability to obtain
additional financing, the timeliness, successful distribution of, and market
acceptance of its current and future software titles, most importantly the D.A.
Pursuit of Justice, The Best of Emergency Room and Emergency Room Intern titles,
the costs of developing, producing and marketing such titles, and various other
factors, some of which may be beyond the Company's control.

     Additionally, in conjunction with the termination of the co-development
agreements with IBM and McGraw-Hill, the Company accelerated its plans to become
a developer/distributor of titles on its own. To achieve this transition the
Company established a sales and marketing organization in early spring 1997. The
Company modified this distribution strategy in June 1997, and is using a
distributor for the retail channel and self distributing in alternative
channels.

     If this transition in distribution methods is not successful the Company
could face short term liquidity requirements that could significantly deplete
current cash resources. At June 30, 1997, the



<PAGE>   24


Company implemented programs designed to improve its liquidity requirements by:
ceasing all costs associated with development of new titles; significantly
curtailing its Internet gaming services; closing one business office;
significantly reducing marketing and public relations efforts; reducing the
total Company staff to four administrative personnel; implementing other
operating cost reductions and seeking additional funding.

     Additionally, although the Company believes that, together with a
successful effort to obtain additional financing to fulfill near-term cash
requirements, its operating plan and efforts to reduce operating expenses, in
conjunction with the acquisition of additional funding, will be adequate to meet
its fiscal 1998 working capital needs, there can be no assurance that the
Company will be able to obtain the necessary financing or that it will not
experience liquidity problems caused by adverse market conditions and other
unfavorable events.

     As of December 31, 1997, the Company had (i) never achieved operating
profits, (ii) had negative working capital of $672,039, and cash on hand of
$14,464, (iii) total short term indebtedness of $783,619, and long term
indebtedness of $161,882, (iv) ceased development of new titles pending the
generation of additional working capital or the implementation of subcontractor
relationships on terms that permit payments to be made by the Company when it
has cash available to make such payments, (v) curtailed its internet gaming
services, (vi) closed one of its business offices, (vii) significantly reduced
marketing and public relations efforts, and (viii) reduced its total number of
employees to four. Revenues from the Company's Emergency Room and derivatives
thereof are continuing to decrease, and revenues from the D.A. Pursuit of
Justice title have been lower than expected. These conditions raise substantial
doubt about the Company's ability to continue as a going concern. On February
28, 1998, the Company was notified by The Nasdaq National Market, Inc.
("NASDAQ") that the Company is not in compliance with NASDAQ's net tangible
assets/market capitalization/net income and minimum bid price requirements, and
that absent compliance, the Company's Common Stock will be delisted from the
NASDAQ SmallCap Exchange.

     The Company has pursued various funding alternatives, but has not been able
to obtain either the debt or equity financing it requires. On March 25, 1998,
the Company signed a non-binding letter of intent (the "Letter of Intent") with
Black Tusk Medical, Inc. ("BTI"), a Nevada corporation engaged in the business
of marketing and distribution software titles. Pursuant to the Letter of Intent,
BTI advanced the Company $30,000 toward two proposed joint ventures for the
development and publication of high production value educational software, and
will purchase 260,000 shares of the Company's Common Stock for $130,000 within
five days following execution of a definitive Merger Agreement. If the Merger is
consummated, the foregoing 260,000 shares would become authorized but unissued
shares of Common Stock and the shareholders of BTI would receive 1,922,588
shares of the Company's Common Stock, at a valuation of $0.40 per share. As a
result, following the merger, the shareholders of BTI will hold approximately
42% of the total outstanding shares of the Company.

     The Company believes that it will be able to complete the Merger, and its
prospects for obtaining additional financing will improve as a result thereof.
However, the Company has not been able to identify other viable financing
alternatives at the present time, and there can be no assurance that the
transactions contemplated by the Letter of Intent ultimately will be effected on
terms acceptable to the Company, or at all.

Year 2000

     The Company is currently reviewing its computer systems in order to
evaluate if any modifications are necessary for the year 2000. The Company
currently does not anticipate that any material modifications or expenditures
will be required in its computer systems for the year 2000 modifications.



<PAGE>   25
RISK FACTORS

     Need for Additional Capital; Uncertainty as a Going Concern At December 31,
1997, the Company had a negative working capital of $672,039 compared to working
capital of $1,155,017 at December 31, 1996. The Company has incurred net losses
since inception and expects to continue to operate at a loss during 1998. The
Company's prospects must be considered in light of the risks, expenses and
difficulties encountered by companies in the early stages of development,
particularly companies in new and rapidly evolving markets. The Company's
ability to maintain operations in the near term and to achieve positive cash
flow in the future depends on a variety of factors. Given the Company's current
working capital deficiency and lack of cash resources, should the Company be
unable to obtain additional funding to supply its near-term cash requirements,
there is substantial doubt as to the Company's ability to continue as a going
concern. In addition, the Company's ability to continue operations and achieve
positive cash flow in the future depends on the timeliness, successful
distribution and market acceptance of its current and future software titles
(including without limitation its D.A. Pursuit of Justice, The Best of Emergency
Room and Emergency Room Intern titles and the Passport2Network internet game
service), the cost of developing, producing and supporting such titles, and the
Company's ability to obtain or generate the resources to fund such efforts.
Should the Company's future income be less than required, or its software title
production and introduction be delayed significantly or fail to generate
sufficient revenues, the Company may require additional capital in the future.
Also, should the Company consummate any acquisition or business combination the
Company will likely require additional capital to effect such transaction and/or
any related integration and/or expansion of its business and operations. The
Company may seek to satisfy any such capital needs through additional public or
private financings or other sources, but there can be no assurance that any such
additional financing would be available on favorable terms, if at all. If the
Company is unable to generate or obtain such additional capital, it could have a
material adverse effect on its business, financial condition and results of
operations.

     Potential Delisting of the Company's Common Stock on NASDAQ. On February
26, 1998. the Company was notified by The Nasdaq Stock Market, Inc. ("NASDAQ")
that the Company is not in compliance with the net tangible assets/market
capitalization/net income requirement(s), pursuant to NASD Marketplace Rule(s)
4310(c )(02) and the minimum bid price requirement, pursuant to NASD Marketplace
Rule 4310(c )(04) both of which became effective on February 23, 1998.
Non-compliance with these and other rules initiated by NASD at that date, will
result in the Company's stock being delisted from the NASDAQ Small Cap Exchange.
Based on instructions provided by NASDAQ the Company has initiated steps to
maintain compliance

1.   The Company will hold its Annual Meeting of Stockholders no later than
May 28, 1998. At that time stockholders will be asked to approve the merger of
Black Tusk Medical, Inc. ("BTI") into the Company and, as a requirement of BTI,
to approve a one for two (1:2) reverse split of the Legacy Common Stock.

     On March 25, 1998 the Company and BTI Medical, Inc. ("BTI"), a Nevada
corporation signed a Letter of Intent to merge BTI into Legacy. The Letter of
Intent is the result of a desire of Legacy and BTI to combine strengths of both
companies to develop, market and distribute Legacy titles as well as titles of
other companies. Through its Black Tusk Interactive division, BTI is a
publisher and marketer of interactive software products in two main
marketplaces: Edutainment (education + entertainment) and medical utility
software. Employing a risk measured portfolio model, BTI will joint venture
product development and publishing with well established corporate partners.
BTI's team brings strong creative and corporate experience to its joint venture
partnerships. To date BTI has advanced $30,000 to the Company to initiate two
joint ventures to develop Legacy titles.

2.   The merger of BTI into Legacy. The steps to effect the merger are:

     a.   an investment by BTI of $130,000 to purchase 260,000 shares of Legacy
common stock within 5 days of the execution of the agreement to merge;
     b.   the exchange of .5756 shares of Legacy common stock for the
outstanding shares of BTI;
     c.   the completion of a definitive merger agreement by April 30, 1998; and
     d.   the conversion of substantially all of the outstanding debt of Legacy
to certain principals of the Company into Legacy Preferred Stock.

     3.   In addition to the merger the Company is in the process of
negotiating the following:

     a.   the reduction of a $480,000 obligation to International Business
Machines Corporation ("IBM") into a series of royalty payments from certain
Legacy products formerly co-developed with IBM as well as products marketed by
Legacy in 1998. The parties have agreed in principal to the following: (1) the
payment of $25,000 by Legacy at the signing of a definitive agreement and; (2)
the payment to IBM of royalties totalling $175,000 plus interest at 10 percent;
     b.   the conversion of 75,954 of Warrants to purchase Legacy Common Stock
held by EBC Trust Company ("EBC") at a conversion rate is $1.31 thereby
generating $99,500 for the Company;
     c.   the elimination of a $50,000 advance made by EBC in July, 1997 to the
Company for a proposed acquisition which was terminated in September, 1997; and
     d.   an investment by EBC of up to $250,000 in the Company.

There can be no assurance that the Company will be successful in maintaining
compliance with the new NASDAQ requirements and if it does maintain compliance
that, in its current financial condition, it can continue to be in compliance.

     Management of Growth; Uncertainties Relating to Acquisitions, Business
Combinations and New Businesses. The Company has pursued, is currently pursuing
and, in the future may pursue, new technologies and businesses internally and
through acquisitions and combinations which involve



                                      ***
<PAGE>   26

significant risks. Any such acquisition or combination may involve, among other
things, the issuance of equity securities, the payment of cash, the incurrence
of contingent liabilities and the amortization of expenses related to goodwill
and other intangible assets, and transaction costs, which have adversely
affected, or may adversely affect, the Company's business results of operations
and financial condition. The Company's ability to integrate and organize any new
businesses and/or products, whether internally developed or obtained by
acquisition or combination, including the Passport2 Internet game and
information service, will likely require significant expansion of the Company's
operations. There is no assurance that the Company will have or be able to
obtain the necessary resources to satisfactorily effect such expansion, and the
failure to do so could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition future acquisitions
and or combinations by the Company involve risks of, among other things,
entering markets or segments in which the Company has no or limited prior
experience, the potential loss of key employees of the acquired company and/or
difficulty, delay or failure in the integration of the operations, management,
personnel and business of any such new business with the Company's business and
operating and financial difficulties of any new or newly combined operations,
any of which could have a materially adverse effect on the Company's business,
financial condition and results of operations. Moreover, there can be no
assurance that the anticipated benefits of any specific acquisition or of any
internally developed new business segment or business combination will be
realized.

     Dependence on Alpha Soft for Substantially All the Company's Revenues. For
the year ended December 31, 1997, approximately 69% of the Company's total
revenue was derived from Alpha Soft on royalty revenue generated by the D.A.
Pursuit of Justice and Emergency Room Intern titles. The royalty revenue from
the Emergency Room title, a DOS-based product, diminished significantly over the
course of 1997, as it faced increased competition from Windows-based products,
and the royalty revenue from the D.A. Pursuit of Justice and Emergency Room
Intern titles increased as these products entered the market in larger numbers.
The Company and IBM have terminated their co-development relationship with
respect to future RealPlay(TM) titles, including, but not limited to, the D.A.
Pursuit of Justice title. In light of the Company's dependence on Alpha Soft for
the distribution and marketing of the D.A. Pursuit of Justice and Emergency Room
Intern titles, if Alpha Soft were to terminate its distribution and marketing
relationships with the Company, if the Company is unable to develop other CD-ROM
titles or other services, if the Company cannot find alternative distribution
arrangements for its present or future titles, or if the Company's other
products and services, if any, do not receive market acceptance, there will be a
material adverse effect on the Company's business, financial condition and
results of operations. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - "General" and "Results of Operations"

     Significant Quarterly Fluctuations in Revenue and Operating Results and
Related Factors. The Company's quarterly operating results have fluctuated
significantly in the past, and are likely to fluctuate significantly in the
future based on a number of factors. Such factors include, but are not limited
to, the size and rate of growth of the consumer edutainment and gaming software
market, uncertainties relating to acquisitions and business combinations, market
acceptance of the Company's products and those of its competitors, competition
for shelf space and promotional support, development and promotional expenses
relating to the introduction of new products or enhancements of existing
products, projected and actual changes in computer formats and platforms and the
Internet, the timing and success of product introductions, product returns,
changes in pricing policies



<PAGE>   27

by the Company and its competitors, the accuracy of retailers' forecasts of
consumer demand, the timing of orders from major customers, order cancellations,
delays in shipment, delays in royalty revenue received from Alpha Soft or
other distributors, the effect of personal computer sales, risks from limited
protection of proprietary rights and significant price reductions in personal
computer software, and consignment shipments of the Company's products. The
Company expects to experience significant fluctuations in its quarterly
operating results as a result of changes in the mix of products with varying
profit margins sold by the Company from quarter to quarter and the timing of
product introductions. In response to competitive pressures, the Company may
take certain pricing or marketing actions that could materially adversely affect
the Company's business, financial condition and results of operations in any
quarter. The Company's expense levels are based, in part, on its expectations
regarding future sales. As a result, operating results would be
disproportionately adversely affected by a decrease in quarterly sales, the
failure to meet the Company's sales expectations for any quarter or costs
associated with sales of defective products, higher customer support costs and
product returns.

     Development of New Titles. The Company currently has several titles in the
conceptual, pre-production and production phases of development. The Company
does not currently plan to begin full-scale development of additional titles
until such time as funding for existing titles is in place. There can be no
assurance, however, that the Company will be able to successfully distribute any
existing or future titles through its own efforts or the efforts of
distributors, which would impair the Company's ability to fund the development
of future titles, and, as a result, have a material adverse effect on the
Company's ability to generate future operating cash flow.

     Rapidly Changing Technologies and Markets. The markets in which the Company
competes are characterized by ongoing technological developments, frequent new
product announcements and introductions, evolving industry standards, changing
customer requirements and new competitors. The introduction of products and
services embodying new technologies and the emergence of new industry standards
and practices, including new platforms, CD-ROMs and the Internet, can render
existing products obsolete and unmarketable. The Company's future success
depends upon its ability to enhance its existing products and services, develop
new products and services that address the changing requirements of its
customers, develop additional products and services for new or other platforms
and environments, such as Windows 98 and the Internet, and anticipate or respond
to technological advances, emerging industry standards and practices and changes
in CD-ROMs, the Internet and other technologies, in a timely, cost-effective
manner. There can be no assurance that any of such initiatives can be
successfully implemented or that they will result in increased revenue or
profits for the Company. Conversely, there can be no assurance that consumers'
use of the Internet, particularly for entertainment and edutainment, will
continue to increase as rapidly as it has during the past few years, nor can
there be any assurance that customers will be willing to pay for such service in
the foreseeable future.

     Competition. Each of the computer software development, Internet technology
and software retail distribution industries is intensely competitive. The
Company's competitors in each industry range from small companies with limited
resources to large, more established companies which have significantly greater
assets and greater financial, technical and personnel resources than those of
the



<PAGE>   28

Company. The Company expects competition to continue and increase in each of
these market segments.

     Increased competition in the software development market, resulting from,
among other things, the timing of competitive product releases and the
similarity of such products to those of the Company, may result in significant
price competition, reduced profit margins, loss of shelf space or a reduction in
sell-through of the Company's products at retail stores, any of which could have
a material adverse effect on the Company's results of operations, business or
financial condition. In addition, the Company believes that large software
companies, media companies and film studios are increasing their focus on the
interactive entertainment and edutainment sectors of the software market and, as
a result of their greater resources, name recognition, customer base and
licensed rights, are significant competitors in the software industry. Current
and future competitors with greater resources than the Company may be able to,
among other things, carry larger inventories, undertake more extensive marketing
campaigns and distribution efforts, adopt more aggressive pricing policies and
make higher offers or guarantees to software developers and co-development
partners than the Company. New hardware formats and electronic delivery systems
may be introduced into the software market and potential new competitors may
enter the software development and distribution market, resulting in greater
competition for the Company. There can be no assurance that the Company will
have the resources required to respond effectively, or at all, to market or
technological changes, or to compete successfully with current or future
competitors, or that competitive pressures faced by the Company will not
materially and adversely affect the Company's business, financial condition and
results of operations.

     In the past, the Company focused primarily on the edutainment product
category. Through the acquisition of On The Toes Of Giants in 1996, the Company
has moved into the area of Internet edutainment products and games. The Internet
category is dominated by a number of very large competitors and is subject to
rapid change in consumer preference. Should the Company increase its presence in
the Internet industry segment, it will experience these additional risks and
competitive pressures.

     Products in the market compete primarily on the basis of subjective
factors, such as entertainment value, and objective factors, such as price,
graphics and sound quality. Large diversified entertainment, cable and
telecommunications companies, in addition to large software companies such as
Microsoft Corporation, are increasing their focus on the interactive
entertainment and education software market, which will result in even greater
competition for the Company. Many of these companies have substantially greater
financial, marketing and technical resources than the Company. As competition
increases, significant price competition and reduced profit margins may result.
In response to increased competition for shelf space, the Company may need to
increase marketing expenditures and/or implement reduced pricing policies. In
addition, competition from new technologies (such as new hardware platforms and
the Internet) may reduce demand in current markets. The Company may have to
commit capital, marketing expenditures and management talent to establish itself
in new markets entered by way of acquisition of, combination with or internal
development of new businesses. There can be no assurance that the Company will
have sufficient resources to make such commitments, or that the Company will be
able to compete successfully in any new market even if such resources are
available.



<PAGE>   29

     Seasonality. Typically, revenues are highest during the fourth fiscal
quarter, decline in the first fiscal quarter and are lowest in the second and
third fiscal quarters. This seasonal pattern is due primarily to the increased
demand for the Company's products during the calendar year-end holiday selling
season. There can be no assurance that the Company will achieve profitability
and, even if achieved, that such profitability will be consistent on a quarterly
or annual basis.

ACCOUNTING PRONOUNCEMENTS

     Statement of Financial Accounting Standard No. 129, "Disclosure of
Information about Capital Structure", ("SFAS 129") issued by the FASB is
effective for financial statements ended after December 15, 1997. The new
standard reinstates various securities disclosure requirements previously in
effect under the Accounting Principles Board Opinion No. 15, which has been
superseded by SFAS No. 129. The Company adopted SFAS No. 129 on December 15,
1997. It had no effect on its financial position or results of operations.

     Statement of Financial Accounting Standard No. 130, "Reporting
Comprehensive Income", ("SFAS 130") issued by the FASB is effective for
financial statements with fiscal years beginning after December 15, 1997. SFAS
130 establishes standards for reporting and display of comprehensive income and
its components in a full set of general-purpose financial statements. The
Company does not expect adoption of SFAS 130 to have an impact on its financial
position or results of operations and any effect will be limited to the form
and content of disclosures.

     Statement of Financial Accounting Standard No. 131, "Disclosures about
Segments of an Enterprise and Related Information", ("SFAS 131") issued by the
FASB is effective for financial statements with fiscal years beginning after
December 15, 1997. SFAS 131 requires that public companies report certain
information about operating segments, products, services and geographical areas
in which they operate and their major customers. The Company does not expect
adoption of SFAS 131 to have an impact on its financial position or results of
operations and any effect will be limited to form and content of its
disclosures.

     Statement of Position 97-2, "Software Revenue Recognition," ("SOP 97-2")
issued by the AICPA is effective for transactions entered into in fiscal years
beginning after December 15, 1997. SOP 97-2 supersedes SOP 91-1 regarding
software revenue recognition. SOP 97-2 establishes standards which require a
company to recognize revenue when (i) persuasive evidence of an arrangement
exists, (ii) delivery has occurred, (iii) the vendor's fee is fixed or
determinable, and (iv) collectability is probable. The SOP also discusses the
revenue recognition criteria for multiple element contracts and allocation of
the fee to various elements based on vendor-specific objective evidence of fair
value. The Company does not expect adoption of this SOP to have a material
effect on the financial statements.

EFFECTS OF INFLATION

     The Company believes that inflation has not had a material effect on its
net sales and results of operations. Substantial increases in labor costs or
video production costs on video produced for use within the Company's software
programs or programs produced by joint ventures could adversely affect the
operations of the Company for future periods.

ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

     Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The Financial Statements and Supplementary Data of the Company required by
this item are set forth on the pages indicated by Item 14(a) and are
incorporated herein by reference.


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

     None.


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



<PAGE>   30

     Information concerning the directors of the Company is contained in
portions of the Proxy Statement for the Company's 1998 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within 120
days after the close of the fiscal year ended December 31, 1997 and incorporated
herein by reference. For information concerning executive officers, see Item 4A
of this Annual Report on Form 10-K.


ITEM 11. EXECUTIVE COMPENSATION

     The information required by this item is incorporated herein by reference
to portions of the Proxy Statement for the Company's 1998 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within 120
days of the close of the fiscal year ended December 31, 1997.


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information required by this item is incorporated herein by reference
to portions of the Proxy Statement for the Company's 1998 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within 120
days of the close of the fiscal year ended December 31, 1997.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by this item is incorporated herein by reference
to portions of the Proxy Statement for the Company's 1998 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within 120
days of the close of the fiscal year ended December 31, 1997. .


                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K.

(a)  DOCUMENTS FILED AS PART OF THIS REPORT:

     1.   FINANCIAL STATEMENTS.

          Report of Independent Certified Public Accountants

          Balance Sheets as of December 31, 1997 and 1996.

          Statements of Operations for the years ended December 31, 1997, 1996
          and 1995.

          Statement of Stockholders' Equity (Deficit) for the years ended
          December 31, 1997,



<PAGE>   31

          1996 and 1995.

          Statements of Cash Flows for the years ended December 31, 1997, 1996
          and 1995.

          Notes to Financial Statements.

     2.   FINANCIAL STATEMENT SCHEDULES.

          Schedule II - Valuation of Qualifying Accounts

     3.   EXHIBITS. Reference is made to item 14 (c ) of this Annual report on
          Form 10-K.

(b)  REPORTS ON FORM 8-K. No reports on Form 8-K were filed during the last
     quarter of the fiscal year covered by this Annual report on Form 10-K.

(c)  EXHIBITS.

     The Company's Financial Statements and the Report of Independent Certified
Public Accountants are presented in the following pages.

          Report of Independent Certified Public Accountants.

          Balance Sheets as of December 31, 1997 and 1996.

          Statements of Operations for the years ended December 31, 1997, 1996
          and 1995.

          Statements of Stockholders' Equity for the years ended December 31,
          1997, 1996 and 1995.

          Statements of Cash Flows for the years ended December 31, 1997, 1996
          and 1995.

          Schedule II - Valuation and Qualifying Accounts

          Notes to Financial Statements.


<PAGE>   32

                          INDEX TO FINANCIAL STATEMENTS

<TABLE>
<S>                                                                    <C>
Report of Independent Certified Public Accountants                     F-2


Financial Statements

         Balance Sheets                                                F-3

         Statements of Operations                                      F-4

         Statements of Stockholders' Equity                            F-5

         Statements of Cash Flows                                      F-6


Notes to Financial Statements                                   F-7 - F-27

Schedule II - Valuation and Qualifying Accounts                       F-28
</TABLE>



                                      F-1
<PAGE>   33


               Report of Independent Certified Public Accountants


To the Stockholders of
Legacy Software, Inc.
Los Angeles, California

We have audited the accompanying balance sheets of Legacy Software, Inc. as of
December 31, 1997 and 1996, and the statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1997. We have also audited the schedule listed in the accompanying index.
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule 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 and schedule are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements and
schedule. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation of the financial statements and schedule. We
believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Legacy Software, Inc., as of
December 31, 1997 and 1996 and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1997 in conformity
with generally accepted accounting principles.

Also, in our opinion, the schedule presents fairly, in all material respects,
the information set forth therein.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2, the Company
has never achieved operating profits, and in addition, has negative working
capital, minimal cash, significant indebtedness and liquidity problems. These
matters raise substantial doubt as to the Company's ability to continue as a
going concern. The Company's future operations are dependent upon generating
funds to finance the marketing and expansion of its operations. Also, as
discussed in Note 2, management plans to generate these funds through a possible
merger and the issuance of the Company's stock. There is no assurance that this
will generate sufficient funds to enable the Company to continue its operations
for the next twelve months.

The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.


                                        BDO SEIDMAN, LLP


Los Angeles, California
March  12, 1998




                                      F-2
<PAGE>   34

                              LEGACY SOFTWARE, INC.

                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                        DECEMBER 31,
                                                  -----------------------
                                                     1997         1996
                                                  ----------   ----------
<S>                                               <C>          <C>
                       ASSETS (NOTE 1 AND 6)

CURRENT ASSETS
      Cash and cash equivalents                   $   14,464   $1,804,779
      Restricted cash (Note 4)                          --         55,240
      Accounts receivable, net of allowances
        for doubtful accounts of $12,500 and $0      148,606        2,767
      Inventory (Note 1)                              22,320
      Other receivables (Notes 5 and 12)              21,016      125,888
      Other current assets                            22,217
                                                  ----------   ----------

      Total current assets                           228,623    1,988,674
                                                  ----------   ----------

Product development costs, net (Note 1)            1,255,570    1,260,478
Property and equipment, net (Note 3)                 128,910      407,632
Other assets                                           1,829       23,723

                                                  ----------   ----------
Total assets                                      $1,614,932   $3,680,507
                                                  ==========   ==========


               LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
      Line of credit (Note 4)                    $      --     $   35,250
      Accounts payable                                55,567      167,097
      Accrued expenses                                18,466       70,489
      Payable to former co-development
        partner (Note 5)                             480,000      400,000
      Deferred revenues                               43,010       40,388
      Notes payable and current portion
        of long-term debt (Note 6)                   303,619      120,433
                                                 -----------   ----------

      Total current liabilities                      900,662      833,657
                                                 -----------   ----------

LONG-TERM DEBT PRIMARILY FROM
  RELATED PARTIES,
          net of current portion
          (Notes 5, 6 and 12)                        161,882      341,369

COMMITMENTS (Note 7)                                    --

STOCKHOLDERS' EQUITY (Note 8)
      Preferred Stock, par value $.001 per share,
        5,000,000 shares authorized; none issued
        and outstanding

      Common Stock, par value $.001 per share,
        10,000,000 shares authorized: 2,655,002
        and 2,523,115 shares issued and outstanding    2,654        2,522

      Additional paid in capital                   7,060,788    6,858,914
      Accumulated deficit                         (6,511,054)  (4,355,955)
                                                 -----------   ----------
        Total stockholders' equity                   552,388    2,505,481
                                                 -----------    ----------
                                                 $ 1,614,932    $3,680,507
                                                 ===========    ==========
</TABLE>
                 See accompanying notes to financial statements.


                                      F-3
<PAGE>   35

                              LEGACY SOFTWARE, INC.

                            STATEMENT OF OPERATIONS


<TABLE>
<CAPTION>
                                                         YEARS ENDED DECEMBER 31,
                                         -----------------------------------------------------------
                                             1997                   1996                       1995
                                         -------------          -------------          -------------
<S>                                         <C>                    <C>                      <C>
REVENUE (Notes 1, 2, 11 and 15)
    Royalties                               $ 411,465              $ 768,716                $ 9,179
    Software sales                             85,723                 13,501                 36,399
    Consulting                                      -                 12,125                  6,000
                                         -------------          -------------          -------------

Total revenue                                 497,188                794,342                 51,578
                                         -------------          -------------          -------------

COSTS AND EXPENSES (Note 1)
    Cost of royalties                         211,308                 76,507                 13,939
    Cost of software sales                     98,881                  9,745                 31,528
    Product development                       619,516              1,664,478                 72,951
    General & administrative                1,351,127              1,585,084                336,457
    Selling                                   267,376                 91,995                 21,216
                                         -------------          -------------          -------------

Total costs and expenses                    2,548,208              3,427,809                476,091
                                         -------------          -------------          -------------

LOSS FROM OPERATIONS                       (2,051,020)             (2,633,467)              (424,513)

INTEREST EXPENSE                              (123,571)              (459,315)              (267,005)

INTEREST INCOME                                19,492                 108,240
                                         -------------          -------------          -------------

NET LOSS                                  ($2,155,099)           ($ 2,984,542)          ($   691,518)
                                         =============          =============          =============

NET LOSS PER COMMON SHARE (Notes 1 and 9)
      BASIC                                    ($0.84)                ($1.59)                 ($0.87)
      DILUTED                                  ($0.84)                ($1.59)                 ($0.87)

WEIGHTED AVERAGE COMMON STOCK SHARES
 OUTSTANDING (Notes 1 and 14)
       BASIC                                2,574,633              1,871,904                 798,200
       DILUTED                              2,574,633              1,871,904                 798,200
</TABLE>

                 See accompanying notes to financial statements


                                      F-4
<PAGE>   36

                              LEGACY SOFTWARE INC.
                       STATEMENT OF STOCKHOLDERS' EQUITY
                  YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995


<TABLE>
<CAPTION>
                                                                                  Additional
                                                                                    Paid-In     Accumulated
                                                            Common Shares           Capital       Deficit       Totals
                                                        ----------------------    ----------    -----------     -------
                                                        Shares         Amount
                                                        ------         ------
<S>                                                     <C>               <C>     <C>            <C>           <C>
BALANCE, January 1, 1995                                720,000           720         4,280      (679,895)     (674,895)

Issue of warrants in conjunction with
  convertible note and the original
  issue discount associated with the
  note's conversion feature, net of
  associated costs (Note 6)                                --            --         499,823          --         499,823

Issuance of common shares in exchange
 for services (Note 8)                                   21,000            21        41,979          --          42,000

Net loss                                                   --            --            --        (691,518)     (691,518)
                                                      ---------         -----     ---------     ---------     ---------
BALANCE, December 31, 1995                              741,000           741       546,082    (1,371,413)     (824,590)

Issuance of common shares in exchange
 for services (Note 8)                                    7,200             7        14,393          --          14,400

Issuance of common shares in conversion
 of note payable (Note 8)                               534,351           534       699,466          --         700,000

Issuance of common shares in initial
 public offering (Note 8)                             1,150,000         1,150     6,898,850          --       6,900,000

Offering costs associated with initial public
 offering (Note 8)                                         --            --      (1,701,952)         --      (1,701,952)

Issuance of common shares in acquisition
 of research and development (Notes 8 and 13)            33,334            33       233,305          --         233,338

Issuance of common shares through employee stock
 purchase plan (Notes 8 and 9)                            7,230             7        28,913          --          28,920

Issuance of common shares in exchange
 for services (Note 8)                                   50,000            50        99,950          --         100,000

Compensation related to nonemployee stock
 options (Notes 8 and 9)                                   --            --          39,907          --          39,907

Net loss                                                   --            --            --      (2,984,542)   (2,984,542)
                                                      ---------         -----     ---------     ---------     ---------
BALANCE, December 31, 1996                            2,523,115         2,522     6,858,914    (4,355,955)    2,505,481


Issuance of common shares through employee stock
 purchase plan (Notes 8 and 9)                            7,842             8        23,518                      23,526

 Issuance of common shares for conversion of
   warrants                                             124,045           124       162,376                     162,500

 Compensation related to nonemployee stock options
 (Notes 8 and 9)                                                                     15,980                      15,980

Net loss                                                                                       (2,155,099)   (2,155,099)
                                                      =========         =====     =========    ==========    ==========
BALANCE, December 31, 1997                            2,655,002         2,654     7,060,788    (6,511,054)      552,388
                                                      =========         =====     =========    ==========    ==========

</TABLE>


                 See accompanying notes to financial statements

                                      F-5
<PAGE>   37

                              LEGACY SOFTWARE, INC.

                             STATEMENT OF CASH FLOWS


<TABLE>
<CAPTION>
                                                                     YEAR ENDED DECEMBER 31,
                                                           -------------------------------------------
                                                               1997           1996            1995
                                                           -----------     -----------     -----------
<S>                                                        <C>             <C>             <C>
Cash flows from operating activities:
   Net loss                                                ($2,155,099)    ($2,984,542)    ($  691,518)
   Adjustments to reconcile net loss to net cash
      used in operating activities:
        Provision for doubtful accounts                         62,500           6,877           7,600
        Amortization of product development costs              134,279          76,507          13,939
        Writedown of product development costs                  75,000              --              --
        Amortization of deferred loan fees and original
          issue discount                                            --         355,307         177,652
        Depreciation                                            99,614          57,399          21,159
        (Gain) loss on disposal of property and
           equipment                                           178,537             144
        Stock based compensation expense                        15,980          44,245
        Issuance of common stock in exchange for
          services                                                  --          14,400
        Issuance of common stock in acquisition of                             233,338
           research and development

Increase (decrease) in cash from changes in:
   Accounts receivable, net                                   (159,967)         (6,691)          2,642
   Other receivables                                           104,872        (125,888)
   Inventories                                                 (22,320)
   Other assets                                                   (323)        (16,624)         (5,099)
   Accounts payable                                           (111,530)        157,145          81,560
   Accrued expenses                                            (19,896)         (5,419)        (23,469)
   Accrued vacation                                            (32,127)         43,101           7,492
   Payable to former co-development partner                                    400,000
   Development expense co-funding billings in
        excess of development expense co-funding
        recognized                                                             (54,637)         28,857
   Deferred revenues                                             2,622          40,388
   Accrued interest                                             80,000        (148,550)         43,570
                                                           -----------     -----------     -----------
        Net cash used in operating activities               (1,747,858)     (1,913,500)       (335,615)
                                                           -----------     -----------     -----------
 Cash flows from investing activities:
   Note receivable                                             (50,000)
   Purchase of property and equipment                           (5,238)       (388,829)        (44,707)
   Proceeds from the disposition of property and
       equipment                                                 7,438           7,750
   Additions to product development costs                     (204,372)     (1,260,478)        (90,446)
                                                           -----------     -----------     -----------
        Net cash used in investing activities                 (252,172)     (1,641,557)       (135,153)
                                                           -----------     -----------     -----------
 Cash flows from financing activities
   Restricted cash                                              55,240         (55,240)
   Payments under line of credit                               (35,250)         35,250
   Proceeds from note payable                                   75,000
   Payments on notes payable and long term debt                (71,301)       (365,534)       (246,441)
   Borrowings on notes payable and long term debt                                              252,326
   Proceeds from private placement of convertible note                                       1,000,000
   Net proceeds from initial public offering                        --       5,355,589
   Registration and financing costs                                                           (190,677)
   Exercise of Common Stock Warrants                           162,500
   Proceeds from issuance of Common Stock                       23,526          24,581
                                                           -----------     -----------     -----------
       Net cash provided by financing activities               209,715       4,994,646         815,208
                                                           -----------     -----------     -----------
 Increase (decrease) in cash and cash equivalents           (1,790,315)      1,439,589         344,440
 Cash and cash equivalents, at beginning of period           1,804,779         365,190          20,750
                                                           -----------     -----------     -----------
 Cash and cash equivalents, at end of period               $    14,464     $ 1,804,779     $   365,190
                                                           ===========     ===========     ===========
Supplemental disclosure of cash flow information

  (a) Non-cash transactions

       On November 20, 1995, the Company issued 21,000 shares of common stock to
       an individual for consulting services (Note 8).

       On January 23, 1996, the Company issued 7,200 shares of common stock to
       an individual for consulting services (Note 8).

       In May, 1996, $700,000 of a convertible note payable to a trust company
       was converted into common stock of the Company (Notes 6 and 8).

       On August 30, 1996, the Company issued 33,334 shares of common stock to
       acquire substantially all of the assets of an internet technology
       company, which consisted primarily of purchased research and development
       (Note 13).

       On November 1, 1996, the Company issued 50,000 shares of common stock to
       an individual in satisfaction of accrued compensation in the amount of
       $100,000 (Note 8).

       During the years ended December 31, 1997 and December 31, 1996, the
       Company recorded $15,980 and $39,907 respectively representing
       compensation in conjunction with nonemployee stock options
       (Notes 8 and 9).

  (b)  Cash paid during the period for:
         Interest                                          $    43,569     $   252,000     $    51,000
                                                           -----------     -----------     -----------
         Income taxes                                               --     $     1,000     $     1,000
                                                           -----------     -----------     -----------
</TABLE>

                 See accompanying notes to financial statements

                                      F-6
<PAGE>   38

                              LEGACY SOFTWARE, INC.

                          NOTES TO FINANCIAL STATEMENTS

Note 1 -- Summary of Significant Accounting Policies

Business

Legacy Software, Inc. (the "Company") develops consumer software products for
the rapidly growing "edutainment" market. An edutainment product combines
entertainment and education content for home and educational use, in which
learning is an integral part of playing a game. The Company also has an Internet
gaming technology, with several interactive games currently operational. The
Company was reincorporated in Delaware in March 1996.

Accounting Estimates

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

Cash Equivalents

For purposes of the statement of cash flows, the Company considers all highly
liquid debt instruments purchased with an initial maturity of three months or
less to be cash equivalents.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation.

Depreciation on property and equipment is computed using the straight-line
method over the estimated useful lives of the assets, which range from three to
seven years.


                                      F-7
<PAGE>   39

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Note 1 -- Summary of Significant Accounting Policies (Continued)

Inventory

Inventory, which consists of finished goods, is valued at the lower of cost or
market. Cost is determined by the first-in, first-out (FIFO) method.

Deferred Loan Costs

Deferred loan costs represent costs incurred in connection with the issuance of
a convertible note payable (See Note 6). The costs were amortized on a straight
line basis over the estimated life of the loan.

Deferred Offering Costs

Deferred offering costs represent costs incurred in connection with the
Company's public offering, and were offset against the proceeds from the public
offering.

Income Taxes

The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109 (SFAS 109) "Accounting for Income Taxes." Under the
asset and liability method, deferred income taxes are recognized for the tax
consequences of "temporary differences" by applying enacted statutory tax rates
applicable to future years to differences between the financial statement
carrying amounts and the tax bases of existing assets and liabilities.

Under SFAS 109, deferred tax assets may be recognized for temporary differences
that will result in deductible amounts in future periods. A valuation allowance
is recognized, if on the weight of available evidence, it is more likely than
not that some portion or all of the deferred tax asset will not be realized.

Revenue Recognition

Royalty Revenue

Royalty revenues consist of royalties earned on sales of software developed with
co-development partners or sales made by distribution partners, from which the
Company earns a specified percentage of the sales price or a specified dollar
amount per unit. Royalty revenues on consignment shipments made by the
co-development partners are only recognized when both (i) the Company can
reasonably estimate the product sell-through from its co-development partners
has occurred and (ii) the Company can comply with Statement of Financial
Accounting Standards No. 48 (SFAS 48), "Revenue Recognition When Right of Return
Exists." The Company has determined that it can recognize revenue in accordance
with SFAS 48 by reviewing and analyzing, among other things, (i) the Company's
and the co-development partners experience on co-development software sales and
returns to date, (ii) sales and returns of the Company's past co-development
software products and other information relating thereto, (iii) sales and
returns of comparable computer software products of other information relating
thereto (iv) information regarding


                                      F-8
<PAGE>   40

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Note 1 -- Summary of Significant Accounting Policies (Continued)


Royalty Revenue (Continued)

significant purchasers of the Company's product, and (v) computer software
industry data and practices. (See Note 15).

Royalty revenues on sales made by distribution partners are recognized upon
shipment to customers less a reasonable estimate for returns (Note 15).

Software Sales

Software sales, which consist of sales of Company-owned software, including
Company developed software, are recorded at the time of shipment provided that
no significant vendor and post-contract support obligations remain outstanding
and collection of the resulting receivable is deemed probable by management. Any
insignificant post-contract support obligations and provisions for estimated
returns, including distributors' stock balancing rights and liability under
price protection programs, are accrued for at the time of sale.

Consulting Revenue

Consulting revenue is recognized as services are performed.

Product Development Costs

The Company records product development costs net of any co-funded development
expenses recognized into operations under co-development agreements. Co-funded
development expenses under co-development agreements to develop software are
recognized as a ratio of related product development costs as these costs are
incurred. This ratio is calculated by dividing total estimated co-funded
development expenses to be received by total estimated product development
costs. Co-funded development expenses are not recognized into the Statement of
Operations until all contractual repayment contingencies, such as the
unconditional repayment of co-funded development expenses upon termination of a
co-development contract without cause, have been eliminated. As contracts can
extend over one or more accounting periods, revisions in costs or co-funded
development expenses estimated during the course of the work are adjusted during
the accounting period in which the facts that require such revisions become
known. The effects of these changes in estimates are then recognized
prospectively throughout the remaining contract life. The liability "development
expense co-funding billings in excess of development expense co-funding
recognized" represents billings under co-development agreements in excess of
amounts recognized into the Statement of Operations. As of December 31, 1995,
the Company was a party to two co-development contracts, the first of which, the
Emergency Room Development and Licensing Agreement, specified that (i) the
Company has granted its co-development partner an exclusive license to, among
other things, use, manufacture, sell and


                                      F-9
<PAGE>   41

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Note 1 -- Summary of Significant Accounting Policies (Continued)


Product Development Costs (Continued)

distribute the software title, (ii) the co-development partner has a right of
first refusal on derivative works within 12 months of acceptance of the title by
the co-development partner, and (iii) the co-development partner is
contractually obligated to pay the Company a royalty based on a fixed percentage
of product revenue (net of returns and allowances), or a fixed dollar amount if
bundled with other software, within 60 days after the conclusion of each
calendar quarter. The terms of the second agreement, the District Attorney
Development and Licensing Agreement (the "DA License Agreement") are identical
to the first agreement, except that (i) the co-development partner may terminate
this agreement without cause, however the co-development partner would be
obligated to pay the Company for any co-development services rendered up to the
termination date and (ii) the royalty structure is different from the first
contract. The DA License Agreement was terminated with the co-development
partner effective January 3, 1997 (See Note 5). The Company has not entered into
any new co-development contracts since that date.

Statement of Financial Accounting Standards No. 86 provides for the
capitalization of certain software development costs once technological
feasibility has been established upon completion of a detail program design. All
costs capitalized are net of related development expense co-funding, and the
Company ceases capitalizing such costs when the product derived from the project
is available for general release to customers. These costs are amortized on a
product-by-product basis at the greater of the amount computed using (a) the
ratio of current revenues for a product to the total of current and anticipated
future revenues or (b) the straight-line method over the remaining estimated
economic life of the product. The Company evaluates the recoverability of any
software development costs capitalized on a quarterly basis by comparing the net
realizable value, determined pursuant to management's estimates of future
product cash flows, with the unamortized balance of software development costs
(see below). Based on this evaluation, the Company recorded a writedown of
software development costs of $75,000 in 1997. During the year ended December
31, 1995, the Company capitalized $90,446 of software development costs related
to the Emergency Room title, $13,939 was amortized into operations in 1995, and
the remaining balance of $76,507 was amortized into operations in 1996. During
the years ended December 31, 1996 and 1997, the Company capitalized $1,260,478
and $140,148 of software development costs related to the D.A. Pursuit of
Justice title respectively and in the year ended December 31, 1997, the Company
amortized $169,080 into operations. During the year ended December 31, 1997 the
Company capitalized $64,224 relating to the Emergency Room Intern title and
amortized $40,199 into operations.



                                      F-10
<PAGE>   42

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Note 1 -- Summary of Significant Accounting Policies (Continued)


Earnings Per Share

The Company adopted SFAS No. 128, "Earnings Per Share", during 1997. SFAS No.
128 requires presentation of basic and diluted earnings per share. Basic
earnings per share is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
reporting period. Diluted earnings per share reflects the potential dilution
that could occur if securities or other contracts, such as stock options, to
issue common stock were exercised or converted into common stock. All prior
period weighted average and per share information has been restated in
accordance with SFAS No. 128.

Stock-Based Compensation

The Company adopted Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation" (SFAS 123), as of January 1, 1996,
which establishes a fair method of accounting for stock-based compensation
plans. In accordance with SFAS 123, the Company has chosen to continue to
account for stock-based compensation utilizing the intrinsic value method
prescribed in APB 25. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the fair market price of the Company's stock
at the date of grant over the amount an employee must pay to acquire the stock.

Also, in accordance with SFAS 123, the Company has provided footnote disclosure
with respect to stock-based employee compensation. The cost of stock-based
employee compensation is measured at the grant date based on the value of the
award and recognized over the service period. The value of the
stock-based award is determined using a pricing model whereby compensation cost
is the excess of the fair value of the stock as determined by the model at grant
date or other measurement date over the amount an employee must pay to acquire
the stock. (See Note 9)




                                      F-11

<PAGE>   43

                            LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Note 1 -- Summary of Significant Accounting Policies (Continued)


New Accounting Pronouncements

Statement of Financial Accounting Standard No. 129, "Disclosure of Information
about Capital Structure", ("SFAS 129") issued by the FASB is effective for
financial statements ended after December 15, 1997. The new standard reinstates
various securities disclosure requirements previously in effect under Accounting
Principles Board Opinion No. 15, which has been superseded by SFAS No. 128. The
Company adopted SFAS No. 129 on December 15, 1997 and it had no effect on its
financial position or results of operations.

Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive
Income", ("SFAS 130") issued by the FASB is effective for financial statements
with fiscal years beginning after December 15, 1997. SFAS 130 establishes
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. The Company does not
expect adoption of SFAS 130 to have an impact on its financial position or
results of operations and any effect will be limited to the form and content of
disclosures.

Statement of Financial Accounting Standard No. 131, "Disclosures about Segments
of an Enterprise and Related Information", ("SFAS 131") issued by the FASB is
effective for financial statements with fiscal years beginning after December
15, 1997. SFAS 131 requires that public companies report certain information
about operating segments, products, services and geographical areas in which
they operate and their major customers. The Company does not expect adoption of
SFAS 131 to have an impact on its financial position or results of operations
and any effect will be limited to form and content of its disclosures.

Statement of Position 97-2, "Software Revenue Recognition," ("SOP 97-2") issued
by the AICPA is effective for transactions entered into in fiscal years
beginning after December 15, 1997. SOP 97-2 supersedes SOP 91-1 regarding
software revenue recognition. SOP 97-2 establishes standards which require a
company to recognize revenue when (i) persuasive evidence of an arrangement
exists, (ii) delivery has occurred, (iii) the vendor's fee is fixed or
determinable, and (iv) collectability is probable. The SOP also discusses the
revenue recognition criteria for multiple element contracts and allocation of
the fee to various elements based on vendor-specific objective evidence of fair
value. The Company does not expect adoption of this SOP to have a material
effect on the financial statements.

Note 2 -- Financial Condition and Liquidity

On May 14, 1996 the Company completed an Initial Public Offering and generated
$5,198,000 of net proceeds. The proceeds have been used to pay off certain
existing debt, to develop three new software titles and provide working capital.
At December 31, 1996 the Company had expended $1,900,000 in operating activities
and $1,600,000 in software development costs and acquisition of property and
equipment compared to expenditures of $1,800,000 in operating activities and
$250,000 in software development costs and acquisition of property and equipment
during the year ended December 31, 1997.


                                      F-12
<PAGE>   44

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


In the fourth quarter of 1996, the Company and IBM mutually agreed to terminate
the DA License Agreement. As consideration for the termination the Company has
agreed to pay IBM the sum of $400,000, the total amount of milestone payments
made by IBM to the Company, as termination costs on or before December 15, 1997
(See Note 5). The Company was unable to make the payment on December 15, 1997
and, in accordance with the terms of the Agreement, accrued $80,000 representing
accrued interest from January 1, 1996 to December 31, 1997. The Company and IBM
have reached an agreement in principal whereby the Company will pay $25,000 to
IBM and IBM will receive a royalty on revenues generated from the ER Intern, ER
Deluxe and DA Pursuit of Justice titles up to a total of an additional $175,000
plus interest at 10 percent. Also in the fourth quarter of 1996, McGraw-Hill
Home Interactive without cause effectively terminated a letter of intent with
the Company. A mutual release was signed in February 1997 at which time the
Company received $75,000 in unfunded development costs. (See Note 5)

As of December 31, 1997, the Company had (i) never achieved operating results,
(ii) had a negative working capital of $672,039, and cash on hand of $14,464,
(iii) total short term indebtedness of $783,619, and long term indebtedness of
$161,882, and (iv) failed to make principal payments on an unsecured note
payable to a related party. Due to the above, the Company, (i) ceased
development of new titles pending the generation of additional working capital
or the implementation of subcontractor relationships on terms that permit
payments to be made by the Company when it has cash available to make such
payments, (ii) curtailed its internet gaming services, (iii) closed one of its
business offices, (iv) significantly reduced marketing and public relation
efforts, and (v) reduced its total number of employees to four. Revenues from
the Company's Emergency Room and derivatives thereof are continuing to decrease,
and revenues from the D.A. Pursuit of Justice title have been lower than
expected. These conditions raise substantial doubt about the Company's ability
to continue as a going concern. The accompanying financial statements do not
include any adjustments relating to the recoverability of reported assets or
liabilities should the Company be unable to continue as a going concern. On
February 28, 1998, the Company was notified by The Nasdaq National Market, Inc.
("NASDAQ") that the Company is not in compliance with NASDAQ's net tangible
assets/market capitalization/net income and minimum bid price requirements, and
that absent compliance, the Company's Common Stock will be delisted from the
NASDAQ SmallCap Exchange.

In the six months ended December 31, 1997 the Company failed to make a
principal payment on an unsecured Note Payable to a related party. The monthly
payment, in the amount of $10,000, was due in accordance with the terms of the
original note dated February 1, 1991, as amended, which provides for monthly
payments of principal and interest commencing on July 1, 1997. (See Note 6)


                                      F-13
<PAGE>   45

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Note 2 - Financial Condition and Liquidity (Continued)

The Company believes that, should it not be able to obtain funding to supply
its near-term cash requirements, there is substantial doubt about the Company's
ability to continue operations.


The Company has pursued various funding alternatives, but has not been able to
obtain either the debt or equity financing it requires. On March 25, 1998, the
Company signed a non-binding letter of intent (the "Letter of Intent") with
Black Tusk Medical, Inc. ("BTI"), a Nevada corporation engaged in the business
of marketing and distribution software titles. Pursuant to the Letter of Intent,
BTI advanced the Company $30,000 toward two proposed joint ventures for the
development and publication of high production value educational software, and
will purchase 260,000 shares of the Company's Common Stock for $130,000 within
five days following execution of a definitive Merger Agreement. If the Merger is
consummated, the foregoing 260,000 shares would become authorized but unissued
shares of Common Stock and the shareholders of BTI would receive 1,922,588
shares of the Company's Common Stock, at a valuation of $0.40 per share. As a
result, following the merger, the shareholders of BTI will hold approximately
42% of the total outstanding shares of the Company.

The Company believes that it will be able to complete the Merger, and its
prospects for obtaining additional financing will improve as a result thereof.
However, the Company has not been able to identify other viable financing
alternatives at the present time, and there can be no assurance that the
transactions contemplated by the Letter of Intent ultimately will be effected on
terms acceptable to the Company, or at all.

However should this transition not be successful the Company could face short
term liquidity requirements that could significantly deplete its current cash
resources. If this occurs the Company believes that liquidity requirements can
be satisfied by ceasing costs associated with development of future titles,
significantly curtailing its Internet gaming services, finding new affiliate
arrangements for future titles and seeking additional financing.

Additionally, although the Company believes that its operating plan and efforts
will be adequate to meet its fiscal 1998 working capital needs there can be no
assurance that the Company may not experience liquidity problems caused by
adverse market conditions or other unfavorable events.



                                      F-14
<PAGE>   46

                              LEGACY SOFTWARE, INC.

                          NOTES TO FINANCIAL STATEMENTS
                                   (CONTINUED)


Note 3 -- Property and Equipment


Property and equipment are summarized as follows:
<TABLE>
<CAPTION>
                                                             December 31,
                                                             ------------
                                                        1997              1996
                                                      --------------------------
<S>                                                   <C>               <C>
Computers and equipment                               $212,688          $322,734
Furniture and fixtures                                  17,930           134,079
Computer software                                       10,496             8,716
Leasehold improvements                                    --              52,303
                                                      --------          --------
                                                       241,114           517,832
Less accumulated depreciation                          112,204           110,200
                                                      --------          --------
Totals                                                $128,910          $407,632
                                                      ========          ========
</TABLE>


Depreciation and amortization expense on property and equipment was $99,614,
$57,399 and $21,159 for the years ended December 31, 1997, 1996, and 1995.

Due to the Company downsizing and relocating its corporate offices, the Company
wrote off $51,885 related to computers and equipment and $32,250 related to
leasehold improvements during 1997. Additionally, the Company sold the majority
of its furniture and fixtures to its Landlord and recorded a loss of
approximately $95,000.

Note 4 -- Short-Term Borrowings and Credit Facilities

The Company had a $50,000 revolving line of credit agreement with a bank which
expired in January 1997, to finance purchases of computers and equipment. During
the term of the agreement, the Company could borrow at prime rate plus 1.75%.
The outstanding balance at December 31, 1996 was $35,250 which was paid down in
January 1997 through redemption of the certificate of deposit. The line was
fully collateralized by a certificate of deposit account with a balance of
$55,240 at December 31, 1996.


Note 5 -- Termination and Acquisition of Co-Development Partner's Rights Under
          Agreements

In the fourth quarter of 1996, the Company and International Business Machines
("IBM") mutually agreed to terminate the DA License Agreement. As consideration
for the termination and for the acquisition of IBM's rights under the agreement,
the Company was obligated to pay IBM the aggregate sum of $400,000, representing
the total amount of milestone payments made by IBM to the Company


                                      F-15
<PAGE>   47

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


under the DA License Agreement. The final termination agreement effective
January 3, 1997, provided payment provisions based upon a fixed percentage of
royalty payments received, or net revenues generated if the Company distributes
the software directly, with payment in full due December 15, 1997. The Company
recorded a $400,000 current liability at December 31, 1996 to account for the
payments under the termination agreement, which effectively increased the
capitalized software development costs related to the D.A. Pursuit of Justice
title. The Company was unable to make the $400,000 payment on December 15, 1997
and, in accordance with the terms of the Agreement, recorded an additional
$80,000 representing accrued interest on the principal amount from January 1,
1996 to December 31, 1997. Subsequent to December 31, 1997, the Company and IBM
have reached an agreement in principal whereby the Company will pay $25,000 to
IBM and IBM will receive a royalty on revenues generated from the ER Intern, ER
Deluxe and DA Pursuit of Justice titles up to a total of an additional $175,000
plus interest at 10%.

Also during 1996 a letter of intent was signed with McGraw Hill Home Interactive
for the development and licensing of the contemplated Animal Doctor title. The
letter of intent was effectively terminated without cause by McGraw Hill Home
Interactive prior to December 31, 1996, at which time the Company was due
$75,000 from McGraw Hill Home Interactive related to unfunded development
expenses. A release and termination agreement was signed in February of 1997 at
which time payment of the $75,000 in unfunded development expenses was received.
At December 31, 1996, the Company recorded the unfunded development expenses due
from McGraw Hill Home Interactive in other receivables as a charge against
product development expenses.

Note 6 -- Long Term Debt

On November 21, 1995, the Company entered into a $1,000,000 convertible note
payable to a trust company (the "Convertible Note") bearing interest at 10%
payable monthly secured by all of the Company's assets. Principal of $300,000
was paid in May 1996 from the net proceeds of an initial public offering of the
Company's common stock. Additionally, in conjunction with the initial public
offering, $700,000 of the Convertible Note was converted into common stock of
the Company. In connection with this note, the Company also granted the trust
company warrants to purchase 200,000 shares of common stock, subject to
adjustment under certain circumstances, at an initial purchase price of $1.31
per share. Of the $1,000,000 of total proceeds, $506,702 was allocated to the
note's conversion feature and the warrants and represents the original issue
discount on the Convertible Note. The original issue discount was fully
amortized as of December 31, 1996.


                                      F-16
<PAGE>   48

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)

Note 6 -- Long Term Debt (Continued)

The Company's long-term debt is as follows:

<TABLE>
<CAPTION>

                                                                                    December 31,
                                                                                    ------------
                                                                                1997          1996
                                                                              --------      --------
<S>                                                                           <C>           <C>
Unsecured note payable to related party bearing interest at 10.5%; all
   accrued interest and principal payable in monthly installments
   of $10,000, from July 1997 through June 1999                               $260,051      $260,051

Unsecured note payable to shareholder bearing interest at 16.7%; all
   accrued interest and principal payable over the course
   of two years from March 1998 through February 2000                           73,200        73,200

Unsecured note payable to shareholder bearing interest at 10.5%; all
   accrued interest and principal payable over the course
   of two years from March 1998 through February 2000                           57,250        68,118

 Unsecured note payable to a third party with outstanding
      principal due December 31, 1998                                           75,000            --

Unsecured note payable to individual bearing interest at 9%; interest
   payable monthly with outstanding principal payable over the course of
   one year from July 1996 through June 1997                                        --        60,422
                                                                              --------      --------
   Total notes payable                                                         465,501       461,791

   Less current portion                                                        303,619       120,433
                                                                              --------      --------

   Long-term portion                                                          $161,882      $341,358
                                                                              ========      ========
</TABLE>


                                      F-17
<PAGE>   49

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Note 6 -- Long Term Debt (Continued)


The aggregate maturities of long-term debt maturing in succeeding years are as
follows:

<TABLE>
<CAPTION>
      December 31,                                Amount
      ------------                              ---------

<S>                                             <C>
        1998                                    $ 303,619
        1999                                      145,224
        2000                                       16,658
                                                ---------
                                                $ 465,501
                                                =========
</TABLE>


The Company is currently in default of making principal payments on its
unsecured note payable for $260,051 to a related party.

The Company was unable to practically estimate the fair value of the notes
payable due to their related party nature.


Note 7 --Commitments

Operating Leases

The Company leases certain equipment under various operating leases which expire
at various dates through November 5, 1999. Future minimum rental payments
required under operating leases that have initial or remaining terms in excess
of one year at December 31, 1997 are as follows:

<TABLE>
<CAPTION>
                                                Operating
      December 31,                                Leases
      ------------                              ---------

<S>                                             <C>
        1998                                    $   9,996
        1999                                        9,893
        2000                                        9,093
                                                ---------
                                                $  28,982
                                                =========
</TABLE>


Rent expense for the years ended December 31, 1997, 1996 and 1995 was $155,013,
$113,569, $30,000.



                                      F-18
<PAGE>   50

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Employment Agreements

During 1997, the Company canceled all of its employment agreements with
employees.

Note 8 -- Stockholders' Equity

Initial Public Offering

In May 1996, the Company consummated an initial public offering of 1,150,000
shares of its common stock. Net proceeds to the Company were approximately
$5,198,048 after deducting all offering-related expenses. During 1996 and 1997,
the Company used a majority of the net proceeds for the development of
additional RealPlayTM (formerly Career SimTM) titles, the development of
Passport2, the Company's Internet gaming technology, certain outstanding debt,
and for working capital purposes.

Capital Stock Transactions

On October 31, 1995, pursuant to a unanimous written consent of the Board of
Directors and stockholders, the Company effected a stock split of the Company's
common stock on a 144 shares to 1 share basis. All share and per share data have
been retroactively adjusted to reflect these events.

During 1995 the Company granted to a trust company a warrant to purchase 200,000
shares of common stock at an initial purchase price of $1.31 per share in
connection with a convertible note payable to the trust company (Note 6).

On November 20, 1995 the Company issued 21,000 shares of common stock to an
individual in exchange for consulting services being rendered throughout 1995.
The Company recorded expenses during 1995 of $42,000 for the fair market value
of these services.

On January 23, 1996, the Company issued 7,200 shares of common stock to an
individual in exchange for consulting services. The Company recorded expenses
during 1996 of $14,400 representing the fair market value of the common shares
issued.

In May 1996 $700,000 of a convertible note payable to a trust company was
converted into 534,351 shares of the Company stock. The number of shares issued
was determined by the exercise price of $1.31 per share (See Note 6).

In May 1996, in conjunction with the initial public offering, the Company
granted to the underwriter a five-year warrant to purchase up to 92,800 shares
of common stock exercisable at $9.00 per share. The Company did not record an
expense during 1996, as the Company determined the value of the warrants was
less than the exercise price.


                                      F-19
<PAGE>   51

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Note 8 -- Stockholders' Equity (Continued)

On August 30, 1996 the Company issued 33,334 shares of common stock to acquire
substantially all of the assets of an internet technology company, which
consisted primarily of purchased research and development. The Company recorded
$233,338 of product development expenses related to this transaction which was
valued based on the fair market value of the stock issued (See Note 13).

On October 31, 1996, the Company issued 7,230 shares of common stock to various
employees under the Employee Stock Purchase Plan. The fair market value of the
stock was $4.00 per share on October 31, 1996 and the purchase price to the plan
was $3.40 per share. The Company recorded compensation expense of $4,338 related
to this transaction (See Note 9).

On November 1, 1996 the Company issued 50,000 shares of common stock to an
individual in satisfaction of accrued consulting compensation. This transaction
was valued at the fair market value of the services received of $100,000.

On May 30, 1997 the Company issued 7,842 shares of common stock to various
employees under the Employee Stock Purchase Plan. The fair market value of the
stock was $3.00 per share on May 30, 1997 and the purchase price to the plan was
$2.55 per share. The Company recorded compensation expense of $3,529 related to
this transaction (See Note 9).

On August 15, 1997 a trust company exchanged 124,045 warrants on the Company's
common stock for $162,500.




                                      F-20
<PAGE>   52


                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Note 8 -- Stockholders' Equity (Continued)


Capital Stock Transactions (Continued)

During the years ended December 31, 1997 and 1996 the Company recorded
stock-based compensation expense of $15,980 and $39,907 related to non-employee
stock options in accordance with SFAS 123 (Note 9).

Warrants

In connection with the Company's initial public offering of common stock, the
Company issued warrants to a trust company to purchase 200,000 shares of common
stock at $1.31 per share. The warrants were exercisable immediately.

During 1997 the trust company exercised warrants to purchase 124,045 shares of
common stock. As of December 31, 1996, warrants to purchase 75,955 shares of
common stock were outstanding.

Note 9 -- Stock Option and Purchase Plans

1995 Stock Option/Stock Issuance Plan

The 1995 Stock Option Plan/Stock Issuance Plan ("the Option Plan") was adopted
by the Board of Directors and approved by the stockholders on November 9, 1995.
Under the Option Plan, 521,800 shares of common stock have been authorized for
issuance. In no event may any one participant in the Option Plan receive option
grants or direct stock issuances for more than 250,000 shares in the aggregate.
In January 1996, 240,000 options were granted to current shareholders at an
exercise price of $6.00 per share. These options vest 50% immediately on being
granted and 50% evenly over the next two years. In addition, on the same date,
110,000 options were also granted to key employees of the Company at an exercise
price of $5.10 per share and 40,000 options were granted to the Company's
outside directors at an exercise price of $6.00 per share. The options granted
to outside directors vest evenly over the next four years and the options
granted to employees vest 25% on the one year anniversary of the grant date and
the remaining 75% vest evenly over the next 36 months. Through November 1996,
the Company granted an additional 111,666 options to key employees at exercise
prices ranging from $3.88 to $7.25 per share, which vest 25% on the one year
anniversary of the grant dates and the remaining 75% vest evenly over the next
36 months. On December 18, 1996 the Stock Option Committee approved the
cancellation of 461,666 outstanding options originally granted to existing
shareholders and key employees and granted new options at exercise prices
ranging from $2.75 to $3.25 per share. All previous vesting was forfeited in
exchange for the new exercise prices. These new options vest at 25% on the one
year anniversary of the grant date and the remaining 75% vest evenly over the
next 36 months. On January 28, 1997, the Company granted 9,996 options to key
employees at an exercise price of $3.75 per share and on May 29, 1997, the
Company granted 5,000 options to non-employee Board members at an exercise
price of $3.00 per share. The options vest 25% on the one year anniversary of
the grant date and the remaining 75% vest evenly over the next 36 months.



                                      F-21
<PAGE>   53

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


1995 Stock Option/Stock Issuance Plan (Continued)


The Option Plan is divided into three separate components: (i) the Discretionary
Option Grant Program under which eligible individuals may, at the discretion of
the Plan Administrator, which is the Stock Option Committee of the Company's
Board of Directors, be granted options to purchase shares of Common Stock at an
exercise price not less than 85% of their fair market value on the grant date;
(ii) the Stock Issuance Program under which such individuals may, at the Plan
Administrator's discretion, be issued shares of Common Stock directly, through
the purchase of shares at a price not less than 85% of their fair market value
at the time of issuance or as a bonus tied to the performance of services; and
(iii) the Automatic Option Grant Program under which option grants will
automatically be made at periodic intervals to eligible non-employee Board
members to purchase shares of Common Stock at an exercise price equal to 100% of
the fair market value on the grant date.

The Discretionary Option Grant Program and the Stock Issuance Program will be
administered by the Stock Option Committee. The Stock Option Committee as Plan
Administrator will have complete discretion to determine which eligible
individuals are to receive option grants or stock issuances, the time or times
when such option grants or stock issuances are to be made, the number of shares
subject to each such grant or issuance, the status of any granted option as
either an incentive stock option or a non-statutory stock option under the
Federal tax laws, the vesting schedule to be in effect for the option grant or
stock issuance and the maximum term for which any granted option is to remain
outstanding.

Under the Automatic Option Grant Program, each individual serving as a
non-employee Board member on the date the Underwriting Agreement for this
offering is executed will receive an option grant on such date for 10,000 shares
of Common Stock provided such individual has not otherwise been in the prior
employ of the Company. Each individual who first becomes a non-employee Board
member thereafter will receive a 10,000 share option grant on the date such
individual joins the Board provided such individual has not been in the prior
employ of the Company. In addition, at each Annual Stockholders Meeting,
beginning with the 1997 Annual Meeting, each individual who is to continue to
serve as a non-employee Board member after the meeting will receive an
additional option grant to purchase 2,500 shares of Common Stock whether or not
such individual has been in the prior employ of the Company.



                                      F-22
<PAGE>   54

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)

            Option activity within each plan is as follows:

<TABLE>
<CAPTION>
                                                                          Weighted
                                             Incentive       Directors      Average
                                             Stock Option    Stock Option   Price
                                              Plans             Plan        Per Share
                                             ------------    ----------     ----------
<S>                                          <C>             <C>             <C>
Balance outstanding, January 1, 1995

            Options granted at
             $3.00 per share                      50,000             -       $ 3.00

                                             ------------    ----------     -------
Balance outstanding December 31, 1995             50,000             -       $ 3.00

            Options granted range from
            $3.00 to $7.25 per share             973,332        40,000       $ 4.53

            Options canceled range from
            $3.00 to $7.25 per share            (551,666)      (20,000)      $ 5.55

                                             ------------    ----------     -------
Balance outstanding December 31, 1996            471,666        20,000       $ 3.18

            Options granted range from
            $3.00 to $3.75 per share               9,996         5,000       $ 3.50

            Options canceled range from
            $3.00 to $7.25 per share            (124,662)                    $ 3.16

                                             ------------    ----------     -------
Balance outstanding, December 31, 1997           357,000        25,000       $ 3.20
                                             ============    ==========     =======

Options exercisable, December 31, 1997           356,666        10,000       $ 3.01
                                             ============    ==========     =======

</TABLE>


         Information relating to stock options at December 31, 1997 summarized
by exercise price are as follows:

<TABLE>
<CAPTION>
                                        Outstanding                               Exercisable
                            -----------------------------------               --------------------
                                          Weighted Average                      Weighted Average
                                      -------------------------               --------------------
Exercise Price                           Life      Exercise                             Exercise
Per Share                   Shares     (Months)      Price                     Shares    Price
                            -----------------------------------               --------------------
<S>                         <C>       <C>           <C>                       <C>       <C>
Incentive Stock
 Option Plan                178,333      107.5       $2.75                    178,333     $2.75
                            178,333      107.5       $3.25                    178,333     $3.25
                                334      108.0       $3.75
                            -------      -----       -----                    -------     -----
                            357,000      107.5       $3.00                    356,666     $3.00
                            =======      =====       =====                    =======     =====
Directors Stock
 Option Plan                  5,000       96.0       $3.00                      5,000     $3.00
                             20,000       96.0       $6.00                      5,000     $6.00
                            -------      -----       -----                    -------     -----
                             25,000       96.0       $5.40                     10,000     $4.50
                            =======      =====       =====                    =======     =====

</TABLE>



                                      F-23
<PAGE>   55

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Note 9 - Stock Option and Purchase Plans (Continued)

1995 Stock Option/Stock Issuance Plan (Continued)

All stock options issued to employees have an exercise price of not less than
85% of the fair market value of the Company's common stock on the date of the
grant, and in accordance with accounting for such options utilizing the
intrinsic value method there is a related compensation expense recorded in the
Company's financial statements representing 15% of the fair market value. Had
the compensation cost for stock-based compensation been determined based on the
fair value of the grant dates consistent with the method of SFAS 123, the
Company's net loss and loss per share for the years ended December 31, 1997,
1996 and 1995 would have been increased to the pro forma amounts presented
below as follows:

<TABLE>

                                        1997            1996             1995
                                        ----            ----             ----
<S>                                     <C>              <C>             <C>
Net loss as reported               $(2,155,099)     $(2,984,542)      $(691,518)
Net loss pro forma                 $(2,621,214)     $(2,997,000)      $(691,518)

Basic net loss per common share
     as reported                   $     (0.84)     $     (1.59)      $   (0.87)
Basic net loss per common share
     pro forma                     $     (1.02)     $     (1.60)      $   (0.87)

Diluted net loss per common share
     as reported                   $     (0.84)     $     (1.59)      $   (0.87)
Diluted net loss per common share
     pro forma                     $     (1.02)     $     (1.60)      $   (0.87)

</TABLE>


The fair value of option grants is estimated on the date of grant utilizing the
Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1997 and 1996; expected life of option of 10 years,
expected volatility of 26.2%, and 14.7% respectively risk-free interest rate of
6.0% and 6.2%, respectively and a 0% and 0% dividend yield, respectively. The
weighted average fair value at date of grants for options granted during 1997
and 1996 was approximately $1.72 and $3.00 per option.

Due to the fact that the Company's stock option programs vest over many years
and additional awards are made each year, the above proforma numbers are not
indicative of the financial impact had the disclosure provisions of SFAS 123
been applicable to all years of previous option grants. The above numbers do not
include the effect of options granted prior to 1995 that vest in 1995, 1996 and
1997.

Under the Company's Automatic Option Grant Program, options were outstanding to
outside directors at December 31, 1997. In accordance with accounting for
options granted to nonemployees utilizing the fair value method in accordance
with SFAS 123, the Company recorded stock-based compensation expense of $15,980
and $39,907 in the Statement of Operations for the years ended December 31, 1997
and 1996, with a corresponding credit to additional paid-in-capital.



                                      F-24
<PAGE>   56

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)


Note 9 - Stock Option and Purchase Plans (Continued)

Employee Stock Purchase Plan

The Company's Employee Stock Purchase Plan (the "Purchase Plan") was adopted by
the Board of Directors on January 15, 1996 and approved by the stockholders on
January 15, 1996. The Purchase Plan is designed to allow eligible employees of
the Company and participating subsidiaries to purchase share of Common Stock, at
semi-annual intervals, through their periodic payroll deductions under the
Purchase Plan, and a reserve of 150,000 shares of Common Stock has been
established for this purpose. Employees will be eligible to participate if they
are employed by the Company for at least 20 hours per week and five (5) months
per calendar year.

The Purchase Plan will be implemented in a series of successive offering
periods, which commenced subsequent to the initial public offering, each with a
maximum duration of 24 months. Payroll deductions may not exceed 15% of base
salary for each semi-annual period. The purchase price per share will be
eighty-five percent (85%) of the lower of (i) the fair market value of the
Common Stock on the participant's entry into the offering period or (ii) the
fair market value on the semi-annual purchase date. Each outstanding purchase
right will be exercised immediately prior to a merger or consolidation of the
Company. On October 31, 1996 the plan purchased 7,230 shares of the Company's
common stock. The fair market value of the stock on this date was $4.00 per
share, and the purchase price to the employees was 85% of fair market value, or
$3.40 per share. Compensation expense in the amount of $4,338 related to this
transaction was recognized in the Statement of Operations for the year ended
December 31, 1996. On May 30, 1997 the plan purchased 7,842 shares of the
Company's common stock. The fair market value was $3.00 per share and the
purchase price to the employees was 85% of fair market value, or $2.55 per
share. Compensation expense in the amount of $3,529 was recognized in the
Statement of Operations for the year ended December 31, 1997.

Note 10 - Income Taxes

At December 31, 1997, the Company has federal and state net operating loss
carryforwards of approximately $5,533,000 and $2,696,000, respectively,
available to offset taxable income through the year 2012. The Tax Reform Act of
1986 contains provisions which limit the federal net operating loss
carryforwards available that can be used in any given year in the event of
certain occurrences, which include significant ownership changes.

At December 31, 1997 and 1996, the Company's net deferred tax asset consisted
primarily of net operating losses. The Company established a valuation allowance
equal to the net deferred tax asset, as the Company could not conclude that it
was more likely than not that the deferred tax asset would be realized. The
valuation allowance at December 31, 1997 and 1996 was $2,253,000 and
$1,290,500.



                                      F-25

<PAGE>   57

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)

Note 11 - Significant Customer

The Company had one significant customer in 1997, 1996 and 1995 which
represented approximately 69%, 94% and 12% of revenue.

Note 12 - Related Party Transactions

During 1997, 1996 and 1995 the Company paid $3,974, $1,527,328 and $37,565 in
production coordination expenses to a company in which an employee is a 50%
owner.

As of December 31, 1997, the Company has a note receivable outstanding of
$7,000, from an outside director, which bears interest at 10% per annum, and is
payable in twenty-four monthly installments from May 1996 through April 1998.

During the year ended December 31, 1997 and 1996, the Company entered into a
number of related party debt transactions as described in Note 6.

Note 13 - Acquisition of Research and Development

In August 1996, the Company acquired substantially all of the assets,
properties, and rights of On the Toes of Giants, Inc., a California corporation
("OTTOG"), pursuant to an Asset Purchase Agreement, dated August 19, 1996, which
consisted primarily of purchased research and development. The Consideration for
the purchased assets consisted of 33,334 newly-issued shares of common stock,
par value $.001, of the Company and the assumption of certain liabilities of
OTTOG. The transaction was valued as of August 30, 1996, the closing date, when
the common stock had a fair market value of $7.00 per share, at a total fair
market value of $233,338, and was recorded as an expense of product development.
The Company plans to develop and operate a separate internet-oriented business
unit based upon the purchased research and development. Proforma information was
not included as the operations were insignificant.

                                      F-26
<PAGE>   58

                             LEGACY SOFTWARE, INC.

                         NOTES TO FINANCIAL STATEMENTS
                                  (CONTINUED)

Note 14 - Earnings Per Share

The following is a reconciliation of the weighted average number of shares used
to compute basic and diluted earnings per share:

<TABLE>
<CAPTION>
                                                     1997        1996           1995
                                                   ---------   ---------       -------
<S>                                                <C>         <C>             <C>
Basic weighted average shares outstanding          2,574,633   1,871,904       798,200
Diluted effect of options                                 --          --            --
                                                   ---------   ---------       -------
Diluted weighted average shares outstanding        2,574,633   1,871,904       798,200
</TABLE>

Options to purchase 382,000 shares were outstanding during the years ended 1997
but were not included in the computation of diluted loss per common share
because the effect would be antidilutive.

Note 15 - Fourth Quarter Transaction

During the fourth quarter of 1996, the Company recognized into its Statement of
Operations $747,995 of royalty revenue from the Emergency room title that
related to the co-development sales. Although the cash had been received in
earlier periods, the Company was unable to reasonably estimate returns on its
early sales of the Emergency Room title in accordance with Statement of
Financial Accounting Standards No. 48 (SFAS 48). However, during the fourth
quarter, sufficient information was available for the Company to reasonably
estimate the returns. Of the royalty revenue recognized in the fourth quarter
of 1996, $312,787, $493,670, $267,592 and $73,946 relates to sales from the
fourth quarter of 1995, and the first, second, and third quarters of 1996,
respectively.



                                      F-27
<PAGE>   59

                             LEGACY SOFTWARE, INC.

                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
Column A                                Column B            Column C             Column D        Column E
--------                                --------            --------             --------        --------
                                                            Additions
                                        Balance at          charged to costs                     Balance at
Description                             beginning of year   and expenses         Deductions      end of year
-----------                             -----------------   ----------------     ----------      ------------
<S>                                     <C>                 <C>                  <C>             <C>
Allowance for possible
  losses on receivables

Year ended December 31,
  1997                                      $     --           $62,500            (50,000)       $ 12,500
  1996                                         7,600                               (7,600)          7,600
  1995                                        10,300                               (2,700)         10,300
  1994                                                          10,300

Accumulated amortization
  of deferred loan costs

Year ended December 31,
  1997                                      $     --
  1996                                            --            17,505                             17,505
  1995                                            --                                                   --
  1994                                                                                                 --

Accumulated amortization
  of software development costs

Year ended December 31,
  1997                                      $ 90,446          $134,279                           $224,724
  1996                                        13,939            76,507                             90,446
  1995                                            --            13,939                             13,939
  1994                                            --                --                                 --
</TABLE>


                                      F-28
<PAGE>   60
                                   SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

                                        LEGACY SOFTWARE, INC.

                                        By: /s/ Ariella J. Lehrer
                                           ------------------------------
                                                Ariella J. Lehrer, Ph.D.
                                                Chief Executive Officer

Dated: March 31, 1998

        KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Ariella J. Lehrer, Ph.D. and William E.
Stiney, and each of them, as his or her true and lawful attorneys-in-fact and
presents, each with full power of substitution and resubstitution, for him or
her and in his or her name, plane and stead, in any and all capacities, to sign
this Report and any amendments hereto, and to file the same, with all exhibits
thereto, and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every act and
thing requisite and necessary to be done in connection therewith, as fully to
all intents and purposes as he or she might or could do in person, hereby
ratifying and confirming all that each of said attorneys-in-fact and agents, or
any of them, or their or his or her substitute or substitutes, may lawfully do
or cause to be done by virtue hereof.

        Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
           Signature                             Title                         Date
           ---------                             -----                         ----
<S>                                  <C>                                 <C>
/s/ Ariella J. Lehrer                President and Chief Executive       March 31, 1998
-------------------------------      Officer (Principal Executive
    Ariella J. Lehrer                Officer)



/s/ William E. Sliney                Vice President of Finance,           March 31, 1998
-------------------------------      Chief Financial Officer and
    William E. Sliney                Treasurer (Principal Financial
                                     and Accounting Officer)


/s/ Ivan M. Rosenberg                Director                             March 31, 1998
-------------------------------
    Ivan M. Rosenberg
</TABLE>
<PAGE>   61

<TABLE>
<CAPTION>
                     CORPORATE AND SHAREHOLDERS INFORMATION
<S>                                          <C>
DIRECTORS                                    PRINCIPAL OFFICE

ARIELLA J. LEHRER, PH.D.                     5340 Alla Road
Chairman of the Board,                       Los Angeles, California 90066
President and                                (310) 823-2423
Chief Executive Officer

WILLIAM E. SLINEY                            INDEPENDENT PUBLIC ACCOUNTANTS
Vice President of Finance,
Chief Financial Officer                      BDO Seldman LLP
Treasurer and Secretary                      Los Angeles, California 90067

IVAN M. ROSENBERG, PH.D.                     LEGAL COUNSEL
Business Information Solutions
                                             Troop Meisinger Steuper & Pasich, LLP
OFFICERS                                     Los Angeles, California 90024-3002

ARIELLA J. LEHRER, PH.D.                     NOTICE OF ANNUAL MEETING
Chairman of the Board,
President and                                The Annual Meeting will take place on
Chief Executive Officer                      Thursday, May 28, 1998 at 10:00 a.m.
                                             at the principal executive offices of
WILLIAM E. SLINEY                            Legacy Software, Inc. at
Vice President of Finance,                   5340 Alla Road,
Chief Financial Officer                      Los Angeles, California 90066.
Treasurer and Secretary                      All shareholders are cordially invited
                                             to attend
TRANSFER AGENT
                                             INVESTOR INFORMATION
Chase Mellon Shareholder Services
400 S. Hope Street                           For general questions regarding your
4th Floor                                    stock, or to be added to our mailing
Los Angeles, California 90071-2806           list, call (310) 823-2423 or write to:
(313) 553-9500                               Legacy Software, Inc.,
                                             Los Angeles, California 90066.
</TABLE>