<PAGE>   1
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                       SECURITIES AND EXCHANGE COMMISSION

                              WASHINGTON D.C. 20549

                      ------------------------------------

                                    FORM 10-K

                        FOR ANNUAL AND TRANSITION REPORTS
                     PURSUANT TO SECTIONS 13 OR 15(D) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                      ------------------------------------


(MARK ONE)

[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, 1995

                                       OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934 [NO FEE REQUIRED]

For the transition period from ______________ to __________________

                          Commission file number 1-6981

                         NATIONAL EDUCATION CORPORATION
             ------------------------------------------------------
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

          DELAWARE                                                95-2774428
-------------------------------                              -------------------
(STATE OR OTHER JURISDICTION OF                               (I.R.S. EMPLOYER
 INCORPORATION OR ORGANIZATION)                              IDENTIFICATION NO.)

       18400 VON KARMAN AVENUE
          IRVINE, CALIFORNIA                                          92715
----------------------------------------                            ----------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                            (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:  (714) 474-9400

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

TITLE OF EACH CLASS                    NAME OF EACH EXCHANGE ON WHICH REGISTERED

Common Stock,                          New York Stock Exchange
$.01 par value                         Pacific Stock Exchange

6 1/2% Convertible Subordinated        New York Stock ExchangE
Debentures Due 2011                    Pacific Stock Exchange

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

None

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

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

         The aggregate market value of the registrant's voting stock held by
nonaffiliates of the registrant as of February 29, 1996, based on the closing
price for such Common Stock on the New York Stock Exchange on such date, was
$323,042,522.

         The number of shares of registrant's Common Stock outstanding as of
February 29, 1996, was 35,166,818.

                       DOCUMENTS INCORPORATED BY REFERENCE

         Part III incorporates information by reference from material that will
be filed with the Securities and Exchange Commission within 120 days of
registrant's fiscal year end (December 31, 1995), as part of a Proxy Statement
for the registrant's Annual Meeting of Stockholders.

                                  Cover Page 2
<PAGE>   3
                                                     PART I

ITEM 1.     BUSINESS.

         National Education Corporation (the "Company") provides training and
educational services and products to individuals, educational institutions,
businesses and governments. The Company was originally incorporated in
California in 1954 and reincorporated in Delaware in 1972. The Company's
business is conducted primarily through three operating entities: ICS Learning
Systems, Inc. ("ICS"), which offers distance education in vocational, academic
and professional studies to consumers and companies throughout the world;
Steck-Vaughn Publishing Corporation ("Steck-Vaughn"), one of the largest
publishers of supplemental educational materials; and National Education
Training Group, Inc. ("NETG"), one of the largest providers of interactive
multimedia products to train information technology professionals and end users
of technology.

                    COMPANY RESULTS AND DEVELOPMENTS IN 1995

         The following provides a brief discussion of the Company's significant
developments in 1995. A more detailed discussion of each of the Company's
primary operating entities appears later in this Item 1; a more detailed
description of the Company's results of operations appears in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," starting on page 15 below.

         Year End 1995. For 1995, the Company reported revenues of $258.6
million, which were 7.0% higher than revenues of $241.6 million in 1994. The
revenue increase is due to revenue growth at ICS and Steck-Vaughn, partially
offset by a reduction in revenue at NETG. For 1995, the Company recorded a net
loss of $87.2 million, principally due to $81.7 million of unusual items related
to restructure charges, write-downs of intangible assets at NETG, write-off of
computer course hardware and related costs at ICS, settlement of litigation at
Steck-Vaughn and severance payment to the Company's former Chief Executive
Officer. These unusual charges were partially offset by an unusual credit for
payment received to settle litigation at NETG. Excluding the unusual items, the
net loss for 1995 would have been $5.5 million, compared with a net loss from
continuing operations of $14.1 million for 1994. Overall, the Company recorded a
net loss of $63.5 million in 1994, which included charges related to the
adoption in 1994 by the Company of AICPA Statement of Position 93-7 (discussed
in the next paragraph), and a $40.0 million charge recorded in the second
quarter of 1994 to write-down the assets of National Education Centers, Inc.
("Education Centers") and provide for estimated costs of closing and
teaching-out certain Education Centers' schools in connection with
discontinuance of the Company's Education Centers operations. Please see
"Discussion of Additional Business Factors--Discontinued Operations: Education
Centers" on page 10 below for more information.

         In December 1993, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
No. 93-7, "Reporting on Advertising Costs" (the "SOP"). The SOP generally
requires advertising costs, other than direct response advertising, to be
expensed as incurred. The SOP is effective for financial statements for fiscal
years beginning after December 15, 1994, but may be adopted early. In the fourth
quarter of 1994, the Company adopted the SOP, effective January 1, 1994.
Adoption of the SOP caused the Company to expense all of ICS' advertising,
selling and promotion costs as they were incurred in 1994, rather than deferring
and amortizing all such costs as in prior periods. In addition, SOP transition
rules required amortization during 1994 of $19.8 million worth of advertising,
selling and promotion costs that had been deferred from periods prior to
December 31, 1993. For more information on adoption by ICS of the SOP, please
see Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations," beginning on page 15 below, and Note 1 to the Company's
Consolidated Financial Statements, beginning on page F-6 below. Adoption of the
SOP did not have a material effect on the Company's other operations.

         ICS Learning Systems, Inc. In 1995, ICS achieved a 16.4% increase in
revenues, from $122.8 million to $143.0 million in 1995. These results were
directly related to a 19,064, or 5.1%, increase in enrollments worldwide,
revenue recognition from the 19.6% growth in enrollments in 1994 and a 15.4%
growth in revenue from ICS' MicroMash subsidiary, which markets Computer Based
Training ("CBT") products to the professional market. The average total
contract price for an ICS student increased during 1995 as a result of more
enrollments in the higher

                                      - 1 -
<PAGE>   4
priced Personal Computer ("PC") courses and other related courses. Revenue per
enrollment also increased as a result of the higher average contract price.
Operating income increased from a loss in 1994 of $3.9 million to income of $7.6
million. The 1994 loss included $19.8 million amortization of prior period
deferred marketing costs pursuant to SOP 93-7 and the 1995 results included $1.5
million of this amortization. Also, the 1995 results included a $4.5 million
unusual item write-off of course computer hardware and related costs. Excluding
the amortization impact and the unusual item, the operating income was $13.6
million (9.5% operating income margin) and $15.9 million (13.0% operating income
margin) for 1995 and 1994, respectively.

         In 1995, ICS' U.S. operation saw PC courses and related training
courses continue as the fastest growing product line with a 17.4% increase over
1994, while enrollments in ICS' High School equivalency course were up 15.2% and
enrollments in ICS' Center for Degree Studies were up 9.2%. All other courses
generating an 8.1% increase in enrollments over 1994. On a worldwide basis, more
than 65,000 students enrolled in ICS High school Diploma programs, and more than
44,000 students enrolled in ICS Associate Degree Programs. In 1995, ICS
introduced the following new products: Dental Assistant, Drafting with Auto CAD,
Electronic Bookkeeping, Home Schooling Teaching Guide, and print and on-line
versions of an Internet Guide.

         Based on statistics compiled by the Distance Education and Training
Council ("DETC"), the accrediting body of independent study schools recognized
by the U.S. Department of Education, ICS continues as the industry leader in
generating enrollments. A consulting firm retained by ICS has analyzed the Adult
Education market in the U.S. and concludes that ICS has a 48% market share of
the self-study vocational market. Worldwide, ICS enrolled over 390,000 new
students in 1995.

         Steck-Vaughn Publishing Corporation. Revenues increased in 1995, led by
strong performances from its elementary and high school ("El/Hi") and library
product lines. Revenues from the El/Hi market, which were up 10.7% over 1994,
were bolstered by strong sales from basic skills products in spelling, math, and
reading. Steck- Vaughn's testing and assessment products also boosted sales,
enhanced by the Berrent Publications product line purchased in November 1994.
Library revenues, which were up 16.3% over 1994, were enhanced by sales of new
titles, as well as sales from Steck-Vaughn's exclusive distribution agreements
with Larousse Kingfisher Chambers, Inc. and Abdo & Daughters. Revenues from the
adult market were down 2.0% with funding in this market segment continuing to
experience federal budget constraints, reducing the funding for adult education.

         Steck-Vaughn's operating income for 1995 was $9.5 million compared to
operating income of $10.5 million in 1994. The decrease in operating income is
due entirely to the unusual item charge of $970,000 for settlement of
litigation. In addition, in 1995 Steck-Vaughn changed its method of accounting
for inventories from the last-in, first-out method to the first-in, first-out
method, to provide a better means of matching current costs with current
revenues, as Steck-Vaughn aggressively pursues its plan to reduce its current
operating inventory levels while increasing inventory turnover. The Company's
financial statements of all prior years have been restated to apply this method
retroactively, which increased Steck-Vaughn's operating income by $1.3 million
and $754,000 for 1995 and 1994, respectively. Excluding the unusual item,
operating income was flat compared to 1994 as income from increased revenues was
offset by higher product development costs and amortization of intangibles and
increased general and administrative costs.

         In 1995, Steck-Vaughn augmented its product lines and marketing
channels with a number of acquisitions and distribution agreements through the
following transaction: (i) in September, Steck-Vaughn entered into an agreement
to be the exclusive distributor for Abdo & Daughters, a small publisher of a
variety of high interest/low reading ability books for grades K-8, adding 300
titles complementing and enhancing Steck-Vaughn's current Raintree/Steck-Vaughn
collection of titles; (ii) in October, Steck-Vaughn acquired substantially all
of the assets of Educational Development Laboratories, Inc. ("EDL"), expanding
Steck-Vaughn's breadth of product for the adult market; and (iii) in December,
Steck-Vaughn acquired substantially all of the assets of Summit Learning, Inc.
("Summit"), a well-established direct response marketing company aimed at
classroom teachers and other key site- based decision makers, and focused on
sales of math and science manipulative and kit-based products.

         National Education Training Group, Inc. NETG's operating loss for 1995
reflects a $30.6 million write- off of excess facility costs, severance payments
for workforce reductions, balance sheet writedown of inventory and

                                      - 2 -
<PAGE>   5
fixed assets, and other related restructuring charges. In addition, NETG wrote
off $47.5 million of goodwill, based on the Company's determination as to the
recoverability of such goodwill. These adjustments to cost structure enabled
NETG to show significant improvement in operating results for the third and
fourth quarters of 1995.

         NETG's revenue for the year 1995 was $54.3 million compared to $61.9
million for the previous year. Eliminating the operating results of Spectrum, a
division of NETG that was discontinued in 1995, NETG's 1995 revenue decreased
$4.0 million from 1994 or 7.0%. NETG domestic revenues declined $10.4 million to
$26.1 million, due to a decrease in customer renewals and the absence of
significant new customers in the domestic operations. Such decrease is
attributable in part to the absence of a full line of client/server training
products that is now in such demand in the multimedia training market; NETG is
addressing that absence in 1996 by introducing over 100 new client/server
training products. Revenue in 1995 from NETG's international operations grew by
$6.5 million.

         In December 1995, NETG received net proceeds of $3.5 million on the
resolution of a dispute with a third party author; NETG used the proceeds of the
resolution to undertake additional investment in product development. The
settlement proceeds are recorded as an unusual item of income, while the
additional product development investment is recorded as product development
expense.

                   FINANCIAL INFORMATION FOR INDUSTRY SEGMENTS

         Revenues and operating income (loss) by industry segment for the
Company's continuing operations for the past three years are as follows (for
more detailed information, please see Note 15 to Consolidated Financial
Statements, beginning on page F-22 below):

<TABLE>
<CAPTION>
NET REVENUES:  (dollars in thousands)            1995           1994          1993
                                               ---------     ---------     ---------
<S>                                            <C>           <C>           <C>      
   ICS                                         $ 143,021     $ 122,815     $ 101,319
   Steck-Vaughn                                   58,226        53,608        53,156
   NETG                                           54,350        61,937        68,259
   Other                                           3,001         3,254         1,438
   -----                                       ---------     ---------     ---------
TOTAL NET REVENUES                             $ 258,598     $ 241,614     $ 224,172
==================                             =========     =========     =========

OPERATING INCOME (LOSS):

   ICS operating income before
      amortization of prior period deferred
      marketing and unusual items              $  13,628     $  15,909     $  21,368
        Amortization of prior period
          deferred marketing                      (1,470)      (19,836)         --
        Unusual Items                             (4,549)         --            --
        -------------                          ---------     ---------     ---------
   ICS                                             7,609        (3,927)       21,368

   Steck-Vaughn before unusual items              10,469        10,459        13,074
        Unusual Items                               (970)         --            --
        -------------                          ---------     ---------     ---------
   Steck-Vaughn                                    9,499        10,459        13,074

   NETG operating loss before
      unusual items                              (15,375)      (13,993)      (25,950)
        Unusual items                            (74,567)         --          (9,232)
        -------------                          ---------     ---------     ---------
   NETG                                          (89,942)      (13,993)      (35,182)

   Other                                             764           (50)         (657)
   -----                                       ---------     ---------     ---------

TOTAL SEGMENT OPERATING LOSS                   $ (72,070)    $  (7,511)    $  (1,397)
============================                   =========     =========     =========
</TABLE>

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                  DESCRIPTION OF BUSINESS BY INDUSTRY SEGMENTS

         ICS LEARNING SYSTEMS, INC.

         ICS Learning Systems, Inc. provides distance education in vocational,
academic and professional studies to consumers and companies under the following
names: ICS Learning Systems, English Language Institute, International
Correspondence Schools, North American Correspondence Schools, and the ICS
Center for Degree Studies (collectively referred to as "ICS"). ICS offers more
than 50 independent study courses in the U.S. and more than 100 courses abroad
in disciplines ranging from high school completion requirements to occupational
training. In addition, ICS offers associate technology degree programs in
business and engineering. All of ICS' independent study courses in the U.S. are
accredited by the Distance Education and Training Council ("DETC"), the
accrediting body for independent study schools recognized by the U.S. Department
of Education. ICS also offers over 1,000 training products and 10,000 hours of
training to industrial clients under the name "ICS Business and Industrial
Training".

         In addition, with the acquisition of MicroMash in 1994, ICS established
a presence in the large and diverse field of professional and continuing
education. MicroMash offers over 70 professional exam and continuing
professional education products to the financial and accounting industries, and
currently is expanding its product offerings to the legal and other professional
fields.

         Curricula and Product Development. Curricula are carefully designed to
reflect the most important trends in employment opportunities, consumer
interest, professional development and industrial training needs. New courses
introduced during 1995 include Dental Assistant, Electronic Bookkeeping,
Drafting with Auto CAD, Home Schooling Teachers Guide, and print and on-line
versions of an Internet Guide.

         Accreditation and Course Recognition. Most ICS courses are approved for
veterans benefits and for DANTES (Defense Activity for Non-Traditional Education
Support). Programs offered through the ICS Center for Degree Studies are
approved for college credit by PONSI (Program on Non-Collegiate Sponsored
Instruction), which is administered by the American Council on Education. ICS is
accredited by the Accrediting Commission of the DETC. The DETC is listed by the
U.S. Department of Education as a nationally recognized accrediting agency and
is a recognized member of the Commission on Recognition of Postsecondary
Accreditation.

         ICS recognizes the value of utilizing technology to deliver products
and services to its students. In June 1995, ICS launched its WorldWide Web site
on the Internet at: "http://www.icslearn.com". Prospective and current ICS
students can visit the ICS electronic campus for course descriptions and
information, faculty profiles and a free ICS "Learning Styles Assessment."
Through the Internet site, customers can contact ICS' international locations,
E-mail for customer service, participate in student-to-instructor discussions,
enroll on-line and download product demonstrations.

         In September 1995, ICS' U.S. operations decided to cease offering
computer hardware as part of its PC courses and other related courses. ICS based
this decision on factors including the lack of profitability on these courses as
a result of including PC hardware with the courses. ICS will continue to develop
and market an aggressive product line for PC skills training, but will do so
without supplying the personal computer as part of the course.

         Traditionally, ICS distance education courses have been structured
around "graded lessons" in which the student receives one section of
instructional material at a time, which must be completed before proceeding to
the next section. Courses are designed to be completed by the typical student in
periods ranging from six to twenty-four months, depending on the course
selected. A computerized student information/testing system permits students,
through touch-tone telephones or voice response, to obtain immediate testing and
feedback on test results. Over 95% of the 2 million exams graded by ICS during
1995 were graded electronically by either the information/testing system via
telephone or by electronic scanner. With improved technology, the cost of
grading an exam is at an all-time low while the speed of correcting an exam and
turnaround to the student have never been faster. ICS utilizes a voice-activated
computer record access system that allows students to obtain key information
from their

                                      - 4 -
<PAGE>   7
records, twenty-four hours a day, without operator assistance.

         Tuition for ICS' distance education courses currently ranges from
approximately $400 to $1,000 per course, which, in many cases, includes
auxiliary equipment for the courses. Certain ICS programs, including those
leading to associates' degrees, require the student to enroll in and complete
more than one course. Students generally pay a portion of the tuition upon
enrollment and the balance on a monthly basis. Although many ICS students
complete their entire distance education course, students have certain rights to
cancel courses in progress and, in some cases, may be entitled to refunds of
tuition paid for future lessons or for cancellation of amounts that have not yet
been paid for future lessons. ICS' accounting treatment recognizes independent
study contract revenues when cash is received, but only to the extent that such
cash can be retained under existing refund policies of the DETC or applicable
law. ICS is working to enhance its customer service and reduce its attrition
rates so that a high percentage of its students will complete their courses. ICS
is not dependent on student financial aid under federal government programs.

         ICS has established telesales departments for its U.S. operations and
in its major foreign operations, by which in-bound telephone inquiries are
answered by ICS telesales representatives. These telesales professionals seek to
enroll students over the telephone without needing to send the customer ICS'
traditional sales literature. During 1995, ICS' U.S. operations expanded its
telemarketing center, which provides current and prospective students the
opportunity to dial directly to ICS for more information or to enroll. As a
result, conversion of inquiries to sales improved by 14.4%, and contributed to
the 11.0% increase in enrollments from 1994 to 1995.

         In 1995, ICS' Business and Industrial Training Division expanded its
marketing efforts by creating an in-house telesales organization. The Division's
catalog of 1,200 products resides on a computer data base, giving each sales
representative the ability to create quickly custom curricula for ICS clients.
In addition, in 1995, the Division dramatically increased the revenue it
generates from corporate tuition assistance programs ("TAP") through development
of new marketing materials and expansion of the sales force committed to the TAP
market.

         ICS' subsidiary, MicroMash, develops and markets educational and
training products and exam preparatory courses for professionals. Prior to 1995,
MicroMash primarily served the needs of accounting and financial professionals
(CPAs, CMAs, CIAs, CFPs) in both business and government. MicroMash expanded its
product line in 1995 through the following activities: (i) MicroMash launched
nineteen new continuing professional education ("CPE") products; (ii) MicroMash
created and marketed a computer-based review for the Special Examination for
Enrolled Agents for practice in front of the U.S. Internal Revenue Service;
and (iii) MicroMash entered the legal field with the introduction of the
computer-based MicroMash/Nord Bar Review for the Multistate Bar Examination and
various print-based review packages for fifteen state bar examinations. In
addition, MicroMash received continuing legal education ("CLE") approval for
several of its computer-based products.

         MicroMash CPE products are recognized by the National Association of
State Boards of Accountancy, The Institute of Certified Management Accountants,
The Institute of Internal Auditors, The International Board of Standards and
Practices for Certified Financial Planners, Inc., and the Internal Revenue
Service, among others. MicroMash CLE is recognized by various state legal
professional licensing boards.

         Advertising and Marketing. ICS markets its independent study courses
throughout its U.S. and international operations utilizing direct response
advertising through print, television media and direct mail marketing. ICS also
offers courses in many English speaking countries throughout the world; in 1995,
ICS enrolled students from more than 150 different countries. Telemarketing also
is used in the U.S., Canada, the United Kingdom and Australia. ICS has over 200
telesales representatives who speak directly to prospective students about
enrolling in courses.

         Competition. The distance education and training industry is highly
competitive. ICS faces direct competition from U.S.-based and foreign
independent study providers and indirect competition from community colleges,
vocational and technical schools, two-year colleges and universities, and, to a
lesser extent, governmental entities and other "distance learning" companies and
schools, including electronic universities. In recent years,

                                      - 5 -
<PAGE>   8
technological changes have increased the variety of choices available to
students in selecting the type of education and the manner in which it is
delivered, thereby increasing the entities with which ICS competes for student
enrollments. ICS believes that the principal competitive factors in its industry
are breadth and quality of course offerings, price and quality of customer
services. Overall, the Company believes that ICS competes favorably on the basis
of these factors.

         STECK-VAUGHN PUBLISHING CORPORATION

         Steck-Vaughn is one of the country's largest publishers of supplemental
educational materials, offering educators a broad range of quality products that
address educational needs from early childhood through adulthood. The term
"supplemental materials" generally refers to softcover, curriculum-based books,
workbooks and other support materials that are used in conjunction with or
instead of traditional hardcover "basal" textbooks. Steck- Vaughn also publishes
reference and nonfiction products for acquisition by school and public
libraries, as well for purchase by the general public through bookstores.

         In July 1993, Steck-Vaughn completed an initial public offering of
2,668,000 shares of its common stock, which represented approximately 18.3% of
Steck-Vaughn's stock, the remainder of which is held by the Company. During
1994, Steck-Vaughn announced a program to repurchase from the public market up
to 500,000 shares of its common stock; through 1995, Steck-Vaughn has
repurchased 255,200 shares, effectively raising the Company's ownership of
Steck-Vaughn's common stock from 81.7% as of the public offering to 83.1%.

         Product Development and Acquisition. Steck-Vaughn continually
evaluates, updates and adds to its product lines through internal development of
new educational materials, performance of development contracts by outside
authors, production of revised and supplementary materials based on existing
products, and acquisitions of educational materials from authors and publishers.
In 1994, Steck-Vaughn produced and released more than 250 new and revised
products.

         In 1995, Steck-Vaughn augmented its product lines with a number of
acquisitions and distribution agreements. In September, Steck-Vaughn entered
into an agreement to be the exclusive distributor for Abdo & Daughters, a small
publisher of a variety of high interest/low reading ability books for grades
K-8. Abdo & Daughters' collection of approximately 300 titles complements and
enhances the current Raintree/Steck-Vaughn collection of titles. The titles
include a 54-book animal series as well as many biographies and social studies
topics, including a series on the Holocaust and a complete series on
environmental studies. In addition, in October, Steck- Vaughn acquired
substantially all of the assets of Educational Development Laboratories, Inc.
("EDL"), which further expands Steck-Vaughn's breadth of product for the adult
market. The EDL product line combines time-tested highly researched
instructional techniques with computer technology in order to deliver
developmental reading programs in an easy-to-administer and user-friendly
format.

         The electronic media segment of the school market is one of the most
rapidly expanding segments. To gain entrance to this market, Steck-Vaughn
entered into a letter of intent in December 1995, and definitive stock purchase
agreement in March 1996, to acquire Edunetics, Ltd. ("Edunetics"), which
develops, markets and sells computer-based (including multimedia) products for
teaching curriculum in the kindergarten through grade 12 market. Edunetics'
offerings include instructional management products that allow teachers, parents
and students to monitor progress as the computer-based products are accessed and
utilized. While consummation of the acquisition depends on satisfaction of a
number of conditions by both parties, Steck-Vaughn and Edunetics hope to
complete the transaction by the end of second quarter 1996.

         Sales and Marketing. Steck-Vaughn markets its products through multiple
distribution channels, including its national sales and telesales organization.
Additionally, Steck-Vaughn markets and sells its products through a distributor
organization that services public libraries, trade outlets and other
nontraditional school markets. Steck- Vaughn has begun to establish a presence
in foreign markets where English language curriculum and library products are in
demand. Steck-Vaughn's customer service group emphasizes prompt and accurate
delivery of published materials.

                                      - 6 -
<PAGE>   9
         During 1995, the instructional materials marketplace continued its
trend toward site-based selling, as more personnel at the school and faculty
level participated in the buying decisions for educational materials. While
site- based selling is a relative strength of Steck-Vaughn, site-based selling
requires a greater number of sales calls per revenue dollar, resulting in
increased selling costs.

         In response to the increased participation of teachers in buying
decisions, Steck-Vaughn acquired substantially all of the assets of Summit
Learning, Inc. ("Summit") in December 1995. Summit is a well established direct
response marketing company aimed at classroom teachers and other key site-based
decision makers. Summit's products, historically, have been focused on math and
science manipulative and kit-based products. Additionally, Summit mails its
Young Explorers catalog to the home market which provides Steck-Vaughn access to
parents.

         Competition. Many companies, large and small, compete with Steck-Vaughn
in the educational publishing field. No single company is dominant in the
industry segments for which Steck-Vaughn publishes. Steck-Vaughn believes that
the principal competitive factors in its industry are breadth and quality of
product offerings, price, channels of distribution, quality of support services
and market responsiveness. Overall, the Company believes that Steck-Vaughn
competes favorably on the basis of these factors, and that growth has occurred
due to new products and increased sales and market penetration.

         NATIONAL EDUCATION TRAINING GROUP, INC.

         Established in the late 1960s, the Company's NETG subsidiary develops,
markets and distributes interactive multimedia products to train information
technology professionals and end users of technology. Headquartered in
Naperville, Illinois, NETG offers multimedia training solutions to help
organizations worldwide maximize their performance and their investments in
people and technology.

         Under the leadership of its new President and Chief Executive Officer,
Chuck Moran, who joined NETG in May 1995, NETG underwent substantial change in
1995. NETG initiatives in 1995 included, among others, the following: (i) the
restructure of its operations by downsizing office and warehouse space in the
U.S. and in Europe and reducing its worldwide workforce; (ii) the development of
new products through an agreement with a third-party to develop exclusively for
NETG, with over 100 new client/server training products to be released in 1996;
and (iii) the development of new relationships with computer software and
hardware companies, including Microsoft and, in early 1996, Novell, which allows
NETG to provide courses for and participate in those companies' certification
programs.

         Products. NETG's current line of over 600 training products addresses
all audience levels, providing an analytical perspective as well as practical
skills and knowledge in information technology (client/server and mainframe),
desktop computing, and management and professional development. NETG's products
are delivered on various forms of technology-based media, including video,
diskette and CD-ROM, and NETG's computer-based products may be run in various
operating environments, including personal computer, mainframe computer and
local area networks. Many of NETG's products provide multimedia training that
combines data, text, audio, video, animation and graphics with computer
technology. In addition, many NETG products use NETG's proprietary SKILL
BUILDER(R) technology, which provides interactive courseware aimed at making the
learning experience acceptable and relevant, focusing the user on what he or she
needs to learn, and not what he or she already knows.

         The NETG course library is divided into four primary areas: Desktop
Computing, Client/Server, Enterprise Systems (Mainframe) and Management and
Professional Development. Desktop Computing courses including courses on
personal computer operating systems (such as DOS, Microsoft Windows 3.x and 95,
and Apple Macintosh), word processing applications (such as WordPerfect and
Microsoft Word) and spreadsheet applications (such as Microsoft Excel and Lotus
1-2-3). Client/Server courses cover such areas as networking and communications,
Novell NetWare, and Microsoft Windows development and support. Enterprise
Systems (Mainframe) courses focus on mainframe operating environments and
software. Management and Professional Development courses cover such topics as
total quality management, interpersonal skills and customer service.

         In 1995, NETG introduced a number of courses to train individuals in
new and updated technologies. For

                                      - 7 -
<PAGE>   10
example, through NETG's relationship with Microsoft, NETG introduced a number of
courses in Microsoft Windows 95 curriculum simultaneously with the release by
Microsoft of Windows 95.

         Product Development. Historically, NETG has offered courses developed
internally or acquired or licensed from various third-party product developers
who were experts in their respective fields. Although the courses acquired
through these methods were of high-quality, the many different developers
created courses with different structures and styles. NETG strives to provide
total training solutions to its customers; accordingly, a customer who licensed
a number of NETG offerings may have received courses developed by a number of
different developers (including NETG and its outside developers). In order to
provide consistent course structure and style to customers who depend on NETG
for training, NETG has refocused its development efforts so that, for 1996, over
200 NETG courses to be introduced during the year will have been developed
internally or by one principal third-party course developer under the direction
of NETG's internal product development organization, as compared to 1995 when
NETG introduced only 32 courses that were developed internally. This will allow
NETG to maintain high-quality products, but with a consistent structure and
style to facilitate each user's ability to train in multiple subjects supported
by NETG.

         In addition, to address the 1995 decline in customer renewals and
significant new customers, NETG is focusing its 1996 development efforts on
increasing its offerings in certification-focused, client/server computing, with
over 100 client/server courses scheduled for introduction in 1996. New products
include courses for client/server training for high demand products developed by
such companies as Microsoft, Novell, Oracle and SAP. Also, throughout 1995, and
again in 1996, in the ordinary course of business, NETG has removed and will
remove from its product offerings courses that no longer reflect current
technology or training methods.

         In 1995, NETG entered into an agreement with Microsoft Corporation to
develop interactive technology- based training products for computer
professionals seeking to become certified specialists for a variety of Microsoft
products. The courses support the Microsoft Certified Systems Engineer and
Microsoft Certified Solution Developer credentials. Also, in early 1996, NETG
entered into an arrangement with Novell to develop multimedia training
curriculum for Novell's Certified NetWare Engineer certification programs. NETG
will design, develop and market self-study training courseware for Novell's
NetWare network operating system and GroupWise messaging software, which courses
will be certified by Novell as Novell Authorized Education products. NETG's
relationships with companies such as Microsoft and Novell allow NETG to better
access the large market of consumers and entities who use products produced by
those companies, and allow NETG to introduce training courses concurrently with
the release of new products.

         In 1995, NETG discontinued the operations of its Spectrum subsidiary,
which developed custom training courses for businesses. Without Spectrum, NETG
can focus development efforts on courses that may be marketed, licensed and
distributed to a broad range of individuals and businesses, rather than
incurring development expense for custom courses licensed and used by only one
business.

         International Operations. NETG maintains its international headquarters
in London, England. NETG's direct sales and marketing operations employ 150
persons, with 110 of those in England and the remainder in other European
countries. NETG has product development centers in Germany, South Africa, India
and Japan. In addition, NETG maintains an international network of distributors
and agents in many other countries, including in a majority of the countries in
the Middle East, each of the Scandinavian countries, many countries in Asia and
Africa, Australia and New Zealand.

         NETG Sales Organization and Distribution Channels. NETG's revenues are
generated primarily by its field sales force that focuses on large business and
government organizations. Customers license NETG's products and libraries under
agreements that, depending on the customer's needs, provide access to all or
part of NETG's product lines on a limited or unlimited basis. In 1995, NETG
initiated a distribution strategy focused on the channel of Microsoft-authorized
education centers; in 1996, that channel will be expanded to include
Novell-authorized education centers.

         NETG's customers are supported by NETG's Customer Assistance, located
in Naperville, Illinois, which

                                      - 8 -
<PAGE>   11
provides customers with toll-free order processing during business hours, and
twenty-four hour, seven day per week technical assistance. Support analysts
provide answers to software and hardware questions and assistance in the
installation and ongoing use of courseware products. In addition, NETG has
established a LAN-based call tracking and reporting system that allows support
analysts to electronically track customer inquiries, problems and solutions for
faster response time to customers.

         Also in 1995, NETG launched its worldwide web storefront, located at
"http://www.netg.com," which includes a catalog of over 600 training products
and multimedia course demonstrations. The catalog includes course descriptions,
objectives, learning times, prerequisites, media choices and pricing.

         Competition. According to International Data Corp., in 1995 the total
information technology training market worldwide was $12.8 billion. Eighty
percent of that (more than $10 billion) is spent on overhead and internal
training staff salaries. The remaining 20% ($2.8 billion) is divided into five
outside expenditures categories of which approximately $.5 billion is computer
based and multimedia materials, where NETG directly competes. NETG is one of the
largest interactive multimedia training companies in this highly fragmented and
competitive market.

         NETG competes in the training market on the factors of timeliness of
new courses, instructional effectiveness, development alliances with key
technology vendors (e.g. Microsoft, Novell), breadth of subject matter and
delivery media, price and solution-oriented customer support. Overall, the
Company believes that NETG is competitive on the basis of these factors. Other
suppliers of media-based training with which NETG competes include CBT Systems,
J3 Learning, DPEC, SRA (a division of McGraw Hill, Inc.) and, to a limited
extent, hardware and software manufacturers.

            FINANCIAL INFORMATION ON THE COMPANY'S FOREIGN OPERATIONS

         The following table shows consolidated net revenues of the Company in
foreign countries for 1995, 1994 and 1993 (for more detailed information, please
see Note 15 to Consolidated Financial Statements beginning on page F-22 below).
These revenues are derived principally from the foreign operations of ICS and
NETG:

<TABLE>
<CAPTION>
(Dollars in thousands)                     1995            1994             1993
                                           ----            ----             ----
<S>                                      <C>             <C>              <C>    
Net revenues outside the
   United States                         $65,231         $55,990          $58,642

Percent of consolidated
   net revenues                             25.2%           23.2%            26.2%
</TABLE>

         Consolidated operating results are reported in U.S. dollars. Because
the foreign subsidiaries of the Company conduct operations in the currencies of
the countries in which they are based, all financial statements of the foreign
subsidiaries must be translated into U.S. dollars. As the value of the U.S.
dollar increases or decreases relative to these foreign currencies, the U.S.
dollar value of items on the financial statements of the foreign subsidiaries is
reduced or increased, respectively. Therefore, changes in dollar sales of the
foreign subsidiaries from year to year are not necessarily indicative of changes
in actual revenues recorded in local currency.

         The Company's ability to continue operations outside of the Unites
States or maintain the profitability of such operations is to some extent
subject to control and regulation by the U.S. government and foreign
governments. The Company's foreign operations are primarily located in the
United Kingdom, Canada, Australia and Germany, which historically have
controlled and regulated businesses in the same manner as the U.S..

                                      - 9 -
<PAGE>   12
                    DISCUSSION OF ADDITIONAL BUSINESS FACTORS

         RESEARCH AND DEVELOPMENT

         The amount spent during 1995, 1994 and 1993 on Company-sponsored
research and development activities was approximately $23 million, $20 million
and $22 million, respectively. In 1995, the Company continued to invest in
research and development to ensure new product availability for future revenue
generation. The Company spends substantial sums primarily in the development of
new products at NETG and Steck-Vaughn, and curricula for ICS.

         SEASONALITY OF THE BUSINESS

         Steck-Vaughn's sales are higher in the third quarter of the year due to
its customers purchasing products in anticipation of classes commencing in the
fall. ICS' business is moderately seasonal with more students studying during
the latter part of the year. NETG's business is seasonal due to the sales cycle
from a disproportionate number of long-term, large contracts for NETG's products
and services that are renewed in the fourth quarter of the year. There is no
customer to whom sales are made in an amount that exceeds two percent or more of
the Company's consolidated annual net revenues.

         ADDITIONAL INFORMATION

         Unearned future tuition revenue for ICS, which represents amounts
estimated to be recognized as revenue in subsequent years as services and
courseware are provided, is described in Note 12 to Consolidated Financial
Statements on page F-19 below.

         Financial information for industry segments is described in Note 15 to
Consolidated Financial Statements on page F-22 below.

         Compliance with federal, state or local provisions concerning the
discharge of materials into the environment or otherwise relating to the
protection of the environment had no material effect in 1995 on the Company's
capital expenditures, earnings or competitive position.

         The Company employed approximately 2,000 persons worldwide as of
February 29, 1996.

         DISCONTINUED OPERATIONS:  EDUCATION CENTERS

         Historically, in addition to ICS, Steck-Vaughn and NETG, the Company
has conducted business through Education Centers. Education Centers had been one
of the largest operators of private postsecondary schools in the U.S.; however,
in 1993, it became more difficult for students at a number of locations,
especially in urban areas, to obtain access to federally guaranteed student
loans. Certain provisions of the Higher Education Act of 1992, as well as the
Omnibus Budget Reconciliation Act, caused some lenders to terminate
participation in federally guaranteed student loan programs. These difficulties
prompted Education Centers to restructure its operations. Anticipating that
decreased access to funding would result in further operating losses in some of
its schools for the year ending December 31, 1993 and future years, in 1993
Education Centers elected to cease new student enrollments at 15 of its 48
schools (two of which later began again taking new enrollments). In 1994
Education Centers elected to cease new student enrollments at an additional 6
schools. Thereafter, in 1994, the Company determined to discontinue Education
Centers' operations, and immediately pursue a strategy to sell off or otherwise
dispose of Education Centers' operations.

         The Company's consolidated statement of operations for 1994 included a
second quarter $40.0 million charge to write-down Education Centers' assets, to
provide for estimated gains/losses on the sale of certain Education Centers'
schools, and to provide for the estimated costs of closing and teaching-out
certain Education Centers' schools. In addition, in 1994, the Company recorded a
$9.4 million operating loss from Education Centers' discontinued operations. In
1995, Education Centers consummated seven separate transactions, ranging

                                     - 10 -
<PAGE>   13
from the sale of one school to the sale of sixteen schools, such that, as of
December 31, 1995, Education Centers had disposed of substantially all of its
operations. For further information, please see Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operations," starting on page
15 below.

                        EXECUTIVE OFFICERS OF THE COMPANY

         The following table provides information regarding executive officers
of the Company, including their ages as of February 29, 1996:

 Name, Age and Title:                        Five-Year Business Experience:

David C. Jones (74)                Chairman of the Board since July 1989. Acting
Chairman of the Board              Chief Executive Officer from July 1989 to    
                                   April 1990. Consultant and lecturer since    
                                   July 1982. Chairman of the Joint Chiefs of   
                                   Staff from June 1978 through June 1982.      
                                   Member of the Board of Advisors for SRA      
                                   International, Inc., an information          
                                   technology company. Chairman of the Board of 
                                   Advisors of the National Civilian Community  
                                   Corps.                                       

Sam Yau (47)                       President, Chief Executive Officer and a     
President and Chief                Director of the Company since May 1995. Chief
Executive Officer                  Operating Officer of Advacare, Inc., a       
                                   medical management company, from May 1993 to 
                                   November 1994. Senior Vice President of      
                                   Finance and Administration for Archive       
                                   Corporation (now part of Seagate             
                                   Technologies, Inc.), a computer storage      
                                   (tape) company, from May 1987 to May 1993.   
                                   Director of Steck-Vaughn Publishing          
                                   Corporation and Milcom International, Inc.   

Philip C. Maynard (41)             Vice President, Secretary and General Counsel
Vice President, Secretary and      since February 1994. General Counsel of      
General Counsel                    Orchids Paper Products Company from February 
                                   1993 through January 1994. Chief Executive   
                                   Officer and Director of McClellan Development
                                   from April 1989 to May 1992; Principal and   
                                   Director until February 1993. General Partner
                                   of Urland, Morello, Dunn & Maynard law       
                                   practice from February 1985 to April 1989.   

Keith K. Ogata (41)                Vice President, Chief Financial Officer and 
Vice President, Chief              Treasurer since April 1991. Vice President  
Financial Officer and              and Treasurer from April 1989 to April 1991.
Treasurer                          Treasurer since January 1987.               

ITEM 2.           PROPERTIES.

         (a) The Company's corporate headquarters are located in leased
facilities aggregating 40,000 square feet in Irvine, California, which lease
expires in May 1996; the Company is relocating to 18,000 square feet of leased
facilities also in Irvine, California, effective April 1996.

         (b) The Company owns real property in Scranton, Pennsylvania, for the
principal offices of ICS. This building consists of 120,000 square feet of space
on 14.3 acres of land.

         (c) The Company owns an 82,000 square foot building on approximately 31
acres of land in Ransom, Pennsylvania for an ICS warehouse.

         (d) The Company owns the land and building serving as the warehouse for
Steck-Vaughn Company. The building, located in Austin, Texas on approximately 13
acres of land, contains 101,000 square feet of space.

                                     - 11 -
<PAGE>   14
         (e) The Company has approximately 34 leases for its operating units and
offices, including the following: NETG's headquarters in Naperville, Illinois -
approximately 72,000 square feet; and Steck-Vaughn's headquarters in Austin,
Texas - approximately 31,000 square feet.

         Overall, the Company's properties are suitable and adequate for the
Company's needs.

ITEM 3.    LEGAL PROCEEDINGS.

         In the ordinary course of business, the Company is generally subject to
claims, complaints and legal actions. The litigation process is inherently
uncertain and it is possible that the resolution of such matters might have a
material adverse effect upon the financial position of the Company. However, in
the opinion of management, such matters are not expected to have a material
adverse effect on the financial position of the Company.

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

         No matters were submitted to a vote of the Company's stockholders
during the fourth quarter of 1995.

                                     PART II

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

         The Company's Common Stock is listed on the New York Stock Exchange and
the Pacific Stock Exchange. The high and low market prices for the Company's
stock during each quarter for the last two years are as follows:

<TABLE>
<CAPTION>
                                 1995                              1994
                                 ----                              ----
                        High              Low               High           Low
                        ----              ---               ----           ---
<S>                   <C>               <C>               <C>            <C>
First Quarter         $ 4 5/8           $ 2 1/2           $ 7 3/8        $ 6
Second Quarter          5 3/4             3 1/8             6 5/8          4 7/8
Third Quarter           8 3/8             4 7/8             5 3/4          4 7/8
Fourth Quarter          8 3/4             6 3/8             5 1/8          3 3/4
</TABLE>

         The number of stockholders of record of the Company's Common Stock as
of February 29, 1996 was 2,552. The number of record holders is based upon the
actual number of holders registered on the stock transfer books for the Company
at such date and does not include holders of shares in "street names" or
persons, partnerships, associations, corporations or other entities identified
in security position listings maintained by depository trust companies.

         No cash or stock dividends have been declared or paid on the Company's
Common Stock during 1995 or 1994. The Company has no present intent to pay cash
dividends; in addition, the Company's Credit Agreement with its lending
institutions restricts the payment of cash dividends.

                                     - 12 -
<PAGE>   15
Item 6.  Selected Financial Data

                 National Education Corporation and Subsidiaries

                         FIVE YEAR FINANCIAL HIGHLIGHTS

<TABLE>
<CAPTION>
(amounts in thousands, except per share amounts)                        1995         1994         1993         1992          1991
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>          <C>          <C>          <C>           <C>      
NET REVENUES                                                         $ 258,598    $ 241,614    $ 224,172    $ 218,269     $ 233,670
                                                                     --------------------------------------------------------------
Income (loss) before amortization of acquired intangible assets,
  amortization of prior period deferred marketing, unusual items,
  nonoperating items, gain on sale of stock, income tax provision
  (benefit) and minority interest                                    $   4,456    $   7,567    $   1,544    $   4,190     $  16,797
   Amortization of acquired intangible assets                            1,602        1,824        4,605        5,936         6,253
   Amortization of prior period deferred marketing                       1,470       19,836         --           --            --
   Unusual items, net*                                                  81,730         --          9,232        2,506          --
   Other nonoperating expenses, net                                      5,722        2,610        3,025        5,141         8,627
   Gain on sale of stock                                                  --         (3,247)     (21,120)        --            --
   Income tax provision (benefit)                                         --           (555)      (4,889)      (3,109)        2,415
   Minority interest                                                     1,155        1,192          599         --            --
                                                                     --------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS                               (87,223)     (14,093)      10,092       (6,284)         (498)
   Income (loss) from discontinued operations                             --         (9,420)     (19,757)       6,799         5,988
   Loss on disposal of discontinued operations                            --        (40,032)        --           --            --
                                                                     --------------------------------------------------------------
NET INCOME (LOSS)                                                    $ (87,223)   $ (63,545)   $  (9,665)   $     515     $   5,490
                                                                     --------------------------------------------------------------

EARNINGS (LOSS) PER SHARE FROM CONTINUING OPERATIONS:

   Primary earnings (loss) per share                                 $   (2.73)   $    (.48)   $     .34    $    (.21)    $    (.02)
                                                                     --------------------------------------------------------------
   Fully diluted earnings (loss) per share                           $   (2.73)   $    (.48)   $     .32    $    (.21)    $    (.02)
                                                                     --------------------------------------------------------------
EARNINGS (LOSS) PER SHARE                                            $   (2.73)   $   (2.14)   $    (.32)   $     .02     $     .18
                                                                     --------------------------------------------------------------
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:

   Primary                                                              31,893       29,640       29,855       30,296        30,116
   Fully diluted                                                        38,025       36,940       34,855       37,596        36,818
SELECTED FINANCIAL INFORMATION

   Cash and investment securities                                    $  23,868    $  28,130    $  54,846    $  59,464     $  23,250
   Total assets                                                        185,262      270,245      325,005      334,881       331,612
   Capital expenditures, including capital leases                        7,781        8,442        8,503        6,784         3,419
   Total debt                                                           78,671       90,290       80,657       82,128        80,839
   Stockholders' equity                                                  7,481       73,016      136,233      151,930       153,456
   Total debt-equity ratio                                              10.5-1        1.2-1         .6-1         .5-1          .5-1
                                                                     --------------------------------------------------------------
</TABLE>

     *See Notes to Consolidated Financial Statements for discussion of the
     unusual items, acquisitions and discontinued operations.

     Effective January 1, 1994, the Company changed its method of accounting for
     advertising and other deferred marketing costs. See Note 1 to Consolidated
     Financial Statements for further discussion.

     No cash dividends were declared in any of the above periods.

                                     - 13 -
<PAGE>   16
Item 6.  Selected Financial Data

                 National Education Corporation and Subsidiaries

Effective in the fourth quarter of 1995, the Company changed its method of
accounting for inventory at Steck-Vaughn from LIFO to FIFO. The effect of the
accounting change for 1995 was to decrease net loss by $1,102,000 or $.03 per
share. The effects of this change, which was accounted for by retroactively
restating prior period financial statements, were as follows:

<TABLE>
<CAPTION>
                                                       Year Ended December 31,
                                                    -----------------------------
(amounts in thousands, except per share amounts)    1994    1993     1992    1991
---------------------------------------------------------------------------------
<S>                                                 <C>     <C>      <C>     <C> 
Adjustment to net income                            $380    $(46)    $--     $131
Adjustment to earnings (loss) per share              .01      --      --       --
</TABLE>

The net income effect for 1993 includes a reduction of the gain on sale of
Steck-Vaughn stock of $140,000.

                                     - 14 -
<PAGE>   17
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations

                 National Education Corporation and Subsidiaries

This Management's Discussion and Analysis contains condensed consolidated
statements of operations followed by financial data on the operating results of
the major segments of business. Following a summary discussion of the
consolidated results of operations are financial data by operating segment and a
discussion of the results of each operating segment.

<TABLE>
<CAPTION>
                                                                             Year Ended December 31,
                                                                     -------------------------------------
          (dollars in thousands)                                        1995          1994          1993
          ------------------------------------------------------------------------------------------------
<S>                                                                  <C>           <C>           <C>      
          NET REVENUES:
             ICS Learning Systems                                    $ 143,021     $ 122,815     $ 101,319
             Steck-Vaughn Publishing                                    58,226        53,608        53,156
             NETG                                                       54,350        61,937        68,259
             Other                                                       3,001         3,254         1,438
                                                                     -------------------------------------
          TOTAL NET REVENUES                                         $ 258,598     $ 241,614     $ 224,172
                                                                     -------------------------------------
          OPERATING INCOME (LOSS):
             ICS Learning Systems before amortization and unusual
               items                                                 $  13,628     $  15,909     $  21,368
                Amortization of prior period deferred marketing         (1,470)      (19,836)         --
                                                                     -------------------------------------
             ICS Learning Systems before unusual items                  12,158        (3,927)       21,368
               Unusual items                                            (4,549)         --            --
                                                                     -------------------------------------
             ICS Learning Systems                                        7,609        (3,927)       21,368
             Steck-Vaughn Publishing before unusual items               10,469        10,459        13,074
               Unusual items                                              (970)         --            --
                                                                     -------------------------------------
             Steck-Vaughn Publishing                                     9,499        10,459        13,074
                                                                     -------------------------------------
             NETG before unusual items                                 (15,375)      (13,993)      (25,950)
               Unusual items                                           (74,567)         --          (9,232)
                                                                     -------------------------------------
             NETG                                                      (89,942)      (13,993)      (35,182)
             Other                                                         764           (50)         (657)
                                                                     -------------------------------------
          TOTAL SEGMENT OPERATING LOSS                                 (72,070)       (7,511)       (1,397)
             General corporate expenses                                 (6,632)       (6,582)      (10,896)
             Interest expense                                           (8,650)       (6,336)       (5,723)
             Investment income                                           2,621         3,234         2,560
             Unusual items                                              (1,644)         --            --
             Other income, net                                             307         3,739        21,258
                                                                     -------------------------------------
          INCOME (LOSS) BEFORE TAX BENEFIT, MINORITY INTEREST AND
           DISCONTINUED OPERATIONS                                     (86,068)      (13,456)        5,802
             Tax benefit                                                  --            (555)       (4,889)
                                                                     -------------------------------------
          INCOME (LOSS) BEFORE MINORITY INTEREST AND DISCONTINUED
           OPERATIONS                                                  (86,068)      (12,901)       10,691
             Minority interest                                           1,155         1,192           599
                                                                     -------------------------------------
          INCOME (LOSS) FROM CONTINUING OPERATIONS                     (87,223)      (14,093)       10,092
             Discontinued operations                                      --         (49,452)      (19,757)
                                                                     -------------------------------------
          NET LOSS                                                   $ (87,223)    $ (63,545)    $  (9,665)
                                                                     -------------------------------------
</TABLE>

                                     - 15 -
<PAGE>   18
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

DETAILED SEGMENT OPERATING RESULTS:

<TABLE>
<CAPTION>
(dollars in thousands)                                            Year Ended December 31, 1995
-----------------------------------------------------------------------------------------------------------------
                                                                    ICS        Steck-
                                                                 Learning      Vaughn
                                                     Total        Systems    Publishing      NETG         Other
                                                  ---------------------------------------------------------------
<S>                                               <C>           <C>          <C>          <C>           <C>      
NET REVENUES                                      $ 258,598     $ 143,021    $  58,226    $  54,350     $   3,001

COSTS AND EXPENSES:
   Contract course materials and service costs       73,003        51,667         --         19,691         1,645
   Publishing costs and materials                    14,867          --         14,867         --            --
   Product development                               23,026         3,632        8,901       10,493          --
   Selling and promotion                            111,112        63,770       18,738       28,165           439
   General and administrative                        25,502        10,210        4,451       10,707           134
   Amortization of prior period deferred
    marketing                                         1,470         1,470         --           --            --
   Amortization of acquired intangible assets         1,602           114          800          669            19
   Unusual items                                     80,086         4,549          970       74,567          --
                                                  ---------     ---------    ---------    ---------     ---------
SEGMENT OPERATING INCOME (LOSS)                   $ (72,070)    $   7,609    $   9,499    $ (89,942)    $     764
                                                  ---------     ---------    ---------    ---------     ---------
</TABLE>

<TABLE>
<CAPTION>
(dollars in thousands)                                             Year Ended December 31, 1994
------------------------------------------------------------------------------------------------------------------
                                                                   ICS         Steck-
                                                                 Learning      Vaughn
                                                     Total       Systems     Publishing       NETG         Other
                                                  ----------------------------------------------------------------
<S>                                               <C>           <C>          <C>           <C>           <C>      
NET REVENUES                                      $ 241,614     $ 122,815     $  53,608    $  61,937     $   3,254

COSTS AND EXPENSES:
   Contract course materials and service costs       60,428        36,708          --         21,429         2,291
   Publishing costs and materials                    13,595          --          13,595         --            --
   Product development                               19,934         3,556         7,627        8,751          --
   Selling and promotion                            111,058        59,592        17,472       33,627           367
   General and administrative                        22,450         6,962         4,069       10,786           633
   Amortization of prior period deferred
    marketing                                        19,836        19,836          --           --            --
   Amortization of acquired intangible assets         1,824            88           386        1,337            13
                                                  ----------------------------------------------------------------
SEGMENT OPERATING INCOME (LOSS)                   $  (7,511)    $  (3,927)    $  10,459    $ (13,993)    $     (50)
                                                  ----------------------------------------------------------------
</TABLE>

                                     - 16 -
<PAGE>   19
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

<TABLE>
<CAPTION>
(dollars in thousands)                                             Year Ended December 31, 1993
-----------------------------------------------------------------------------------------------------------------
                                                                   ICS        Steck-
                                                                 Learning     Vaughn
                                                     Total       Systems    Publishing       NETG         Other
                                                  ---------------------------------------------------------------
<S>                                               <C>           <C>          <C>          <C>           <C>      
NET REVENUES                                      $ 224,172     $ 101,319    $  53,156    $  68,259     $   1,438

COSTS AND EXPENSES:
   Contract course materials and service costs       57,332        29,675         --         26,895           762
   Publishing costs and materials                    12,721          --         12,721         --            --
   Product development                               22,328         2,006        6,723       13,599          --
   Selling and promotion                             93,046        41,989       16,279       34,250           528
   General and administrative                        26,305         6,248        4,144       15,121           792
   Amortization of acquired intangible assets         4,605            33          215        4,344            13
   Unusual items                                      9,232          --           --          9,232          --
                                                  ---------------------------------------------------------------
SEGMENT OPERATING INCOME (LOSS)                   $  (1,397)    $  21,368    $  13,074    $ (35,182)    $    (657)
                                                  ---------------------------------------------------------------
</TABLE>

CONSOLIDATED RESULTS OF OPERATIONS:

Revenues of $258,598,000 for the year ended December 31, 1995 were $16,984,000
or 7.0% higher than revenues of $241,614,000 in the prior year. The increase is
due to revenue growth at the ICS Learning Systems and Steck-Vaughn segments
partially offset by a reduction in the NETG segment. For the year ended December
31, 1995, the Company recorded a net loss of $87,223,000 or $2.73 per share
principally due to $81,730,000 of unusual items related to restructure charges
and write-downs of intangible assets at NETG; severance payment to the former
CEO at Corporate; write-off of computer course hardware and related costs at
ICS; and settlement of litigation at Steck-Vaughn. These unusual charges were
partially offset by an unusual credit for payment received to settle litigation
at NETG. This compares with a loss from continuing operations of $14,093,000 or
$.48 per share for the year ended December 31, 1994. The 1994 results of
operations were restated to reflect a change at Steck-Vaughn from the LIFO to
the FIFO method of accounting for inventories. This change decreased the net
loss by $1,102,000 or $.03 per share and $380,000 or $.01 per share for 1995 and
1994, respectively. Excluding the impact of unusual items in 1995 and the
amortization of prior period deferred marketing as a result of the adoption of
the SOP in 1994 as discussed below results in net loss of $5,493,000 ($.17 per
share) and income from continuing operations of $5,743,000 ($.16 per share on a
fully diluted basis) for the years ended December 31, 1995 and 1994,
respectively.

The 1994 results were unfavorably impacted by the adoption of AICPA Statement of
Position No. 93-7 ("SOP"), "Reporting on Advertising Costs". The SOP generally
requires advertising costs, other than direct-response advertising, to be
expensed as incurred. In the fourth quarter of 1994, the Company adopted the SOP
at its ICS Learning Systems subsidiary effective January 1, 1994. In adopting
the SOP in 1994, ICS' total advertising, selling and promotion costs were
expensed as incurred rather than deferred and amortized as in prior periods.
Furthermore, the transition rules of the SOP required amortization of the
deferred balances existing as of the beginning of the year in accordance with
the Company's previous accounting policy. The SOP does not permit restatement of
prior periods. The effect of the transition rules is to reflect as an expense in
the year of adoption (1994) both the current year's advertising, selling and
promotion costs, and the amortization of balances deferred as of the beginning
of the year. Adoption of the SOP in 1994 resulted in a charge of $27,410,000
($21,181,000 after tax or $.72 per share). The charge consists of two
components. First, a charge of $19,836,000 resulted from the amortization of the
deferred marketing balance as of December 31, 1993 into 1994. Second, a charge
of $7,574,000 resulted from increased

                                     - 17 -
<PAGE>   20
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED:)

selling and promotion spending above the amortization that would have been
expensed in accordance with the Company's previous accounting policy. For
comparative purposes only, assuming the Company had adopted the SOP effective
January 1, 1993, income before taxes would have decreased $3,411,000 ($2,251,000
after tax or $.08 per share) in 1993. The Company's advertising and promotion
expenses, excluding the amortization of prior period deferred marketing, were
$59,073,000, $56,301,000 and $44,032,000 for the years ended December 31, 1995,
1994 and 1993, respectively.

The 1994 results were also negatively impacted by a $40,032,000 charge ($1.35
per share) related to the planned disposition of the Education Centers
subsidiary. Effective June 30, 1994, the Company adopted a plan to dispose of
the Education Centers subsidiary. The charge was to write-down assets, provide
for estimated gains/losses on the sale of certain schools and to provide for the
estimated costs of closing and teaching-out certain schools. The revenues and
expenses of the Education Centers have been netted out and segregated as
discontinued operations in the statements of operations for 1994 and prior. In
1995, the Company substantially completed the sale, closure and teach-out of the
schools within the estimated loss amount previously provided in the financial
statements.

General corporate expenses of $6,632,000 were essentially flat with the prior
year. Investment income decreased $613,000 and interest expense increased
$2,314,000 as the Company sold investments and increased borrowings to meet cash
needs.

Effective September 11, 1995, the holders of $20,000,000 of the Company's 10%
senior subordinated convertible debentures converted such debentures, including
accrued interest, into 5,021,000 shares of the Company's common stock. As a
result of this conversion, interest expense will be lower in future periods by
$2,000,000 on an annual basis; however, the additional shares outstanding will
have a potential dilutive impact on earnings per share. The conversion was
actually anti-dilutive for the fourth quarter of 1995. If the conversion had not
occurred loss per share for the fourth quarter would have been $.11 compared to
the reported loss per share of $.08, and the loss per share for the full year
would have been $2.89 compared to the $2.73 reported.

The Company's businesses tend to be seasonal in nature with most of the revenue
historically being recognized in the latter half of the year. Accordingly,
commencing in 1995, a portion of the selling and marketing costs incurred during
interim periods is capitalized and fully amortized within the calendar year to
better match the expenses with when the revenue is recognized. The quarterly
results of operations for 1995 presented in Note 16 of the Notes to Consolidated
Financial Statements were restated to reflect the interim deferral of these
costs. Accounting principles, however, do not permit restated quarterly results
of operations for 1994.

                                     - 18 -
<PAGE>   21
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

ICS LEARNING SYSTEMS:

Set forth below are key indices which aid in understanding the results of
operations of ICS Learning Systems.

<TABLE>
<CAPTION>
                                                                 Year Ended December 31,
                                                            --------------------------------
          (dollars in thousands)                               1995        1994       1993
          ----------------------------------------------------------------------------------
<S>                                                         <C>         <C>         <C>     
          REVENUES:
          Traditional Distance Education - Domestic         $ 85,224    $ 69,464    $ 55,455
          Traditional Distance Education - International      43,983      40,868      39,523
          Industrial and Business                              7,963       7,414       6,341
          MicroMash                                            5,851       5,069        --
                                                            --------------------------------
             Total Revenues                                 $143,021    $122,815    $101,319
                                                            --------------------------------
          Traditional Business:
             New Enrollments:
              Domestic                                       276,727     249,273     187,780
              International                                  115,226     123,616     124,003
                                                            --------------------------------
             Total New Enrollments                           391,953     372,889     311,783
                                                            --------------------------------
             Gross Enrollment Value (GEV):
              Domestic                                      $180,102    $143,959    $130,240
              International                                   75,707      68,981      68,272
                                                            --------------------------------
             Total GEV                                      $255,809    $212,940    $198,512
                                                            --------------------------------
             Selling and Promotion Spending:
              Domestic                                      $ 41,001    $ 36,287    $ 26,735
              International                                   17,312      15,860      14,027
                                                            --------------------------------
             Total Selling and Promotion Spending           $ 58,313    $ 52,147    $ 40,762
                                                            --------------------------------
             Unearned Gross Future Tuition Revenue          $153,489    $163,050    $126,167
                                                            --------------------------------
</TABLE>

ICS - 1995 COMPARED TO 1994:

Revenue for 1995 of $143,021,000 increased $20,206,000 or 16.5% compared to
$122,815,000 in the prior year. Revenue increased in all areas with most of the
increase in the traditional domestic operations. Traditional domestic revenue
increased $15,760,000 or 22.7%. This increase in traditional domestic revenue
was due to approximately 61,000 more students carried in from the prior year
plus a domestic enrollment increase of 27,454 students (an 11.0% increase). The
increased revenue is due to more enrollments through increased telesales
efforts, as well as higher selling and promotion expense which yielded more
enrollments. Telesales have proven to be a very cost effective marketing method
resulting in a higher conversion rate of inquiries to enrollments and typically
resulting in more tuition down payment than other marketing methods. Industrial
and Business revenue increased $549,000 or 7.4%. MicroMash revenues grew
$782,000 or 15.4% due to overall business growth.

International revenue of $43,983,000 increased $3,115,000 or 7.6%. The increase
in international revenue was due primarily to stronger enrollments in Canada
(4.2% increase) and International Mail Sales (IMS - 7.7% increase), better
collections in Australia/New Zealand and higher per unit course revenue as a
result of a higher mix of PC based course sales. Overall international
enrollments were down 6.8% due primarily to 14.8% fewer enrollments in the U.K.

                                     - 19 -
<PAGE>   22
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

ICS - 1995 COMPARED TO 1994 (CONTINUED:)

Operating income increased from a loss in 1994 of $3,927,000 to income of
$7,609,000. The 1994 loss included $19,836,000 amortization of prior period
deferred marketing costs pursuant to SOP 93-7 and the 1995 results included
$1,470,000 of this amortization. Also, the 1995 results included a $4,549,000
unusual item write-off of course computer hardware and related costs. Excluding
the amortization impact and the unusual item, the operating income was
$13,628,000 (9.5% operating income margin) and $15,909,000 (13.0% operating
income margin) for 1995 and 1994, respectively. This decrease in operating
income and margin is due primarily to higher contract course materials and
service costs of $14,959,000 (representing an erosion in operating margin of 6.2
percentage points) and increased general and administrative expenses of
$3,248,000 (representing an erosion in operating margin of 1.4 percentage
points). Despite the increase in selling and promotion expenses of $4,178,000,
these expenses as a percentage of revenues improved 3.9 percentage points.

The increase in course service costs is due to increased enrollments and a
higher mix of computer training courses which included computer hardware. Course
service costs also increased due to higher servicing/distribution costs in an
effort to provide better customer service. The increase in selling and
promotional expense is principally due to increased telesales and advertising
and promotional spending, which resulted in 19,064 more enrollments, $42,869,000
increase in gross enrollment value and $20,206,000 more revenue.

The increase in general and administrative expense is mostly due to higher
outside service charges for the mainframe computer usage, increased computer
programming costs to convert and integrate new information systems and lower
1994 expenses resulting from favorable insurance loss experience.

Prior to September 15, 1995, ICS offered computer courses which included the
sale to the student of a computer which, after shipment, was recorded as an
asset and amortized over the projected twelve month period of the remaining
course payments. Subsequent to September 15, 1995, the Company changed the
manner in which computer training courses were marketed, no longer including the
computer hardware with such courses. In the fourth quarter of 1995, the Company
reviewed the realizability of the carrying value of the computer and related
assets and determined that a portion of the capitalized balance for computers
related to enrollments for which there was no further revenue to be recognized.
As a result, the Company recorded a write-down of the unamortized balance of
computers and other related costs of $4,549,000 ($.14 per share), which is
reflected as an unusual item. In addition, the Company reduced the period over
which the computers are amortized to six months.

Domestic gross enrollment value increased $36,143,000 or 25.1% due to the
increase in new enrollments and a higher value per course due to the higher
priced computer courses prior to September 15, 1995. International gross
enrollment value increased $6,726,000 or 9.8% due to the increased enrollments
in Canada and IMS and the change in mix to higher priced PC courses. Unearned
future tuition revenue decreased $9,561,000 or 5.9% principally because
effective September 15, 1995, the Company unbundled sales of computer hardware
from the computer courses and lowered the price of the course to reflect the
elimination of the computer from the course. Following this unbundling,
enrollments in computer courses dropped in the fourth quarter. Based upon
previous experience, approximately 45% of the unearned future tuition revenue
was ultimately recognized into revenue.

                                     - 20 -
<PAGE>   23
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

STECK-VAUGHN PUBLISHING - 1995 COMPARED TO 1994:

<TABLE>
<CAPTION>
                                          Year Ended December 31,
                                         -------------------------
          (dollars in thousands)           1995     1994    1993
          --------------------------------------------------------
<S>                                      <C>      <C>      <C>    
          REVENUES:
          Elementary/High School         $34,971  $31,578  $29,377
          Adult Education                 12,677   12,934   13,817
          Library                         10,578    9,096    9,962
                                         -------  -------  -------
            Total Revenues               $58,226  $53,608  $53,156
                                         -------  -------  -------
</TABLE>

Revenues of $58,226,000 increased $4,618,000 or 8.6% from revenues of
$53,608,000 in the prior year. Revenue growth was supported by general price
increases of 10.1% and 5.7% effective September 1, 1995 and 1994, respectively.
Operating income for 1995 was $9,499,000 compared to operating income of
$10,459,000 in 1994. The decrease in operating income is due entirely to the
unusual item charge of $970,000 or $.03 per share for settlement of litigation.
Excluding this unusual item, operating income for 1995 would have been
$10,469,000 (18.0% operating income margin) as compared to $10,459,000 (19.5%
operating income margin) in 1994.

Revenue growth stemmed from the elementary and library markets. The
elementary/high school market, up $3,393,000 or 10.7% was bolstered by strong
sales from basic skills products in spelling, math and reading. The Company's
testing and assessment products also boosted sales, enhanced by the Berrent
Publications product line purchased in November 1994.

Library sales of $10,578,000, up 16.3%, were stimulated by the Company's strong
list of new titles, as well as new exclusive distribution agreements with
Larouse Kingfisher Chambers, Inc. and Abdo & Daughters. Adult sales were down
$257,000 or 2.0% due to continued federal budget constraints reducing the
funding for adult education. The Company purchased the product line of
Educational Development Laboratories, Inc. (EDL) in October 1995 to strengthen
its adult product offerings.

Publishing costs and materials of $14,867,000 increased $1,272,000 or 9.4%, but
remained relatively constant as a percentage of revenues. Manufacturing costs
rose due to the increased cost of paper and the increased sales of library
titles to wholesalers at their typical discounted prices. The Company's price
increase offset much of the increase in paper cost. Royalty expense declined as
a percentage of revenues due to the acquisition of product lines with lower
royalty costs and the addition of the new library lines through distribution
arrangements rather than internal development.

In 1995, Steck-Vaughn changed its method of accounting for inventories from the
last-in, first-out (LIFO) method to the first-in, first-out (FIFO) method. The
new method was adopted to provide a better means of matching current costs with
current revenues, as the company aggressively pursues its plan to reduce its
current operating inventory levels while increasing inventory turnover. In
addition, commencing in late 1995 and continuing into 1996, paper prices
declined. Management expects this trend to continue. The financial statements of
all prior years have been restated to apply the method retroactively. The effect
of this change was to increase Steck-Vaughn's 1994 operating income by
$1,326,000 and $754,000 for 1995 and 1994, respectively.

Product development expense of $8,901,000 increased $1,274,000 or 16.7% as the
Company continued to augment its product offerings with new and revised titles.
Of particular interest is the revision of two major series scheduled for release
in 1996: the 53-volume Portrait of America series and the 24-volume Raintree
Illustrated Science Encyclopedia. The acquisitions of Berrent Publications and
EDL, whose separate development offices were retained, also contributed to the
increase.

                                     - 21 -
<PAGE>   24
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

STECK-VAUGHN PUBLISHING - 1995 COMPARED TO 1994 (CONTINUED:)

Selling and promotion expense of $18,738,000 increased $1,266,000 or 7.2%, but
as a percentage of revenues was down slightly. In nominal terms, expenses rose
due to increased commissions on the higher sales volume. Partially offsetting
the increased costs were some cost reductions achieved through a slight
reduction in the field sales force and an 18% reduction in the telemarketing
sales force.

General and administrative costs were higher due to increased headcount,
enhancement of MIS capabilities and nonrecurring insurance credits in 1994.
Amortization of acquired intangible assets increased as a result of the three
acquisitions made in the last fourteen months.

NETG:

<TABLE>
<CAPTION>
                                         Year Ended December 31,
                                      -----------------------------
            (dollars in thousands)     1995       1994       1993
            -------------------------------------------------------
<S>                                   <C>        <C>        <C>    
            REVENUES:
            Domestic                  $26,129    $36,564    $39,144
            Spectrum                    1,618      5,247      5,266
            International              26,603     20,126     23,849
                                      -----------------------------
              Total Revenues          $54,350    $61,937    $68,259
                                      -----------------------------
</TABLE>

NETG - 1995 COMPARED TO 1994:

Revenues for NETG were $54,350,000, a decrease of $7,587,000 or 12.2% from the
$61,937,000 in 1994. Domestic revenues of $26,129,000 decreased $10,435,000 or
28.5% from the prior year due to decrease in customer renewals and the absence
of significant new customers. The decrease in customer renewals and significant
new customers in the domestic operation is due in part to the absence of a full
line of client/server training products that is now in such demand in the
multimedia training marketplace. During 1995, NETG introduced 32 internally
developed products in the marketplace, most of which were in the desktop
computer training area. In order to stem the revenue decline and grow the
business in the future, NETG will introduce approximately 200 internally
developed training courses in 1996, of which approximately 110 will be in the
client/server training area.

Spectrum revenue for 1995 was $1,618,000, or $3,629,000 lower than in 1994
because the Company began the process to discontinue Spectrum's product line in
June 1995.

International revenue of $26,603,000 increased $6,477,000 or 32.2% from the
prior year primarily in the U.K. and Germany. The increase in the U.K. was due
to increased renewals and new business in 1995. The improved results were
attributable to an experienced management team together with effective sales and
marketing strategies implemented in 1994, particularly in Product License and
Consulting/Multimedia products. The increase in revenues in Germany is mostly
due to increased training revenue in SAP R/3 products, as well as increased
revenue due to a program whereby the government subsidizes certain private
sector training.

Operating loss of NETG increased from $13,993,000 in 1994 to $89,942,000 in 1995
due primarily to net unusual items of $74,567,000 related to the restructuring
of NETG ($30,604,000), write-off of goodwill ($47,509,000) and an unusual credit
($3,546,000) which resulted from a favorable legal arbitration award.

                                     - 22 -
<PAGE>   25
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

NETG - 1995 COMPARED TO 1994 (CONTINUED:)

Course service costs of $19,691,000 were $1,738,000 or 8.1% lower than the prior
year. This is due to the lower volume of domestic business, as well as the
savings from the reorganization of the business, offset partially by an increase
in instructor led training costs as a result of the revenue growth in that area
and an increase in material costs and royalty costs due to revenue growth in the
International market. Also the provision for doubtful accounts increased by
$1,300,000 in International operations.

Product development costs of $10,493,000 increased $1,742,000 or 19.9% due to an
increase in product development of client/server training courses, of which
$3,500,000 was expensed in December of 1995 as part of the project to produce
approximately 110 client/server products to be delivered in the last half of
1996. This increase was partially offset by headcount and related savings due to
the restructuring, as well as discontinuance of the Spectrum products.

Selling and promotion expense of $28,165,000 decreased $5,462,000 or 16.2% due
to lower headcount, fewer sales offices, reduced promotional spending and lower
commission expense due to the lower revenue and the restructuring in June 1995.
The decrease was partially offset by increased costs in international and
distributor channels due to the higher revenue levels.

General and administrative expenses of $10,707,000 were $79,000 or 0.7% lower
than in 1994. Amortization of acquired intangible assets was $668,000 or 50.0%
lower than the prior year as the intangible assets were written-off in June 1995
as further explained below.

In 1995, NETG recorded $74,567,000 of net unusual item charges which are
explained below. NETG experienced significant operating losses over the past
several years in an environment of substantial changes in training related to
information systems and technology. As a result of continuing losses through the
second quarter of 1995, management concluded that NETG could not return to
profitability in the foreseeable future without significant changes in its
operating structure and business direction. Consequently, the Company resolved
to significantly lower the overall cost structure while focusing on specific
training areas to permit NETG to return to profitability. Accordingly, the
Company approved a restructuring plan for NETG in June 1995 to discontinue
certain product lines and to reorganize its sales and marketing efforts to
enhance its channels of distribution. This restructure plan resulted in a
nonrecurring charge of $28,652,000 ($.90 per share). In the fourth quarter of
1995, NETG further reduced its organization in Germany and recorded a
restructure charge of $1,952,000 ($.06 per share). No tax benefits were provided
on these charges. The charges include severance related payments, excess
facilities costs, the write-down of inventory and fixed assets of certain
discontinued products and other restructuring related items such as charges
related to canceled contracts and agreements. These restructure actions are
expected to reduce annual operating expenses by $15,000,000.

In the second quarter of 1995, as a result of the changes at NETG, the Company
revised NETG's financial projections. Based upon this estimate of the future
results of operations, the estimated net cash flows over the remaining life of
NETG's intangible assets (goodwill) are less than the net book value of the
goodwill at June 30, 1995 and under the provisions of Financial Accounting
Standard No. 121 "Accounting for the Impairment of Long-Lived Assets", the
Company estimated the fair value of its investment in NETG by discounting
estimated future net cash flows at a rate commensurate with the related risk.
Based upon this analysis, management believes NETG to have only a nominal fair
value such that the goodwill balance of $42,719,000 ($1.34 per share) related to
the Company's 1986 acquisition of what is now NETG was written-off during the
second quarter.

                                     - 23 -
<PAGE>   26
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

NETG - 1995 COMPARED TO 1994 (CONTINUED:)

Additionally, in the second quarter, the Company discontinued the operations of
Spectrum, a subsidiary of NETG which provided primarily custom developed
training to businesses. As a result, the Company recorded the assets and
liabilities of Spectrum at their fair value and recorded a write-off of goodwill
in the amount of $4,790,000 ($.15 per share) during the second quarter.
Spectrum's operating losses before amortization of intangibles and unusual
items, were $1,433,000 and $1,125,000 for 1995 and 1994, respectively.

During the fourth quarter of 1995, a legal dispute with a third-party author for
NETG was settled in the Company's favor. The Company recorded a gain to the
extent payment was received. A portion of the settlement in the amount of
$1,343,000 is held in escrow pending the outcome of various legal issues. The
gain was partially offset with other minor legal settlements which involved
parties related to the third party author resulting in a net unusual credit of
$3,546,000.

OTHER:

Revenues from National Education International (NEI) which provides training
services to foreign governments primarily in the Middle East, of $3,001,000 were
up slightly from the prior year. This increase was more than offset by a
$327,000 decrease in other revenue from 1994 due to revenues from the investment
in an entity which was sold in 1994.

During the second quarter of 1995, an unusual charge was recorded in the amount
of $1,644,000 ($.05 per share) at NEC Corporate primarily for severance related
payments to the former chief executive officer and corporate expenses related to
the restructuring of NETG.

Operating results of ICS and NETG foreign operations by geographic region
experienced similar changes in revenues and income as previously discussed.
Foreign currency gains of $307,000 were recorded during 1995 compared to gains
of $492,000 in 1994. The current year currency gains primarily resulted from the
rise in the exchange rates of the British pound and the German mark and their
effect on the U.S. dollar denominated current intercompany balances at NETG-U.K.
and NETG-Germany payable to the U.S. operations.

1994 COMPARED TO 1993:

CONSOLIDATED RESULTS OF OPERATIONS:

Revenues of $241,614,000 for the year ended December 31, 1994 were $17,442,000
or 7.8% higher than revenues of $224,172,000 in the prior year. Loss from
continuing operations was $14,093,000 or $.48 loss per fully diluted share
compared to income from continuing operations of $10,092,000 or $.32 per fully
diluted share in 1993. Net loss of $63,545,000 or $2.14 loss per share compared
to net loss of $9,665,000 or $.32 loss per share in 1993.

The 1994 results were restated to reflect Steck-Vaughn changing from the LIFO to
the FIFO basis of accounting for inventories. This change decreased net loss by
$380,000 ($.01 per share) in 1994 and increased net loss by $46,000 ($.00 per
share) in 1993. The 1994 results were negatively impacted by the adoption of the
SOP discussed earlier. The SOP did not allow the restatement of the 1993
results. The 1994 results were also unfavorably impacted by the $40,032,000
charge ($1.35 per share) related to the discontinuance of the Education Centers
subsidiary referred to earlier.

                                     - 24 -
<PAGE>   27
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED:)

Increased revenues from continuing operations related to ICS, Steck-Vaughn and
National Education International were partially offset by reduced revenues at
NETG. The decline in income from continuing operations of $24,185,000 was due to
the 1994 adoption of the SOP discussed above, and a nonrecurring 1993 after tax
gain of $21,120,000 ($.71 per share) resulting from an initial public offering
of 2,668,000 shares of Steck-Vaughn Publishing Corporation common stock
partially offset by the 1993 unusual charge of $9,232,000 ($6,558,000 after tax
or $.22 loss per share) recorded at NETG for the write-down of certain acquired
intangible assets. Excluding the effects of the net unusual items, income from
continuing operations in 1994 was favorably impacted by reduced operating losses
at NETG and a gain on sale of a partnership interest of a start-up operation in
the amount of $3,247,000 ($2,143,000 after tax or $.07 per share). The net loss
was primarily related to the loss from discontinued operations and the loss on
disposal of discontinued operations of the Education Centers totaling
$49,452,000 in 1994. The loss from discontinued operations decreased from the
prior year due to the nonrecurring unusual charge of $23,626,000 ($16,363,000
after tax or $.55 loss per share) resulting from a restructuring charge for the
write-down of certain assets and the estimated costs of closing the 14 schools
announced in the third quarter of 1993.

ICS LEARNING SYSTEMS:

ICS Learning Systems revenues of $122,815,000 increased $21,496,000 or 21.2%
from revenues of $101,319,000 in 1993. Operating loss of $3,927,000 decreased
$25,295,000 from operating income of $21,368,000 in the prior year solely due to
the change in accounting for advertising, selling and promotion costs required
by the SOP as discussed earlier. The revenues at ICS increased primarily due to
strong revenue performance at the domestic operation. The international
operations experienced a slight increase in revenues. Domestic revenues grew
significantly due to a 32.7% increase in enrollments, revenues from MicroMash,
and increases in Business and Industrial Division revenues. The significant
domestic enrollment increase primarily resulted from the success of the expanded
telesales efforts, which have produced a higher conversion of leads to
enrollments and tuition down payments upon enrollment than that experienced in
the prior year. In addition, a shift in product mix towards higher priced
computer related courses contributed to the revenue growth. During the first
quarter, ICS acquired MicroMash, a leading provider of computer based
interactive courses for accounting professionals and students. Through this
acquisition, which contributed $5,069,000 to revenue in 1994, ICS is
strategically positioned to aggressively pursue the continuing professional
education marketplace. Business and Industrial Division revenues grew during the
year as a result of further selling penetration of the existing marketplace. The
revenue increase at the international operation primarily resulted from higher
revenues at the Australia/New Zealand, Canada and International Mail Sales (IMS)
operations. The combined Australia/New Zealand operation experienced strong
enrollment growth of 17.9% as a result of the successful telesales efforts which
increased conversion of leads to enrollments. The higher revenues at Canada and
IMS primarily resulted from increased student payments partially reduced by a
decrease in Canada's enrollments.

The United Kingdom experienced lower revenues due to lower student payments
despite flat enrollments as compared to the prior year.

As a result of the increased traditional business selling and promotion spending
of $11,385,000 in 1994 over 1993, revenues increased $21,496,000 and unearned
future tuition revenue on student contracts at ICS increased $36,883,000 or
29.2% to $163,050,000. As required by the SOP, expensing these costs as incurred
fully burdens the current year with expenses that benefit future years with the
related revenue stream. Higher course service costs at the domestic operation
were primarily related to the significant volume increases and changes in
product mix towards a higher percentage of lower margin computer related
courses. General and administrative costs were higher during the year primarily
due to costs associated with MicroMash and the initial costs to convert and
integrate new information systems. These costs were partially offset by lower
insurance costs related to favorable loss experience.

                                     - 25 -
<PAGE>   28
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

STECK VAUGHN PUBLISHING:

Steck-Vaughn Publishing Corporation revenues of $53,608,000 were $452,000 or .9%
higher than revenues of $53,156,000 in the prior year. Operating income of
$10,459,000 decreased $2,615,000 or 20.0% as compared to operating income of
$13,074,000 in 1993. The 1994 and 1993 results were restated to reflect a change
from the LIFO to the FIFO method of accounting for inventories. This change
increased operating income by $754,000 and $144,000 in 1994 and 1993,
respectively.

The slight increase in revenue was attributable to a general price increase of
6.7% and a modest increase in sales of the elementary school product line which
benefited from growth primarily in the Math, Reading, and Science products and a
full year of Magnetic Way product sales. The adult education product line
experienced a decrease in revenues due to a reduction in software sales of GED
products, new competition for GED products and tight funding in the adult
education sector. In addition, a decline in sales of mature library products was
not entirely offset by sales of newer products, resulting in lower library
revenues. Several factors contributed to these results. Selling conditions in
early 1994 were hampered by adverse winter weather conditions which affected the
midwest, mid-Atlantic and northeast regions of the United States.

Additionally, the sales force expansion and related reorganization effective
January 1994, resulted in longer than anticipated assimilation and reduced sales
productivity. Finally, a continuing trend towards site-based selling, which is a
competitive strength of Steck-Vaughn, is driving the decision making process
down to the faculty level requiring a greater number of sales calls per revenue
dollar, resulting in an increase in selling costs.

Operating income decreased significantly during 1994 primarily due to an
increase in publishing costs, product development expenses, and selling and
promotion costs. Higher publishing costs primarily resulted from the higher
distributor and Magnetic Way sales which have lower profit margins and resulted
in a slight increase in publishing costs as a percentage of revenues. Publishing
costs and materials, which include product development and product acquisition
expenses, increased over the prior year due to Steck-Vaughn's commitment to
develop new and revised products and to acquire certain library products to
position Steck-Vaughn for growth in the supplemental educational marketplace. By
continuing to expand its product offerings, Steck-Vaughn expects to continue to
capitalize on the anticipated increasing demand for supplemental educational,
library and adult education products despite severe budgetary pressure on
schools located in certain geographic areas of the country. Selling and
promotion costs increased during the year due to the expansion of the sales
organization during January 1994. The expansion and related reorganization
resulted in the segmentation of the sales force into two groups. One group
focuses on the elementary, junior high and library marketplaces while the other
group focuses on the high school and adult education marketplaces. This
segmentation positions Steck-Vaughn to maximize the opportunities of their
rapidly expanding product offerings and to respond to additional requirements
resulting from the trend towards site-based selling. General and administrative
expenses decreased in 1994 primarily due to lower insurance expenses caused by
favorable loss experience and reduced management incentive compensation
expenses.

NETG:

NETG revenues of $61,937,000 decreased $6,322,000 or 9.3% from revenues of
$68,259,000 in the prior year. Operating losses of $13,993,000 decreased
$11,957,000 from losses before unusual items of $25,950,000 in the prior year.
During the third quarter of 1993, NETG recorded an unusual charge of $9,232,000
which resulted from the write-down of certain acquired intangible assets. The
decrease in revenues at the domestic and international operations primarily
resulted from lower contract backlog at the beginning of 1994 as compared to
1993 and slightly

                                     - 26 -
<PAGE>   29
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

NETG (CONTINUED:)

lower volume of new orders in the domestic operation. In addition, the decrease
in revenues was partially attributable to the introduction in the third quarter
of a new product licensing agreement, called Multimedia Licensing Agreement
(MLA), which simplifies the customers' ability to acquire NETG products;
however, unlike sales contracts used in prior years, the MLA does not require
upfront commitments to acquire product upon the signing of a contract. As the
number of customers signing MLAs increases, new orders will become less
meaningful as a key indicator of future revenue activity. New orders increased
in the international operation due to increased new business activity in the
United Kingdom operation; however, decreasing contract backlog, which more than
offset the new orders business, and the sale of NETG-Canada in 1993 resulted in
reduced revenues in the international operation. During December 1993, NETG sold
certain assets and liabilities of NETG-Canada to SHL Systemhouse, Inc. at
approximately book value.

Operating losses before unusual items decreased significantly in the domestic
operation during 1994 primarily due to reductions in product development costs,
general and administrative expenses and amortization of acquired intangible
assets. Reengineering the processes in product development and focusing the 1994
development efforts to concentrate in areas such as multimedia end user desktop
computing and client/server computing resulted in a 35.6% reduction in product
development expenses. The decrease in general and administrative expenses
primarily resulted from lower employee headcount and favorable loss experience
which resulted in lower insurance expenses partially offset by higher consulting
costs. Amortization of acquired intangible assets decreased in 1994 due to the
write-down of certain acquired intangible assets in 1993 which was recorded as
an unusual charge of $9,232,000. Despite slightly lower selling and promotion
expenses, these expenses increased as a percentage of revenue during 1994
primarily as a result of the revenue decline.

CORPORATE AND OTHER:

National Education International (NEI) revenues of $2,927,000 increased
$1,675,000 or 133.8% above the prior year revenues of $1,252,000. Operating
income of $958,000 increased $742,000 over the prior year income of $216,000.
The higher revenue and operating income levels are attributable to multi-year
training contracts with Egypt and Kuwait, which span from one to four years in
duration.

In December 1994, the Company sold its interest in a start-up partnership
venture previously entered into for the development of an automated enrollment
and financial aid application process. As a result of the sale, which was
accounted for as a sale of stock, the Company recorded a gain on sale of
$3,247,000 ($2,143,000 after tax or $.07 per share).

General corporate expenses of $6,582,000 decreased $4,314,000 or 39.6% from
expenses of $10,896,000 in the prior year. The decrease in corporate expenses
primarily resulted from a one-time contract settlement charge in 1993, favorable
loss experience which resulted in lower insurance expenses, reduced outside
consulting costs primarily from the company-wide financial reengineering effort
and other cost reductions.

Operating results of ICS and NETG foreign operations by geographic region
experienced similar changes in revenues and income as previously discussed.
Foreign currency gains of $492,000 were recorded during 1994 compared to losses
of $243,000 in 1993. The current year currency gains primarily resulted from the
rise in the exchange rates of the British pound and the German mark and their
effect on the U.S. dollar denominated current intercompany balances at NETG-U.K.
and NETG-Germany payable to the U.S. operations.

                                     - 27 -
<PAGE>   30
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

LIQUIDITY AND CAPITAL RESOURCES

The Company's primary sources of liquidity are cash, investment securities and
cash provided from operations. At December 31, 1995, the Company had $23,868,000
in cash and investment securities, of which $11,790,000 was held in the account
of Steck-Vaughn.

As of December 31, 1995, the Company had a revolving bank credit agreement in
the amount of $10,000,000, all of which was outstanding. In January 1996, the
Company terminated the bank credit agreement in the amount of $10,000,000 and
entered into a two-year, $20,000,000 revolving credit agreement with a bank. The
revolving credit, which is secured by stock of certain principal subsidiaries
and certain assets, will initially provide for borrowing at the bank's base rate
plus 1.75% or, at the Company's option, at LIBOR plus 3%, with
borrowing rate decreases subject to certain financial performance measures. The
revolving credit agreement provides for the intercompany agreement between the
Company and Steck-Vaughn in the amount of $10,000,000 which expires March 31,
1996. Effective February 1, 1996, the Company reduced the amount of the
intercompany agreement to $5,000,000. The agreement provides that any borrowing
by the Company will bear interest at LIBOR plus 2%, and will be secured
by the Company's holdings of Steck-Vaughn stock. Steck-Vaughn also received an
option to repurchase from the Company up to 290,000 shares of Steck-Vaughn stock
held by the Company, at $6.50 per share. The option becomes exercisable one year
after grant, expires March 31, 1997, and may be redeemed by the Company prior to
exercise or expiration for the greater of $75,000 per month ($37,500 effective
February 1, 1996) or the amount necessary to increase to 25% the
annualized yield to Steck-Vaughn on all amounts borrowed by the Company under
the intercompany loan agreement. At December 31, 1995, $4,000,000 was
outstanding under the intercompany agreement and was eliminated in
consolidation.

Steck-Vaughn has a revolving bank credit agreement in the amount of $10,000,000
with a maturity of June 10, 1997. The agreement provides for borrowings at prime
or, at Steck-Vaughn's option, LIBOR plus 1.5%. The bank credit agreement
replaced Steck-Vaughn's borrowing ability from the Company pursuant to an
intercompany agreement. No amounts were outstanding under the bank credit
facility in 1994 or 1995. Annual commitment fees of .25% are paid on the unused
line of credit.

In September 1995, the holders of $20,000,000 of the Company's 10% senior
subordinated convertible debentures converted such debentures, including accrued
interest, into 5,021,000 shares of the Company's common stock.

During 1994, the Company adopted a plan to dispose of its Education Centers
subsidiary. As a result, the Company recorded a charge of $40,032,000 to
write-down assets to estimated net realizable value and provide for estimated
costs of disposing of the operation. As of December 31, 1995, substantially all
of the operations and schools were sold, closed or terminated.

Subsequent to December 31, 1995, the Company entered into a definitive agreement
to acquire all of the stock of Edunetics, Ltd., an Israeli corporation engaged
in the development of educational software, for cash consideration of
$12,000,000. The closing remains subject to certain conditions including
approval by the shareholders of Edunetics and receipt of certain regulatory
approvals under Israeli law.

The Company expects that cash, marketable securities, the bank credit
facilities, cash provided from operations, the intercompany credit agreement
with Steck-Vaughn, which under certain conditions may be extended, and an
expected IRS refund in the amount of approximately $10,000,000 will be
sufficient to provide for planned working capital requirements, product
development, capital expenditures, debt service and the pending acquisition of
Edunetics, Ltd. At closing, the purchase price for Edunetics, Ltd. will be
funded by cash on hand and advances under the Steck-Vaughn revolving bank credit
agreement.

                                     - 28 -
<PAGE>   31
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations (continued)

                 National Education Corporation and Subsidiaries

LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)

Net cash outflow from operating activities of $11,000 in 1995 improved
$1,418,000 from the negative cash outflow of $1,429,000 reported in 1994. The
improvements in working capital items such as receivables, accounts payable,
accrued expenses, and accrued and deferred income taxes were partially offset by
increases of inventories, primarily at Steck-Vaughn and decreases of deferred
contract revenues, primarily at NETG due to the reduced level of contract and
revenue activity.

In addition, net cash flows for 1995 were further impacted by acquisitions of
Summit Learning, Inc. and EDL in the amount of $3,260,000. The cash outflow of
$2,337,000 at the Education Centers improved $18,748,000 from the cash outflow
of $21,085,000 in 1994. The improved cash flow at these discontinued operations
resulted from the proceeds from the sale of schools of $10,647,000 and the
significant reductions in Education Centers' headquarters expenses.

The Company accounts for income taxes under Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes (FAS 109). FAS 109 requires the
recognition of deferred tax liabilities and assets for the expected future tax
consequences of temporary differences between the financial statement and tax
basis of assets and liabilities. As of December 31, 1995, the Company had a
gross deferred tax asset of $84,488,000 (see Notes to Consolidated Financial
Statements). A significant portion of the deferred tax asset is comprised of
U.S. federal and international net operating loss carryforwards. At December 31,
1995, the Company had available federal consolidated net operating loss
carryforwards of $108,000,000 (exclusive of certain "SRLY" losses) expiring
through 2010. In addition, the Company had federal SRLY loss carryforwards
totaling $17,400,000 ($5,918,000 deferred tax asset) expiring in years 1998
through 2010 that may only be used to offset income generated by the particular
entities that generated the losses.

FAS 109 requires that the Company record a valuation allowance when it is "more
likely than not that some portion of the deferred tax asset will not be
realized". As a result of the Company's significant losses in recent years, the
Company has recorded a valuation allowance of $50,952,000, including full
allowance against the 1995 losses and the SRLY loss carryforwards.

The ultimate realization of deferred tax assets, net of the valuation allowance,
of $33,536,000 depends on the Company's ability to generate sufficient taxable
income in the future. A portion of this asset will be realized through the
reversal of taxable temporary differences totaling $11,661,000 reflected as
deferred tax liabilities in the financial statements. The improving operating
income throughout the last two quarters in 1995 and into 1996, together with the
reversal of taxable temporary differences, provides the basis for management's
conclusion that it is more likely than not that the Company will generate
sufficient taxable income to realize the net deferred tax asset.

The effect of inflation had little impact on the Company in 1995.

                                     - 29 -
<PAGE>   32
ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

         The Company's consolidated financial statements at December 31, 1995
and 1994, and for each of the three years in the period ended December 31, 1995,
and the Report of Price Waterhouse LLP, Independent Accountants, are included in
this Annual Report on Form 10-K on pages F-1 through F-26 below.

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

         The Company has no information to report in response to this item.

                                    PART III

ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.

         (a) The information required by Item 10 with respect to the directors
of the Company is incorporated herein by reference from material that will be
filed with the Securities and Exchange Commission within 120 days of the
Company's fiscal year end (December 31, 1995) as part of a Proxy Statement for
the Company's Annual Meeting of Stockholders.

         (b) The information required by Item 10 with respect to executive
officers of the Company is furnished in a separate item captioned "Executive
Officers of the Company" and included in Part I of this Annual Report on Form
10-K.

ITEM 11.   EXECUTIVE COMPENSATION.

         The information required by Item 11 is incorporated herein by reference
from material that will be filed with the Securities and Exchange Commission
within 120 days of the Company's fiscal year end (December 31, 1995) as part of
a Proxy Statement for the Company's Annual Meeting of Stockholders.

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

         The information required by Item 12 is incorporated herein by reference
from material that will be filed with the Securities and Exchange Commission
within 120 days of the Company's fiscal year end (December 31, 1995) as part of
a Proxy Statement for the Company's Annual Meeting of Stockholders.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         The information required by Item 13 is incorporated herein by reference
from material that will be filed with the Securities and Exchange Commission
within 120 days of the Company's fiscal year end (December 31, 1995) as part of
a Proxy Statement for the Company's Annual Meeting of Stockholders.

                                     - 30 -
<PAGE>   33
                                     PART IV

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

(a)     The following documents are filed as
        part of this report:

<TABLE>
<CAPTION>
                                                                              Page Number
                                                                              -----------
<S>                                                                           <C>
        (1)    Financial Statements:

               Report of Independent Accountants...........................       F-1
               Consolidated Statements of Operations for each of the
                 three years in the period ended December 31, 1995.........       F-2
               Consolidated Balance Sheets at December 31, 1995 and 1994...       F-3
               Consolidated Statements of Cash Flows for each of the

                 three years in the period ended December 31, 1995.........       F-4
               Consolidated Statements of Stockholders' Equity for each

                 of the three years in the period ended December 31, 1995..       F-5
               Notes to Consolidated Financial Statements..................       F-6

        (2)    Financial Statement Schedules: **

                     II      Valuation and Qualifying Accounts.............       F-26
</TABLE>

               **      Schedules numbered in accordance with Rule 5.04 of
                       Regulation S-X. All other financial statement schedules
                       are omitted because they are not applicable or the
                       required information is shown in the financial statements
                       or notes thereto.

        (3)    Exhibits: Management contracts and compensatory plans and
               arrangements required to be filed as an exhibit to this Annual
               Report on Form 10-K are denoted with an "**" after the Exhibit
               number.

<TABLE>
<CAPTION>
                                                                                               Sequentially
Exhibit                                                                                         Numbered
Number         Description                                                                         Page
-------        -----------                                                                     ------------
<S>            <C>                                                                             <C> 
3.1            Restated Certificate of Incorporation of the National Education
               Corporation (23).............................................................

3.2            By-Laws of National Education Corporation, as amended (1)....................        *

10.1 **        National Education Corporation Retirement Plan (Restated as of

               January 1, 1989 and as Amended through January 1, 1992) (2)..................        *

10.2 **        Advanced Systems, Incorporated 1984 Stock Option and Stock
               Appreciation Rights Plan (3).................................................        *

10.3 **        1986 Stock Option and Incentive Plan, as amended (4).........................        *

10.4 **        Amended and Restated 1990 Stock Option and Incentive Plan (5)................        *

10.5 **        Amended and Restated 1991 Directors' Stock Option and Award Plan (6).........        *
</TABLE>

                                     - 31 -
<PAGE>   34
<TABLE>
<CAPTION>
                                                                                               Sequentially
Exhibit                                                                                          Numbered
Number         Description                                                                         Page
-------        -----------                                                                     ------------
<S>            <C>                                                                             <C> 
10.6           Rights Agreement, dated October 29, 1986, between National Education
               Corporation and Bank of America National Trust and Savings
               Association, Rights Agent (including exhibits thereto) (7)...................        *

10.7           Addendum No. 1 to Rights Agreement, dated August 5, 1991 (8).................        *

10.8           Indenture, dated as of May 15, 1986, between National Education
               Corporation and Continental Illinois National Bank and Trust Company
               of Chicago, as Trustee (9)...................................................        *

10.9           Tripartite Agreement Dated as of May 31, 1990, among National
               Education Corporation, Continental Bank as Resigning Trustee, and IBJ
               Schroder Bank & Trust Company as Successor Trustee (10)......................        *

10.10 **       National Education Corporation Supplemental Executive Retirement Plan,
               as amended (11)..............................................................        *

10.11 **       Supplemental Benefit Plan for Non-Employee Directors (12) ...................        *

10.12 **       Executive Employment Agreement between National Education Corporation
               and Sam Yau (13).............................................................        *

10.13          Intercompany Agreement Between National Education Corporation and
               Steck-Vaughn Publishing Corporation dated June 30, 1993 (the "Intercompany
               Agreement") (14).............................................................        *

10.14          First Amendment to Intercompany Agreement, dated June 10, 1994 (15)..........        *

10.15          Tax Sharing Agreement Between National Education Corporation and Its
               Direct and Indirect Corporate Subsidiaries dated January 1, 1993 (16)........        *

10.16          $13,500,000 Amended and Restated Credit Agreement among National
               Education Corporation, the Banks named therein and Bankers Trust
               Company as Agent, dated February 28, 1995 (the "Credit Agreement")
               (Confidential treatment under Rule 24b-2 has been granted for portions
               of this exhibit) (17) .......................................................        *

10.17          First Amendment and Limited Waiver to Credit Agreement, dated
               July 31, 1995 (18)...........................................................        *

10.18          Second Amendment to Credit Agreement, dated December 21, 1995 (23)...........

10.19          $10,000,000 Credit Agreement between Steck-Vaughn Company and
               NationsBank of Texas, dated as of June 10, 1994 (19).........................        *

10.20          Amendment of Loan Agreement between NationsBank of Texas, N.A. and
               Steck-Vaughn Company, dated September 29, 1995 (20)..........................        *

10.21          Revolving Line of Credit Note and Option Agreement between National
               Education Corporation and Steck-Vaughn Publishing Corporation, dated
               February 28, 1995 (21).......................................................        *
</TABLE>

                                     - 32 -
<PAGE>   35
<TABLE>
<CAPTION>
                                                                                               Sequentially
Exhibit                                                                                          Numbered
Number         Description                                                                         Page
-------        -----------                                                                     ------------
<S>            <C>                                                                             <C> 
10.22          Renewal and Extension Agreement between National Education Corporation and
               Steck-Vaughn Publishing Corporation, effective December 31, 1995 (23)........

10.23          First Amendment to Stock Option Agreement between National Education
               Corporation and Steck-Vaughn Publishing Corporation, effective December 31,
               1995 (23)....................................................................

10.24          Letter Amendment to Stock Option Agreement between National Education
               Corporation and Steck-Vaughn Publishing Corporation, dated February 1,
               1996 (23)....................................................................

10.25          Debenture Conversion Agreement among National Education Corporation
               and the Holders identified therein, dated August 31, 1995 (22)...............        *

10.26          Credit Agreement among National Education Corporation, certain banks and
               BZW Division of Barclays Bank PLC, as Agent, dated January 19, 1996
               (Confidential treatment under Rule 24b-2 has been requested for portions
               of this exhibit) (23)........................................................

11.1           Calculation of Primary Earnings Per Share (23)...............................

11.2           Calculation of Fully Diluted Earnings Per Share (23).........................

18             Letter from Price Waterhouse LLP regarding change in accounting
               principles (23) .............................................................

21             Subsidiaries of National Education Corporation (23)..........................

23             Consent of Price Waterhouse LLP (23).........................................

27.1           Financial Data Schedule (23)
</TABLE>

------------------
      *        incorporated by reference from a previously filed document
      **       denotes management contract or compensatory plan or arrangement

      (1)      Incorporated by reference to Exhibit 10 filed with National
               Education Corporation's Quarterly Report on Form 10-Q for the
               quarter ended June 30, 1990.

      (2)      Incorporated by reference to Exhibit 10.1 filed with National
               Education Corporation's Annual Report on Form 10-K for the year
               ended December 31, 1992, filed March 22, 1993.

      (3)      Incorporated by reference to Exhibit 10.15 filed with National
               Education Corporation's Annual Report on Form 10-K for the year
               ended December 31, 1987, filed March 30, 1988.

      (4)      Incorporated by reference to Exhibit 10.17 filed with National
               Education Corporation's Annual Report on Form 10-K for the year
               ended December 31, 1990, filed April 1, 1991.

      (5)      Incorporated by reference to Exhibit "B" filed with National
               Education Corporation's Proxy Statement furnished in connection
               with the Annual Meeting of Stockholders held June 27, 1995, filed
               May 22, 1995.

                                     - 33 -
<PAGE>   36
      (6)      Incorporated by reference to Exhibit "A" filed with National
               Education Corporation's Proxy Statement furnished in connection
               with the Annual Meeting of Stockholders held June 27, 1995, filed
               May 22, 1995.

      (7)      Incorporated by reference to Exhibit 4.1 filed with National
               Education Corporation's Current Report on Form 8-K, dated October
               29, 1986, filed October 30, 1986.

      (8)      Incorporated by reference to Exhibit 10.19 filed with National
               Education Corporation's Annual Report on Form 10-K for the year
               ended December 31, 1991, filed April 1, 1992.

      (9)      Incorporated by reference to Exhibit 4.2 filed with Amendment No.
               1 to National Education Corporation's Registration Statement on
               Form S-3 (No. 33-5552), filed May 16, 1986.

      (10)     Incorporated by reference to Exhibit 4 filed with National
               Education Corporation's Quarterly Report on Form 10-Q for the
               quarter ended June 30, 1990.

      (11)     Incorporated by reference to Exhibit 10.17 filed with National
               Education Corporation's Annual Report on Form 10-K for the year
               ended December 31, 1991, filed April 1, 1992.

      (12)     Incorporated by reference to Exhibit 10.18 filed with National
               Education Corporation's Annual Report on Form 10-K for the year
               ended December 31, 1991, filed April 1, 1992.

      (13)     Incorporated by reference to Exhibit 10.21 filed with National
               Education Corporation's Quarterly Report on Form 10-Q for the
               quarter ended March 31, 1995.

      (14)     Incorporated by reference to Exhibit 10.8 filed with Amendment
               No. 1 to Steck-Vaughn Publishing Corporation's Registration
               Statement on Form S-1, (No. 33-62334), filed June 17, 1993.

      (15)     Incorporated by reference to Exhibit 10.23 filed with National
               Education Corporation's Quarterly Report on Form 10-Q for the
               quarter ended June 30, 1994, filed August 11, 1994.

      (16)     Incorporated by reference to Exhibit 10.9 filed with Amendment
               No. 1 to Steck-Vaughn Publishing Corporation's Registration
               Statement on Form S-1, (No. 33-62334), filed June 17, 1993.

      (17)     Incorporated by reference to Exhibit 10.18 filed with National
               Education Corporation's Annual Report on Form 10-K for the year
               ended December 31, 1994, filed March 31, 1995.

      (18)     Incorporated by reference to Exhibit 10.22 filed with National
               Education Corporation's Quarterly Report on Form 10-Q for the
               quarter ended September 30, 1995, filed November 9, 1995.

      (19)     Incorporated by reference to Exhibit 10.14 filed with
               Steck-Vaughn Publishing Corporation's Quarterly Report on Form
               10-Q for the quarter ended June 30, 1994, filed August 11, 1994.

      (20)     Incorporated by reference to Exhibit 10.24 filed with National
               Education Corporation's Quarterly Report on Form 10-Q for the
               quarter ended September 30, 1995, filed November 9, 1995.

      (21)     Incorporated by reference to Exhibit 10.12 filed with
               Steck-Vaughn Publishing Corporation's Annual Report on Form 10-K
               for the year ended December 31, 1994, filed March 29, 1995.

      (22)     Incorporated by reference to Exhibit 10.23 filed with National
               Education Corporation's Quarterly Report on Form 10-Q for the
               quarter ended September 30, 1995, filed November 9, 1995.

      (23)     Filed herewith.

(b)   No reports on Form 8-K were filed during the fourth quarter of 1995.

                                     - 34 -
<PAGE>   37
(c)   The exhibits required by this Item are listed under Item 14(a)(3) above.

(d)   The consolidated financial statements required by this Item are listed\
      under Item 14(a)(2).

                                     - 35 -
<PAGE>   38
                                   SIGNATURES


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

NATIONAL EDUCATION CORPORATION                                 Date


By    /s/ SAM YAU                                          March 14, 1996
      ---------------                                                           
       Sam Yau
       President and Chief
       Executive Officer



         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
Company and in the capacities and on the dates indicated.

                                                               Date


By    /s/ SAM YAU                                          March 14, 1996
      ---------------                                                    
       Sam Yau
       Director, President and Chief
       Executive Officer
       (Principal Executive Officer)



By    /s/ KEITH K. OGATA                                   March 14, 1996
      ---------------------------                                        
       Keith K. Ogata, Vice President,
       Chief Financial Officer and
       Treasurer (Principal Financial
       Officer)



By    /s/ GLEN E. MEDWID                                   March 14, 1996
      --------------------                                               
       Glen E. Medwid, Corporate
       Controller (Principal
       Accounting Officer)






                                     - 36 -
<PAGE>   39
                                                               Date


By:    /s/ RICHARD C. BLUM                                 March 11, 1996
       ----------------------------                                      
        Richard C. Blum, Director



By:    /s/ DAVID BONDERMAN                                 March 11, 1996
       ----------------------------                                      
       David Bonderman, Director



By:    /s/ DAVID R. DUKES                                  March 13, 1996
       ---------------------------                                       
       David R. Dukes, Director



By:    /s/ LEONARD W. JAFFE                                March 11, 1996
       ----------------------------                                      
        Leonard W. Jaffe, Director



By:    /s/ DAVID C. JONES                                  March 11, 1996
       -----------------------------                                     
        David C. Jones, Director



By:    /s/ MICHAEL R. KLEIN                                March 12, 1996
       ----------------------------                                      
        Michael R. Klein, Director



By:    /s/ PAUL B. MACCREADY                               March 9, 1996
       ----------------------------                                     
        Paul B. MacCready, Director



By:    /s/ FREDERIC V. MALEK                               March 9, 1996
       ---------------------------                                      
        Frederic V. Malek, Director



By:    /s/ JOHN J. MCNAUGHTON                              March 11, 1996
       ----------------------------                                      
        John J. McNaughton, Director



By:    /s/ WILLIAM D. WALSH                                March 9, 1996
       ----------------------------                                     
        William D. Walsh, Director






                                     - 37 -
<PAGE>   40
                         NATIONAL EDUCATION CORPORATION

                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Stockholders
of National Education Corporation



In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) and (2) on page 31 present fairly, in all material
respects, the financial position of National Education Corporation and its
subsidiaries at December 31, 1995 and 1994, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1995, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.

As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for advertising costs in 1994, changed its
method of accounting for inventory cost in 1995 and changed its method of
accounting for the impairment of long-lived and intangible assets in 1995.





Price Waterhouse LLP

Costa Mesa, California
February 5, 1996, except as to Note 4, which is as of March 1, 1996





                                       F-1





<PAGE>   41
                 National Education Corporation and Subsidiaries

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                    Year Ended December 31,
                                                               ----------------------------------
                                                                              As          As
                                                                           Restated    Restated
                                                                           (Note 1)    (Note 1)
(amounts in thousands, except per share amounts)                  1995       1994        1993
-------------------------------------------------------------------------------------------------
<S>                                                             <C>         <C>        <C>
TUITION AND CONTRACT REVENUES                                   $200,372    $188,006   $171,016
PUBLISHING REVENUES                                               58,226      53,608     53,156
                                                                -------------------------------
NET REVENUES                                                     258,598     241,614    224,172
COSTS AND EXPENSES:
   Contract course materials and service costs                    73,003      60,428     57,332
   Publishing costs and materials                                 14,867      13,595     12,721
   Product development                                            23,026      19,934     22,328
   Selling and promotion                                         111,112     111,058     93,046
   General and administrative                                     32,134      29,032     37,201
   Amortization of acquired intangible assets                      1,602       1,824      4,605
   Amortization of prior period deferred marketing                 1,470      19,836         --
   Unusual items, net                                             81,730          --      9,232
   Interest expense                                                8,650       6,336      5,723
   Investment income                                              (2,621)     (3,234)    (2,560)
   Other income                                                     (307)       (492)      (138)
   Gain on sale of stock                                              --      (3,247)   (21,120)
                                                                -------------------------------
INCOME (LOSS) BEFORE INCOME TAXES (BENEFIT), MINORITY
  INTEREST AND DISCONTINUED OPERATIONS                           (86,068)    (13,456)     5,802
   Income tax benefit                                                 --        (555)    (4,889)
                                                                -------------------------------
INCOME (LOSS) BEFORE MINORITY INTEREST AND DISCONTINUED
  OPERATIONS                                                     (86,068)    (12,901)    10,691
   Minority interest in consolidated subsidiary                    1,155       1,192        599
                                                                -------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS                         (87,223)    (14,093)    10,092
   Loss from discontinued operations                                  --      (9,420)   (19,757)
   Loss on disposal of discontinued operations                        --     (40,032)        --
                                                                -------------------------------
NET LOSS                                                        $(87,223)   $(63,545)  $ (9,665)
                                                                -------------------------------
EARNINGS (LOSS) PER SHARE FROM CONTINUING OPERATIONS:
   Primary earnings (loss) per share                            $  (2.73)   $   (.48)  $    .34
                                                                -------------------------------
   Fully diluted earnings (loss) per share                      $  (2.73)   $   (.48)  $    .32
                                                                -------------------------------
EARNINGS (LOSS) PER SHARE                                       $  (2.73)   $  (2.14)  $   (.32)
                                                                -------------------------------
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
   Primary shares                                                 31,893      29,640     29,855
   Fully diluted shares                                           38,025      36,940     34,855
                                                                -------------------------------
</TABLE>

                 See Notes to Consolidated Financial Statements.

                                      F-2


<PAGE>   42


                 National Education Corporation and Subsidiaries

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                              December 31,
                                                                         ----------------------
(dollars in thousands)                                                      1995        1994
-----------------------------------------------------------------------------------------------
<S>                                                                      <C>         <C>
ASSETS
CURRENT ASSETS
  Cash and cash equivalents                                              $  22,120    $ 17,297
  Investment securities                                                      1,748      10,833
  Receivables, net of allowance of $2,742 and $2,787                        36,397      45,438
  Inventories and supplies                                                  31,847      25,695
  Net assets held for disposition                                               --      25,867
  Income tax receivable                                                      9,313       9,313
  Other current assets                                                      13,440      17,695
                                                                         ---------------------
    Total current assets                                                   114,865     152,138
Land, buildings, and equipment, net                                         24,028      25,404
Acquired intangible assets, net                                             13,428      52,691
Deferred income taxes                                                       24,768      28,482
Other assets                                                                 8,173      11,530
                                                                         ---------------------
                                                                         $ 185,262    $270,245
                                                                         ---------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
  Accounts payable                                                       $   6,072    $  7,771
  Accrued expenses                                                          29,022      29,328
  Accrued short-term restructuring charges                                   8,246          --
  Accrued salaries and wages                                                 5,627       5,448
  Accrued disposition costs                                                     --      25,116
  Deferred contract revenues                                                 7,421      11,905
  Current portion of long-term debt and short-term borrowings               12,338       6,407
  Accrued and deferred income taxes                                         14,446      11,281
                                                                         ---------------------
    Total current liabilities                                               83,172      97,256
                                                                         ---------------------
LIABILITIES PAYABLE AFTER ONE YEAR
  Long-term debt, less current portion                                       8,839       6,389
  Senior subordinated convertible debentures                                    --      20,000
  Convertible subordinated debentures                                       57,494      57,494
  Accrued long-term restructuring charges                                   10,089          --
  Other noncurrent liabilities                                               8,683       7,667
                                                                         ---------------------
                                                                            85,105      91,550
                                                                         ---------------------
MINORITY INTEREST IN EQUITY OF CONSOLIDATED SUBSIDIARY                       9,504       8,423
                                                                         ---------------------
STOCKHOLDERS' EQUITY
  Preferred stock, $.10 par value; 5,000,000 shares 
    authorized and unissued                                                     --          --
  Common stock, $.01 par value; 50,000,000 shares 
    authorized; 35,820,468 and 30,275,381 shares issued                      2,166       2,110
  Additional paid-in capital                                               155,100     133,043
  Accumulated deficit                                                     (136,484)    (49,261)
  Unrealized gain (loss) on available-for-sale securities, net of tax           10         (21)
  Cumulative foreign exchange translation adjustment                        (7,005)     (7,947)
  Notes receivable under stock option plans                                 (1,398)         --
                                                                         ---------------------
                                                                            12,389      77,924
  Less common stock in treasury                                             (4,908)     (4,908)
                                                                         ---------------------
    Total stockholders' equity                                               7,481      73,016
                                                                         ---------------------
                                                                         $ 185,262    $270,245
                                                                         ---------------------
</TABLE>

                 See Notes to Consolidated Financial Statements.

                                       F-3
<PAGE>   43
                 National Education Corporation and Subsidiaries

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                         Year Ended December 31,
                                                                  ------------------------------------
 (dollars in thousands)                                              1995         1994        1993
 -----------------------------------------------------------------------------------------------------
<S>                                                                <C>          <C>         <C>
 CASH FLOWS FROM OPERATING ACTIVITIES:
 Net loss                                                          $(87,223)    $(63,545)   $ (9,665)
 Adjustments to reconcile net loss to net cash provided by
  (used for) operating activities:
    Loss from discontinued operations                                    --        9,420      19,757
    Income tax benefits on discontinued operations                       --        1,008       8,769
    Loss on disposal of discontinued operations                          --       40,032          --
    Depreciation and amortization                                     5,587        5,610       7,390
    Amortization of acquired intangible assets                        1,602        1,824       4,605
    Amortization of prior period deferred marketing                   1,470       19,836          --
    Provision for doubtful accounts                                   1,642          250       1,777
    Gain on sale of stock                                                --       (3,247)    (21,120)
    Gain on sale of land, buildings and equipment                        --           --        (381)
    Write-off of acquired intangible assets                          47,509           --       9,232
    Write-off of course computer hardware costs                       4,549           --          --
    (Gain) loss on foreign currency exchange                           (299)        (492)        243
    Change in assets and liabilities:
      Receivables, net                                                8,142         (187)     13,669
      Inventories and supplies                                       (4,586)        (353)        281
      Deferred marketing expenses                                       287          270      (3,605)
      Accounts payable and accrued expenses                            (520)     (10,840)      4,121
      Accrued restructuring reserve                                  25,695           --          --
      Accrued and deferred income taxes                                 802       (4,457)    (16,746)
      Deferred contract revenues                                     (4,534)       1,170      (5,469)
      Other                                                            (134)       2,272      (4,535)
                                                                   ---------------------------------
     Net cash from operating activities                                 (11)      (1,429)      8,323
                                                                   ---------------------------------
 CASH FLOWS FOR INVESTING ACTIVITIES:
    Additions to land, buildings and equipment                       (4,527)      (6,788)     (8,503)
    Dispositions of land, buildings and equipment                       (63)        (171)        260
    Proceeds from sales of investment securities                      9,327       10,680       3,310
    Purchases of investment securities                                 (189)      (5,249)     (8,615)
    Acquisition of business, net of cash acquired                    (3,260)      (6,430)     (5,417)
    Discontinued operations                                          (2,337)     (21,085)    (22,815)
                                                                   ---------------------------------
    Net cash for investing activities                                (1,049)     (29,043)    (41,780)
                                                                   ---------------------------------
 CASH FLOWS FROM FINANCING ACTIVITIES:
    Additions to long-term debt                                          --        4,036          --
    Reductions in long-term debt                                     (1,709)        (703)       (654)
    Net proceeds from Steck-Vaughn Publishing Corporation public
     stock offering                                                      --           --      28,701
    Changes in short-term borrowings                                  4,961        5,305          --
    Minority interest in equity of consolidated subsidiary            1,081          242         599
    Common stock, stock options and related tax benefits                573          783         360
    Payments received on notes receivable under stock option          
     plans                                                               --           --         107
    Purchase of common stock for treasury                                --          (53)     (4,685)
                                                                   ---------------------------------
    Net cash from financing activities                                4,906        9,610      24,428
                                                                   ---------------------------------
 EFFECT OF EXCHANGE RATE CHANGES ON CASH                                977         (387)       (894)
                                                                   ---------------------------------
 NET CHANGE IN CASH AND EQUIVALENTS                                   4,823      (21,249)     (9,923)
 CASH AND EQUIVALENTS AT THE BEGINNING OF THE YEAR                   17,297       38,546      48,469
                                                                   ---------------------------------
 CASH AND EQUIVALENTS AT THE END OF THE YEAR                       $ 22,120     $ 17,297    $ 38,546
                                                                   ---------------------------------
</TABLE>

                 See Notes to Consolidated Financial Statements.

                                       F-4


<PAGE>   44
                 National Education Corporation and Subsidiaries

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                               1995                   1994                   1993
                                       --------------------------------------------------------------------
(amounts in thousands)                  Shares      Amount     Shares      Amount     Shares      Amount
-----------------------------------------------------------------------------------------------------------
<S>                                     <C>        <C>         <C>         <C>        <C>        <C>
COMMON STOCK AND PAID-IN CAPITAL
  Balance at beginning of year            30,275   $ 135,153     30,093    $134,370     30,018   $134,010
  Stock options and related tax               
    benefits                                  95         423        182         783         75        360
  Restricted stock                           444       1,548         --          --         --         --
  Conversion of debentures                 5,021      20,142         --          --         --         --
                                       --------------------------------------------------------------------
  Balance at end of year                  35,835   $ 157,266     30,275    $135,153     30,093   $134,370
                                       --------------------------------------------------------------------
RETAINED EARNINGS (DEFICIT)
  Balance at beginning of year as                  
    reported                                       $      --               $     --              $ 23,300
  Adjustment for change in valuation
    of inventories                                        --                     --                   649
  Balance at beginning of year as                    
    restated                                         (49,261)                14,284                23,949
  Net loss, as restated                              (87,223)               (63,545)               (9,665)
                                       --------------------------------------------------------------------
  Balance at end of year                           $(136,484)              $(49,261)             $ 14,284
                                       --------------------------------------------------------------------
TREASURY STOCK
  Balance at beginning of year               697   $  (4,908)       689    $ (4,855)        50   $   (170)
  Purchase of common stock for             
    treasury                                  --          --         8          (53)       639     (4,685)
                                       --------------------------------------------------------------------
  Balance at end of year                     697   $  (4,908)       697    $ (4,908)       689   $ (4,855)
                                       --------------------------------------------------------------------
</TABLE>

                 See Notes to Consolidated Financial Statements.

                                      F-5


<PAGE>   45

                 National Education Corporation and Subsidiaries

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

DESCRIPTION OF BUSINESS

National Education Corporation (the "Company", a Delaware Corporation) provides
training and educational services and products to individuals, businesses and
governments. The Company's current business is conducted primarily through three
operating entities. ICS Learning Systems, Inc. ("ICS") offers to individuals
distance education opportunities such as, associate degree programs, training in
paraprofessional and occupational fields, high school diploma programs and
courses for personal achievement, as well as, computer-based, interactive
courses for accounting and legal professionals and students. ICS also offers
training opportunities to business and government. Steck-Vaughn Publishing
Corporation ("Steck-Vaughn") is one of the largest publishers of printed and
multimedia supplemental educational materials sold to individuals, elementary
and secondary schools, and libraries. National Education Training Group, Inc.
("NETG") is a provider of multimedia products to educate and train corporate and
government employees, with specific emphasis on information systems training.
See Note 15 for a summary of industry segment data and locations where the
company conducts business. Historically, the Company also conducted business
through a fourth operating entity, National Education Centers, Inc. ("Education
Centers"); however, in 1994 those operations were reclassified as discontinued
operations as the Company pursued a strategy to sell off or otherwise dispose of
Education Centers' operations as further explained in Note 3.

PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

The consolidated financial statements include the accounts of the Company and
all subsidiaries. All material intercompany accounts and transactions are
eliminated in consolidation. Certain prior year amounts have been reclassified
to conform with 1995 presentation.

USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

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.

ACCOUNTING CHANGE

In the fourth quarter of 1995, the Company changed its method of accounting for
inventory at Steck-Vaughn from last-in, first out (LIFO), to first-in, first-out
(FIFO). This change reduced net loss by $1,102,000 or $.03 per share in 1995.
This change has been applied to prior years by retroactively restating the
financial statements and, accordingly, the amounts for 1994 and 1993, and the
interim periods presented in Note 16, were restated. The effect of the change in
accounting principle was to reduce the net loss by $380,000 ($754,000 pretax) or
$.01 earnings per share and to increase the net loss by $46,000 ($144,000
pretax) or $.00 earnings per share for 1994 and 1993, respectively. The effect
of this restatement was to increase retained earnings as of January 1, 1993 by
$649,000. This accounting change also reduced goodwill in 1994 by $12,000 and,
in 1993, reduced the gain on sale of Steck-Vaughn stock by $140,000 and
increased minority interest by this amount.

This change was made because management believes the FIFO method better reflects
the matching of current costs with the related revenue due to continued
aggressive steps to reduce inventories and anticipated declines in paper prices
at Steck-Vaughn.

                                       F-6


<PAGE>   46


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


REVENUE RECOGNITION

ICS tuition revenues are recognized when cash is received, but only to the
extent such cash is earned and can be retained by the Company. Cash received in
excess of revenue recognized is recorded as deferred contract revenues.
Generally, the Company follows the guidelines of the Distance Education Training
Council in determining retention rights. Steck-Vaughn revenues are recognized
upon shipment of product. NETG revenues are recognized upon shipment of
courseware.

SELLING AND PROMOTION COSTS

The Company accounts for its advertising costs pursuant to Statement of Position
No. 93-7 ("SOP"), "Reporting on Advertising Costs" issued by the Accounting
Standards Executive Committee of the American Institute of Certified Public
Accountants (AICPA). The SOP generally requires advertising costs, other than
direct-response advertising, to be expensed as incurred. In the fourth quarter
of 1994, the Company adopted the SOP effective January 1, 1994. In adopting the
SOP in 1994, ICS' total advertising, selling and promotion costs were expensed
as incurred in 1994 rather than deferred and amortized as in prior periods.
Adoption of the SOP in 1994 resulted in a charge of $27,410,000 ($21,181,000
after tax or $.72 per share). The charge consists of two components. First, a
charge of $19,836,000 results from the amortization of the deferred marketing
balance as of December 31, 1993 into 1994. Second, a charge of $7,574,000
results from increased selling and promotion spending above the amortization
that would have been expensed in accordance with the Company's previous
accounting policy. The remaining deferred marketing balance of $1,470,000 at
December 31, 1994 was amortized in the first and second quarters of 1995.
Adoption of the SOP did not have a material impact on the Company's other
operations. The Company's advertising and promotion expenses, excluding the
amortization of prior period deferred marketing, were $59,073,000, $56,301,000
and $44,032,000 for the years ended December 31, 1995, 1994 and 1993,
respectively.

Selling and marketing expenses are expensed within the calendar year except for
sales commissions on training contracts sold at NETG and development of product
catalogs at Steck-Vaughn. Sales commissions on training contracts sold are
deferred and amortized to expense as contract revenues are recognized. The costs
of product catalogs are capitalized and expensed when the catalogs are
distributed. In interim periods, a portion of selling and marketing expenses is
deferred and fully amortized in subsequent interim periods within the calendar
year to better match the expenses with revenues due to the seasonal nature of
the revenue and spending.

COURSE SERVICE AND PRODUCT DEVELOPMENT COSTS

Course service costs and product development costs are expensed as incurred.

INCOME TAXES

Income taxes are accounted for using an asset and liability approach which
requires the recognition of deferred tax liabilities and assets for the expected
future tax consequences of temporary differences between the financial statement
and tax bases of assets and liabilities at the applicable enacted tax rates.

                                      F-7
<PAGE>   47


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


EARNINGS (LOSS) PER SHARE

Primary earnings (loss) per share are computed based on the weighted average
number of common shares outstanding during the respective periods, including
dilutive stock options. Fully diluted earnings per share for 1993 are computed
based on the assumption that the senior convertible debentures had been
converted to common stock, with a corresponding increase in net income to
reflect a reduction in related interest expense, less applicable taxes. For 1995
and 1994 fully diluted and primary earnings per share are the same as inclusion
of the debentures would be anti-dilutive.

Effective September 11, 1995, the holders of $20,000,000 of the Company's senior
subordinated convertible debentures converted such debentures, including
interest at 10%, into 5,021,000 shares of the Company's common stock. The
conversion had an anti-dilutive effect on loss per share for the fourth quarter
of 1995. If the conversion had not occurred, loss per share for the fourth
quarter would have been $.11 compared to the reported loss per share of $.08,
and the loss per share for the full year would have been $2.89 compared to the
$2.73 reported.

APB 15 requires the presentation of supplementary earnings per share data to
reflect the conversion as if it had occurred at the beginning of each period
presented below. The following supplementary presentation reflects the reduction
of interest expense, less applicable taxes, and an increase in the number of
shares outstanding.

<TABLE>
<CAPTION>
(amounts in thousands, except per share amounts)          1995          1994         1993
---------------------------------------------------------------------------------------------
<S>                                                      <C>          <C>         <C>
Earnings (loss) per share from continuing operations     $  (2.44)    $   (.38)   $    .32
Loss per share                                              (2.44)       (1.80)       (.25)
                                                       --------------------------------------
Weighted average number of shares outstanding              35,373       34,640      34,855
</TABLE>


INVESTMENT SECURITIES

The Company's debt and equity securities are considered as either
held-to-maturity or available-for-sale. Held-to-maturity securities represent
those securities that the Company has both the intent and ability to hold to
maturity and are carried at amortized cost. Available-for-sale securities
represent those securities that do not meet the classification of
held-to-maturity, are not actively traded and are carried at fair value.
Unrealized gains and losses on these securities are excluded from earnings and
are reported as a separate component of stockholders' equity, net of applicable
taxes, until realized.

INVENTORIES AND SUPPLIES

Inventories, primarily consisting of course materials and supplies, are stated
at the lower of first-in, first-out cost or market.

LAND, BUILDINGS AND EQUIPMENT

Land, buildings and equipment are stated at cost and are depreciated principally
using the straight-line method over the estimated useful lives of the various
classes of property.

ACQUIRED INTANGIBLE ASSETS

Acquired intangible assets representing the excess of cost over the fair value
of acquired net assets purchased by the Company in conjunction with various
acquisitions are amortized ratably over lives which do not exceed forty years.
All other acquired intangible assets are amortized ratably over various useful
lives which do not exceed ten years.

                                      F-8
<PAGE>   48


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


IMPAIRMENT OF LONG LIVED ASSETS

The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets" (FAS
121). Prior to January 1, 1995, the Company reviewed the recoverability of its
long-lived assets and intangible assets by comparing projected related cash
flows on an undiscounted basis to the net book value of the assets. In the event
the recoverability of the assets was impaired, the Company would have measured
the impairment by comparing projected operating income and related cash flows on
an undiscounted basis to the net book value of the assets. Under the provisions
of FAS 121, the Company will continue to review the recoverability of long-lived
assets and intangible assets by comparing cash flows on an undiscounted basis to
the net book value of the assets. In the event the projected undiscounted cash
flows are less than the net book value of the assets, the carrying value of the
assets will be written-down to their fair value, less cost to sell. In addition,
FAS 121 requires that assets to be disposed of be measured at the lower of cost
or fair value, less cost to sell. Adopting FAS 121 had no effect on the
Company's financial statements except for the write-off of goodwill as described
further in Note 4.

DEFERRED CONTRACT REVENUES

Deferred contract revenues represent the portion of training contract payments
and student tuition received in advance of services being performed.

MINORITY INTEREST

Minority interest in equity of consolidated subsidiary represents the minority
stockholders' proportionate share of the equity of Steck-Vaughn. During 1994 and
1995, Steck-Vaughn repurchased 230,200 and 25,000 shares, respectively, of its
outstanding common stock which effectively increased the Company's ownership
interest to 83.0% and 83.1%, respectively.

FOREIGN CURRENCY TRANSLATION

Assets and liabilities of international subsidiaries have been translated at
current exchange rates. Revenues, expenses and cash flows have been translated
at average rates of exchange in effect during the year. Resulting cumulative
foreign exchange translation adjustments have been recorded as a separate
component of stockholders' equity. Also included in this component of
stockholders' equity are exchange gains and losses on hedges of foreign
intercompany accounts of a long-term nature. Gains and losses on foreign
currency transactions are recorded to other income and expense.

NEW ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation", which
establishes a fair value based method of accounting for stock-based compensation
plans. The statement allows companies to continue to use the intrinsic value
based approach, supplemented by footnote disclosure of the pro forma net income
and earnings per share of the fair value based approach. The Company intends to
follow this latter method and, as a result, adoption of this pronouncement in
1996 will have no effect on the Company's financial statements.

NOTE 2 - BUSINESS COMBINATIONS

The Company, through Steck-Vaughn, purchased substantially all of the assets of
the following entities on the dates set forth as follows: Summit Learning, Inc.
(Summit), a direct response marketer of educational products (December 1995),
Educational Development Laboratories, Inc. (EDL) a developer and publisher of
reading and writing instructional material based in both software and print
products (October 1995) and Berrent Publications,

                                      F-9
<PAGE>   49
                          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 2 - BUSINESS COMBINATIONS (CONTINUED:)

Inc. (Berrent) a publisher of test preparation and assessment materials
(November 1994). During the first quarter of 1994, the Company, through ICS,
purchased the stock of M-Mash, Inc. (MicroMash), a leading provider of
computer-based, interactive courses for accounting professionals and students.
In April 1993, Steck-Vaughn purchased certain assets of Creative Edge, Inc.
(Magnetic Way product line), a provider of educational products and materials
for the elementary and secondary school marketplace. All five transactions were
accounted for as purchases and the operating results were included in the
Company's consolidated financial statements since the dates of acquisition. The
net assets and operating results of the purchased entities were not material to
the consolidated financial statements of the Company.

NOTE 3 - BUSINESS DISPOSITIONS

In June 1994, the Company adopted a plan to discontinue the operation of its
Education Centers subsidiary. As a result, the Company recorded a second quarter
charge of $40,032,000 ($1.35 per share) to write-down assets to estimated net
realizable value and provide for estimated costs of disposing of the operation.
No tax benefits were provided on this charge.

Of the 29 remaining Education Centers schools as of December 31, 1994, the
Company in 1995 transferred students at one of its schools to a nearby
competitor for the purposes of completing their courses, and substantially
completed the disposition of the remaining schools as of December 31, 1995.

As of December 31, 1995, the remaining assets and liabilities include accrued
expenses for outstanding litigation and regulatory matters, and obligations to
maintain and service future financial aid and accounting matters as required by
the Department of Education. These outstanding obligations are offset by certain
notes receivable from buyers in connection with the sale of schools. The net
amount of these assets and liabilities is not material to the consolidated
financial statements of the Company.

The Education Centers' negative cash flow of $2,337,000 in 1995 improved
$18,748,000 from the prior year due primarily to proceeds from the sale of
schools of $10,647,000 and significant reductions of Education Centers'
headquarters expenses.

Results of operations for the Education Centers which are being accounted for as
discontinued operations in the results of operations were as follows:

<TABLE>
<CAPTION>
(dollars in thousands)                                     1994          1993
--------------------------------------------------------------------------------
<S>                                                     <C>           <C>
Net Revenues                                            $ 97,138      $131,713
Loss before income tax benefit                           (10,428)      (28,526)
Income tax benefit                                        (1,008)       (8,769)
Loss from discontinued operations                         (9,420)      (19,757)
Primary loss per share                                      (.32)         (.66)
Loss on disposal of discontinued operations              (40,032)            -
Loss per share                                             (1.35)            -
</TABLE>


In December 1994, the Company sold its interest in a partnership venture whose
purpose was to develop an automated enrollment and financial aid application
process. As a result of the sale, the Company recorded a gain on sale of
$3,247,000 ($2,143,000 after tax or $.07 per share).

                                      F-10
<PAGE>   50
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 4 - UNUSUAL ITEMS

Unusual items, net, consist of the following items:

<TABLE>
<CAPTION>
(dollars in thousands)                                    1995         1993
-----------------------------------------------------------------------------
<S>                                                      <C>        <C>
Write-off of intangible assets                           $47,509    $  9,232
Restructuring charges                                     32,248          --
Write-off of course computer hardware costs                4,549          --
Litigation settlements, net                               (2,576)         --
                                                       ----------------------
                                                         $81,730    $  9,232
                                                       ----------------------
</TABLE>

No tax benefits were reflected for the 1995 unusual items.

WRITE-OFF OF INTANGIBLE ASSETS

NETG experienced significant operating losses over the past several years in an
environment of substantial changes in training related to information systems
and technology. Due to the many outstanding opportunities in the training
marketplace, especially in information technology, the Company remained
optimistic over the past periods about future sales and earnings, such that
through the first quarter of 1995, management's best estimates of the future
results of NETG's operations supported the recoverability of recorded goodwill
balances. However, given continuing losses through the second quarter of 1995,
management concluded that NETG could not return to profitability in the
foreseeable future without significant changes in its operating structure and
business direction.

As a result, the Company implemented a reorganization and downsizing of NETG's
operations in the second quarter of 1995. In addition, certain product lines
were discontinued and the subsidiary reorganized its sales and marketing effort
to enhance its channels of distribution which, among other things, resulted in
the restructuring described below. As a result of these changes, in the second
quarter of 1995 the Company revised NETG's financial projections, consistent
with management's best estimate of future results of operations. Based upon this
estimate of the future results of operations, the estimated net cash flows over
the remaining life of NETG's intangible assets (goodwill) were less than the net
book value of the goodwill at June 30, 1995. Under the provisions of FAS 121,
the Company estimated the fair value of its investment in NETG by discounting
estimated future net cash flows at a rate commensurate with the related risk.
Based upon this analysis, management believes NETG to have only a nominal fair
value such that the goodwill balance of $42,719,000 related to the Company's
1986 acquisition of what is now NETG was written-off (resulting in a loss of
$1.34 per share) during the second quarter of 1995.

Additionally, in connection with the above restructuring of NETG during the
second quarter of 1995, the Company discontinued the operations of Spectrum, a
subsidiary of NETG which provided primarily custom developed training to
businesses. As a result, the Company recorded the assets and liabilities of
Spectrum at their fair value and recorded a write-off of goodwill in the amount
of $4,790,000 ($.15 per share) during the second quarter. The goodwill was
related to an acquisition made by Spectrum prior to 1988. Spectrum's revenue and
operating loss before amortization of intangibles and unusual items were as
follows:

<TABLE>
<CAPTION>
(dollars in thousands)                        1995              1994
-----------------------------------------------------------------------------
<S>                                        <C>               <C>
Revenues                                   $  1,618          $  5,247
Operating loss before amortization
  of intangibles and unusual items         $ (1,433)         $ (1,125)
</TABLE>

                                      F-11
<PAGE>   51
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


WRITE-OFF OF INTANGIBLE ASSETS (continued:)

The 1993 unusual item represented a third quarter charge of $9,232,000
($6,558,000 after tax or $.22 per share) related to the write-down of certain
acquired intangible assets of NETG.

RESTRUCTURING CHARGES

As a result of continued losses at NETG, the Company resolved to significantly
lower the overall cost structure while focusing on specific training areas to
permit NETG to return to profitability. Accordingly, the Company approved a
restructuring plan for NETG in June 1995 which resulted in a nonrecurring charge
of $28,652,000 ($.90 per share). Additionally, in December 1995, NETG recorded a
restructure charge of $1,952,000 ($.06 per share) to reorganize its operations
in Germany. These charges include severance related payments, excess facilities
costs, the write-down of inventory and fixed assets of certain discontinued
products, and other restructuring related items such as charges related to
canceled contracts and agreements. The following summarizes these charges, the
related write-offs and cash paid in connection with the restructuring.

<TABLE>
<CAPTION>
                             Severance      Excess      Fixed Assets
(dollars in thousands)       Payments     Facilities    and Inventory     Other        Total
----------------------       ---------    ----------   --------------     -----        -----
<S>                          <C>        <C>            <C>              <C>          <C> 
1995 restructuring           $   4,706    $  16,480     $    4,020      $   5,398    $  30,604
charges
Noncash write-off                   --           --         (3,758)        (3,521)      (7,279)
Cash (paid) received            (2,095)      (1,923)            13         (1,606)      (5,611)
                             ---------    ---------     ----------      ---------    ---------
Accrued restructuring at
  December 31, 1995          $   2,611    $  14,557     $      275      $     271    $  17,714
                             =========    =========     ==========      =========    =========
</TABLE>

Amounts related to severance covered approximately 110 employees involved
primarily in sales and marketing, distribution and other administrative
functions at NETG's domestic and European locations. Amounts related to
facilities reflect the cost of leases for excess space arising from the
consolidation of space within the subsidiary's U.S. headquarters and the
subsidiary's European offices. The noncurrent portion of the restructuring
charges relates primarily to leases on unutilized space which will require
payments through 2004.

Additionally, during the second quarter, an unusual charge was recorded in the
amount of $1,644,000 ($.05 per share) at NEC Corporate primarily for severance
related payments to the former chief executive officer and corporate expenses
related to the restructuring of NETG. The cumulative cash paid in connection
with this charge was $911,000 and noncash write-offs were $112,000.

WRITE-OFF OF COURSE COMPUTER HARDWARE AND RELATED COSTS

Prior to September 15, 1995, ICS offered computer courses which included the
sale of computers to students which, after shipment, were recorded as assets and
amortized over the projected twelve month period of the remaining course
payments. Subsequent to September 15, 1995, the Company changed the manner in
which computers were marketed, no longer including the computer hardware with
such courses. In the fourth quarter of 1995, the Company reviewed the
realizability of the carrying value of the computer and related assets and
determined that a portion of the capitalized balance for computers related to
enrollments for which there was no further revenue to be recognized. As a
result, the Company recorded a write-down of the unamortized balance of
computers and other related costs of $4,549,000 ($.14 per share). In addition,
the Company reduced the period over which the computers are amortized to six
months.

                                      F-12
<PAGE>   52
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


LITIGATION SETTLEMENTS, NET

During the fourth quarter of 1995, a legal dispute with a third-party author for
NETG was settled in the Company's favor. The Company recorded a gain to the
extent payment was received. A portion of the settlement in the amount of
$1,343,000 is held in escrow pending the outcome of various legal issues. The
gain was partially offset with other minor legal settlements which involved
parties related to the third party author resulting in a net unusual credit of
approximately $3,546,000 or $.11 per share.

In March 1996, the Company settled a lawsuit at Steck-Vaughn brought by a
product development company in 1995. Settlement costs and legal expenses
associated with the lawsuit totaled $970,000 or $.03 per share and were included
in the results of operations for the year ended December 31, 1995.

NOTE 5 - PUBLIC OFFERING OF SUBSIDIARY COMMON STOCK

During the third quarter of 1993, Steck-Vaughn Publishing Corporation completed
an initial public offering of 2,668,000 shares of its common stock at $12.00 per
share. The offering resulted in proceeds of $29,775,000 of which $20,000,000
were remitted to the Company as payment for a previously declared dividend. The
proceeds were reduced by expenses of $1,074,000 which were incurred in
connection with the offering, of which $393,000 was paid to Richard C. Blum and
Associates (RCBA). The Chairman of the Board of RCBA is Richard C. Blum, a
director of the Company. The completion of the offering decreased the Company's
ownership of Steck-Vaughn from 100% to 81.7% at the date of the offering. As a
result of the offering, the Company recorded a gain of $21,120,000 or $.71 per
share (after restatement for the inventory accounting change at Steck-Vaughn)
which is included in the results of operations for the year ended December 31,
1993. The gain was nontaxable and deferred tax expense was not provided for on
this gain given the Company's ability and intent to indefinitely postpone the
payment of tax in the future.

NOTE 6 - INCOME TAXES

Income (loss) before tax from continuing operations was taxed under the
following jurisdictions:

<TABLE>
<CAPTION>
(dollars in thousands)                                    1995         1994       1993
-----------------------------------------------------------------------------------------
<S>                                                      <C>         <C>       <C>
Domestic                                                 $(75,881)   $ (5,307)  $  4,339
Foreign                                                   (10,187)     (8,149)     1,463
                                                        ---------------------------------
Total                                                    $(86,068)   $(13,456)  $  5,802
                                                        ---------------------------------
</TABLE>


Taxes (benefits) on income from continuing operations were provided as follows:

<TABLE>
<CAPTION>
(dollars in thousands)                                    1995         1994       1993
----------------------------------------------------------------------------------------
<S>                                                      <C>         <C>       <C>
CURRENT:
  State                                                  $   500     $ 1,110   $  1,999
  Foreign                                                  1,837       1,457      1,883
                                                        --------------------------------
Total current provision                                    2,337       2,567      3,882
                                                        --------------------------------
DEFERRED:
  Federal                                                 (2,469)        220     (6,184)
  Foreign                                                    132      (3,498)    (2,680)
                                                        --------------------------------
Total deferred provision (benefit)                        (2,337)     (3,278)    (8,864)
                                                        --------------------------------
CURRENT TAX BENEFITS NOT TREATED AS A REDUCTION OF
  INCOME TAX EXPENSE RESULTING FROM:
  Exercise of stock options                                   --         156         93
                                                        --------------------------------
Total income tax provision (benefit)                     $    --     $  (555)  $ (4,889)
                                                        --------------------------------
</TABLE>

                                      F-13


<PAGE>   53


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 6 - INCOME TAXES (CONTINUED)

Deferred tax liabilities and assets reflected in the balance sheet as of
December 31, 1995 and December 31, 1994 are comprised of the following:

<TABLE>
<CAPTION>
(dollars in thousands)                                                1995       1994
-----------------------------------------------------------------------------------------
<S>                                                                 <C>         <C>
DEFERRED TAX LIABILITIES:
  Revenue recognition differences                                   $  1,416    $  3,948
  Advertising/commissions                                              2,393       3,244
  Prepaid expenses                                                     6,351       6,386
  Other                                                                1,501       3,720
                                                                   ----------------------
Gross Deferred Tax Liabilities                                      $ 11,661    $ 17,298
                                                                   ----------------------
DEFERRED TAX ASSETS:
  Property, plant and equipment                                     $  5,590    $  3,269
  Inventories                                                          5,804       6,374
  Revenue recognition differences                                      3,001       4,007
  Allowance for doubtful accounts                                      1,449       3,532
  Restructuring reserve                                                6,478         889
  Loss carryforwards                                                  48,607      35,939
  Credit carryforwards                                                 4,276       4,673
  Loss on discontinued operations                                        106       8,500
  Other                                                                9,177       5,702
                                                                   ----------------------
Gross Deferred Tax Assets                                             84,488      72,885
  Deferred tax assets valuation allowance                            (50,952)    (30,613)
                                                                   ----------------------
Deferred Tax Assets, Net of Valuation Allowance                     $ 33,536    $ 42,272
                                                                   ----------------------
</TABLE>


The Company has recorded a valuation allowance in the amount set forth in the
above table for certain deductible temporary differences for which it is likely,
at this time, that the Company will not receive future tax benefit. The 1995
income tax provision includes an increase in the valuation allowance for
deferred tax assets of $20,339,000. The valuation reserve increase primarily
relates to current year losses and restructuring reserves for which no tax
benefits have been provided. Realization of the remaining deferred tax assets is
dependent on generating sufficient future taxable income. Although realization
is not assured, management believes it is more likely than not that the
remaining deferred tax assets will be realized. The amount of the deferred tax
asset considered realizable, however, could be reduced in the near term if
estimates of future taxable income are reduced.

At December 31, 1995, the Company had federal net operating loss carryforwards
of approximately $108,000,000 expiring through 2010. In addition, the Company
had available $1,275,000 of alternative minimum tax credit carryforwards, with
no expiration date, which may be utilized to offset future regular tax
liabilities. If certain substantial changes in the Company's ownership should
occur, there could be an annual limitation on the amount of carryforwards
available for utilization. The Company also has available federal net operating
loss carryforwards of approximately $13,200,000 at Spectrum, a subsidiary of
NETG, expiring through 2003. This amount may be utilized to offset Spectrum's
future taxable income.

During 1995, the Company tentatively agreed to a settlement with the Internal
Revenue Service regarding its 1985 through 1988 income tax audits. As a result
of this settlement, the Company will receive approximately $9,313,000, in tax
refunds and interest. The benefit for this refund, and the related receivable,
were recorded in a prior year.

                                      F-14
<PAGE>   54
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 6 - INCOME TAXES (CONTINUED)

A reconciliation of the income tax provision (benefit) with the amount computed
by applying the federal statutory tax rate to pretax income from continuing
operations is as follows:

<TABLE>
<CAPTION>
(dollars in thousands)                                    1995         1994       1993
-------------------------------------------------------------------------------------------
<S>                                                      <C>         <C>        <C>
Tax (benefit) computed at statutory rate                 $(29,263)   $(4,575)   $  1,973
State taxes, net of federal benefit                           330        733       1,319
Effect of foreign operations                                5,432        354      (1,580)
Dividend income and municipal interest exclusion              (89)      (332)       (436)
Losses not benefited                                        5,742         --          --
Amortization of excess of costs over acquired net            
  assets                                                      121        218         164
Write-off of certain intangibles                           16,153         --          --
Gain on public stock offering of subsidiary                    --         --      (7,228)
Other, net                                                  1,574      3,047         899
                                                       ------------------------------------
Total income tax provision (benefit)                     $     --    $  (555)   $ (4,889)
                                                       ------------------------------------
</TABLE>

Provision has not been made for U.S. or additional foreign taxes on the
undistributed earnings of the Company's foreign subsidiaries. Those earnings are
expected to be reinvested in the foreign operations. Such earnings would become
subject to additional U.S. and foreign taxes if remitted as dividends. It is not
practicable to estimate the amount of additional tax that might be payable on
the foreign earnings; however, the Company believes that U.S. foreign tax
credits would for the most part eliminate any additional U.S. tax.

NOTE 7 - INVESTMENT SECURITIES

The amortized cost and estimated fair value of the investment securities are as
follows:

<TABLE>
<CAPTION>
                                                           December 31, 1995
                                          ---------------------------------------------------
                                                             Gross        Gross
                                            Amortized   Unrealized   Unrealized     Carrying
 (dollars in thousands)                          Cost         Gain         Loss        Value
 --------------------------------------------------------------------------------------------
<S>                                         <C>          <C>          <C>         <C>    
 Held-to-maturity:
     Taxable municipal funds                $   1,000    $      --    $     --    $   1,000
                                          -------------------------------------- ------------
 Total held-to-maturity                         1,000           --          --        1,000
                                          -------------------------------------- ------------
 Available-for-sale:
     Corporate income funds                     1,042           52          --        1,094
     Preferred stock                              689           --         (35)         654
                                          -------------------------------------- ------------
 Total available-for-sale                       1,731           52         (35)       1,748
                                          -------------------------------------- ------------
                                                2,731           52         (35)       2,748
 Less cash equivalents                         (1,000)          --          --       (1,000)
                                          -------------------------------------- ------------
 Total investment securities                $   1,731    $      52    $    (35)   $   1,748
                                          -------------------------------------- ------------
</TABLE>

                                      F-15
<PAGE>   55


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7 - INVESTMENT SECURITIES (CONTINUED)

<TABLE>
<CAPTION>
                                                           December 31, 1994
                                          ---------------------------------------------------
                                                             Gross        Gross
                                            Amortized   Unrealized   Unrealized     Carrying
 (dollars in thousands)                          Cost         Gain         Loss        Value
 --------------------------------------------------------------------------------------------
<S>                                        <C>           <C>          <C>          <C>
 Held-to-maturity:
     Banking certificates                   $   3,236    $       -    $       -    $   3,236
     Tax exempt municipal bond funds           12,700            -            -       12,700
                                          ---------------------------------------------------
 Total held-to-maturity                        15,936            -            -       15,936
                                          ---------------------------------------------------
 Available-for-sale:
     Corporate income funds                     1,170            6            -        1,176
     Preferred stock                            1,262           52          (93)       1,221
                                          ---------------------------------------------------
 Total available-for-sale                       2,432           58          (93)       2,397
                                          ---------------------------------------------------
                                               18,368           58          (93)      18,333
 Less cash equivalents                         (7,500)           -            -       (7,500)
                                          ---------------------------------------------------
 Total investment securities                $  10,868    $      58    $     (93)   $  10,833
                                          ---------------------------------------------------
</TABLE>


Investments in debt securities classified as held-to-maturity at December 31,
1995, have various maturity dates which do not exceed one year.

Using the specific identification method, realized gains and losses on the
available-for-sale investment securities are as follows:

<TABLE>
<CAPTION>
(dollars in thousands)                                    1995         1994       1993
-----------------------------------------------------------------------------------------
<S>                                                      <C>         <C>        <C>
Realized gains                                           $    18     $ 1,616    $   135
Realized losses                                                5         387        226
</TABLE>

NOTE 8 - LAND, BUILDINGS AND EQUIPMENT

<TABLE>
<CAPTION>
(dollars in thousands)                         Depreciable Lives             1995         1994
--------------------------------------------------------------------------------------------------
<S>                                            <C>                        <C>          <C>
Land                                                   --                 $  1,289     $  1,289
Buildings and improvements                     Not to exceed 40 years       10,414        8,910
Leaseholds and improvements                    Life of lease                 3,327        7,852
Machinery and equipment                        Not to exceed 10 years       28,636       52,321
Furniture and fixtures                         Not to exceed 10 years       12,354       18,272
                                                                         -------------------------
                                                                            56,020       88,644

Less accumulated depreciation and                                          (31,992)     (63,240)
amortization

                                                                         -------------------------
Total                                                                     $ 24,028     $ 25,404
                                                                         -------------------------
</TABLE>

Machinery and equipment and furniture and fixtures under capital leases were
$4,908,000 and $2,460,000 with related accumulated depreciation and amortization
of $201,000 and $593,000 at December 31, 1995 and 1994, respectively.

                                      F-16
<PAGE>   56
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9 - ACQUIRED INTANGIBLE ASSETS

<TABLE>
<CAPTION>
(dollars in thousands)                                                       1995         1994
--------------------------------------------------------------------------------------------------
<S>                                                                       <C>          <C>
Product and text materials, courseware, etc.                              $ 13,758     $ 55,898
Rental contracts                                                                --       20,559
Excess of cost over net assets of businesses                                 6,560       59,268
acquired
Other acquired intangible assets                                             6,443        5,971
                                                                         -------------------------
                                                                            26,761      141,696
Less accumulated amortization                                              (13,333)     (89,005)
                                                                         -------------------------
Total                                                                     $ 13,428     $ 52,691
                                                                         =========================
</TABLE>

See Note 4 for a discussion of the write-offs of certain intangible assets in
1995.

NOTE 10 - DEBT

<TABLE>
<CAPTION>
(dollars in thousands)                                                       1995         1994
--------------------------------------------------------------------------------------------------
<S>                                                                        <C>          <C>
Short-term bank borrowings                                                 $10,000      $ 5,000
                                                                        --------------------------
Long-term debt:
 Mortgage and installment notes, maturing on various
  dates through 2004, with interest from 6.0% to 8.9%                      $ 7,144      $ 5,946
 Capital lease obligations                                                   4,033        1,850
                                                                        --------------------------
                                                                            11,177        7,796
 Less current portion of long-term debt                                     (2,338)      (1,407)
                                                                        --------------------------
Total long-term debt                                                       $ 8,839      $ 6,389
                                                                        --------------------------
Senior subordinated convertible debentures                                 $    --      $20,000
                                                                        --------------------------
Convertible subordinated debentures                                        $57,494      $57,494
                                                                        --------------------------
</TABLE>


As of December 31, 1995, the Company had a revolving bank credit agreement in
the amount of $10,000,000, of which $10,000,000 was outstanding. The credit
agreement initially provided borrowings at prime plus 1 percent or, at the
Company's option, at LIBOR plus 2 percent, with incremental borrowing rate
increases at June 30 and September 30, 1995. Commitment fees were paid on the
unused line of credit. The weighted average interest rates for the short-term
bank borrowings were 8.7% and 6.3% for 1995 and 1994, respectively. The average
borrowings were $9,510,000 and $3,956,000 during the years ended December 31,
1995 and 1994, respectively.

Effective January 19, 1995, the Company entered into a $20 million revolving
credit agreement with another bank and repaid the aforementioned $10 million
revolving credit borrowings. Under the new agreement, which expires January 19,
1998, the Company can borrow at the bank's base rate plus 1.75%, or at the LIBOR
rate plus 3.0%. The base rate is the higher of the bank's prime rate and .5%
above the Federal Funds Rate. This credit facility is secured by stock of
certain principal subsidiaries and certain assets of NEC. This revolving credit
is subject to certain restrictions on dividend payments, indebtedness and other
covenants including financial performance and condition.

Steck-Vaughn has a revolving bank credit agreement in the amount of $10,000,000
with a maturity of June 10, 1997. The agreement provides for borrowings at prime
or, at Steck-Vaughn's option, LIBOR plus 1.5%. The bank credit agreement
replaced Steck-Vaughn's borrowing ability from the Company pursuant to an
intercompany agreement. No amounts were outstanding under the bank credit
facility in 1994 or 1995. Annual commitment fees of .25% are paid on the unused
line of credit.

                                      F-17
<PAGE>   57
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 10 - DEBT (CONTINUED)

Effective February 28, 1995, the Company and Steck-Vaughn entered into an
intercompany revolving loan agreement under which the Company could borrow up to
$10,000,000 through December 31, 1995. At December 31, 1995, $4,000,000 was
outstanding and was eliminated in consolidation in the accompanying balance
sheet. Subsequent to year end this credit facility was reduced to $5,000,000
with an expiration date of March 31, 1996. This agreement provides that any
borrowing by the Company will bear interest at LIBOR plus 2 percent, and will be
secured by the Company's holdings of Steck-Vaughn stock. Steck-Vaughn also
received an option to repurchase from the Company up to 290,000 shares of
Steck-Vaughn stock held by the Company, at $6.50 per share. This option becomes
exercisable one year after grant, expires March 31, 1997, and may be redeemed by
the Company prior to exercise or expiration for the greater of $75,000 per month
($37,500 per month effective February 1, 1996) or the amount necessary to
increase to 25 percent the annualized yield to Steck-Vaughn on all amounts
borrowed by the Company under the revolving loan agreement. The Company has paid
the redemption price through December 31, 1995.

Effective September 11, 1995, the holders of $20,000,000 of the Company's 10%
senior subordinated convertible debentures converted such debentures, including
accrued interest, into 5,021,000 shares of the Company's common stock. The
debentures had been issued to certain entities affiliated with Richard C. Blum &
Associates, L.P. (RCBA), who maintained discretionary investment control over
these entities. The Chairman of the Board of RCBA is Richard C. Blum, a director
of the Company.

At December 31, 1995, the Company had outstanding $57,494,000 of 6.5%
convertible subordinated debentures due May 14, 2011, which are convertible at
any time prior to maturity into common stock at $25.00 per share. The debentures
are redeemable at the option of the Company, in whole or in part, at 100.65% of
the principal amount through May 14, 1996, and thereafter at 100%. The
debentures are subject to an annual sinking fund requirement beginning May 15,
1997 sufficient to retire 70% of the aggregate principal amount of the
debentures prior to maturity. Based on the December 31, 1995 closing price of
the Company's convertible subordinated debentures as traded on the New York
Stock Exchange of $70.00, the fair value of the convertible subordinated
debentures is $40,246,000.

Mortgage notes aggregating $5,141,000 at December 31, 1995 were collateralized
by certain real and personal property having a net book value of $8,378,000. At
December 31, 1995, the fair value of the mortgage notes approximated their
carrying value.

Aggregate maturities of long-term debt, including the annual sinking fund
principal requirement of $2,875,000 for the subordinated debentures, in each of
the following years are: 1997 - $7,072,000, 1998 - $4,243,000, 1999 - $3,497,000
and 2000 - $3,154,000.

NOTE 11 - COMMITMENTS AND CONTINGENCIES

Aggregate commitments at December 31, 1995 under noncancelable operating leases
for land, buildings and equipment are as follows:

<TABLE>
<CAPTION>
(dollars in thousands)
---------------------------------------------------------------------
<S>                                                         <C>
FISCAL YEAR:
1996                                                        $ 6,342
1997                                                          5,454
1998                                                          4,811
1999                                                          3,747
2000                                                          2,932
2001 and thereafter                                          23,889
                                                          -----------
Total                                                       $47,175
                                                          -----------
</TABLE>

                                      F-18
<PAGE>   58
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 11 - COMMITMENTS AND CONTINGENCIES (CONTINUED)

Some of the leases contain renewal options, escalation clauses and requirements
that the Company pay taxes, insurance and maintenance costs. Total rent expense
aggregated $7,820,000, $10,841,000 and $11,695,000 for years ended December 31,
1995, 1994, and 1993, respectively.

At December 31, 1995, there were no material commitments outstanding for capital
expenditures.

In the ordinary course of business, the Company is generally subject to claims,
complaints and legal actions. The litigation process is inherently uncertain and
it is possible that the resolution of such matters might have a material adverse
effect upon the financial position of the Company. However, in the opinion of
management, such matters are not expected to have a material adverse effect on
the financial position of the Company.

NOTE 12 - UNEARNED FUTURE TUITION REVENUE

Unearned future tuition revenue on student contracts at ICS Learning Systems
totaled $153,489,000 and $163,050,000 at December 31, 1995 and 1994,
respectively. Based upon previous experience, approximately 45% of the unearned
future tuition revenue was ultimately recognized into revenue. Unearned future
tuition revenue will be included in revenues in future years when services and
courseware are provided as described in Note 1.

NOTE 13 - STOCKHOLDERS' EQUITY

The Company has stock option plans that authorize the granting of options to key
employees and directors to purchase common stock subject to certain conditions,
such as continued employment. Options are generally granted at the fair market
value of the Company's common stock at the date of grant, vest and become
exercisable prorata over the four years following the date of grant, and expire
in ten years.

Changes during the years ended December 31, 1995, 1994 and 1993 under the plans
were as follows:

<TABLE>
<CAPTION>
                                                                   Average           
                                                         Number    Exercise      Total      
(amounts in thousands, except per share amounts)          of        Price       Option   
                                                         Shares    Per Share     Value
-----------------------------------------------------------------------------------------
<S>                                                      <C>       <C>           <C>
Balance, December 31, 1992                                1,281    $  5.69       $7,286  
  Granted                                                   392       5.86        2,296  
  Canceled                                                 (306)      6.68       (2,044) 
  Exercised                                                 (75)      3.55         (266) 
                                                         --------------------------------
Balance, December 31, 1993                                1,292       5.63        7,272  
  Granted                                                   407       6.28        2,557  
  Canceled                                                 (163)      7.29       (1,188) 
  Exercised                                                (182)      3.44         (627) 
                                                         --------------------------------
Balance, December 31, 1994                                1,354       5.92        8,014  
  Granted                                                 2,800       3.62       10,132  
  Canceled                                                 (395)      6.55       (2,587) 
  Exercised                                                (538)      3.66       (1,972) 
                                                         --------------------------------
Balance, December 31, 1995                                3,221    $  4.22       $13,587 
                                                         --------------------------------
</TABLE>

                                      F-19
<PAGE>   59
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 13 - STOCKHOLDERS' EQUITY (CONTINUED)

During 1995, the Company made loans to three executive officers and two
subsidiary presidents to enable them to purchase 410,000 shares of stock
pursuant to the 1990 stock option plan, as amended. These loans bear interest at
rates from 6.8% to 7.1% and are payable in full upon the earlier of 90 days
following the date of termination or May 1, 2001. These loans are with recourse
and are secured by the shares of stock purchased by the officers. These loans
are reflected as a reduction in equity in the accompanying balance sheet. In
1995, the Company granted to the new CEO options to purchase 500,000 shares of
stock at $3.00 per share, the fair value at date of grant. The option vests
monthly in pro rata increments over 36 months beginning June 1995, and remains
exercisable through March 17, 2005. The new CEO was also granted options to
purchase another 600,000 shares of stock at $3.00 per share, the fair value at
date of grant. These options vest on an accelerated basis if the price of the
Company's stock reaches and maintains certain price levels; otherwise, these
options fully vest no later than November 2004 and remain exercisable for six
months thereafter.

Common shares reserved for future grants under the above option plans totaled
737,000 and 1,018,000 at December 31, 1995 and 1994, respectively. Of the
3,221,000 shares previously granted and outstanding at December 31, 1995,
1,123,000 shares were vested and exercisable at prices ranging from $3.00 to
$12.92 per share.

There are no charges to income in connection with the issuance of options. Upon
exercise, proceeds from the sale of shares under the stock options plans are
credited to common stock and additional paid-in capital.

In October 1986, the Company declared a dividend of one preferred stock purchase
right for each share of common stock. Under certain conditions, each right may
be exercised to purchase one-hundredth of a share of a new series of
participating junior preferred stock at a purchase price of $75.00, subject to
adjustment.

The rights may be exercised only after a public announcement that a person has
acquired or obtained the right to acquire 20% or more of the Company's
outstanding common stock, or after commencement or public announcement of an
offer for 30% or more of the Company's outstanding common stock. The rights,
which do not have voting rights, may be redeemed by the Company at a price of
$.05 per right within ten days after the announcement that a person has acquired
20% or more of the outstanding common stock of the Company and the redemption
period may be extended under certain circumstances. In the event that the
Company is acquired in a merger or other business combination transaction,
provision shall be made so that each holder of a right shall have the right to
receive that number of shares of common stock of the surviving company which at
the time of the transaction would have a market value of two times the exercise
price of the right.

NOTE 14 - STATEMENTS OF CASH FLOWS

For purposes of presenting the Consolidated Statements of Cash Flows, the
Company considers all highly liquid debt securities to be cash equivalents.

                                      F-20
<PAGE>   60
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 14 - STATEMENTS OF CASH FLOWS (CONTINUED)

Supplementary information excluding Education Centers:

<TABLE>
<CAPTION>

(dollars in thousands)                                        1995         1994       1993
----------------------------------------------------------------------------------------------
<S>                                                          <C>         <C>        <C>
CASH PAID DURING THE YEAR FOR:
  Interest expense                                           $ 9,304     $ 6,531    $ 5,806
  Income taxes, net of refunds                                   (75)      2,634      2,489

DETAIL OF NONCASH INVESTING AND FINANCING ACTIVITIES:
  Sale of land, building and equipment in exchange
   for note receivable                                            --         583         --
  Assets acquired through capital leases                       3,254       1,654         --

  Acquisition of businesses:
   Working capital, other than cash                           (1,999)     (1,291)    (1,327)
   Property, plant and equipment                                (161)       (373)      (152)
   Other assets                                               (4,311)     (5,833)    (3,938)
   Liabilities assumed in acquisition                          3,211       1,067         --
                                                            ----------------------------------
   Net cash used to acquire businesses                        (3,260)     (6,430)    (5,417)
  Conversion of senior subordinated debentures and
   related interest                                           20,142          --         --
   into shares of common stock
  Notes receivable under stock option plans                    1,398          --         --
</TABLE>

                                      F-21
<PAGE>   61
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 15 - INDUSTRY SEGMENT DATA

Information about the Company's operations (excluding Education Centers except
for identifiable assets balances) in different industries is as follows:

<TABLE>
<CAPTION>
                                                                                               Restated
                                                                                      -------------------------
(dollars in thousands)                                                       1995         1994         1993
---------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>          <C>           <C>
NET REVENUES:

  ICS Learning Systems                                                    $143,021     $122,815      $101,319
  Steck-Vaughn Publishing Corporation                                       58,226       53,608        53,156
  National Education Training Group                                         54,350       61,937        68,259
  Other                                                                      3,001        3,254         1,438
                                                                        ---------------------------------------
Total Net Revenues                                                        $258,598     $241,614      $224,172
                                                                        ---------------------------------------
OPERATING INCOME (LOSS):
  ICS Learning Systems operating income before amortization of prior
   period deferred marketing and unusual items                            $ 13,628     $ 15,909      $ 21,368
    Amortization of prior period deferred marketing                         (1,470)     (19,836)           --
    Unusual items                                                           (4,549)          --            --
                                                                        ---------------------------------------
  ICS Learning Systems                                                       7,609       (3,927)       21,368
                                                                        ---------------------------------------
  Steck-Vaughn Publishing Corporation operating income before
   unusual items                                                            10,469       10,459        13,074
    Unusual items                                                             (970)          --            --
                                                                        ---------------------------------------
  Steck-Vaughn Publishing Corporation                                        9,499       10,459        13,074
                                                                        ---------------------------------------
  National Education Training Group operating loss before unusual items    (15,375)     (13,993)      (25,950)
    Unusual items                                                          (74,567)          --        (9,232)
                                                                        ---------------------------------------
  National Education Training Group                                        (89,942)     (13,993)      (35,182)
                                                                        ---------------------------------------
  Other                                                                        764          (50)         (657)
                                                                        ---------------------------------------
  Total segment operating loss                                             (72,070)      (7,511)       (1,397)
  General corporate expenses                                                (6,632)      (6,582)      (10,896)
  Interest (expense) and investment income, net                             (6,029)      (3,102)       (3,163)
  Other income                                                                 307          492           138
  Unusual items                                                             (1,644)          --            --
  Gain on sale of stock                                                         --        3,247        21,120
                                                                        ---------------------------------------
Income (Loss) Before Income Taxes (Benefit) and Minority Interest         $(86,068)    $(13,456)     $  5,802
                                                                        ---------------------------------------
IDENTIFIABLE ASSETS:
  ICS Learning Systems                                                    $ 44,180     $ 48,194      $ 60,576
  Steck-Vaughn Publishing Corporation                                       65,529       58,922        56,394
  National Education Training Group                                         27,748       84,918        93,592
  Education Centers                                                             --           --        58,525
  Other                                                                      1,298        1,756           795
                                                                        ---------------------------------------
  Segments subtotal                                                        138,755      193,790       269,882
  Corporate assets                                                          46,507       50,588        55,123
  Education Centers assets held for disposition                                 --       25,867            --
                                                                        ---------------------------------------
Total Assets                                                              $185,262     $270,245      $325,005
                                                                        ---------------------------------------

TOTAL DEPRECIATION AND AMORTIZATION (INCLUDING AMORTIZATION OF PRIOR
 PERIOD DEFERRED MARKETING):
  ICS Learning Systems                                                    $  3,196     $ 21,055      $    920
  Steck-Vaughn Publishing Corporation                                        2,001        1,564         1,157
  National Education Training Group                                          2,857        3,999         9,315
  Other                                                                         11           63            33
                                                                        ---------------------------------------
Total Segments                                                            $  8,065     $ 26,681      $ 11,425
                                                                        ---------------------------------------
CAPITAL EXPENDITURES, INCLUDING CAPITAL LEASES:
  ICS Learning Systems                                                    $  5,510     $  4,887      $  2,209
  Steck-Vaughn Publishing Corporation                                          939          890         2,804
  National Education Training Group                                          1,118        1,929         2,591
  Other                                                                         13          249            76
                                                                        ---------------------------------------
Total Segments                                                            $  7,580     $  7,955      $  7,680
                                                                        ---------------------------------------
</TABLE>

                                      F-22

<PAGE>   62

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 15 - INDUSTRY SEGMENT DATA (CONTINUED)

The following table sets out the amount of consolidated net revenues, operating
income (loss) and identifiable assets by geographic area:

<TABLE>
<CAPTION>
                                                                            Restated
                                                                    -------------------------
(dollars in thousands)                                     1995         1994         1993
---------------------------------------------------------------------------------------------
<S>                                                     <C>         <C>           <C>
NET REVENUES:
  United States                                         $193,367     $185,624      $165,530
  Europe                                                  34,324       26,815        28,000
  Canada                                                  18,115       16,579        19,547
  Other foreign                                           12,792       12,596        11,095
                                                      ---------------------------------------
Total Net Revenues                                      $258,598     $241,614      $224,172
                                                      ---------------------------------------
OPERATING INCOME(LOSS):
  United States operating income before amortization
   of prior period deferred marketing and unusual
   items                                                $ 11,678     $ 13,016      $  4,582
    Amortization of prior period deferred marketing       (1,164)     (14,949)           --
    Unusual items                                        (72,723)          --        (9,232)
                                                      ---------------------------------------
  United States                                          (62,209)      (1,933)       (4,650)
                                                      ---------------------------------------
  European operating loss before amortization of
   prior period deferred marketing and unusual items      (3,617)      (4,029)       (1,902)
    Amortization of prior period deferred marketing           --         (822)           --
    Unusual items                                         (8,692)          --            --
                                                      ---------------------------------------
  Europe                                                 (12,309)      (4,851)       (1,902)
                                                      ---------------------------------------
  Canada operating income before amortization of
   prior period deferred marketing                            99          258         2,032
    Amortization of prior period deferred marketing         (306)      (3,456)           --
                                                      ---------------------------------------
  Canada                                                    (207)      (3,198)        2,032
                                                      ---------------------------------------
  Other foreign operating income before amortization
   of prior period deferred marketing and unusual
   items                                                   2,970        3,080         3,123
    Amortization of prior period deferred marketing           --         (609)           --
    Unusual items                                           (315)          --            --
                                                      ---------------------------------------
  Other foreign                                            2,655        2,471         3,123
                                                      ---------------------------------------
Total Segment Operating Loss                            $(72,070)    $ (7,511)     $ (1,397)
                                                      ---------------------------------------
IDENTIFIABLE ASSETS:
  United States                                         $110,481     $163,640      $223,305
  Europe                                                  17,546       18,968        26,964
  Canada                                                   6,452        7,422        14,417
  Other foreign                                            4,276        3,760         5,196
                                                      ---------------------------------------
Total Segment Assets                                    $138,755     $193,790      $269,882
                                                      ---------------------------------------
</TABLE>


The Company's operations are conducted in the United States, Canada, United
Kingdom, Germany, Australia, New Zealand and Singapore.

Operating income by segment and geographic area includes net revenues less
operating expenses. The operating income (loss) by segment and geographic area
excludes general corporate expenses, net interest expense and income taxes.
Unusual items are more fully described in the Notes to the Consolidated
Financial Statements. Intersegment sales were immaterial for all years
presented. Identifiable assets are those assets used in the Company's operations
in each segment and geographic area and exclude corporate assets and Education
Centers assets held for disposition.

                                      F-23
<PAGE>   63
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 16 - QUARTERLY FINANCIAL DATA (UNAUDITED)

The following table summarizes quarterly financial data for 1995 and 1994. The
1995 periods presented were restated to reflect deferring certain selling and
marketing costs incurred during interim periods and fully amortizing them within
the calendar year when the related revenue is recognized. SOP 93-7 does not
permit restatement of the periods for 1994. The 1994 results were restated to
reflect the change at Steck-Vaughn from the LIFO to the FIFO method of
accounting for inventory. The restated results together with a reconciliation to
the previously reported amounts are as follows:

<TABLE>
<CAPTION>
                                                              First       Second       Third     Fourth
(amounts in thousands, except per share amounts)            Quarter      Quarter     Quarter    Quarter
--------------------------------------------------------------------------------------------------------
<S>     <C>    <C>    <C>    <C>    <C>    <C>
1995
NET REVENUES                                                $ 55,959     $ 62,264    $ 72,029   $ 68,346
 Income (loss) before amortization of acquired intangible
  assets, amortization of prior period deferred
  marketing, unusual items, nonoperating items, income 
  taxes (benefit) and minority interest                       (2,859)      (3,599)      8,167      2,747
   Amortization of acquired intangible assets                    565          545         219        273
   Amortization of prior period deferred marketing             1,311          159          --         --
   Unusual items, net                                             --       77,805          --      3,925
   Other nonoperating expenses                                 1,332        1,567       1,496      1,327
   Income taxes (benefit)                                         --           --          --         --
   Minority interest                                              90          350         625         90
                                                           ---------------------------------------------
NET INCOME (LOSS)                                           $ (6,157)    $(84,025)   $  5,827   $ (2,868)
                                                           ---------------------------------------------
  Earnings (loss) per share                                 $   (.21)    $  (2.79)   $    .18   $   (.08)
                                                           ---------------------------------------------
Net income (loss) as previously reported                    $ (8,508)    $(81,970)   $  2,395   $    860
Adjustment for interim deferral of selling and promotion       6,884       (2,055)      1,502     (6,331)
expense
Tax impact of accounting change                               (4,533)          --       1,930      2,603
                                                           ---------------------------------------------
Net Income (loss) as restated                               $ (6,157)    $(84,025)   $  5,827   $ (2,868)
                                                           ---------------------------------------------
</TABLE>

                                      F-24
<PAGE>   64


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 16 - QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)

<TABLE>
<CAPTION>
                                                                First     Second       Third     Fourth
(amounts in thousands, except per share amounts)              Quarter    Quarter     Quarter    Quarter
--------------------------------------------------------------------------------------------------------
<S>                                                         <C>          <C>        <C>        <C>    
1994
NET REVENUES                                                $ 49,472    $ 58,337   $  63,339   $ 70,466
 Income (loss) before amortization of acquired
  intangible assets, amortization of prior period 
  deferred marketing, nonoperating items, gain on
  sale of stock, income taxes (benefit) and minority
  interest                                                    (6,199)      2,826       1,805      9,135
   Amortization of acquired intangible assets                    426         427         530        441
   Amortization of prior period deferred marketing             7,369       5,837       4,007      2,623
   Other nonoperating (income) expenses                          844         (87)        892        961
   Gain on sale of stock                                          --          --          --     (3,247)
   Income taxes (benefit)                                     (3,626)       (299)       (111)     3,481
   Minority interest                                             129         384         601         78
                                                           ---------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS                     (11,341)     (3,436)     (4,114)     4,798
   Loss from discontinued operations                          (2,008)     (7,412)         --         --
   Loss on disposal of discontinued operations                    --     (40,032)         --         --
                                                           ---------------------------------------------
NET INCOME (LOSS)                                           $(13,349)   $(50,880)  $  (4,114)  $  4,798
                                                           ---------------------------------------------

EARNINGS (LOSS) PER SHARE FROM CONTINUING OPERATIONS        $   (.38)   $   (.12)  $    (.14)  $    .16
                                                           ---------------------------------------------

EARNINGS (LOSS) PER SHARE                                   $   (.45)   $  (1.72)  $    (.14)  $    .16
                                                           ---------------------------------------------

Net income (loss) as previously reported                    $(13,382)   $(50,923)  $  (4,148)  $  4,528
Adjustment to publishing costs and materials for
 inventory accounting change                                      65          85          75        529
Impact of accounting change on minority interest                  (7)         (9)        (12)       (52)
Tax impact of accounting change                                  (25)        (33)        (29)      (207)
                                                           ---------------------------------------------
Net income (loss) as restated                               $(13,349)   $(50,880)  $  (4,114)  $  4,798
                                                           ---------------------------------------------
</TABLE>

                                      F-25
<PAGE>   65


                 National Education Corporation and Subsidiaries

                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

(dollars in thousands)
<TABLE>
<CAPTION>
                                      Balance at   Charge/(Credit)                       Balance at
                                    Beginning of     to Costs and     Deductions/            End of
Classification                            Period         Expenses           Other            Period
----------------------------------------------------------------------------------------------------
<S>                                     <C>             <C>             <C>                <C>    
YEAR END 1995:
Allowance for doubtful receivables      $ 2,787         $ 1,642         $ (1,687)          $ 2,742
Reserve for inventories                   2,145           1,626               85             3,856
Accumulated amortization of
acquired intangible assets               89,005           1,602          (77,274) (A)       13,333
   

YEAR END 1994:
Allowance for doubtful receivables      $10,437         $(1,304)        $ (6,346)          $ 2,787
Reserve for inventories                   2,437             (98)            (194)            2,145
Accumulated amortization of
acquired intangible assets               95,635           1,824           (8,454) (B)       89,005
  

YEAR END 1993:  (C)
Allowance for doubtful receivables      $10,119         $ 4,664         $ (4,346)          $10,437
Reserve for inventories                   1,982             391               64             2,437
Accumulated amortization of
acquired intangible assets               78,865           4,775           11,995  (D)       95,635
  
</TABLE>

A) This amount represents the write-off of intangible assets of NETG and
   Spectrum, a subsidiary of NETG.

B) This amount primarily represents the Education Centers reclassification to
   net assets held for disposition.

C) Balances have not been restated to exclude the discontinued Education
   Centers.

D) This amount primarily represents the write-off of intangible assets for NETG
   of $9,232,000 and the Education Centers of $2,766,000.

                                      F-26
<PAGE>   66
                             EXHIBITS FILED HEREIN
<TABLE>
<CAPTION>
                                                                                           Sequentially
Exhibit                                                                                    Numbered
Number        Description                                                                  Page
------        -----------                                                                  ----
<S>           <C>                                                                          <C>
3.1           Restated Certificate of Incorporation of the
              National Education Corporation    . . . . . . . . . . . . . . . . . . . .

10.18         Second Amendment to Credit Agreement, dated
              December 21, 1995   . . . . . . . . . . . . . . . . . . . . . . . . . . .

10.22         Renewal and Extension Agreement between National
              Education Corporation and Steck-Vaughn Publishing
              Corporation, effective December 31, 1995    . . . . . . . . . . . . . . .

10.23         First Amendment to Stock Option Agreement between
              National Education Corporation and Steck-Vaughn
              Publishing Corporation, effective December
              31, 1995    . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10.24         Letter Amendment to Stock Option Agreement
              between National Education Corporation and
              Steck-Vaughn Publishing Corporation, dated
              February 1, 1996    . . . . . . . . . . . . . . . . . . . . . . . . . . .

10.26         Credit Agreement among National Education
              Corporation, certain banks and BZW Division of
              Barclays Bank PLC, as Agent, dated  January
              19, 1996 (Confidential treatment under
              Rule 24b-2 has been requested for portions
              of this exhibit)    . . . . . . . . . . . . . . . . . . . . . . . . . . .

11.1          Calculation of Primary Earnings Per Share   . . . . . . . . . . . . . . .

11.2          Calculation of Fully Diluted Earnings Per Share   . . . . . . . . . . . .

18            Letter from Price Waterhouse LLP regarding change
              in accounting principles (23)   . . . . . . . . . . . . . . . . . . . . .

21            Subsidiaries of National Education Corporation    . . . . . . . . . . . .

23            Consent of Price Waterhouse LLP   . . . . . . . . . . . . . . . . . . . .

27.1          Financial Data Schedule   . . . . . . . . . . . . . . . . . . . . . . . .
</TABLE>