<PAGE>   1
 
================================================================================
 
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549

                            ------------------------
                                   FORM 10-K
                            ------------------------
 
           [X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                             SECURITIES EXCHANGE ACT OF 1934
 
                   FOR THE FISCAL YEAR ENDED JANUARY 4, 1997.
 
                        COMMISSION FILE NUMBER : 0-13069
 
                           THE LEARNING COMPANY, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                  DELAWARE                                      94-2562108
       (STATE OR OTHER JURISDICTION OF               (IRS EMPLOYER IDENTIFICATION NO.)
                INCORPORATION)

            ONE ATHENAEUM STREET
          CAMBRIDGE, MASSACHUSETTS                                 02142
  (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                      (ZIP CODE)
</TABLE>
 
       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (617) 494-1200
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
 
<TABLE>
<S>                                            <C>
             TITLE OF EACH CLASS                   NAME OF EXCHANGE ON WHICH REGISTERED
        Common Stock, $.01 par value                      New York Stock Exchange
</TABLE>
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
 
                                      None
 
     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.
 
     The aggregate market value of voting stock of the registrant held by
non-affiliates of the registrant as of March 1, 1997 was approximately
$427,917,345.63. As of March 1, 1997, 44,458,945 shares of the registrant's
common stock were outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     Portions of the Proxy Statement for the Annual Meeting of Stockholders
expected to be held in May 1997 are incorporated by reference into Part III.
 
================================================================================
<PAGE>   2
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                                          PAGE
                                                                                          ----
 <C>  <S>                                                                                  <C>
                                        PART I
  1.  Business                                                                              1
  2.  Properties                                                                           10
  3.  Legal Proceedings                                                                    11
  4.  Submission of Matters to a Vote of Security Holders                                  11
                                        PART II
  5.  Market for the Registrant's Common Stock and Related Stockholder Matters             11
  6.  Selected Financial Data                                                              13
  7.  Management's Discussion and Analysis of Financial Condition and Results of
      Operations                                                                           13
  8.  Consolidated Financial Statements and Supplementary Data                             23
  9.  Changes in and Disagreements with Accountants on Accounting and Financial
      Disclosure                                                                           47
                                        PART III
 10.  Directors and Executive Officers of the Registrant                                   47
 11.  Executive Compensation                                                               47
 12.  Security Ownership of Certain Beneficial Owners and Management                       47
 13.  Certain Relationships and Related Transactions                                       47
                                        PART IV
 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K                      47
</TABLE>
 
                                       (i)
<PAGE>   3
 
                                     PART I
 
ITEM 1.  BUSINESS
 
     The Learning Company, Inc. ("TLC" or the "Company") develops and publishes
a broad range of high quality consumer software for personal computers ("PCs")
that educate across every age category, from young children to adults. The
Company's primary emphasis is in education and reference software, but it also
offers a selection of lifestyle, productivity and, to a lesser extent,
entertainment products, both in North America and internationally.
 
     The Company's families of educational products are principally sold under
The Learning Company and MECC brands and include the "Reader Rabbit" family,
"Trail" family, "Treasure" family, "Super Solvers" family, "Writing and
Creativity Tools" family, "College Prep" family, and the "Foreign Languages"
family. In addition to consumer versions, the Company also publishes school
editions of a number of these products. The Company's reference products include
a line of Compton's Home Library branded products (including Compton's
Interactive Encyclopedia) as well as the American Heritage Talking Dictionary,
Mosby's Medical Encyclopedia and BodyWorks. The Company's premium productivity
and lifestyle products are largely published under the SoftKey brand. The
Company also publishes lower priced boxed products under the "Key" brand and a
line of budget, jewel-case only products under the "Platinum" brand.
 
     The Company distributes its products through retail channels, including
direct sales to computer electronics stores, office superstores, mass
merchandisers, discount warehouse stores and software specialty stores which
control over 23,000 North American storefronts. The Company also sells its
products directly to consumers through the mail, telemarketing and the Internet,
and directly to schools. The Company's international sales are conducted from
subsidiaries in Germany, France, Holland, Ireland, the United Kingdom, Australia
and Japan. The Company also derives revenue from licensing its products to
original equipment manufacturers ("OEMs") which bundle the Company's products
for sale with computer systems or components and through on-line offerings.
 
     The Company's strategy is to develop and publish a broad range of high
quality software products with significant unit-volume potential and to
continuously introduce these new products through a wide variety of established
and emerging distribution channels worldwide. Other key elements of this
strategy include focusing on consumer software that is broadly sold at multiple
price points, building strong relationships with the retail channel, acquiring
complementary products, technologies and businesses and enhancing brand
awareness and customer loyalty.
 
     The Company has a history of acquiring companies in order to broaden its
product lines and sales channels. In May 1996 the Company consummated the
acquisition of Minnesota Educational Computing Corporation (MECC) ("MECC"). That
acquisition, together with the acquisitions in December 1995 of The Learning
Company ("The Former Learning Company") and Compton's NewMedia, Inc.
("Compton's"), marked the completion of a strategic initiative launched by the
Company in 1995 to expand its educational software franchise. The Company also
continued to expand internationally in 1996. In August 1996, the Company
acquired all the outstanding shares of Edusoft S.A., a French developer and
publisher of educational software ("Edusoft"), and in September it acquired
Domus Software B.V., a Dutch publisher of consumer software.
 
     The Company was incorporated in California in October 1978 and
reincorporated in Delaware in October 1986. In February 1994, the Company, which
was then known as WordStar International Incorporated, completed a three-way
business combination with SoftKey Software Products Inc. and Spinnaker Software
Corporation in which the Company changed its name to SoftKey International Inc.
In October 1996, the Company changed its name to The Learning Company, Inc. to
reflect its expanded emphasis on educational software. The Company's executive
offices are located at One Athenaeum Street, Cambridge, Massachusetts 02142. Its
telephone number is (617) 494-1200, and its internet web site is located at
http:/www.learningco.com.
<PAGE>   4
 
INDUSTRY BACKGROUND
 
     The consumer software market has grown significantly over the past few
years as a result of several major trends, including the increasing installed
base of PCs in the home, the improved multimedia capabilities of PCs and the
increasing demand for a greater number of high quality, affordably priced
software applications. In addition, consumers are exposed to software purchase
opportunities from a wide variety of sources and with increased frequency.
 
     Declining retail prices, improved performance, expanded memory and enhanced
multimedia capabilities have been the main drivers of growth in the consumer
software market. Improvements in multimedia technology have made possible
engaging, highly interactive environments filled with rich content such as
enhanced graphics, animation and photographs, realistic sounds and music and
clips of film and video. These capabilities are particularly relevant to the
education, reference, lifestyle and entertainment categories, as specific
software purchases within these categories are largely driven by their content,
appearance and degree of interactivity.
 
     The demand for a large number and broad spectrum of value-priced software
products is also having significant impact on consumer software distribution.
The distribution of consumer software has expanded beyond traditional software
retailers and computer stores to include mass merchandisers, book stores,
grocery stores and drug stores. As demand for consumer software has grown with
improvements in multimedia technology, consumers have also grown more
sophisticated in their expectations for software, requiring increasingly easy to
use, content rich products. Furthermore, competition has continued to increase
among new and existing multimedia software publishers, increasing price pressure
and competition for limited retail shelf space. As this trend continues, it will
become increasingly important for software developers and publishers to create
significant brand name recognition, establish strong retail relationships and
consistently publish high-quality software at affordable prices to consumers.
 
PRODUCTS
 
     TLC develops, publishes and markets premium CD-ROM software products for
Windows and Macintosh platforms that educate across every age, from young
children to adults. The Company's product line comprises education, reference,
lifestyle and productivity categories under such high quality brands as The
Learning Company, MECC, Compton's Home Library and SoftKey.
 
     The Company's strategy is to leverage its name brands and breadth of
content by selling across a range of price points and through multiple
distribution channels. Products range in price from "Premium" ($29.95 to $59.95)
to "Key" ($19.95 to $29.95) to "Value" ($9.95 to $19.95). The Learning Company's
products are sold in more than 23,000 retail stores in North America and through
such diverse channels as international, school, direct response, OEM and
on-line.
 
     Products are organized by brand and by category with corresponding
packaging, merchandising and promotional activities designed in support of the
products.
 
  The Learning Company and MECC Educational Software
 
     These brands represent a series of products tailored to support the most
fundamental learning topics taught in school. The product line is organized by
age and by subject area, covering everything from learning essentials for
preschoolers to test preparation for college-bound students and foreign language
instruction for adults. Market research and an experienced staff of educational
specialists seek to ensure that the content of each program is educational,
engaging, age-appropriate, non-violent and effectively delivered. Highlights
from the product line include:
 
     - The Reader Rabbit family of language arts software is designed to develop
a lifelong love of reading in children ages 2 through 9. This series of ten
titles covers everything from letter recognition and phonics to reading
comprehension. The Reader Rabbit products have been developed based on a wealth
of research by educators, parents, children and reading specialists in order to
create the most educational, engaging, easy-to-use reading software.
 
                                        2
<PAGE>   5
 
     - The Writing and Creativity Tools family is designed to make writing and
communication fun and exciting for children at all ages -- from age 4 all the
way through high school age. Every program includes specific features to meet
the needs of children at each stage of their writing and communication
development, along with creativity features to spark the imagination.
 
     - The Super Solvers family of products for children ages 8 to 14 was
developed to take advantage of children's interest in fast-action games. Each
title in this family offers children a different challenge to solve in areas
such as spelling, math, deductive reasoning and physical science.
 
     - Designed for children ages 5 to 9, the Treasure family engages young
minds with learning adventures that enrich math, science, reading and thinking
skills. Each Treasure title is a different world featuring its own unique
characters, surprises and learning challenges.
 
     - The Munchers family of products for children ages 6 to 12 is used widely
in both schools and homes to build children's skills and confidence in math,
spelling and trivia.
 
     - The Trail series, including Oregon Trail II, are simulation games where
children learn about history and geography while taking part in exciting
adventures.
 
     - TLC is a leader in foreign language software with its Learn To Speak,
Berlitz Think & Talk, Practice Makes Perfect and Travel Talk series of products
covering language instruction in Spanish, French, German, Italian, Japanese and
English. Appropriate for high school age through adult users, each line combines
state-of-the-art technology with advanced learning methodologies to create
highly interactive and effective products.
 
  Reference and Lifestyle Software
 
     - The Compton's Home Library brand comprises a complete line of core
reference, lifestyle and special interest programs. The Compton's Home Library
products are designed specifically to meet consumers' home information needs.
Each product in the line provides easy access to a wealth of information for
researching, learning and exploring, with many providing direct links to the
World-Wide-Web for up-to-date information. Products in this line include
Compton's Interactive Encyclopedia -- 1997 Edition, Compton's World Atlas, The
Complete Interactive Cookbook and Compton's Interactive Bible -- NIV.
 
     - SoftKey branded reference products are among the best-selling titles in
the industry. Strong brands and rich multimedia content enable the Company to
sell these products across all its channels. Some of the most popular titles
include: BodyWorks 5.0, American Heritage Talking Dictionary, Infopedia and Time
Almanac.
 
  Productivity Software
 
     Productivity titles targeted at the home, small business and home office
users are the flagship titles under the SoftKey brand. The price points and
content of these programs are designed for the consumer who purchases programs
to meet very specific needs. The Key line is designed to meet productivity needs
of those users who appreciate a good value. This line includes a range of
personal productivity tools, content such as fonts and clip art, office
productivity solutions and design tools. Popular titles in the Productivity line
include: Calendar Creator 4.0, Labels Unlimited, Super Mega Clip Art and KeyCAD
Pro.
 
  Value Software
 
     The Value line under the Platinum, KeyKids and Classic brands are
recognized as top performers in the budget category of software. This CD-ROM
line offers consumers brand name software at affordable prices in a jewel case
only and boxed format. The line covers all software categories including
reference, education, productivity, lifestyle and games.
 
  Tax Software and Services
 
     In Canada, the Company is a supplier of income tax software products and
services through its subsidiary SoftKey Software Products Inc. ("SoftKey
Software"). Large and small accounting firms, corporations and
 
                                        3
<PAGE>   6
 
small businesses in Canada rely on the Company to develop and update software
products for all aspects of income tax preparation. The Company also publishes
personal tax preparation software for use by individuals. The Company offers tax
software products under the TaxPrep, CanTax, Informatrix, HomeTax and L'Impot
Personnel brands.
 
SALES AND MARKETING
 
     The Company distributes its consumer software products through retail
channels, direct response, OEMs and school channels within North America and
through international channels throughout Europe and the Pacific Rim.
 
     Retail Channels.  The Company has relationships with over 50 national
retailers and direct distributors controlling over 23,000 individual North
American storefronts where most of the nation's software sales occur. The
Company's retail distribution strategy is to foster strong direct relationships
with large retailers through a broad product offering, actively assisting in
channel management and innovative merchandising. These direct relationships have
been the result of an established history of developing and publishing a wide
range of products and actively working with retailers to understand consumer
purchasing behavior and trends. Retailers routinely share sell-through data with
the Company, providing the Company with the ability to proactively tailor its
product offerings, modify distribution tactics and optimize product marketing,
merchandising, promotion and mix for specific retail channels and stores. The
Company sponsors merchandising programs and provides electronic data interchange
("EDI") to most major accounts. The Company intends to continue to build its
relationships with the retail channels in an effort to further strengthen these
strategic relationships. The Company's dealer sales channel consists of
traditional PC hardware and software retail stores, including national and
regional chains and superstores. Increasingly, the Company sells its products to
office superstores such as Office Depot, OfficeMax and Staples, electronic
superstores such as CompUSA, Circuit City and Best Buy and mass merchants such
as Wal-Mart, K-Mart and Sears. In addition, the Company sells to distributors
such as Ingram Micro Inc., GT Interactive and Navarre.
 
     Direct Response.  The Company's database of over 5 million end-users
provides many cross-marketing opportunities. The Company mailed over 30 million
pieces of targeted direct mail in fiscal 1996. The Company typically utilizes
targeted customer mailings highlighting specific products. Prior to a full
mailing, the Company conducts test mailings at different price points and
marketing approaches in order to maximize response rates from its customers. The
Company also sells its products through direct mailings to potential end-users
who are not part of the installed user base using rented mailing lists. The
Company made over 1.4 million outbound telephone calls in 1996 to sell products
to its customers. In 1996, the Company launched its "virtual store," an on-line
catalog on the Company's internet website. Using the virtual store, customers
can browse through the Company's products, try on-line before buying and submit
an on-line or telephone order. The Company has recently introduced electronic
registration for its consumer products that allows it to collect data from its
customers that in turn provide customer leads for the direct response business.
 
     Original Equipment Manufacturers.  The objective of the Company's OEM
strategy is to assist hardware manufacturers and on-line services to
differentiate their product lines and to introduce the Company's brands to new
computer hardware buyers. The Company licenses its software products to OEMs
(including IBM, Apple, Compaq, Hewlett-Packard and America On-Line), which
typically purchase the Company's products in higher volumes and at lower prices
than retail stores and distributors. The manufacturing costs incurred by the
Company for OEM sales are typically lower than its boxed product because in many
cases the products are duplicated by the OEMs and sold without packaging or, in
some instances, documentation. In addition, the Company receives royalties from
a number of OEMs that have no production costs, which results in higher gross
margins.
 
     School Channel.  The Company's efforts in the school channel focus on the
unique needs of the school market through targeted and specialized marketing and
services. The Company sells products directly to schools and school districts
through field based direct sales representatives, telemarketing and direct mail.
Sales are also made through authorized resellers and distributors including
Education Resources, Ingram Micro and Baker & Taylor. The Company markets its
school products to over 795 key school districts, 84,500
 
                                        4
<PAGE>   7
 
school buildings and, in turn, to over 2.6 million classrooms across the United
States. The Company believes that through its MECC, The Learning Company and
Compton's brands it has a 24% share of the 1996 installed base of school
districts in the United States. The Company intends to continue to leverage its
established position in the school market to expand its sales in the home
market. The Company believes that the history of acceptance of its products in
schools, coupled with its broad range of award-winning products, positions it to
further enhance its market share position and brand awareness in the home
market.
 
     International.  The Company believes that the international consumer
software markets are rapidly growing as a result of trends similar to those
driving the North American market. The Company operates subsidiaries outside of
North America in Germany, France, Holland, Ireland, Australia, Japan, the United
Kingdom and Ireland. In addition, the Company has distributors in major
European, Latin American and Pacific Rim countries, as well as in South Africa.
The Company's subsidiaries in Ireland and Germany generally coordinate
manufacturing and distribution for all of the Company's sales in Europe, Latin
America and the Pacific Rim. Generally, retail stores outside of North America
are more reliant on distributors than retail stores in North America. As
distribution environments differ from country to country, the Company tailors
its distribution strategy accordingly. Financial information pertaining to the
Company's international and domestic operations is set forth in the Consolidated
Financial Statements Note 12 included in Item 8 and presented as a separate
section of this report.
 
PRODUCT DEVELOPMENT
 
     The Company develops and publishes products through internal development as
well as licensing. Approximately 86% of the Company's domestic 1996 revenues
were derived from products that have been internally developed. Through this
dual product strategy approach, the Company is able to introduce new products
while managing its research and development costs. During 1996, the Company
launched a total of 49 new and upgraded premium education, reference and
productivity products, of which 35 were developed internally.
 
     Internal Product Development.  The Company's internal product development
efforts are designed to result in efficient and timely product introductions by
focusing on "core code" development. Where possible, the Company specifies,
develops and manages (or purchases) one base of source code from which many
products are created. Using one base of source code permits the Company to
maximize programming efficiency because the investment of time and capital in
developing the base source code is shared among multiple products and additional
programming time is minimized. As a result, production schedules are more
predictable and development costs are lower since the underlying code for new
programs has previously been tested and debugged and the software already
documented. Even with these "core codes" the Company must continuously update
and improve the content and the technology of its products in order to remain
competitive.
 
     In certain instances, the Company's internally developed products contain
components that have been developed by outside developers or authors and are
licensed by the Company. The Company generally pays these outside
developers/authors royalties based on a percentage of net sales.
 
     The Company maintains research and development facilities and personnel in
Fremont, CA, Knoxville, TN and Minneapolis, MN. The Company's development
efforts include product development, documentation and testing as well as the
translation of certain of its products into foreign languages.
 
     The Company believes that its premium educational products require
significant investments in product marketing and research and development in
order to take advantage of new technologies that benefit educational software
products and to remain competitive. In addition to expenses related to
engineering and quality assurance, the Company's research and development
expenses include costs associated with the identification and validation of
educational content and engagement features and the development and
incorporation of new technologies into new products.
 
     The Company's premium educational products require varying degrees of
development time, frequently depending on treatment of the subject matter, the
number of activities and the general complexity of the
 
                                        5
<PAGE>   8
 
product. The typical length of research and development time ranges from 6 to 24
months with the first product in a new family generally requiring the longest
period of development. The development and introduction of new products that
operate on, and the adaptation of existing titles to new platforms or operating
systems or that incorporate emerging technologies may require greater
development time and expense and may generate less revenue per product as
compared with recent introductions of new products or product adaptations.
 
     Most of the Company's educational products have been designed and developed
internally by Company employees. The Company occasionally uses third-party
designers, artists and programmers in its research and development efforts and
will continue to do so in the future. The Company believes that a mix of
internal and external third-party resources, as well as potential acquisitions
of products or technologies, is a cost-effective method of facilitating the
development of new educational software products. Products that are developed
using external third parties are generally owned or licensed exclusively by the
Company and are published and marketed under the Company's various brand names,
including The Learning Company, MECC, SoftKey and Compton's brands.
 
     Licensed Products.  The Company supplements its development efforts by
acquiring the rights to products on either an exclusive or non-exclusive basis,
both through the purchase of products and under royalty-bearing licenses.
Generally, the Company's license agreements provide for the payment of royalties
based on a percentage of the Company's net sales proceeds of such products.
 
     The licensed products typically are repackaged under the Company's
proprietary labels and sold through its distribution channels. The advantage of
this distribution method to the outside software developers is that the Company
is generally able to provide a significantly greater volume of sales than the
software developer would be able to command itself. The Company leverages its
broad distribution strength and reputation for successfully publishing products
to attract outside developers/authors and further enhance its relationships with
the software development community. Retail and direct response marketers benefit
from this arrangement by having convenient access to a wide range of products
offered by the Company.
 
     The Company's licensing of fully developed products allows for efficiencies
because the cost of development is borne by the licensor. Licensing also reduces
the financial and market risk to the Company from a product that is not well
accepted by customers since the Company generally pays royalties based on actual
net sales.
 
     Both internally developed and licensed products under development are
extensively tested by the Company's quality assurance department before being
released for production. The department tests for defects, functionality,
ease-of-use and compatibility with the many popular PC and printer
configurations that are available to consumers.
 
     The process of developing software products such as those offered by the
Company is extremely complex and is becoming more complex and expensive over
time. As a result, the financial risks borne by the Company associated with new
product development have increased. The Company's product development expense
levels are based largely on its expectations regarding future sales, and,
accordingly, operating results would be disproportionately adversely affected by
a decrease in sales or failure to meet the Company's sales expectations due to
delays in new product introductions, or lower than expected demand. If the
Company does not accurately anticipate and successfully adapt its products to
emerging platforms, environments and technologies, or new products are not
introduced when planned or do not achieve anticipated revenues, the Company's
operating results could be materially adversely affected. In addition, the
Company believes that on-line or Internet products and services will become an
increasingly important platform and distribution media; and as such the
Company's failure to timely and successfully adapt to and utilize such
technologies could materially and adversely affect its competitive position and
its financial results.
 
PRODUCTION
 
     The Company strives to minimize production costs, driving costs down as
unit volumes and the rate of new title introductions increase through process
efficiencies and economies of scale. Production of the
 
                                        6
<PAGE>   9
 
Company's products involves the duplication of diskettes or CD-ROM disks and the
printing and assembly of packaging, labels, user manuals and other purchased
components. The Company subcontracts all of the manufacture and fulfillment of
its products to third party vendors. In 1996, the production, assembly and
distribution of the Company's North American budget, jewel-case only line of
products was performed by two units of Bertelsmann AG (collectively, "BMG"), and
the production, assembly and distribution of the Company's other North American
products, with certain exceptions (including duplication of CD-ROM disks, School
and OEM products), was performed by Stream International Inc. ("Stream"), a
different third party vendor. On February 24, 1997 the Company terminated its
business relationship with Stream due to Stream's inability to perform its
contractual obligations. See Item 3 -- Legal Proceedings. In connection with the
termination, in February 1997 units of BMG began to provide substantially all
duplication, assembly and fulfillment of the Company's North American products,
other than school products. While the Company believes that its expanded
relationship with BMG will result in greater manufacturing and fulfillment
efficiency, there can be no assurance that the Company will not experience
difficulties or delays in the manufacture and fulfillment as a result of the
transition of those functions. The Company believes that its existing production
capacity is sufficient to handle anticipated increases in volume and titles into
the foreseeable future. Duplication of diskettes and assembly of the Company's
international products take place primarily at the Company's facilities in
Dublin, Ireland and to a lesser extent in Munich, Germany.
 
TECHNICAL SUPPORT
 
     The Company provides a variety of technical support services to dealers,
distributors, corporations and end users. Users of the Company's products
generally receive free telephone support for the life of the product (until the
next version is released or manufacturing of the product is discontinued). This
support is provided by the Company's Technical Support Center in Knoxville, TN.
 
COMPETITION
 
     The consumer software industry is intensely and increasingly competitive
and is characterized by rapid changes in technology and customer requirements.
The Company competes for retail shelf space and general consumer awareness with
a number of companies that market consumer software. The Company encounters
competition from both established companies, including the largest companies in
the industry, and new companies that may develop comparable or superior
products. A number of the Company's competitors and potential competitors
possess significantly greater capital, marketing resources and brand recognition
than the Company. Rapid changes in technology, product obsolescence and advances
in computer software and hardware require the Company to develop or acquire new
products and to enhance its existing products on a timely basis. The Company's
marketplace has recently experienced a higher emphasis on on-line and Internet
related services and content tailored for this new distribution channel. To the
extent that demand increases for on-line products and content, the demand for
the Company's existing products may change. There can be no assurance that the
Company will be able to maintain market share or that the market will not
continue to erode, and otherwise compete successfully in the future.
 
     Competitive pressures in the software industry have resulted, and the
Company believes are likely to continue to result, in pressure to reduce the
prices of its products or risk loss of market share. In response to such
competitive pressures the Company has reduced the price of certain of its
educational products. There can be no assurance that the Company's product
prices will not continue to decline in the future or that the Company will not
respond to such declines with additional price reductions. Such price reductions
may reduce the Company's revenues and operating margins in the future.
 
     Large companies with substantial bases of intellectual property content in
the motion picture and media industries, sophisticated product marketing and
technical abilities and/or financial resources that may not need to realize an
immediate profit or return on investment have increasingly entered or announced
their intention to enter the consumer software market. These competitors
include: Microsoft, Disney, Mattel, Hasbro and CUC International Inc. For
example, technology companies have begun to acquire greater access to content,
and content-oriented companies have begun to acquire greater technological
capabilities. To the extent that competitors achieve a performance, price or
distribution advantage, the Company could be
 
                                        7
<PAGE>   10
 
adversely affected. Furthermore, increased consolidation of the consumer
software market may impact future growth potential and performance.
 
     In the retail distribution channel resellers typically have a limited
amount of shelf space and promotional resources. There is intense competition
for high quality and adequate levels of shelf space and promotional support from
retailers. To the extent that the number of consumer computer platforms and
products increases, this competition for shelf space may also increase. The
retail channel increasingly includes non-traditional software retailers such as
book, music, video, magazine, toy, gift, convenience, drug and grocery store
chains. Mass merchants such as Wal-Mart and K-Mart are increasingly representing
a larger portion of the Company's sales. As these retailers achieve greater
market share from the traditional software retailers, the Company may experience
higher marketing costs and increased competition for shelf space which could
impact future sales and operating margins. Additionally, as technology changes,
the type and number of distribution channels will further change and new types
of competitors, such as cable or telephone companies, are likely to emerge.
There can be no assurance that the Company will compete effectively in these
channels.
 
     The retail channels of distribution available for products are subject to
rapid changes as retailers and distributors enter and exit the consumer software
market or alter their product inventory preferences. Other types of retail
outlets and methods of product distribution may become important in the future.
These new methods may include delivery of software using on-line services or the
Internet which will necessitate certain changes in the Company's business and
operations including addressing operational challenges such as improving
download time for pictures, images and programs, ensuring proper regulation of
content quality and developing sophisticated security for transmitting payments.
Should on-line distribution channels increase, the Company will be required to
modify its existing technology platforms in order for its products to be
compatible and remain competitive. It is critical to the success of the Company
that, as these changes occur, it maintain access to those channels of
distribution offering software in its market segments.
 
     In both the professional and home income tax preparation markets in Canada,
there are relatively few barriers to entry for competitors. In Canada, there are
numerous companies offering tax preparation software products for both the
professional and home user. As a result, there is significant price and product
competition in this market. Currently, the Company's tax products are generally
designed to run on DOS and Windows operating systems, with certain professional
packages running on the Macintosh system. The demand for and ability to develop
successful packages to run in the Windows operating environment may affect the
success of such products.
 
PROPRIETARY RIGHTS AND LICENSES
 
     Consistent with industry practice, the Company does not have signed license
agreements with the end users of its products, and its products do not contain
mechanisms to inhibit unauthorized copying. Instead, the Company relies on the
copyright laws to prevent unauthorized distribution of its software. The Company
also relies on a combination of trade secret, patent, trademark and other
proprietary rights, laws and license agreements to protect its proprietary
rights. Existing copyright laws afford only limited protection. It may be
possible for unauthorized third parties to copy the Company's products or to
obtain and use information the Company regards as proprietary.
 
     Policing unauthorized use and distribution of the Company's products is
difficult, and while it is difficult to determine the extent to which such use
or distribution exists, software piracy can be expected to be a persistent
problem. These problems are particularly acute in certain international markets
such as South America, the Middle East, the Pacific Rim and the Far East, and
the laws of certain countries in which the Company's products are or may be
distributed provide less protection than those of the United States.
 
     The Company periodically receives communications alleging or suggesting
that its products may incorporate material covered by the copyrights, trademarks
or other proprietary rights of third parties. With increased use of music and
animation in CD-ROM products and the increased number of products on the market
generally, the Company is likely to experience an increase in the number of
infringement claims asserted against it in the future. With respect to licensed
products, the Company is generally indemnified against liability on these
matters. The Company's policy is to investigate the factual basis of such
 
                                        8
<PAGE>   11
 
communications and to resolve such matters promptly by enforcing its rights,
negotiating licenses (if necessary) or taking other appropriate actions.
 
     In certain circumstances, litigation may be necessary to enforce the
Company's proprietary rights, to protect copyrights, trademarks and trade
secrets and other intellectual property rights owned by the Company or its
licensors, to defend the Company against claimed infringements of the rights of
others and to determine the scope and validity of the proprietary rights of the
Company and others. Any such litigation, whether with or without merit, could be
costly and could result in a diversion of management's attention, which could
have an adverse effect on the Company's business, operating results or financial
condition. Adverse determinations in litigation relating to any of the Company's
products could result in the loss of the Company's proprietary rights, subject
the Company to liabilities, require the Company to seek licenses from third
parties or prevent the Company from selling particular products.
 
HISTORY
 
     Corporate Background.  The Company was founded and incorporated in
California under the name MicroPro International Corporation in October 1978. In
November 1986, it changed its state of incorporation from California to
Delaware, and in May 1989, it changed its corporate name to WordStar
International Incorporated. In February 1994, WordStar changed its name to
SoftKey International Inc. in connection with a three-way business combination
including the Company, SoftKey Software Products Inc. ("Former SoftKey") and
Spinnaker Software Corporation (the "Three-Party Combination"). The business of
Former SoftKey prior to such transaction commenced in 1984 and focused
originally on vertical software applications, or software packages designed for
specific types of businesses. By 1993, Former SoftKey was generally engaged in
the computer software and services businesses, operating in three business
units: a publishing division, which acquired software application packages from
various software developers and distributed them to end users; a tax division,
which developed and distributed professional tax software products and also
engaged in the computer processing of tax data; and a consulting division, which
has been discontinued. After the Three-Party Combination, SoftKey Software
publishing division operations were consolidated with the operations of the
Company and SoftKey Software continued to operate the businesses of the tax
division.
 
     In 1995 and 1996, the Company acquired several consumer software companies,
including The Former Learning Company, Compton's, tewi Verlag, Edusoft S.A., and
MECC. In October 1996, the Company changed its name to The Learning Company,
Inc. to reflect its expanded emphasis on educational software.
 
EMPLOYEES
 
     At March 1, 1997, the Company had approximately 990 full time employees.
The Company believes that its success is highly dependent on its ability to
attract and retain qualified employees. As necessary, the Company supplements
its regular employees with temporary and contract personnel. No employees are
covered by a collective bargaining agreement, and there have been no work
stoppages.
 
FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS
 
     Financial Information pertaining to the Company's foreign and domestic
operations is set forth in the Consolidated Financial Statements -- Note 12
included in Item 8 and presented as a separate section of this report.
 
FORWARD LOOKING STATEMENTS
 
     Certain of the information contained in this Annual Report on Form 10-K,
including without limitation statements made under this Part I, Item 1,
"Business" and part II, Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" which are not historical facts,
may include "forward-looking statements" within the meaning of Section 21E of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The
Company's actual results may differ materially from those set forth in such
forward-looking statements.
 
                                        9
<PAGE>   12
 
     Important factors and assumptions that could cause the Company's actual
results to differ materially from those included in the forward-looking
statements made herein include the factors which are responsible for
period-to-period fluctuations in the Company's operating results generally.
These factors include without limitation the integration of operations resulting
from acquisitions of companies, delays in customer purchases in anticipation of
upgrades to existing products or release of competitive products, currency
fluctuations, dealer and distributor order patterns and seasonality of buying
patterns of customers and the historic and recurring pattern of Company sales by
which a disproportionate percentage of a quarter's total sales occur in the last
month and weeks of each quarter, making predictions of revenues and earnings
especially difficult and resulting in substantial risk of variance of actual
results from those foregoing at any time prior to near the quarter close.
Additional factors and assumptions that could generally cause the Company's
actual results to differ materially from those included in the forward-looking
statements made herein include without limitation the Company's ability to
develop and introduce new products or new versions of existing products, the
timing of such new product introductions, expenses relating to the development
and promotion of such new product introductions, changes in pricing policies by
the Company or its competitors, projected and actual changes in platforms and
technologies, timely and successful adaptation to such platforms or
technologies, the accuracy of forecasts of consumer demand, product returns,
market seasonality, changes or disruptions in the consumer software distribution
channels, the effects of general economic conditions, the rate of growth in the
consumer software industry, the impact of competitive products and pricing in
the consumer software industry, the sufficiency of the Company's production
capacity to meet future demand for its products and the Company's ability to
continue to exploit new channels of distribution for its products. Additional
factors that may cause the Company's actual results to vary from those set forth
in forward-looking statements are described elsewhere in the Annual Report on
Form 10-K under the heading "Future Operating Results".
 
     Other factors and assumptions not identified above were also involved in
the derivation of these forward-looking statements and the failure of such other
assumptions to be realized, as well as other factors, may also cause actual
results to differ materially from those projected. The Company assumes no
obligation to update these forward-looking statements to reflect actual results
or changes in factors or assumptions affecting such forward-looking statements.
 
ITEM 2.  PROPERTIES
 
FACILITIES
 
     The Company's headquarters are currently located in approximately 71,000
square feet of leased space in an office building in Cambridge, Massachusetts,
where the Company's executive, operational, administrative and certain sales
activities are currently conducted. The lease for the Cambridge facility expires
in December 2002. The Company leases approximately 71,480 square feet of office
and warehouse space in Fremont, California expiring from October 1999 to March
2003, which is primarily used for marketing and development of its products. The
Company leases approximately 50,000 square feet of office space in Minneapolis,
Minnesota which is used primarily for its school sales operation and the
development of certain educational products expiring in April 1998. In addition,
the Company leases 18,656 square feet of office space in Knoxville, Tennessee,
which is used for development of the Company's foreign language based products
and for its technical support activities. The lease for this facility expires in
May 2000.
 
     The Company's Canadian subsidiary, SoftKey Software Products Inc., owns
land and a building with approximately 18,600 square feet of office space in
Sherbrooke, Quebec, leases approximately 22,000 square feet of office space in
Mississauga, Ontario, and leases additional warehouse and office space in
Mississauga, Ontario, Sherbrooke, Quebec, and Calgary, Alberta.
 
     The Company also leases office, manufacturing and warehouse space in
London, England; Dublin, Ireland; Munich, Germany; Amsterdam, Holland; Paris,
France and certain other foreign countries in which it operates.
 
     The Company believes that its facilities, in general, are adequate for its
present and currently foreseeable needs. All properties leased or owned by the
Company are in suitable condition for the purposes for which they are used by
the Company.
 
                                       10
<PAGE>   13
 
ITEM 3.  LEGAL PROCEEDINGS
 
     On February 24, 1997, the Company terminated its business relationship with
Stream International, Inc. ("Stream"). Stream had been providing the Company
with duplication, assembly and fulfillment services for certain of the Company's
products. In September 1996, Stream relocated the operations to a new facility.
The Company terminated the relationship due to Stream's inability to perform its
contractual obligations at the new location. On February 26, 1997, the Company
filed suit against Stream in Massachusetts Superior Court for Middlesex County,
seeking injunctive relief and damages resulting from Stream's delayed and
defective performance of its manufacturing and distribution obligations.
Specifically, the Complaint asserts that the Company has been harmed by Stream's
misrepresentations, breaches of guarantee, breaches of duty and conversion.
While the Company continues to assess the full nature and amount of its damages,
the Company currently estimates that in litigation it will be seeking direct and
consequential damages from Stream in an amount in excess of $38 million. The
Company sought a pretrial determination of the status of certain proprietary
materials in the possession of Stream, which are used in the manufacture of the
Company's products. On March 10, 1997, the Court ordered that Stream place such
materials in escrow with an independent third-party pending resolution of the
action. The Court did not place restrictions on the sale of certain inventory in
Stream's possession. Stream has responded to the complaint by denying the
Company's claims and asserting counterclaims for certain outstanding invoices
and other matters in the amount of approximately $26 million.
 
     The Company is subject to various other pending claims. Management, after
review and consultation with counsel, considers that any liability from the
disposition of such lawsuits in the aggregate would not have a material adverse
effect upon the consolidated financial position or results of operations 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 the fiscal year covered by this report.
 
                                    PART II
 
ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
         MATTERS
 
     The Company's common stock is listed on the New York Stock Exchange under
the symbol "TLC." As of March 1, 1997, to the Company's knowledge, there were
approximately 1,371 holders of record of the common stock. The Company has not
paid cash dividends on its common stock and does not anticipate doing so in the
foreseeable future.
 
     The following sets forth the quarterly high and low sales prices for the
fiscal periods indicated.
 
<TABLE>
<CAPTION>
                                                                HIGH         LOW
                                                              --------     -------
            <S>                                               <C>          <C>
            1995
              First Quarter                                   $29.125      $22.00
              Second Quarter                                   32.125       21.00
              Third Quarter                                    51.75        30.375
              Fourth Quarter                                   45.625       20.375
 
            1996                                                HIGH         LOW
                                                              --------     -------
              First Quarter                                   $27.75       $13.375
              Second Quarter                                   30.3125      17.25
              Third Quarter                                    22.375       15.25
              Fourth Quarter                                   25.75        13.375
</TABLE>
 
     On April 5, 1996 the Company issued 158,099 shares of common stock to
Tribune Company in payment of a $3 million promissory note and all interest
accrued thereon. The Company has relied upon the exemption from registration
under Section 4(2) of the Securities Act of 1933, as amended (the "Securities
Act"). The
 
                                       11
<PAGE>   14
 
basis for this exemption is satisfaction of the conditions of Rule 506 under the
Securities Act in that the offers and sales satisfied all the terms and
conditions of Rules 501 and 502 under the Securities Act, there were no more
than 35 purchasers of securities from the Company and the purchaser was an
accredited investor.
 
     On May 21, 1996 the Company issued 500,000 shares (the "Bear Stearns
Shares") of common stock to Bear, Stearns & Co., Inc. ("Bear Stearns") pursuant
to the terms and provisions of an Adjustment Agreement dated as of May 20, 1996.
The Adjustment Agreement relates to the settlement of up to $10,131,394.17 in
fees, costs and expenses (the "Aggregate Fee Amount") payable by the Company to
Bear Stearns for investment banking advice and financial advisory services
rendered by Bear Stearns to the Company in connection with certain acquisitions
and the reimbursement and settlement of certain fees, costs and expenses in
connection therewith. Pursuant to the terms of the Adjustment Agreement, if the
Sale Proceeds (as defined in the Adjustment Agreement) to Bear Stearns relating
to the offer and sale of the Bear Stearns Shares were less than the Aggregate
Fee Amount, the Company agreed to pay Bear Stearns an amount in cash equal to
the difference in price between the Aggregate Fee Amount and the Sale Proceeds.
If the Sale Proceeds exceeded the Aggregate Fee Amount, Bear Stearns agreed to
pay the Company an amount in cash equal to the portion of the Sale Proceeds
which exceeded the Aggregate Fee Amount.
 
     Under the Adjustment Agreement, Bear Stearns agreed to use all reasonable
efforts to sell all of the Bear Stearns Shares by the halt of trading on the
twentieth trading day after the date of the effectiveness of a registration
statement covering Bear Stearns' resale of the Bear Stearns Shares. If all Bear
Stearns Shares were not sold by the halt of the trading on the twentieth trading
day after such date, such remaining Bear Stearns Shares were to be sold by Bear
Stearns for its own account pursuant to the terms of the Adjustment Agreement.
Such sales could be made by Bear Stearns, subject to the timing, volume and
price limitations of the Adjustment Agreement described below, in transactions
on the Nasdaq National Market, in negotiated transactions, pursuant to an
underwritten offering or pursuant to one or more of the following methods (among
others): (a) purchases by a broker-dealer as principal and resale by such broker
or dealer for its account pursuant to a prospectus; (b) ordinary brokerage
transactions and transactions in which a broker solicits purchasers; and (c)
block trades in which a broker-dealer so engaged would attempt to sell the Bear
Stearns Shares as agent but could take a position and resell a portion of the
block as principal to facilitate the transaction. In connection with any such
sales, Bear Stearns could be deemed to have received compensation from the
Company in the form of underwriting discounts or commissions and could also
receive commissions from purchasers of the Bear Stearns Shares for whom it may
act as agent.
 
     Pursuant to the terms of the Adjustment Agreement, Bear Stearns agreed to
sell no more than 75,000 Shares in any single trading day without the prior
consent of the Company and to sell all of the Bear Stearns Shares at a price
equal to or in excess of the prevailing per share market price of the Common
Stock at the time of sale, as determined by reference to then current quotations
on the Nasdaq National Market, unless the Company gave prior consent to a sale
of the Bear Stearns Shares at a lower price.
 
     The Adjustment Agreement provided that the Company would indemnify Bear
Stearns against certain liabilities, including civil liabilities under the
Securities Act, or would contribute to certain payments Bear Stearns may be
required to make in respect thereof.
 
     The Company has relied upon the exemption from registration under Section
4(2) of the Securities Act of 1933, as amended (the "Securities Act"). The basis
for this exemption is satisfaction of the conditions of Rule 506 under the
Securities Act in that the offers and sales satisfied all the terms and
conditions of Rules 501 and 502 under the Securities Act, there were no more
than 35 purchasers of securities from the Company and each purchaser who was not
an accredited investor, either alone or with his purchaser representative, had
such knowledge and experience in financial and business matters that he was
capable of evaluating the merits and risks of the prospective investment.
 
     On August 12, 1996 the Company issued an aggregate of 752,275 shares of
common stock to Beaucour Investissements, Society Fabry SCS and Michel Bussac,
the three selling stockholders of Edusoft, as the consideration for the purchase
by the Company of all the outstanding shares of Edusoft. The Company has relied
upon the exemption from registration under Section 4(2) of the Securities Act.
The basis for this exemption is satisfaction of the conditions of Rule 506 under
the Securities Act in that the offers and sales
 
                                       12
<PAGE>   15
 
satisfied all the terms and conditions of Rules 501 and 502 under the Securities
Act, there were no more than 35 purchasers of securities from the Company and
each purchaser who was not an accredited investor, either alone or with his
purchaser representative, had such knowledge and experience in financial and
business matters that he was capable of evaluating the merits and risks of the
prospective investment.
 
ITEM 6.  SELECTED FINANCIAL DATA
 
     The selected financial data presented below for the Years Ended December
31, 1996, 1995 and 1994, the six month period ended December 31, 1993 (the
"Transition Period Ended December 31, 1993") and the Years Ended June 30, 1993
and 1992 are derived from the Company's audited consolidated financial
statements. The following selected financial information should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements and the
notes thereto, included elsewhere in this report.
 
OPERATING INFORMATION:
 
<TABLE>
<CAPTION>
                                                                      TRANSITION
                                                                     PERIOD ENDED
                                    YEARS ENDED DECEMBER 31,         DECEMBER 31,    YEARS ENDED JUNE 30,
                              ------------------------------------   -----------    -----------------------
                                 1996         1995         1994          1993          1993         1992
                              ----------   ----------   ----------   ------------   ----------   ----------
                                             (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S>                          <C>           <C>           <C>           <C>           <C>          <C>
Revenues                     $   343,321   $   167,042   $   121,287   $    41,645   $   109,704  $   119,518
Operating income (loss)         (381,312)      (60,870)       25,741       (69,057)      (56,981)        (599)
Net income (loss)               (405,451)      (65,960)       21,145       (73,258)      (57,250)      (4,983)
Net income (loss) per
  share (fully diluted)      $     (9.94)  $     (2.65)  $      1.04   $     (5.01)  $     (4.36) $      (.47)
Weighted average number
  of shares outstanding --
  fully diluted               40,801,000    24,855,000    21,115,000    14,618,000    13,129,000   10,502,000
</TABLE>
 
BALANCE SHEET INFORMATION:
 
<TABLE>
<CAPTION>
                                                   DECEMBER 31,                       JUNE 30,
                                     -----------------------------------------   -------------------
                                       1996       1995       1994       1993       1993       1992
                                     --------   --------   --------   --------   --------   --------
                                                             (IN THOUSANDS)
<S>                                  <C>        <C>         <C>        <C>       <C>        <C>
Total assets                         $793,518   $900,413    $90,815    $79,334   $128,474   $132,862
Total long-term obligations           574,928    561,101     21,859     24,687     30,248     23,449
Total stockholders' equity
  (deficit)                           104,937    214,519     37,485     (8,632)    61,933     87,049
</TABLE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS
 
     The following discussion should be read in conjunction with the
consolidated financial statements and the notes thereto, and the information
included elsewhere herein. All dollar amounts presented in this Management's
Discussion and Analysis of Financial Condition and Results of Operations are
presented in thousands, except share and per share amounts.
 
GENERAL
 
  Business Combinations
 
     On February 4, 1994, the Company completed a three-way business combination
(the "Three-Party Combination") among SoftKey Software Products Inc. ("Former
SoftKey"), WordStar International Incorporated ("WordStar") and Spinnaker
Software Corporation ("Spinnaker"). The Three-Party Combination was accounted
for using the pooling-of-interests method of accounting. On February 4, 1994,
WordStar changed its name to SoftKey International Inc. and on October 24, 1996,
changed its name to The Learning
 
                                       13
<PAGE>   16
 
Company, Inc. ("TLC" or the "Company"). See "Consolidated Financial
Statements -- Note 2 -- Business Combinations" for further discussion.
 
     On May 17, 1996, the Company acquired Minnesota Educational Computing
Corporation (MECC) ("MECC"), a publisher and developer of high quality
educational software for children sold to consumers and schools, in exchange for
9,214,007 shares of common stock. The total purchase price was $284,631,
including estimated transaction costs, the value of stock options assumed and
deferred income taxes related to certain identifiable intangible assets
acquired. In the transaction, approximately 1,048,000 MECC employee stock
options were converted into options to purchase approximately 1,198,000 shares
of TLC common stock. The transaction was accounted for as a purchase.
 
     On August 12, 1996, the Company acquired Edusoft S.A. ("Edusoft"), an
educational software company located in Paris, France, in exchange for the
issuance of 752,275 shares of common stock. The total purchase price was
$13,313, including estimated transaction costs. In addition, certain
stockholders are eligible to earn additional purchase price dependent upon
future operating results and certain other conditions. The amount may be settled
annually in shares of the Company's common stock, the number of which is to be
determined on a volume-weighted average of the closing stock price following the
close of each fiscal year. This acquisition was accounted for as a purchase.
 
     On December 28, 1995, the Company purchased Compton's NewMedia, Inc. and
Compton's Learning Company (collectively, "Compton's"), developers and
publishers of educational and reference multimedia software titles and each a
former wholly-owned subsidiary of Tribune Company. In and in connection with the
acquisition, the Company issued a total of 5,052,697 shares of common stock,
which included 587,036 shares to settle $14,000 of intercompany debt to Tribune
Company and executed a promissory note to Tribune Company for $3,000 in
cancellation of certain remaining intercompany indebtedness. The total purchase
price was $104,394, including estimated transaction costs, settlement of certain
intercompany debt to Tribune Company, deferred income taxes related to certain
identifiable intangible assets acquired and assumption of the fair value of net
liabilities of Compton's. The $3,000 promissory note was repaid in 1996 by the
issuance of 158,099 shares of common stock. The transaction was accounted for as
a purchase.
 
     On December 22, 1995, the Company acquired control of The Learning Company
("The Former Learning Company"), a leading developer of education software
products for use at home and school. Under the terms of the merger agreement,
the Company acquired, in a two step business combination, all of the outstanding
common stock of The Former Learning Company for total consideration of $684,066,
including estimated transaction costs, value of stock options assumed and
deferred income taxes related to certain identifiable intangible assets
acquired. Approximately $543,163 of the purchase price was settled in cash.
Approximately 1.1 million unvested Former Learning Company stock options were
assumed and converted into stock options to purchase 3,123,000 shares of TLC
common stock, based on the merger consideration of $67.50 per share, and were
vested on or before January 26, 1996. This transaction was accounted for as a
purchase.
 
     On August 31, 1995, the Company acquired all of the issued and outstanding
capital stock of Future Vision Holding, Inc. ("Future Vision"), a multimedia
software company, in exchange for 1,088,149 shares of common stock. This
transaction was accounted for using the pooling-of-interests method of
accounting. The consolidated financial statements of the Company for the years
prior to December 31, 1995 included in this report do not include the results
and balances of Future Vision as they were determined to be immaterial to the
consolidated financial statements for those periods.
 
     On July 21, 1995, the Company acquired tewi Verlag GmbH ("tewi"), a German
software publisher and distributor, for a combination of cash and stock. This
transaction was accounted for as a purchase. One of the former stockholders of
tewi is eligible to receive additional consideration for the purchase up to a
maximum of DM 1,080 in each of fiscal 1996 and 1997 based upon achievement of
certain revenue and profitability goals. The amount may be settled annually in
shares of the Company's common stock, the number of which to be determined based
on a volume-weighted average of the closing stock price following the closing of
each fiscal year.
 
                                       14
<PAGE>   17
 
  Fiscal Periods
 
     On January 27, 1994, the Company changed its fiscal year end to the 52 or
53 weeks ending on or after December 31. For clarity of presentation herein, all
references to the Year Ended December 31, 1996 relate to the period January 7,
1996 to January 4, 1997; all references to the Year Ended December 31, 1995
relate to the period January 1, 1995 to January 6, 1996; all references to the
Year Ended December 31, 1994 relate to the period January 2, 1994 to December
31, 1994.
 
  Period-to-Period Comparisons
 
     A variety of factors may cause period-to-period fluctuations in the
Company's operating results, including the integration of operations resulting
from acquisitions of companies, revenues and expenses related to the
introduction of new products or new versions of existing products, delays in
customer purchases in anticipation of upgrades to existing products, currency
fluctuations, dealer and distributor order patterns and seasonality of buying
patterns of customers. Historical operating results are not indicative of future
operating results and performance. This is particularly true of historical data
presented herein, which reflects the results of TLC prior to its acquisitions of
The Former Learning Company, MECC and Compton's.
 
     Certain prior period amounts have been reclassified in order to conform
with current year presentation.
 
  Summary of Results
 
     The following table summarizes the audited results of operations of the
Company for the periods shown. Reference is made to the Consolidated Financial
Statements included in this report and on which the following table is based.
 
<TABLE>
<CAPTION>
                                                             YEARS ENDED DECEMBER 31,
                                                        -----------------------------------
                                                          1996          1995         1994
                                                        ---------     --------     --------
    <S>                                                 <C>           <C>          <C>
    Revenues                                            $ 343,321     $167,042     $121,287
    Operating income (loss)                              (381,312)     (60,870)      25,741
    Net income (loss)                                    (405,451)     (65,960)      21,145
    Net income (loss) per share (fully diluted)         $   (9.94)    $  (2.65)    $   1.04
</TABLE>
 
     Operating income (loss) includes amortization and merger related charges
related to acquisitions of $501,330, $103,172 and $2,432 in the Years Ended
December 31, 1996, 1995 and 1994, respectively.
 
RESULTS OF OPERATIONS -- YEAR ENDED DECEMBER 31, 1996 AS COMPARED TO YEAR ENDED
DECEMBER 31, 1995
 
  Revenues
 
     Revenues by distribution channel for the Years Ended December 31, 1996 and
1995 are as follows:
 
<TABLE>
<CAPTION>
                                            YEAR ENDED                      YEAR ENDED
                                           DECEMBER 31,     % OF TOTAL     DECEMBER 31,     % OF TOTAL
    DISTRIBUTION CHANNEL                       1996          REVENUES          1995          REVENUES
    --------------------                   ------------     ----------     ------------     ----------
    <S>                                      <C>                <C>          <C>                <C>
    Retail                                   $174,812            51          $ 75,734            45
    OEM                                        27,855             8            20,021            12
    School                                     21,701             6                --            --
    Direct response                            38,548            11            26,203            16
    International                              57,684            17            25,631            15
    Tax software and services                  22,721             7            19,453            12
                                             --------           ---          --------           ---
                                             $343,321           100          $167,042           100
                                             ========           ===          ========           ===
</TABLE>
 
     Total revenues increased 106% in the Year Ended December 31, 1996 as
compared to the Year Ended December 31, 1995 due to several factors, including
the effect of revenues from the acquisitions of The Former Learning Company,
Compton's and MECC and an increase in sales of new and upgraded products
launched by the Company during the year. Retail revenues increased as a result
of the acquisitions of The
 
                                       15
<PAGE>   18
 
Former Learning Company, Compton's and MECC plus a general increase in sales of
consumer software products through retailers such as Wal-Mart, Office Depot,
K-Mart and OfficeMax and sales from new and upgraded products. International
sales increased primarily as a result of the acquisition of Edusoft in 1996, a
full year of sales from tewi which was acquired in July 1995 and an increase in
the number of translated foreign language versions of the Company's products
available for sale in the international markets. Original equipment manufacturer
("OEM") revenues increased due to the availability of new product offerings for
this channel and an increased demand for multi-language titles. Direct response
revenues increased on a dollar basis but decreased as a percentage of revenues
due to the overall increase in revenues resulting from product sales of the
acquired companies, which did not formerly participate in the direct response
channel. Direct response revenues also increased as a result of the introduction
of an outbound telephone sales program during 1996. Prior to the acquisitions of
The Former Learning Company and MECC, the Company did not participate in the
school channel. Revenues from tax software and services increased for the Year
Ended December 31, 1996 as compared to the Year Ended December 31, 1995 as a
result of earlier delivery of product to the Company's customers.
 
     The Company expects that its future revenue growth will depend on, among
other things, its ability to introduce new and upgraded products to the
marketplace, the extent of competition, unit pricing trends, the rate of
proliferation of personal computers into the home market and the demand for its
consumer software products along with the Company's respective share in the
consumer software market. Unit pricing will be affected by the extent of
competition in the consumer software industry, which is expected to increase. In
addition, the Company's ability to develop products for new platforms and
introduce titles into new distribution channels will impact future revenues and
growth rates. The consumer software industry has experienced continued
consolidation of formerly independent companies. To the extent that these
companies gain greater market share than the Company, future results will be
affected negatively. During 1996, the Company experienced lower dollar and unit
market share in the retail consumer software market in the United States as
compared to the prior year. The Company believes that this combined company loss
of market share is due primarily to the entrance of large competitors with well
known brands such as Disney and Mattel and due to the success of a certain
number of its competitors' strategies to introduce lower priced offerings and
reduce current pricing. As a result of this increased competition the Company's
future revenues and market share may be adversely effected.
 
  Costs and Expenses
 
     The Company's costs and expenses and the respective percentages of revenues
for the Year Ended December 31, 1996 as compared to the Year Ended December 31,
1995 are as follows:
 
<TABLE>
<CAPTION>
                                            YEAR ENDED                      YEAR ENDED
                                           DECEMBER 31,     % OF TOTAL     DECEMBER 31,     % OF TOTAL
                                               1996          REVENUES          1995          REVENUES
                                           ------------     ----------     ------------     ----------
    <S>                                      <C>                <C>          <C>                <C>
    Costs of production                      $ 91,045            27          $ 53,070            32
    Sales and marketing                        67,690            20            38,370            23
    General and administrative                 28,550             8            20,813            12
    Research and development                   36,018            10            12,487             7
    Amortization and merger related
      charges                                 501,330           146           103,172            62
                                             --------           ---          --------           ---
                                             $724,633           211          $227,912           136
                                             ========           ===          ========           ===
</TABLE>
 
     Total costs and expenses increased as a percentage of revenues to 211% in
the Year Ended December 31, 1996, as compared with 136% in the Year Ended
December 31, 1995. This increase as a percentage of revenues was caused
primarily by the charges for incomplete technology, the amortization of goodwill
and acquired technology resulting from the acquisitions of The Former Learning
Company, Compton's and MECC, offset by the reduction in general and
administrative costs, sales and marketing costs and costs of production as a
percentage of revenues as a result of the integration and centralization of the
operations of the acquired companies.
 
     Costs of production includes the cost of manuals, packaging, diskettes and
CD-ROM disks, duplication, assembly and fulfillment charges. In addition, costs
of production includes royalties paid to third party
 
                                       16
<PAGE>   19
 
developers and inventory obsolescence reserves. Costs of production, as a
percentage of revenues, decreased to 27% in the Year Ended December 31, 1996 as
compared to 32% in the Year Ended December 31, 1995. The decrease in costs of
production as a percentage of revenues was caused by reduced prices on the cost
to manufacture product due to increased unit volumes, changes in the production
components, the impact from The Former Learning Company and MECC having
historically higher gross margin selling products than the Company prior to the
acquisitions. In addition, during 1996 the Company experienced an increase in
revenues in the OEM, school and direct response channels, all of which typically
experience higher gross margins than the Company's traditional retail box
product sales channel. As well, the Company has seen an increase in sales of its
Value line of products, which, due to the nature of the low cost packaging in a
jewel-case, also generate higher gross margins.
 
     The Company expects costs of production as a percentage of revenues to
increase in the foreseeable future due to sales pricing pressure on its products
by retailers. In February 1997, the Company moved a substantial portion of its
North American manufacturing operations from Stream International Inc., located
in Utah, to Sonopress, Inc. and BMG Distribution, units of Bertelsmann AG,
located in North Carolina. There can be no assurance that the Company will not
experience transition difficulties in connection with this move, which in turn
could result in higher costs of production and shipping delays to customers. If
the Company experiences higher costs of production and shipping delays, its
results of operations may be adversely affected.
 
     Sales and marketing expenses decreased to 20% of revenues in the Year Ended
December 31, 1996 as compared to 23% of revenues in the Year Ended December 31,
1995. The percentage decrease was a result of the Company reducing both fixed
costs and employee headcount of its combined operations following the
acquisitions in late 1995 and May 1996.
 
     General and administrative expenses decreased to 8% of revenues in the Year
Ended December 31, 1996 as compared to 12% in the Year Ended December 31, 1995.
This is primarily the result of a general reduction in overhead costs and
employee headcount following the acquisitions in 1995 and 1996.
 
     Research and development expenses increased to 10% of revenues for the Year
Ended December 31, 1996 as compared to 7% in the Year Ended December 31, 1995.
The increase is a result of a higher proportion of internally developed products
from The Former Learning Company, Compton's and MECC than developed by the
Company prior to these acquisitions. The Company expects that as technologies
become more complex it will continue to spend an increasing percentage of its
revenues on research and development.
 
     Amortization and merger related charges increased to 146% of revenues in
the Year Ended December 31, 1996 as compared to 62% in the Year Ended December
31, 1995. The increase results from the amortization of the goodwill and
acquired technology arising on the acquisitions of The Former Learning Company
and Compton's for a full year in the Year Ended December 31, 1996 as compared to
less than a month in the Year Ended December 31, 1995, and from the amortization
of goodwill and acquired technology and the charge for incomplete technology
arising from the acquisition of MECC in May 1996.
 
     Amortization and merger related charges are as follows:
 
<TABLE>
<CAPTION>
                                                                      YEARS ENDED
                                                                     DECEMBER 31,
                                                                 ---------------------
                                                                   1996         1995
                                                                 --------     --------
        <S>                                                      <C>          <C>
        Amortization of goodwill and other assets                $333,858     $ 24,783
        Amortization of acquired technology                       101,008        7,185
        Charge for incomplete technology                           56,688       60,483
        Employee severance costs                                    4,260        1,304
        Provision for earn-outs                                     2,917           --
        Professional fees and other transaction related costs       1,267        5,653
        Other                                                       1,332        1,131
        Provision for litigation                                       --        2,633
                                                                 --------     --------
                                                                 $501,330     $103,172
                                                                 ========     ========
</TABLE>
 
                                       17
<PAGE>   20
 
     The increase in amortization of goodwill and other assets in the Year Ended
December 31, 1996 as compared to the Year Ended December 31, 1995 relates
primarily to the goodwill resulting from acquisitions of MECC in May 1996 and a
full year of amortization of goodwill arising from The Former Learning Company
and Compton's, which were acquired in December 1995. Goodwill is primarily being
amortized on a straight-line basis over two years.
 
     The increase in amortization of technology and of product related costs in
the Year Ended December 31, 1996 as compared to the Year Ended December 31, 1995
relates to the amortization of acquired technology in connection with the
acquisition of MECC in May 1996 and a full year of amortization of technology
and product related costs arising from The Former Learning Company and
Compton's, which were acquired in December 1995.
 
     The charge for incomplete technology for the Year Ended December 31, 1996
relates to products being developed by MECC and in the Year Ended December 31,
1995 for products developed by The Former Learning Company and Compton's which
the Company believes had not yet reached technological feasibility at the date
of acquisition and for which additional development was required to complete the
software technology and products.
 
     Employee severance costs in each year related to severance paid to
employees of the Company terminated in connection with the acquisitions.
 
     The provision for earn-outs relates to additional payments which may be
earned by the former owners of certain international acquisitions purchased in
1996 and 1995. The earn-out requirements are based upon meeting certain
financial and other goals and will be recorded when those conditions are met.
 
     Professional fees decreased in the Year Ended December 31, 1996 as compared
to the Year Ended December 31, 1995 due to decreased charges related to the
investment banking, legal and accounting costs.
 
  Interest Income (Expense)
 
     Interest income (expense) increased to a net expense of $24,139 in the Year
Ended December 31, 1996 as compared to net income of $705 in 1995 as a result of
increased interest expense arising from the Senior Convertible Notes issued by
the Company in 1995.
 
RESULTS OF OPERATIONS -- YEAR ENDED DECEMBER 31, 1995 AS COMPARED TO YEAR ENDED
DECEMBER 31, 1994
 
  Revenues
 
     Revenues by distribution channel for the Years Ended December 31, 1995 and
1994 are as follows:
 
<TABLE>
<CAPTION>
                                           YEAR ENDED                      YEAR ENDED
                                          DECEMBER 31,     % OF TOTAL     DECEMBER 31,     % OF TOTAL
    DISTRIBUTION CHANNEL                     1995          REVENUES          1994          REVENUES
    --------------------                  ------------     ----------     ------------     ----------
    <S>                                     <C>                <C>          <C>                <C>
    Retail                                  $ 75,734            45          $ 48,085            39
    OEM                                       20,021            12            15,912            13
    Catalog                                       --            --             3,176             3
    Direct response                           26,203            16            17,951            15
    International                             25,631            15            13,067            11
    Tax software and services                 19,453            12            18,158            15
    Lansa software                                --            --             4,938             4
                                            --------           ---          --------           ---
                                            $167,042           100          $121,287           100
                                            ========           ===          ========           ===
</TABLE>
 
     Total revenues increased by 38% in the Year Ended December 31, 1995 as
compared to the Year Ended December 31, 1994 due to general growth in the
consumer software market and the expansion of market share by the Company
through various acquisitions and new product offerings. Retail revenues
increased by 58% in the Year Ended December 31, 1995 as compared to the Year
Ended December 31, 1994 due to the foregoing as well as an increase in the
number of North American retail outlets selling the Company's products from
approximately 15,000 to 22,000, an increase in the number of products available
for sale and an increase in the sales of the Company's Platinum "jewel-case
only" line of products, which was launched in December 1994.
 
                                       18
<PAGE>   21
 
OEM sales increased by 26% in the Year Ended December 31, 1995 as compared to
the Year Ended December 31, 1994 primarily due to the acquisition of Future
Vision which had a strong presence and sales network in the OEM channel. Direct
response sales increased by 46% in the Year Ended December 31, 1995 as compared
to the Year Ended December 31, 1994 primarily due to an increase in the number
of mailings completed by the Company during the year. The Company's
international revenues increased by 96% in the Year Ended December 31, 1995 as
compared to the Year Ended December 31, 1994. This increase was driven by both
the acquisition of tewi, a German software company, on July 21, 1995 and
increased penetration of personal computers in Europe, which in turn caused an
increase in demand for and sales of consumer software products. Tax software and
services revenues were relatively constant on a year over year basis due to
increasing competition and the saturation of the tax software market in Canada.
During 1994, the Company closed its catalog operations and sold its Lansa
software operations.
 
  Costs and Expenses
 
     The Company's costs and expenses and the respective percentages of revenues
for the Year Ended December 31, 1995 as compared to the Year Ended December 31,
1994 are as follows:
 
<TABLE>
<CAPTION>
                                           YEAR ENDED                      YEAR ENDED
                                          DECEMBER 31,     % OF TOTAL     DECEMBER 31,     % OF TOTAL
                                              1995          REVENUES          1994          REVENUES
                                          ------------     ----------     ------------     ----------
    <S>                                     <C>                <C>           <C>                <C>
    Costs of production                     $ 53,070            32           $37,885            31
    Sales and marketing                       38,370            23            27,274            22
    General and administrative                20,813            12            21,259            18
    Research and development                  12,487             7             6,696             6
    Amortization and merger related
      charges                                103,172            62             2,432             2
                                            --------           ---           -------            --
                                            $227,912           136           $95,546            79
                                            ========           ===           =======            ==
</TABLE>
 
     Costs of production are comprised of, among other things, the cost of
product documentation, packaging and disks. Other items included in costs of
production are royalties to third-party developers and reserves for obsolete
inventory. Costs of production as a percentage of revenues increased to 32% in
the Year Ended December 31, 1995 from 31% in the Year Ended December 31, 1994.
Costs of production increased in the Year Ended December 31, 1995 primarily due
to the acquisition of tewi, which operates at a higher costs of production due
to the distribution element of its revenue base. This increase was somewhat
offset by lower costs of production caused by improved manufacturing costs in
North America, which primarily relate to the lower cost of purchasing CD-ROMs
and a greater proportion of business on CD-ROM as compared to magnetic disk.
 
     Sales and marketing expenses increased slightly as a percentage of revenues
in the Year Ended December 31, 1995 as compared to the Year Ended December 31,
1994 due to a higher proportion of the Company's revenues arising from its
international and direct response distribution channels. Each of these
distribution channels have higher sales and marketing costs as a percentage of
revenues than the other distribution channels of the Company.
 
     General and administrative expenses were lower on a percentage of revenues
basis in the Year Ended December 31, 1995 as compared to the Year Ended December
31, 1994, but are relatively consistent with the prior year in absolute dollar
amounts due to flat employee head count.
 
     Amortization and merger related charges increased to $103,172 in the Year
Ended December 31, 1995 as compared to $2,432 in the Year Ended December 31,
1994. The increase is related to the amortization and merger related charges
associated with the acquisitions of The Former Learning Company, Compton's, tewi
and Future Vision, among others, during the Year Ended December 31, 1995 and
certain charges associated with the merger with MECC.
 
                                       19
<PAGE>   22
 
     Amortization and merger related charges are as follows:
 
<TABLE>
<CAPTION>
                                                                       YEARS ENDED
                                                                      DECEMBER 31,
                                                                   -------------------
                                                                     1995        1994
                                                                   --------     ------
        <S>                                                        <C>          <C>
        Charge for incomplete technology                           $ 60,483     $   --
        Amortization of goodwill and other assets                    24,783      1,185
        Amortization of technology and product related costs          7,185        422
        Professional fees and transaction related costs               5,653        636
        Other                                                         5,068        189
                                                                   --------     ------
                                                                   $103,172     $2,432
                                                                   ========     ======
</TABLE>
 
     The charge for incomplete technology relates to products being developed by
The Former Learning Company and Compton's which the Company believes had not yet
reached technological feasibility at the date of acquisition and for which
additional development was required to complete the software technology and
products.
 
     The increase in amortization of goodwill and other assets relates primarily
to the goodwill resulting from acquisitions of The Former Learning Company,
Compton's and tewi and a full year's amortization of the goodwill resulting from
the acquisition of Software Marketing Corporation, which was acquired in
September 1994. Goodwill is primarily being amortized on a straight-line basis
over two years.
 
     The increase in amortization of technology and of product related costs in
the Year Ended December 31, 1995 as compared to the Year Ended December 31, 1994
relates to the amortization of completed technology and products acquired in
connection with the acquisitions of The Former Learning Company and Compton's
plus increased amortization of product development costs related to products
acquired in connection with the merger with Future Vision during the year.
 
     Professional fees increased in the Year Ended December 31, 1995 as compared
to the Year Ended December 31, 1994 due to charges related to the investment
banking, legal and accounting costs incurred through year end for the merger
with MECC and the professional fees associated with the acquisition of Future
Vision on August 31, 1995. Approximately $3,500 of these costs remained to be
paid at December 31, 1995. The remainder was paid prior to December 31, 1996.
Professional fees in 1994 were for investment banking, accounting and legal fees
incurred in connection with the acquisitions of Aris Multimedia Entertainment,
Inc. and Compact Publishing, Inc.. These costs have been paid. The other costs
relate primarily to the consolidation of the acquired facilities and related
work force reductions and litigation costs.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Cash and cash equivalents increased to $110,120 at December 31, 1996 from
$77,832 at December 31, 1995. This increase was attributable to the cash
provided by general operations, cash received from the acquisition of MECC of
$21,481 and proceeds from stock option exercises and other stock related
transactions of $27,905, offset by the repayment of approximately $38,091 of
merger related liabilities, repurchase of Senior Convertible Notes of $18,350
and purchases of equipment for $4,939. During the Year Ended December 31, 1996
the Company paid $25,025 of amounts due to the stockholders of The Former
Learning Company as the remaining purchase price due from the acquisition in
1995 and drew $25,000 on its line of credit. During the Year Ended December 31,
1996 the Company generated cash from operations of $65,655.
 
     As of February 6, 1997, the Company has outstanding $331,650 principal
amount 5 1/2% Senior Convertible Notes due 2000 (the "Senior Convertible Notes")
and $150,000 principal amount 5 1/2% Senior Convertible/Exchangeable Notes due
2000 held by the Tribune Company (the "Tribune Notes"). The Senior Convertible
Notes and Tribune Notes will be redeemable by the Company on or after November
2, 1998 at declining redemption prices. Should the Senior Convertible Notes and
the Tribune Notes not convert under their terms into common stock, there can be
no assurances that the Company will have sufficient cash flows
 
                                       20
<PAGE>   23
 
from future operations to meet payment requirements under the debt or be able to
re-finance the notes under favorable terms or at all.
 
     On August 1, 1996, the Company announced that its Board of Directors
authorized the repurchase by the Company over the next twelve months of up to
$50 million principal amount of its Senior Convertible Notes from time to time
in the open market and privately negotiated transactions. Any purchases would
depend on price, market conditions and other factors. During the Year Ended
December 31, 1996 Senior Convertible Notes declined by $18,350 through
repurchases.
 
     In March 1997, the Company announced that its Board of Directors authorized
the repurchase by the Company of up to 3 million shares of its common stock from
time to time in open market and privately negotiated transactions. Any purchases
would depend on price, market conditions and other factors.
 
     The Company also has in place a revolving line of credit (the "Line") with
a bank, to provide for a maximum availability of $50,000. Borrowings under the
Line become due on July 1, 1998 and bear interest at the prime rate (8.25% at
December 31, 1996). The Line is subject to certain financial covenants, is
secured by a general security interest in certain operating subsidiaries of the
Company and by a pledge of the stock of certain of its subsidiaries. The Line is
guaranteed by the Company. There was $25,000 drawn on the Line at December 31,
1996, which has been subsequently repaid.
 
     Income generated by the Company's subsidiaries in certain foreign countries
cannot be repatriated to the Company in the United States without payment of
additional taxes since the Company does not currently receive a U.S. tax credit
with respect to income taxes paid by the Company (including its subsidiaries) in
those foreign countries. The Company also conducts its tax software business in
Canada, which has experienced foreign currency exchange rate fluctuation
relative to the US dollar.
 
     At the present time, the Company expects that its cash and cash equivalents
and cash flows from operations will be sufficient to finance the Company's
operations for at least the next twelve months. Longer-term cash requirements
are dictated by a number of external factors, which include the Company's
ability to launch new and competitive products, the strength of competition in
the consumer software industry and the growth of the home computer market. In
addition, the Company's Senior Convertible Notes and Tribune Notes mature in the
year 2000. If not converted to common stock, the Company may be required to
secure alternative financing sources. There can be no assurance that alternative
financing sources will be available on terms acceptable to the Company in the
future or at all. The Company continuously evaluates products and technologies
for acquisitions, however no estimation of short-term or long-term cash
requirements for such acquisitions can be made at this time.
 
                            FUTURE OPERATING RESULTS
 
     The Company operates in a rapidly changing environment that is subject to
many risks and uncertainties. Some of the important risks and uncertainties
which may cause the Company's operating results to differ materially or
adversely are discussed below and elsewhere in this Annual Report on Form 10-K.
 
INTENSE COMPETITIVE ENVIRONMENT
 
     The consumer software industry is intensely and increasingly competitive
and is characterized by rapid changes in technology and customer requirements.
The Company competes for retail shelf space and general consumer awareness with
a number of companies that market consumer software. The Company encounters
competition from both established companies, including the largest companies in
the industry, and new companies that may develop comparable or superior
products. A number of the Company's competitors and potential competitors
possess significantly greater capital, marketing resources and brand recognition
than the Company. Rapid changes in technology, product obsolescence and advances
in computer software and hardware require the Company to develop or acquire new
products and to enhance its existing products on a timely basis. The Company's
marketplace has recently experienced a higher emphasis on on-line and Internet
related services and content tailored for this new delivery vehicle. To the
extent that demand increases for on-line products and content, the demand for
the Company's existing products may change. There can be no
 
                                       21
<PAGE>   24
 
assurance that the Company will be able to successfully maintain market share
and otherwise compete successfully in the future.
 
     Competitive pressures in the software industry have resulted, and the
Company believes are likely to continue to result, in pressure to reduce the
prices of its products or risk loss of market share. In response to such
competitive pressures the Company has reduced the price of certain of its
educational products. There can be no assurance that Company's product prices
will not continue to decline in the future or that the Company will not respond
to such declines with additional price reductions. Such price reductions may
reduce the Company's revenues and operating margins in the future.
 
     Large companies with substantial bases of intellectual property content in
the motion picture and media industries, sophisticated product marketing and
technical abilities and/or financial resources that may not need to realize an
immediate profit or return on investment have increasingly entered or announced
their intention to enter the consumer software market. These competitors include
Microsoft, Disney, Mattel, Hasbro and CUC International Inc. For example,
technology companies have begun to acquire greater access to content, and
content-oriented companies have begun to acquire greater technological
capabilities. To the extent that competitors achieve a performance, price or
distribution advantage, the Company could be adversely affected. Furthermore,
increased consolidation of the consumer software market may impact future growth
potential and performance.
 
     In the retail distribution channel resellers typically have a limited
amount of shelf space and promotional resources. There is intense competition
for high quality and adequate levels of shelf space and promotional support from
retailers. To the extent that the number of consumer computer platforms and
products increases, this competition for shelf space may also increase. The
retail channel increasingly includes non-traditional software retailers such as
book, music, video, magazine, toy, gift, convenience, drug and grocery store
chains. Mass merchants such as Wal-Mart and K-Mart are increasingly becoming a
larger portion of the Company's sales. As these retailers achieve greater market
share from the traditional software retailers, the Company may experience higher
marketing costs and increased competition for shelf space, which could impact
future sales and operating margins. Additionally, as technology changes, the
type and number of distribution channels will further change and new types of
competitors, such as cable or telephone companies, are likely to emerge. There
can be no assurance that the Company will compete effectively in these channels.
 
     The retail channels of distribution available for products are subject to
rapid changes as retailers and distributors enter and exit the consumer software
market or alter their product inventory preferences. Other types of retail
outlets and methods of product distribution may become important in the future.
These new methods may include delivery of software using on-line services or the
Internet which will necessitate certain changes in the Company's business and
operations including addressing operational challenges such as improving
download time for pictures, images and programs, ensuring proper regulation of
content quality and developing sophisticated security for transmitting payments.
Should on-line distribution channels increase, the Company will be required to
modify its existing technology platforms in order for its products to be
compatible and remain competitive. It is critical to the success of the Company
that, as these changes occur, it maintain access to those channels of
distribution offering software in its market segments.
 
NEW PRODUCTS AND RAPID TECHNOLOGICAL CHANGE
 
     The Company operates in a highly competitive and technology driven
environment. The consumer software industry is undergoing substantial change and
is subject to a high level of uncertainty. Software companies must continue to
develop or acquire new products or upgrade existing products on a timely basis
to sustain revenues and profitable operations. Factors contributing to the short
life span of PC software have included rapid technological change and an
expanded demand for content-rich products. Software companies must continue to
create or acquire innovative new products reflecting technological changes in
hardware and software and translate current products into newly accepted
hardware and software formats, in order to gain and maintain a viable market for
their products. PC hardware, in particular, is steadily advancing in power and
function, expanding the market for increasingly complex and flexible software
products. This has also resulted in longer periods necessary for research and
development of new products and a greater degree of
 
                                       22
<PAGE>   25
 
unpredictability in the time necessary to develop products. Furthermore, the
rapid changes in the market and the increasing number of new products available
to consumers have increased the degree of consumer acceptance risk with respect
to any specific title that the Company may publish. It is expected that this
trend will continue and may become more pronounced in the future.
 
     Similarly, the Company's recent product-content focus and enhanced presence
in the educational and reference software market have required and will continue
to require the Company to evaluate and adopt appropriate development and
marketing strategies and methods, which may differ from those historically
employed by the Company and subject the Company to the risks and competitive
pressures associated with those new strategies.
 
     The Company's rights to license many of its software products are
non-exclusive and, generally, of limited duration, and there is no assurance the
Company will be able to continue to obtain new products from developers or to
maintain or expand its market share in the event that a competitor offers the
same or similar software products. If the Company is unable to develop or
acquire new products in a timely manner as revenues decrease from products
reaching the end of their natural life cycle, the Company's results of
operations will be adversely affected.
 
DEPENDENCE ON MAJOR SUPPLIER
 
     In 1996, the production, assembly and distribution of the Company's North
American budget, jewel-case only line of products was performed by two units of
Bertelsmann AG (collectively, "BMG"), and the production, assembly and
distribution of the Company's other North American products, with certain
exceptions (including duplication of CD-ROM disks, School and OEM products), was
performed by Stream International, Inc. In February 1997, BMG began to provide
substantially all duplication, assembly and fulfillment of the Company's North
American products, other than school products. While the Company believes that
its expanded relationship with BMG will result in greater manufacturing and
fulfillment efficiency, there can be no assurance that the Company will not
experience difficulties or delays in the manufacture and fulfillment as a result
of the transition of those functions. The Company believes that its existing
production capacity is sufficient to handle anticipated increases in volume and
titles into the foreseeable future. Although the Company believes that suitable
alternative suppliers exist, there can be no assurance that any termination or
modification of its arrangement with BMG would not result in a short-term
business interruption for the Company.
 
EFFECT OF NEW ACCOUNTING PRONOUNCEMENT
 
     The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share", which modifies
the way in which earnings per share ("EPS") is calculated and disclosed.
Currently, the Company discloses primary and fully diluted EPS. Upon adoption of
this standard for the fiscal year ending December 27, 1997, the Company will
disclose basic and diluted EPS for fiscal 1997 and will restate all prior period
EPS data presented. Basic EPS excludes dilution and is computed by dividing
income available to common stockholders by the weighted-average number of common
shares outstanding for this period. Diluted EPS, similar to fully diluted EPS,
reflects the potential that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shares in the earnings of the entity.
Management believes the adoption of SFAS 128 will not have a material impact on
reported earnings per share.
 
ITEM 8.  CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
     See Index to Consolidated Financial Statements set forth on page 24 hereof.
 
                                       23
<PAGE>   26
 
                           THE LEARNING COMPANY, INC.
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                                        PAGE
                                                                                        ----
<S>                                                                                      <C>
Report of Independent Accountants                                                        25

Consolidated Balance Sheets as of December 31, 1996 and 1995                             26

Consolidated Statements of Operations for the Years Ended December 31, 1996,
  1995 and 1994                                                                          27

Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended
  December 31, 1996, 1995 and 1994                                                       28

Consolidated Statements of Cash Flows for the Years Ended December 31, 1996,
  1995 and 1994                                                                          29

Notes to Consolidated Financial Statements                                               31

Financial Statement Schedule of Valuation and Qualifying Accounts for the Years Ended
  December 31, 1996, 1995 and 1994                                                       46
</TABLE>
 
                                       24
<PAGE>   27
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Stockholders and the Board of Directors of
  The Learning Company, Inc.:
 
     We have audited the accompanying consolidated balance sheets of The
Learning Company, Inc. (formerly known as SoftKey International Inc.) as of
January 4, 1997 and January 6, 1996 and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three fiscal
years in the period ended January 4, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of The Learning
Company, Inc. as of January 4, 1997 and January 6, 1996 and the consolidated
results of its operations and its cash flows for each of the three fiscal years
in the period ended January 4, 1997 in conformity with generally accepted
accounting principles.
 
     In connection with our audits of the financial statements referred to
above, we have also audited the related financial statement schedule of
valuation and qualifying accounts. In our opinion, this financial statement
schedule for each of the three fiscal years in the period ended January 4, 1997,
when considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
 
                                          COOPERS & LYBRAND L.L.P.
 
Boston, Massachusetts
March 27, 1997

 
                                       25
<PAGE>   28
 
                           THE LEARNING COMPANY, INC.
                          CONSOLIDATED BALANCE SHEETS
               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                     DECEMBER 31,     DECEMBER 31,
                                                                         1996             1995
                                                                     ------------     ------------
<S>                                                                    <C>              <C>
ASSETS
 
Current assets:
  Cash and cash equivalents                                            $110,120         $ 77,832
  Accounts receivable, less allowances for returns and doubtful
     accounts of $15,191 and $6,851, respectively                        79,610           32,402
  Inventories                                                            15,894           18,997
  Other current assets                                                   20,349           23,627
                                                                       --------         --------
                                                                        225,973          152,858
                                                                       --------         --------
  Other long-term assets, net                                            22,975           19,621
  Goodwill and other intangible assets, net                             544,570          727,934
                                                                       --------         --------
                                                                       $793,518         $900,413
                                                                       ========         ========
LIABILITIES AND STOCKHOLDERS' EQUITY
 
Current liabilities:
  Accounts payable and accrued expenses                                $ 65,729         $ 47,485
  Line of credit                                                         25,000               --
  Merger related accruals                                                10,667           40,089
  Current portion of long-term obligations                                2,819              963
  Current portion of related party debt                                   5,264            4,314
  Purchase price payable                                                  3,245           25,353
  Other current liabilities                                                 929            6,589
                                                                       --------         --------
                                                                        113,653          124,793
                                                                       --------         --------
Long-term obligations:
  Long-term debt                                                        332,930          350,651
  Related party debt                                                    150,000          150,000
  Deferred income taxes                                                  86,920           57,119
  Other long-term obligations                                             5,078            3,331
                                                                       --------         --------
                                                                        574,928          561,101
                                                                       --------         --------
COMMITMENTS AND CONTINGENCIES (NOTE 7)
 
Stockholders' equity:
  Common stock, $.01 par value -- Authorized -- 120,000,000 and
     60,000,000 shares; issued and outstanding 44,379,781 and
     30,364,710 shares at December 31, 1996 and 1995, respectively          444              304
  Special voting stock -- Authorized and issued -- one share
     representing the voting rights of 1,551,428 and 1,596,742
     outstanding Exchangeable Shares (for common stock) at December
     31, 1996 and 1995, respectively                                         --               --
  Additional paid-in-capital                                            733,229          436,261
  Accumulated deficit                                                  (618,047)        (212,596)
  Cumulative translation adjustment                                     (10,689)          (9,450)
                                                                       --------         --------
                                                                        104,937          214,519
                                                                       --------         --------
                                                                       $793,518         $900,413
                                                                       ========         ========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                   statements
 
                                       26
<PAGE>   29
 
                           THE LEARNING COMPANY, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                      -------------------------------------------
                                                         1996            1995            1994
                                                      -----------     -----------     -----------
<S>                                                   <C>             <C>             <C>
REVENUES                                              $   343,321     $   167,042     $   121,287
COSTS AND EXPENSES:
  Costs of production                                      91,045          53,070          37,885
  Sales and marketing                                      67,690          38,370          27,274
  General and administrative                               28,550          20,813          21,259
  Research and development                                 36,018          12,487           6,696
  Amortization and merger related charges                 501,330         103,172           2,432
                                                      -----------     -----------     -----------
          Total operating expenses                        724,633         227,912          95,546
                                                      -----------     -----------     -----------
OPERATING INCOME (LOSS)                                  (381,312)        (60,870)         25,741
                                                      -----------     -----------     -----------
INTEREST INCOME (EXPENSE):
  Interest income                                           2,564           6,020             520
  Interest expense                                        (26,703)         (5,315)         (1,055)
                                                      -----------     -----------     -----------
          Total interest income (expense)                 (24,139)            705            (535)
                                                      -----------     -----------     -----------
INCOME (LOSS) BEFORE TAXES                               (405,451)        (60,165)         25,206
PROVISION FOR INCOME TAXES:
  Current                                                  23,645           5,795           4,061
  Deferred                                                (23,645)             --              --
                                                      -----------     -----------     -----------
                                                               --           5,795           4,061
                                                      -----------     -----------     -----------
NET INCOME (LOSS)                                     $  (405,451)    $   (65,960)    $    21,145
                                                      ===========     ===========     ===========
NET INCOME (LOSS) PER SHARE:
  Primary                                             $     (9.94)    $     (2.65)    $      1.07
  Fully diluted                                       $     (9.94)    $     (2.65)    $      1.04
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
  Primary                                              40,801,000      24,855,000      19,672,000
  Fully diluted                                        40,801,000      24,855,000      21,115,000
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                   statements
 
                                       27
<PAGE>   30
 
                           THE LEARNING COMPANY, INC.
           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                          SERIES A    SERIES B      COMMON STOCK      ADDITIONAL                  CUMULATIVE
                                          PREFERRED   PREFERRED   -----------------    PAID-IN     ACCUMULATED    TRANSLATION
                                            STOCK       STOCK      SHARES    AMOUNT    CAPITAL       DEFICIT      ADJUSTMENT
                                          ---------   ---------   --------   ------   ----------   -----------    ----------
<S>                                          <C>         <C>        <C>       <C>      <C>          <C>            <C>
BALANCE, DECEMBER 31, 1993                   $ --        $ 52       14,768    $148     $162,650     $(163,025)     $ (8,313)
  Acquisition of Aris                          --          --          463       5            5          (230)           --
  Acquisition of Compact                       --          --          409       4          848          (382)           --
  Acquisition of SMC                           --          --          602       6        6,809            --            --
  Spinnaker rights offering and                --         (52)       2,668      27           25            --            --
    redemption of Series B preferred
    stock
  Issuance of Series A preferred stock         30          --           --      --        2,970            --            --
    upon conversion of Phemus debt
  Preferred dividend                            3          --           --      --          297          (300)           --
  Conversion of common stock to                --          --       (7,582)    (75)          75            --            --
    Exchangeable Shares
  Conversion of Exchangeable Shares to         --          --        4,156      41          (41)           --            --
    common stock
  Conversion of debt to common stock           --          --          126       1        9,637            --            --
  Conversion of Series A preferred stock      (33)         --          268       3           30            --            --
    to common stock
  Treasury stock purchased                     --          --           --      --           --            --            --
  Stock issued under exercise of options       --          --          648       6        5,811            --            --
    and warrants
  Stock issued for settlement of               --          --          171       1        2,274            --            --
    expenses
  Translation adjustments                      --          --           --      --           --            --        (1,338)
  Net income                                   --          --           --      --           --        21,145            --
                                             ----        ----       ------    ----     --------     ---------      --------
BALANCE, DECEMBER 31, 1994                     --          --       16,697     167      191,390      (142,792)       (9,651)
  Acquisition of Future                        --          --        1,135      11        8,455        (3,608)           --
    Vision
  Acquisition of tewi                          --          --           99       1        3,639            --            --
  Acquisition of The Former Learning           --          --           --      --       43,369            --            --
    Company
  Acquisition of Compton's                     --          --        5,053      51       86,634            --            --
  Other acquisitions                           --          --          262       3        2,673          (236)           --
  Sale of common stock                         --          --        2,713      27       73,584            --            --
  Stock issued under exercise of options       --          --        1,898      19       28,171            --            --
    and warrants
  Treasury stock retirement                    --          --           --      --       (1,629)           --            --
  Conversion of Exchangeable Shares to         --          --        2,508      25          (25)           --            --
    common stock
  Translation adjustments                      --          --           --      --           --            --           201
  Net loss                                     --          --           --      --           --       (65,960)           --
                                             ----        ----       ------    ----     --------     ---------      --------
BALANCE, DECEMBER 31, 1995                     --          --       30,365     304      436,261      (212,596)       (9,450)
  Acquisition of MECC                          --          --        9,214      92      240,670            --            --
  Other acquisitions                           --          --          899       9       15,247            --            --
  Conversion of debt to common stock           --          --          158       2        3,051            --            --
  Stock issued under exercise of options       --          --        3,198      32       24,985            --            --
  Conversion of Exchangeable Shares to         --          --           45      --           --            --            --
    common stock
  Stock issued for settlement of               --          --          500       5       13,015            --            --
    expenses
  Translation adjustments                      --          --           --      --           --            --        (1,239)
  Net loss                                     --          --           --      --           --      (405,451)           --
                                             ----        ----       ------    ----     --------     ---------      --------
BALANCE, DECEMBER 31, 1996                   $ --        $ --       44,379    $444     $733,229     $(618,047)     $(10,689)
                                             ====        ====       ======    ====     ========     =========      ========
 
<CAPTION>
                                                         TOTAL
                                                     STOCKHOLDERS'
                                          TREASURY      EQUITY
                                           STOCK       (DEFICIT)
                                          --------   -------------
<S>                                        <C>         <C>
BALANCE, DECEMBER 31, 1993                 $ (144)     $  (8,632)
  Acquisition of Aris                          --           (220)
  Acquisition of Compact                       --            470
  Acquisition of SMC                           --          6,815
  Spinnaker rights offering and                --             --
    redemption of Series B preferred
    stock
  Issuance of Series A preferred stock         --          3,000
    upon conversion of Phemus debt
  Preferred dividend                           --             --
  Conversion of common stock to                --             --
    Exchangeable Shares
  Conversion of Exchangeable Shares to         --             --
    common stock
  Conversion of debt to common stock           --          9,638
  Conversion of Series A preferred stock       --             --
    to common stock
  Treasury stock purchased                 (1,485)        (1,485)
  Stock issued under exercise of options       --          5,817
    and warrants
  Stock issued for settlement of               --          2,275
    expenses
  Translation adjustments                      --         (1,338)
  Net income                                   --         21,145
                                           ------      ---------
BALANCE, DECEMBER 31, 1994                 (1,629)        37,485
  Acquisition of Future                        --          4,858
    Vision
  Acquisition of tewi                          --          3,640
  Acquisition of The Former Learning           --         43,369
    Company
  Acquisition of Compton's                     --         86,685
  Other acquisitions                           --          2,440
  Sale of common stock                         --         73,611
  Stock issued under exercise of options       --         28,190
    and warrants
  Treasury stock retirement                 1,629             --
  Conversion of Exchangeable Shares to         --             --
    common stock
  Translation adjustments                      --            201
  Net loss                                     --        (65,960)
                                           ------      ---------
BALANCE, DECEMBER 31, 1995                     --        214,519
  Acquisition of MECC                          --        240,762
  Other acquisitions                           --         15,256
  Conversion of debt to common stock           --          3,053
  Stock issued under exercise of options       --         25,017
  Conversion of Exchangeable Shares to         --             --
    common stock
  Stock issued for settlement of               --         13,020
    expenses
  Translation adjustments                      --         (1,239)
  Net loss                                     --       (405,451)
                                           ------      ---------
BALANCE, DECEMBER 31, 1996                 $   --      $ 104,937
                                           ======      =========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                   statements
 
                                       28
<PAGE>   31
 
                           THE LEARNING COMPANY, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                           ------------------------------------
                                                             1996          1995          1994
                                                           ---------     ---------     --------
<S>                                                        <C>           <C>           <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)                                          $(405,451)    $ (65,960)    $ 21,145
Adjustments to reconcile net income (loss) to net cash
  provided by operating activities:
       Depreciation and amortization                         451,133        29,802        5,217
       Charge for incomplete technology                       56,688        60,483           --
       Provision for returns and doubtful accounts            38,112        22,358       13,744
Change in assets and liabilities (net of acquired assets
  and liabilities):
       Accounts receivable                                   (91,413)      (39,811)     (17,193)
       Inventories                                             3,332        (4,441)      (4,763)
       Other current assets                                    4,203         8,865       (2,460)
       Other long-term assets                                 (4,308)       11,990        1,380
       Accounts payable and accrued expenses                  12,338         3,600      (10,594)
       Other current liabilities                               1,021         6,342        2,676
       Other long-term obligations                                --        (2,294)          23
                                                           ---------     ---------     --------
Net cash provided by operating activities                     65,655        30,934        9,175
                                                           ---------     ---------     --------
 
CASH FLOWS FROM INVESTING ACTIVITIES:
  Cash paid for businesses acquired, net of cash on-hand      21,518      (547,889)          --
  Purchases of property and equipment, net                    (4,939)       (7,811)      (5,514)
  Software development costs                                 (12,344)       (2,410)      (1,200)
  Merger related accruals                                    (38,091)       (7,341)     (19,903)
  Payments to stockholders of The Former Learning Company    (25,025)           --           --
                                                           ---------     ---------     --------
Net Cash (Used for) Provided by Investing Activities         (58,881)     (565,451)     (26,617)
                                                           ---------     ---------     --------
 
CASH FLOWS FROM FINANCING ACTIVITIES:
  Net proceeds from sale of stock, options and warrants       27,905       106,616        8,852
  Borrowings under term notes and line of credit              25,000         3,150        7,700
  Payments on term notes and line of credit                   (4,832)       (8,815)      (2,500)
  Payments on capital lease obligations                       (1,874)       (1,008)        (904)
  Other                                                       (1,092)           --           --
  Sale (repurchase) of senior notes                          (18,350)      500,000         (500)
  Redemption of Series B preferred stock                          --            --       (4,660)
                                                           ---------     ---------     --------
NET CASH PROVIDED BY FINANCING ACTIVITIES                     26,757       599,943        7,988
                                                           ---------     ---------     --------
 
EFFECT OF EXCHANGE RATE CHANGES ON NET CASH                   (1,243)          201       (1,138)
                                                           ---------     ---------     --------
NET CHANGE IN CASH AND CASH EQUIVALENTS                       32,288        65,627      (10,592)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD              77,832        12,205       22,797
                                                           ---------     ---------     --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD                 $ 110,120     $  77,832     $ 12,205
                                                           =========     =========     ========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                   statements
 
                                       29
<PAGE>   32
 
                           THE LEARNING COMPANY, INC.
              CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                   YEARS ENDED DECEMBER 31,
                                                                -------------------------------
                                                                  1996        1995        1994
                                                                --------     -------     ------
<S>                                                             <C>          <C>         <C>
SUPPLEMENTAL SCHEDULING OF NON-CASH INVESTING AND FINANCING
  ACTIVITIES:
  Common stock issued to acquire MECC                           $221,319     $    --     $   --
  Increase in APIC due to value of in-the-money employee stock
     options acquired in connection with the acquisition of
     MECC                                                         19,444          --         --
  Common stock issued to acquire Edusoft                          13,099          --         --
  Conversion of debt to equity                                     3,053       3,471      9,638
  Common stock issued to acquire others                            2,156       4,967         --
  Common stock issued for settlement of expenses                  10,132         111      2,275
  Equipment acquired under capital leases                          1,262         627      1,475
  Common stock issued to acquire tewi                                 --       3,640         --
  Common stock issued to acquire Compton's                            --      86,685         --
  Increase in APIC due to value of in-the money employee stock
     options in connection with the acquisition of The Former
     Learning Company                                                 --      43,369         --
  Common stock issued to purchase SMC                                 --          --      6,815
  Common stock issued on conversion of Series A preferred
     stock                                                            --          --      3,000
  Dividend on Series A preferred stock settled by issuance
     of common stock                                                  --          --        300
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
  Cash paid (refunded) during period for:
     Interest paid                                              $ 28,466     $   524     $1,387
     Income taxes refunded                                        (7,886)        (12)      (254)
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                   statements
 
                                       30
<PAGE>   33
 
                           THE LEARNING COMPANY, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
 
(1)  DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  The Business
 
     The Learning Company, Inc. ("TLC" or the "Company") develops, publishes and
markets consumer software in the education, reference, productivity, lifestyle
and, to a lesser extent, entertainment categories. The Company sells its
products in the retail channel through mass merchants, consumer electronic
stores, price clubs, office supply stores, software specialty stores and
distributors; to original equipment manufacturers (OEMs); to schools and to end
users through direct response methods. The Company also develops and distributes
income tax software products and offers computerized processing of income tax
returns in Canada. The Company's principal market is in the United States and
Canada. The Company has international operations in Germany, Ireland, France,
Holland, the United Kingdom, Japan and Australia. On October 24, 1996, SoftKey
International Inc. changed its name to The Learning Company, Inc.
 
     The Company's fiscal year is the 52 or 53 weeks ending on or after December
31. For clarity of presentation herein, all references to December 31, 1996
relate to balances as of January 4, 1997, references to December 31, 1995 relate
to balances as of January 6, 1996, the period from January 7, 1996 to January 4,
1997 is referred to as the "Year Ended December 31, 1996", the period from
January 1, 1995 to January 6, 1996 is referred to as the "Year Ended December
31, 1995", and the period from January 2, 1994 to December 31, 1994 is referred
to as the "Year Ended December 31, 1994".
 
  Basis of Presentation
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make assumptions regarding
items such as return reserves and allowances, net realizable value of intangible
assets and valuation allowances for deferred tax assets that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Significant estimates in
these financial statements include: return reserves, inventory reserves,
valuation of deferred tax assets and valuation of intangible assets.
 
     Certain prior period amounts have been reclassified to conform with current
year presentation.
 
  Principles of Consolidation
 
     The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant intercompany
amounts and transactions have been eliminated.
 
  Revenue Recognition
 
     Revenues are primarily derived from the sale of software products and from
software licensing and royalty arrangements. Revenues from the sale of software
products are recognized upon shipment, provided that no significant obligations
remain outstanding and collection of the receivable is probable. Costs related
to insignificant post shipment technical support and other obligations are
accrued when revenue is recognized for the sale of the related products.
Allowances for estimated returns are provided at the time of sale. The Company
evaluates the adequacy of allowances for returns and doubtful accounts primarily
based upon its evaluation of historical and expected sales experience and by
channel of distribution. The estimates determined for reserves for returns and
allowances are based upon information available at the reporting date. To the
extent the future market, sell through experience, channels of distribution and
general economic conditions change, the estimated reserves required for returns
and allowances may also change. Revenues
 
                                       31
<PAGE>   34
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
from royalty and license arrangements are recognized as earned based upon
performance or product shipments.
 
  Cash Equivalents
 
     Cash equivalents are valued at cost, which approximates market value, and
consist principally of commercial paper, bankers' acceptances, short-term
government securities and money market accounts. The Company considers all such
investments having maturities at purchase of less than 90 days to be cash
equivalents.
 
  Inventories
 
     Inventories are stated at the lower of weighted average cost or net
realizable value, and include third-party assembly costs, CD-ROM disks, manuals
and an allocation of fixed overhead.
 
<TABLE>
<CAPTION>
                                                                  December 31,
                                                               -------------------
                                                                1996        1995
                                                               -------     -------
            <S>                                                <C>         <C>
            Components                                         $ 1,213     $ 2,526
            Finished goods                                      14,681      16,471
                                                               -------     -------
                                                               $15,894     $18,997
                                                               =======     =======
</TABLE>
 
  Property and Equipment
 
     Property and equipment are stated at the lower of cost, net of accumulated
depreciation or net realizable value. Depreciation is calculated using
accelerated and straight-line methods over the following useful lives:
 
<TABLE>
            <S>                                     <C>
            Building                                40 years
            Computer equipment                      3-5 years
            Furniture and fixtures                  3-5 years
            Leasehold improvements                  Shorter of the life of the lease
                                                    or the estimated useful life
</TABLE>
 
     Betterments and major renewals are capitalized and included in property,
plant, and equipment accounts while expenditures for maintenance and repairs and
minor renewals are charged to expense. When assets are retired or otherwise
disposed of, the assets and related allowances for depreciation and amortization
are eliminated from the accounts and any resulting gain or loss is reflected in
income.
 
  Goodwill and Intangible Assets
 
     The excess cost over the fair value of net assets acquired, goodwill, is
amortized on a straight-line basis over 2 years, except for the goodwill
associated with the Company's Canadian income tax software business, which is
being amortized on a straight-line basis over its estimated useful life of 40
years. The cost of identified intangible assets is generally amortized on a
straight-line basis over its estimated useful life of 2 to 3 years. Deferred
financing costs are being amortized on a straight-line basis over the term of
the related debt financing. The carrying value of goodwill and intangible assets
is reviewed on a quarterly and annual basis for the existence of facts or
circumstances both internally and externally that may suggest impairment. To
date no such impairment has occurred. Should there be an impairment in the
future, the Company will measure the amount of the impairment based on
discounted expected future cash flows. The cash flow estimates that will be used
will contain management's best estimates, using appropriate and customary
assumptions and
 
                                       32
<PAGE>   35
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
projections at the time. Goodwill and other intangible assets have been
presented net of accumulated amortization of $354,813 and $21,916 as of December
31, 1996 and 1995, respectively.
 
<TABLE>
<CAPTION>
                                                                                Net Balance
                                                          Estimated           at December 31,
                                                         Useful Life       ---------------------
    Description                                           in Years          1996         1995
    -----------                                          -----------       --------     --------
    <S>                                                  <C>               <C>          <C>
    Goodwill                                             2 and 40          $397,459     $580,165
    Purchased technology and product related costs        1 to 2            126,763      123,929
    Brands                                                   2               10,061       10,798
    Deferred financing costs                                 5                9,423       11,188
    Other intangible assets                                  3                  864        1,854
                                                                           --------     --------
                                                                           $544,570     $727,934
                                                                           ========     ========
</TABLE>
 
     The Company operates in a highly competitive and technology driven
environment. The consumer software industry is undergoing substantial change and
is subject to a high level of uncertainty. The Company has estimated the useful
life of the majority of its goodwill and acquired technology to be a short
period based upon rapidly changing industry trends, an intense competitive
environment, changing technology trends and rapidly changing customer
preferences for the Company's products and other anticipated economic factors.
Should the Company's business environment or conditions of business change, it
may result in an impairment of these assets and may in turn result in an
adjustment of the future carrying values or may result in a change in estimated
useful life.
 
  Research and Development Costs
 
     Research and development costs are expensed as incurred. Development costs
for new software products and enhancements to existing software products are
expensed as incurred until technological feasibility has been established.
Capitalized software development costs are being amortized on a straight-line
basis over the estimated product life, generally twelve months.
 
  Income Taxes
 
     Deferred tax liabilities and assets are determined based on the differences
between the financial statement basis and tax basis of assets and liabilities,
using enacted tax rates in effect for the year in which the differences are
expected to reverse.
 
  Foreign Currency
 
     The functional currency of each foreign subsidiary is the local currency.
Accordingly, assets and liabilities of foreign subsidiaries are translated to
U.S. dollars at period end exchange rates. Revenues and expenses are translated
using the average rates during the period. The effects of foreign currency
translation adjustments have been accumulated and are included as a separate
component of stockholders' equity.
 
  Computation of Earnings Per Share
 
     Net income (loss) per share is computed using the weighted average number
of common and dilutive common stock equivalent shares outstanding during the
period. Dilutive common stock equivalent shares consist of convertible
debentures and notes, convertible Series A preferred stock and stock options and
warrants using the treasury stock method. The computations do not include common
stock equivalents where the effect would be antidilutive.
 
                                       33
<PAGE>   36
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(2)  BUSINESS COMBINATIONS
 
  Three-Party Combination
 
     On February 4, 1994, the Company completed a three-way business combination
(the "Three-Party Combination") among SoftKey Software Products Inc. ("Former
SoftKey"), WordStar International Incorporated ("WordStar") and Spinnaker
Software Corporation ("Spinnaker"). In connection with the Three-Party
Combination, each Former SoftKey stockholder was entitled to receive, for each
share held, .36 shares of the Company's common stock or .36 Exchangeable
Non-Voting Shares (the "Exchangeable Shares") of SoftKey Software Products Inc.
("SoftKey Software"), the successor by amalgamation to Former SoftKey. Upon
completion of the Three-Party Combination, the Company issued Former SoftKey
stockholders a total of 1,354,219 shares of common stock and 7,582,498
Exchangeable Shares. The Company also issued a special voting share (the "Voting
Share") which has a number of votes equal to the number of Exchangeable Shares
outstanding. The holder of the Voting Share is not entitled to dividends and
shall vote with the common stockholders as a single class. The Exchangeable
Shares may be exchanged for the Company's common stock on a one-for-one basis
until February 4, 2005, at which time any outstanding Exchangeable Shares
automatically convert to shares of the Company's common stock. Each share of
Spinnaker common stock was converted into .1624 shares of the Company's common
stock. In connection with the Three-Party Combination and the Spinnaker rights
offering, the Company issued a total of 5,887,295 shares of common stock to the
former Spinnaker stockholders. The Three-Party Combination was accounted for
using the pooling-of-interests method of accounting.
 
  MECC
 
     On May 17, 1996, the Company acquired Minnesota Educational Computing
Corporation (MECC) ("MECC"), a publisher and developer of high quality
educational software for children sold to consumers and schools, in exchange for
9,214,007 shares of the Company's common stock. The total purchase price was
$284,631, including estimated transaction costs, value of stock options assumed
and deferred income taxes related to certain identifiable intangible assets
acquired. Approximately 1,048,000 MECC employee stock options were converted
into stock options to purchase approximately 1,198,000 shares of TLC common
stock.
 
  Compton's
 
     On December 28, 1995, the Company acquired Compton's New Media, Inc. and
Compton's Learning Company (collectively, "Compton's"), developers and
publishers of multimedia software titles. In and in connection with the
acquisition, TLC issued a total of 5,052,697 shares of the Company's common
stock, which included 587,036 shares of common stock to settle $14,000 of
intercompany debt due to Tribune Company and executed a promissory note for
$3,000 in cancellation of the remaining intercompany debt. The total purchase
price was $104,394, including estimated transaction costs, deferred income taxes
related to certain identifiable intangible assets acquired, settlement of
certain intercompany debt to Tribune Company and the fair value of net
liabilities assumed. The promissory note was repaid in 1996.
 
  The Learning Company
 
     On December 22, 1995, the Company acquired control of The Learning Company
(the "The Former Learning Company"), a leading developer of educational software
products for use at home and school. Under the terms of the merger agreement,
the Company acquired, in a two-step business combination, all of the outstanding
shares of The Former Learning Company for total consideration of approximately
$684,066, including the value of stock options assumed, estimated transaction
related costs and deferred income taxes related to certain identifiable
intangible assets acquired. Approximately 1.1 million unvested employee stock
options of The Former Learning Company were converted into options to purchase
3,123,000 shares of the
 
                                       34
<PAGE>   37
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Company's common stock, based on the merger consideration of $67.50 per share
and were vested on or before January 26, 1996. Approximately $543,163 of the
purchase price was settled in cash.
 
  tewi Verlag GmbH
 
     On July 21, 1995, the Company acquired tewi Verlag GmbH ("tewi"), a
publisher and distributor of CD-ROM software and computer-related books, located
in Munich, Germany. The purchase price was settled by a combination of cash and
issuance of common stock. The Company issued 99,045 shares of common stock
valued at $3,640 and may issue additional shares of common stock to a former
shareholder of tewi pursuant to an earn-out agreement. The Company paid cash
consideration of $12,688 for tewi. The additional shares issuable under the
earn-out agreement have been treated as contingent consideration and will be
recorded if and when certain future conditions are met. During 1996, $540 of
consideration related to the contingent consideration was earned and recorded as
expense by the Company.
 
     The purchase price for the 1996 acquisitions has been allocated based on
fair value as follows:
 
<TABLE>
<CAPTION>
                                                           MECC        Others       Total
                                                         --------     --------     --------
    <S>                                                  <C>          <C>          <C>
    Purchase price                                       $284,631     $ 15,681     $300,312
    Less: fair value of net tangible assets
      (liabilities)                                        13,990      (15,424)      (1,434)
                                                         --------     --------     --------
    Excess to allocate                                    270,641       31,105      301,746
    Less: excess allocated to:
      Incomplete technology                                56,688           --       56,688
      Completed technology and products                    88,501          285       88,786
      Brand and trademarks                                    894           --          894
                                                         --------     --------     --------
                                                          146,083          285      146,368
                                                         --------     --------     --------
    Goodwill                                             $124,558     $ 30,820     $155,378
                                                         ========     ========     ========
</TABLE>
 
     The purchase price for the 1995 acquisitions has been allocated based on
fair value as follows:
 
<TABLE>
<CAPTION>
                                                   The Former
                                                    Learning
                                         tewi       Company      Compton's    Others       Total
                                        -------     --------     --------     -------     --------
<S>                                     <C>         <C>          <C>          <C>         <C>
Purchase price                          $16,915     $684,066     $104,394     $ 8,571     $813,946
Less: fair value of net tangible
  assets (liabilities)                   (3,757)      72,595      (12,075)     (1,102)      55,661
                                        -------     --------     --------     -------     --------
Excess to allocate                       20,672      611,471      116,469       9,673      758,285
Less: excess allocated to:
  Incomplete technology                      --       41,409       19,074          --       60,483
  Completed technology and products          --      100,171       22,483          --      122,654
  Brands and trademarks                      --        9,759        1,100          --       10,859
                                        -------     --------     --------     -------     --------
                                             --      151,339       42,657          --      193,996
                                        -------     --------     --------     -------     --------
Goodwill                                $20,672     $460,132     $ 73,812     $ 9,673     $564,289
                                        =======     ========     ========     =======     ========
</TABLE>
 
     The Company engaged a nationally recognized, independent appraiser to
express an opinion with respect to the estimated fair market value of a
substantial portion of the assets acquired, to serve as a basis for the
allocation of the purchase price for MECC, The Former Learning Company and
Compton's. The Company primarily used the income approach to determine the fair
market value of the identified intangible assets acquired. The debt-free cash
flows, net of provision for operating expenses, were discounted to a net present
value. The value of certain completed technology was based upon comparable fair
values in the open market.
 
                                       35
<PAGE>   38
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Software technology was divided into two categories. Software technology and
products under development not considered to have reached technological
feasibility were expensed on acquisition.
 
     Each of the above acquisitions was accounted for using the purchase method
of accounting. The pro forma adjustments detailed below include the effect of
amortization of intangible assets and goodwill related to the acquisitions over
their estimated useful lives of two years and the interest expense related to
the issue of the $500,000 of debt for the period prior to acquisition or
issuance, net of any related income tax effects. Unaudited pro forma results of
operations for the transactions accounted for using the purchase method of
accounting as though the acquisitions had occurred at the beginning of the Years
Ended December 31, 1996 and 1995 are as follows:
 
<TABLE>
<CAPTION>
                                                           The Former
Year Ended                                                  Learning            Pro forma   Pro forma
December 31, 1996             TLC       tewi     Compton's  Company    MECC     Adjustments Combined
-----------------          ---------   -------   --------   -------   -------   ---------   ---------
<S>                        <C>         <C>       <C>        <C>       <C>       <C>         <C>
Revenues                   $ 343,321   $    --   $     --   $    --   $ 7,800   $      --   $ 351,121
Operating income (loss)     (381,312)       --         --        --    (9,212)    (41,128)   (431,652)
Net income (loss)           (405,451)       --         --        --    (7,021)    (34,009)   (446,481)
Net income (loss) per
  share                        (9.94)       --         --        --        --          --      (10.12)
</TABLE>
 
<TABLE>
<CAPTION>
Year Ended
December 31, 1995
-----------------
<S>                        <C>         <C>       <C>        <C>       <C>       <C>         <C>
Revenues                   $ 167,042   $ 3,720   $ 23,204   $60,698   $33,815   $      --   $ 288,479
Operating income (loss)      (60,870)   (3,589)   (13,904)   10,874     6,079    (428,239)   (489,649)
Net income (loss)            (65,960)   (3,643)    (9,626)    7,398     5,070    (398,195)   (464,956)
Net income (loss) per
  share                        (2.65)       --         --        --        --          --      (12.01)
</TABLE>
 
  Future Vision Holding, Inc.
 
     On August 31, 1995, the Company acquired all of the issued and outstanding
capital stock of Future Vision Holding, Inc. ("Future Vision"), a multimedia
software company, in exchange for the issuance of 1,088,149 shares of common
stock of the Company. This acquisition has been accounted for using the pooling-
of-interests method of accounting. The financial statements for periods prior to
the Year Ended December 31, 1995 do not include amounts for this acquisition as
they were deemed to be immaterial to the consolidated financial statements for
those periods.
 
(3)  OTHER LONG-TERM ASSETS
 
<TABLE>
<CAPTION>
                                                                         December 31,
                                                                     ---------------------
                                                                       1996         1995
                                                                     --------     --------
    <S>                                                              <C>          <C>
    Building, land and leasehold improvements                        $  4,516     $  3,770
    Computer equipment                                                 26,362       22,695
    Furniture and fixtures                                              9,062        8,738
                                                                     --------     --------
                                                                       39,940       35,203
    Less: accumulated depreciation and amortization                   (22,273)     (15,582)
                                                                     --------     --------
                                                                       17,667       19,621
    Other                                                               5,308           --
                                                                     --------     --------
                                                                     $ 22,975     $ 19,621
                                                                     ========     ========
</TABLE>
 
                                       36
<PAGE>   39
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Included in computer equipment is equipment under capital lease of $2,207
and $3,340 at December 31, 1996 and 1995, respectively. Depreciation expense was
$6,491, $6,767 and $2,832 in each of the Years Ended December 31, 1996, 1995 and
1994, respectively.
 
(4)  LINE OF CREDIT
 
     TLC Multimedia Inc., a wholly owned subsidiary of the Company, has a
revolving line of credit (the "Line"), to provide for a maximum availability of
$50,000. Borrowings under the Line become due on July 1, 1998 and bear interest
at the prime rate (8 1/4% at December 31, 1996). The Line is subject to certain
financial covenants, is secured by a general security interest in the assets of
The Learning Company, Inc. and certain other subsidiaries of the Company and by
a pledge of the stock of certain of its subsidiaries. The Line is guaranteed by
the Company. $25,000 was drawn on the Line at December 31, 1996. This amount was
repaid subsequent to year end.
 
(5)  LONG-TERM DEBT
 
<TABLE>
<CAPTION>
                                                                         December 31,
                                                                     ---------------------
                                                                       1996         1995
                                                                     --------     --------
    <S>                                                              <C>          <C>
    Senior Convertible Notes                                         $331,650     $350,000
    Obligations under capital leases                                    2,099        1,614
                                                                     --------     --------
                                                                      333,749      351,614
    Less: current portion                                                (819)        (963)
                                                                     --------     --------
                                                                     $332,930     $350,651
                                                                     ========     ========
</TABLE>
 
     On October 23, 1995, the Company completed a private offering of $350,000
principal amount 5 1/2% Senior Convertible Notes due 2000 (the "Notes"), which
are unsecured. The Notes will be redeemable by the Company on or after November
2, 1998 at redemption prices of 102.2% on November 2, 1998, 101.1% on November
1, 1999 and 100% on or after November 1, 2000 and are convertible into common
stock at a price of $53 per share. Interest is payable on the Notes
semi-annually on May 1 and November 1 each year. Principal totaling $18,350 was
repurchased during the year.
 
(6)  RELATED PARTY DEBT
 
<TABLE>
<CAPTION>
                                                                         December 31,
                                                                     ---------------------
                                                                       1996         1995
                                                                     --------     --------
    <S>                                                              <C>          <C>
    Senior Convertible/Exchangeable Notes                            $150,000     $150,000
    Accrued interest                                                    5,264          100
    Term Notes                                                             --        4,214
                                                                     --------     --------
                                                                      155,264      154,314
    Less: current portion                                              (5,264)      (4,314)
                                                                     --------     --------
                                                                     $150,000     $150,000
                                                                     ========     ========
</TABLE>
 
     On December 28, 1995, Tribune Company made a strategic investment in the
Company in the form of $150,000 principal amount 5 1/2% Senior
Convertible/Exchangeable Notes due 2000 (the "Tribune Notes"). The Tribune Notes
are exchangeable into 5 1/2% Series C Convertible Preferred Stock (the
"Preferred Shares") at Tribune Company's option. The Tribune Notes and Preferred
Shares will be redeemable by the Company on or after November 2, 1998 at
redemption prices of 102.2% on November 2, 1998, 101.1% on November 1, 1999 and
100% on November 1, 2000 and are convertible into common stock at a price of $53
per share. The Tribune Notes rank pari passu with the Notes and are unsecured.
Interest is payable on the Tribune Notes semi-annually on May 1 and November 1
each year.
 
                                       37
<PAGE>   40
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     In and in connection with the acquisition of Compton's from the Tribune
Company, the Company issued a $3,000 note payable (the "Compton's Note"). The
Compton's Note bore interest at a rate of 6 1/2% and was repaid in April 1996
through the issuance of 158,099 shares of common stock.
 
(7)  COMMITMENTS AND CONTINGENCIES
 
  Lease Obligations
 
     The Company leases office facilities and equipment under operating and
capital leases. Rental expense for operating leases was approximately $3,234,
$2,308 and $1,756 for the Years Ended December 31, 1996, 1995 and 1994,
respectively. Future annual payments under capital and operating leases are as
follows:
 
<TABLE>
<CAPTION>
                                                                       Capital     Operating
                                                                       Leases       Leases
                                                                       -------     ---------
    <S>                                                                 <C>         <C>
    1997                                                                $  960      $ 5,403
    1998                                                                   797        5,128
    1999                                                                   573        4,503
    2000                                                                    91        4,162
    2001                                                                    --        3,412
    Thereafter                                                              --          616
                                                                        ------      -------
                                                                         2,421      $23,224
                                                                                    =======
    Less: interest                                                        (322)
    Less: current portion                                                 (819)
                                                                        ------
                                                                        $1,280
                                                                        ======
</TABLE>
 
  Legal Claims
 
     On February 24, 1997, the Company terminated its business relationship with
Stream International, Inc. ("Stream") which had been providing duplication,
assembly and fulfillment services for certain of the Company's products. The
Company terminated the relationship due to Stream's inability to perform its
obligations under its contract after it relocated the facility responsible for
the manufacture of the Company's product. The Company filed suit against Stream
and currently estimates that in litigation it will be seeking direct and
consequential damages from Stream in an amount in excess of $38 million. Stream
has asserted counterclaims for certain outstanding invoices and other matters in
the amount of approximately $26 million. Management believes that the outcome of
these claims will not have a material adverse effect on the financial position
or results of operations of the Company.
 
(8)  COMMON STOCK
 
     At December 31, 1996, the Company has reserved for issuance approximately
11,762,648 shares of its common stock related to options and warrants. In
addition, the Company has reserved a total of 9,433,963 shares of its common
stock for issuance related to the Notes and the Tribune Note. In connection with
the Three-Party Combination, the Company has reserved 1,551,428 shares of its
common stock for issuance related to the Exchangeable Shares at December 31,
1996. The Exchangeable Shares are represented by the one share of Special Voting
Stock. During the Year Ended December 31, 1996, the Company increased its
authorized common stock from 60,000,000 to 120,000,000 shares.
 
                                       38
<PAGE>   41
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(9)  STOCK OPTIONS AND WARRANTS
 
  Stock Option Plans
 
     1990 Long-Term Equity Incentive Plan
 
     The Company has a Long-Term Equity Incentive Plan (the "LTIP"). The LTIP
allows for incentive stock options, nonqualified stock options and various other
stock awards. Administration of the LTIP is conducted by the Company's
Compensation Committee of the Board of Directors. The Compensation Committee
determines the amount and type of option or award and terms and conditions and
vesting schedules of the award or option. Upon a change of control, as defined,
awards and options then outstanding become fully vested, subject to certain
limitations.
 
     On May 28, 1996, the Board of Directors of the Company approved an
amendment to increase the maximum number of shares of common stock issuable
under the LTIP to 7,000,000 from 5,450,000. The total number of shares of common
stock reserved and available for issuance under the LTIP at December 31, 1996
was 4,800,599 shares, 1,232,883 of which remained available for grant.
 
     1996 Non-Qualified Stock Option Plan
 
     The Company initiated a non-qualified stock option plan (the "1996 Plan")
that was approved by the Company's Board of Directors on February 5, 1996. The
1996 plan allows for non-qualified stock options and various other stock awards.
Administration of the 1996 Plan is conducted by the Company's Compensation
Committee of the Board of Directors. The administrator determines the amount and
type of option or award and terms and conditions and vesting schedules of the
award or option. Upon a change of control, as defined, awards and options then
outstanding become fully vested, subject to certain limitations. The maximum
number of shares issuable under the 1996 plan is 5,000,000. The total number of
shares of common stock reserved and available under the 1996 Plan at December
31, 1996 was 4,967,133 shares, 219,645 of which remained available for grant.
 
     1994 Non-Employee Director Stock Option Plans
 
     On April 26, 1994, the Board of Directors approved a non-employee director
stock option plan (the "Non-Employee Directors Plan"). The Non-Employee
Directors Plan provides for an initial grant of 20,000 options at fair market
value to be issued to each non-employee director who first became a director of
the Company after February 1, 1994 ("Initial Grants"). During the Year Ended
December 31, 1995 a further 100,000 options were granted to each of the
non-employee directors. During the Year Ended December 31, 1996, a further
26,667 options were granted to each of the non-employee directors. The maximum
number of common shares issuable under the Non-Employee Directors Plan is
500,000, all of which were granted at December 31, 1996. Options granted to
non-employee directors as Initial Grants were 100% exercisable at the time of
grant and options issued as subsequent grants become exercisable over a
three-year period. All such options are exercisable for a period of 10 years
from date of grant.
 
                                       39
<PAGE>   42
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The following table summarizes the stock option activity under the LTIP,
the 1996 Plan and the Non-Employee Directors Plan:
 
<TABLE>
<CAPTION>
                              December 31, 1996             December 31, 1995             December 31, 1994
                         ---------------------------   ---------------------------   ---------------------------
                                         Weighted                      Weighted                      Weighted
                                         Average                       Average                       Average
                           Shares     Exercise Price     Shares     Exercise Price     Shares     Exercise Price
                         ----------   --------------   ----------   --------------   ----------   --------------
<S>                      <C>              <C>          <C>              <C>           <C>             <C>
Beginning                 6,663,769       $14.30        2,599,980       $11.62        1,999,203       $12.02
Assumed in acquisitions   1,197,852         8.39        3,123,938         8.10               --           --
Granted                   7,202,103        17.79        2,446,996        25.72        1,287,707        11.60
Exercised                (3,198,476)        7.73       (1,394,035)       28.76         (513,078)       11.08
Canceled                 (1,787,297)       19.77         (113,110)       19.81         (173,852)       15.96
                         ----------       ------       ----------       ------        ---------       ------
Ending                   10,077,951       $17.22        6,663,769       $14.30        2,599,980       $11.62
                         ==========       ======       ==========       ======        =========       ======
</TABLE>
 
     The following table summarizes information about stock options outstanding
at December 31, 1996:
 
<TABLE>
<CAPTION>
                                        Options Outstanding                         Options Exercisable
                          ------------------------------------------------     ------------------------------     
                                             Weighted                          
                                              Average
                             Number          Remaining         Weighted          Number           Weighted
  Range of Exercise        Outstanding      Contractual        Average         Exercisable        Average
       Prices              at 12/31/96         Life         Exercise Price     at 12/31/96     Exercise Price
---------------------     -------------     -----------     --------------     -----------     --------------
<S>         <C>          <C>                 <C>             <C>             <C>                <C>
$ 0.05   -  $14.05        2,042,707          6.58            $ 9.35          1,781,554          $ 9.15
 14.87   -   16.06        4,394,275          8.99             16.05            731,721           16.05
 16.19   -   22.75        2,599,363          7.77             21.12          1,326,341           22.17
 23.40   -   38.62        1,036,606          9.19             27.78            194,028           28.09
 39.62   -   39.62            5,000          8.66             39.63              2,085           39.63
------      ------       ----------          ----            ------          ---------          ------
$ 0.05   -  $39.62       10,077,951          8.21            $17.22          4,035,729          $15.61
======      ======       ==========          ====            ======          =========          ======
</TABLE>
 
     Options to purchase 4,035,729, 1,697,054 and 2,043,357 shares of common
stock were exercisable at December 31, 1996, 1995 and 1994, respectively.
 
     The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees", in accounting for its plans. The Company has
adopted the disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123").
Accordingly, no compensation expense has been recognized for the stock option
plans as calculated under SFAS 123. Had compensation cost for the Company's
stock option plans been determined based on the fair value at the grant date for
awards in 1996 and 1995 consistent with the provisions of SFAS 123, the
Company's net loss and net loss per share would have been increased to the pro
forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                                                      1996          1995
                                                                    ---------     --------
    <S>                                                             <C>           <C>
    Net loss -- as reported                                         $(405,451)    $(65,960)
    Net loss -- pro forma                                            (430,765)     (80,670)
    Net loss per share -- as reported                                   (9.94)       (2.65)
    Net loss per share -- pro forma                                    (10.56)       (3.25)
</TABLE>
 
     The above compensation cost does not include the fair value of the stock
options assumed in connection with the acquisitions, as the fair value of such
options have been included in the purchase price of the acquired companies.
 
                                       40
<PAGE>   43
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1996 and 1995:
 
<TABLE>
<CAPTION>
                                                                    1996       1995
                                                                   ------     ------
          <S>                                                      <C>        <C>
          Dividend yield                                               --         --
          Expected volatility                                       .7857      .6827
          Risk free interest rate                                   5.47%      5.31%
          Expected lives                                            4 yrs      4 yrs
          Weighted average grant-date fair value of options
            granted                                                $10.79     $15.61
</TABLE>
 
     The effects of applying SFAS 123 in this disclosure are not indicative of
future amounts. SFAS 123 does not apply to grants prior to 1995, and additional
grants in future years are anticipated.
 
     On March 13, 1997, the Company instituted an Option Exchange Program under
which certain employees (other than employees who are directors) with options
exercisable at $10.40 per share or higher were given the opportunity to exchange
such options for options with an exercise price of $10.40 per share.
 
  Warrants
 
     On July 31, 1995, the Company announced that it would redeem all of its
2,925,000 publicly traded warrants for $0.10 per warrant on August 31, 1995 in
accordance with the terms and conditions of the warrants. Holders of such
warrants received in exchange for the warrants an aggregate of 289,959 shares of
common stock. The remaining 25,410 warrants were redeemed by the Company.
 
(10)  AMORTIZATION AND MERGER RELATED CHARGES
 
     During the year ended December 31, 1996 the Company completed the
acquisition of MECC. During the Year Ended December 31, 1995 the Company
completed the acquisitions of The Former Learning Company, Compton's, tewi and
Future Vision. Amortization and merger related charges are as follows:
 
<TABLE>
<CAPTION>
                                                               Years Ended December 31,
                                                           --------------------------------
                                                             1996         1995        1994
                                                           --------     --------     ------
    <S>                                                    <C>          <C>          <C>
    Amortization of goodwill and other assets              $333,858     $ 24,783     $1,185
    Amortization of acquired technology                     101,008        7,185        422
    Charge for incomplete technology                         56,688       60,483         --
    Employee severance costs                                  4,260        1,304        163
    Provision for earnouts                                    2,917           --         --
    Professional fees and other transaction related costs     1,267        5,653        636
    Other                                                     1,332        1,131        280
    Provision for (reversal of) litigation                       --        2,633       (254)
                                                           --------     --------     ------
                                                           $501,330     $103,172     $2,432
                                                           ========     ========     ======
</TABLE>
 
     Merger related costs were expensed as incurred or were recorded when it
became probable that the transaction would occur and the expense could be
reasonably estimated.
 
     The amortization of goodwill and acquired technology related costs in 1996
and 1995 represent primarily the amortization of the goodwill and acquired
technology assets in connection with the acquisitions of MECC, The Former
Learning Company and Compton's. The charge for incomplete technology in the Year
Ended December 31, 1996 relates to products being developed by MECC and in the
Year Ended December 31, 1995 relates to products being developed by The Former
Learning Company and Compton's, in each case which the Company believes had not
reached technological feasibility at the date of acquisition and additional
development would be required to complete the software technology.
 
                                       41
<PAGE>   44
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Professional fees and other transaction related costs in the Year Ended
December 31, 1996 relate to additional legal and accounting costs incurred
primarily in the first quarter of 1996 in connection with the acquisition of
MECC. Professional fees and other transaction related costs in the Year Ended
December 31, 1995 relate to the investment banking, legal and accounting costs
incurred to such date for the proposed merger with MECC and the professional
fees associated with the acquisition of Future Vision on August 31, 1995.
Substantially all of these costs were paid prior to December 31, 1996.
 
     Employee severance costs in the Year Ended December 31, 1996 related to
termination of employees of the Company in connection with the acquisitions of
The Former Learning Company and MECC and the related changes in strategy. A
total of 108 employees were terminated in the areas of operations, marketing,
sales, technical support and product development. Employee severance costs in
the Year Ended December 31, 1995 related to termination of employees in
connection with the acquisitions of Future Vision and certain severances related
to changes in the Company's operations related to the acquisitions and changes
in strategy. A total of 63 employees were terminated in the areas of operations,
product development and administration. These costs were all substantially paid
prior to December 31, 1996.
 
     The provision for litigation in the Year Ended December 31, 1995 relates
primarily to estimated legal settlements for claims that were determined by the
Company to be probable related to the operations of Future Vision. Substantially
all of these amounts were paid prior to December 31, 1996.
 
     At December 31, 1996, the Company had merger related accruals of $10,667,
primarily related to the acquisitions. The accruals consisted of amounts due for
investment banking fees, settlement of litigation, legal and accounting fees,
employee severance and lease termination costs related to the acquisitions. The
Company expects to substantially pay the remaining amounts prior to December 31,
1997.
 
(11)  INCOME TAXES
 
     The Company's net income for the years ended December 31, 1996, 1995 and
1994 includes amortization and acquisition charges of $501,330, $103,172 and $0,
respectively, which are not deductible for income tax purposes. The Company's
income (loss) before income taxes consists of the following:
 
<TABLE>
<CAPTION>
                                                             Years Ended December 31,
                                                        -----------------------------------
                                                          1996          1995         1994
                                                        ---------     --------     --------
    <S>                                                 <C>           <C>           <C>
    United States                                       $(420,905)    $(64,987)     $13,734
    Foreign                                                15,454        4,822       11,472
                                                        ---------     --------      -------
                                                        $(405,451)    $(60,165)     $25,206
                                                        =========     ========      =======
</TABLE>
 
                                       42
<PAGE>   45
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The provision for income taxes consists of the following:
 
<TABLE>
<CAPTION>
                                                                Years Ended December 31,
                                                              -----------------------------
                                                               1996        1995       1994
                                                              -------     ------     ------
    <S>                                                      <C>         <C>         <C>
    Current income taxes:
      Federal                                                $ 16,777    $ 6,000     $   70
      State                                                     2,868      1,500         50
      Foreign                                                   4,000        250         --
                                                             --------    -------     ------
                                                               23,645      7,750        120
                                                             --------    -------     ------
    Deferred income taxes (benefit):
      Federal                                                 (23,645)    (1,955)        --
      State                                                        --         --         --
      Foreign                                                      --         --      3,941
                                                             --------    -------     ------
                                                              (23,645)    (1,955)     3,941
                                                             --------    -------     ------
                                                             $     --    $ 5,795     $4,061
                                                             ========    =======     ======
</TABLE>
 
     Deferred taxes result from timing differences in the recognition of certain
items for income tax and financial reporting purposes. The source of these
differences and the tax effects are primarily from tax depreciation and certain
allowances and reserves not deductible in the current period.
 
     The Company's actual tax, with 1996, 1995 and 1994 statutory tax reported
on income before acquisition related charges, is as follows:
 
<TABLE>
<CAPTION>
                                                              Years Ended December 31,
                                                          ---------------------------------
                                                            1996         1995        1994
                                                          --------     --------     -------
    <S>                                                   <C>          <C>          <C>
    Tax provision at statutory federal
      income tax rate (35%)                               $ 33,558     $ 15,052     $ 8,822
    State income tax, net of federal benefit                 5,571        2,500          50
    Net foreign earnings taxed at rates
      different than federal tax rate                        2,319          700         (74)
    Utilization of prior year tax benefits                 (41,448)     (12,457)     (4,737)
                                                          --------     --------     -------
                                                          $     --     $  5,795     $ 4,061
                                                          ========     ========     =======
</TABLE>
 
                                       43
<PAGE>   46
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities are as follows:
 
<TABLE>
<CAPTION>
                                                                    Years Ended December
                                                                             31,
                                                                   -----------------------
                                                                     1996           1995
                                                                   --------       --------
    <S>                                                            <C>            <C>
    Deferred tax assets:
      Net operating losses and credits                             $ 14,284       $ 19,300
      Accounts receivable reserves                                      286          3,557
      Development costs                                                  --          1,848
      Other reserves and accruals                                     7,818          1,605
                                                                   --------       --------
                                                                     22,388         26,310
    Less: Valuation allowance                                       (18,052)       (17,214)
                                                                   --------       --------
                                                                      4,336          9,096
                                                                   --------       --------
    Tax liabilities:
      Acquired intangible assets                                    (54,429)       (54,656)
      Deferred foreign taxes                                         (3,941)        (3,941)
      Other liabilities                                             (28,550)        (7,618)
                                                                   --------       --------
                                                                    (86,920)       (66,215)
                                                                   --------       --------
    Net deferred tax liability                                     $(82,584)      $(57,119)
                                                                   ========       ========
</TABLE>
 
     The valuation allowance relates to uncertainties surrounding the
recoverability of deferred tax assets. In assessing the realizability of
deferred assets, management considers whether it is more likely than not that
some or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during periods in which benefits from net operating loss carry
forwards are available and temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income, and other matters in making this assessment. As a result of its
evaluation of these factors at December 31, 1996 management recorded a valuation
reserve for deferred tax assets of $18,052. At December 31, 1996, the Company
had worldwide net operating loss carryforwards and other tax benefits before
merger related benefits of approximately $40,810 for income tax purposes,
expiring from the year 1999 through 2009. The Company expects to reduce its
deferred tax liability in proportion to the amortization taken on certain
intangible assets established in the acquisitions. The reduction of the
intangible assets and the deferred tax liability will not impact future cash
flows of the Company. The utilization of tax loss carryforwards is subject to
limitations under Section 382 of the Internal Revenue Code, the US consolidated
tax return provisions, and local country tax regulations.
 
                                       44
<PAGE>   47
 
                           THE LEARNING COMPANY, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(12)  GEOGRAPHIC INFORMATION
 
     The Company operates primarily in one business segment -- software for use
with microcomputers. The following table presents information concerning the
Company's North American, European and other operations during the Years Ended
December 31, 1996, 1995 and 1994.
 
<TABLE>
<CAPTION>
                                             NORTH
                                            AMERICA     EUROPE     OTHER    ELIMINATION'S   CONSOLIDATED
                                           ---------    -------    ------   -------------   ------------
<S>                                        <C>          <C>        <C>         <C>            <C>
DECEMBER 31, 1996
REVENUES:
  Customers                                $ 284,537    $57,094    $1,690      $    --        $ 343,321
  Inter-company                                  383      6,698        --       (7,081)              --
                                           ---------    -------    ------      -------        ---------
     Total                                 $ 284,920    $63,792    $1,690      $(7,081)       $ 343,321
                                           =========    =======    ======      =======        =========
INCOME (LOSS) FROM OPERATIONS              $(392,905)   $10,531    $1,062      $    --        $(381,312)
                                           =========    =======    ======      =======        =========
IDENTIFIABLE ASSETS                        $ 769,338    $23,096    $1,084      $    --        $ 793,518
                                           =========    =======    ======      =======        =========
DECEMBER 31, 1995
REVENUES:
  Customers                                $ 140,811    $27,380    $1,227      $(2,376)       $ 167,042
  Inter-company                                  696     (3,071)       (1)       2,376               --
                                           ---------    -------    ------      -------        ---------
     Total                                 $ 141,507    $24,309    $1,226      $    --          167,042
                                           =========    =======    ======      =======        =========
INCOME (LOSS) FROM OPERATIONS              $ (64,754)   $ 3,256    $  628      $    --          (60,870)
                                           =========    =======    ======      =======        =========
IDENTIFIABLE ASSETS                        $ 891,266    $ 9,062    $   85      $    --        $ 900,413
                                           =========    =======    ======      =======        =========
DECEMBER 31, 1994
REVENUES:
  Customers                                $ 110,278    $11,422    $1,093      $(1,506)       $ 121,287
  Inter-company                                3,006      2,172       (60)      (5,118)              --
                                           ---------    -------    ------      -------        ---------
     Total                                 $ 113,284    $13,594    $1,033      $(6,624)       $ 121,287
                                           =========    =======    ======      =======        =========
INCOME FROM OPERATIONS                     $  24,617    $ 1,096    $  482      $  (454)       $  25,741
                                           =========    =======    ======      =======        =========
IDENTIFIABLE ASSETS                        $  89,131    $ 2,801    $ (146)     $  (971)       $  90,815
                                           =========    =======    ======      =======        =========
</TABLE>
 
     The Company conducts a portion of its operations outside the United States.
At December 31, 1996, $8,432 of cash and cash equivalents were subject to
currency fluctuations. Sales and transfers between geographic areas are
generally priced at market, less an allowance for marketing costs. No single
customer accounted for greater than 10% of revenues for any of the periods
presented.
 
                                       45
<PAGE>   48
 
                                                                     SCHEDULE II
 
                           THE LEARNING COMPANY, INC.
                       VALUATION AND QUALIFYING ACCOUNTS
             For the Years Ended December 31, 1996, 1995 and 1994,
                                 (In thousands)
 
<TABLE>
<CAPTION>
                                                                Additions
                                                       ---------------------------
                                         Balance at    Charged to                                  Balance at
                                        Beginning of    Cost and      Charged to                     End of
                                           Period       Expenses    Other Accounts   Deductions(1)   Period
                                        ------------   ----------   --------------   -----------   ----------
<S>                                       <C>            <C>              <C>          <C>           <C>
YEAR ENDED DECEMBER 31, 1996
  Allowance for returns and doubtful
     accounts                             $ 6,851        $38,112          --           $(29,772)     $15,191
YEAR ENDED DECEMBER 31, 1995
  Allowance for returns and doubtful
     accounts                             $ 6,744        $22,358          --           $(22,251)     $ 6,851
YEAR ENDED DECEMBER 31, 1994
  Allowance for returns and doubtful
     accounts                             $16,216        $13,744          --           $(23,216)     $ 6,744
</TABLE>
 
---------------
 
(1) Deductions relate to credits issued for returns and allowances against
accounts receivable.
 
                                       46
<PAGE>   49
 
                                    PART III
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE
 
     None.
 
ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
     Information required by this Item appears in sections captioned "Nominees,"
"Executive Officers," and "Management's Stock Ownership" in the Company's
definitive Proxy Statement to be delivered to stockholders in connection with
the 1997 Annual Meeting of Stockholders (the "1997 Proxy Statement"). Such
information is incorporated herein by reference.
 
ITEM 11.  EXECUTIVE COMPENSATION
 
     Information required by this Item appears in sections captioned
"Compensation of Directors," "Compensation Committee Interlocks and Insider
Participation," "Compensation Committee Report," "Comparative Stock
Performance," "Executive Compensation," "Employment and Severance Arrangements,"
"Stock Options Granted in 1997," "Option Exercises and Values for 1996" and
section 16(a) "Beneficial Ownership Reporting Compliance" in the 1997 Proxy
Statement. Such information is incorporated herein by reference.
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     Information required by this Item appears in sections captioned
"Management's Stock Ownership" and "Security Ownership of Certain Beneficial
Owners" in the 1997 Proxy Statement. Such information is incorporated herein by
reference.
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     Information required by this Item appears in section(s) captioned
"Compensation of Directors" and "Related Transactions" in the 1997 Proxy
Statement. Such information is incorporated herein by reference.
 
                                    PART IV
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
  (a) Documents filed as part of this report
 
      (1) FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                                        PAGE
                                                                                        ----
       <S>                                                                              <C>
       CONSOLIDATED FINANCIAL STATEMENTS:
         Report of Independent Accountants                                               25
         Consolidated Balance Sheets as of December 31, 1996 and 1995                    26
         Consolidated Statements of Operations for the Years Ended December 31, 1996,
            1995 and 1994                                                                27
         Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended
            December 31, 1996, 1995 and 1994                                             28
         Consolidated Statements of Cash Flows for the Years Ended December 31, 1996,
            1995 and 1994                                                                29
         Notes to Consolidated Financial Statements                                      31
</TABLE>
 
      (2) FINANCIAL STATEMENT SCHEDULE
 
<TABLE>
<CAPTION>
                                                                                        PAGE
                                                                                        ----
       <S>                                                                              <C>
       CONSOLIDATED SUPPLEMENTARY FINANCIAL SCHEDULE:
         Schedule II -- Valuation and Qualifying Accounts                                46
</TABLE>
 
                                       47
<PAGE>   50
 
      (3) EXHIBITS
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                          DESCRIPTION
-------                                         -----------
 <C>      <C><S>
  2.1     -- Amended and Restated Combination Agreement by and among WordStar International
             Incorporated, SoftKey Software Products Inc., Spinnaker Software Corporation and
             SSC Acquisition Corporation dated as of August 17, 1993, as amended(1)

  3.1     -- Restated Certificate of Incorporation, as amended(2)

  3.2     -- Bylaws of the Company, as amended(2)

  4.1     -- Indenture dated as of October 16, 1995 between the Company and State Street Bank
             and Trust Company, as Trustee, for 5 1/2% Senior Convertible Notes due 2000 (the
             "Indenture")(3)

  4.2     -- First Supplemental Indenture to the Indenture, dated as of November 22, 1995, by
             and between the Company and State Street Bank and Trust Company, as Trustee(4)

  4.3     -- Note Resale Registration Rights Agreement dated as of October 23, 1995 by and
             between the Company, on the one hand, and the Initial Purchasers set forth
             therein, on the other hand (the "Registration Rights Agreement")(4)

  4.4     -- Letter Agreement dated November 22, 1995 amending the Registration Rights
             Agreement(4)

  4.5     -- Form of Securities Resale Registration Rights Agreement by and among the Company
             and Tribune Company(5)

  4.6     -- Form of Indenture between the Company and State Street Bank and Trust Company, as
             Trustee, for 5 1/2% Senior Convertible/Exchangeable Notes Due 2000(6)

 10.1     -- Employment Agreement dated March 5, 1997 by and between the Company and Tony
             Bordon*

 10.2     -- Employment Agreement dated May 27, 1994 by and between the Company and Michael
             Perik(7)*

 10.3     -- Employment Agreement dated May 27, 1994 by and between the Company and Kevin
             O'Leary(7)*

 10.4     -- Employment Agreement dated February 1, 1994 by and between the Company and R.
             Scott Murray(8)*

 10.5     -- Employment Agreement dated October 8, 1993 by and between SoftKey Software
             Products Inc. and David E. Patrick(8)*

 10.6     -- 1994 Non-Employee Director Stock Option Plan, as amended and restated effective
             February 5, 1996(9)*

 10.7     -- Form of Stock Option Agreement under 1994 Non-Employee Director Stock Option
             Plan(9)*

 10.8     -- Credit Agreement dated as of September 30, 1994 between SoftKey Inc. and Fleet
             Bank of Massachusetts, N.A. (10)

 10.9     -- Second Amendment dated as of May 17, 1995 by and between SoftKey Inc. and Fleet
             Bank of Massachusetts, N.A. to Credit Agreement dated as of September 30, 1994(11)

 10.10    -- Third Amendment dated as of December 22, 1995 by and among SoftKey Inc. and Fleet
             Bank of Massachusetts, N.A. to Credit Agreement dated as of September 30, 1994(9)

 10.11    -- Fourth Amendment dated as of February 28, 1996 by and among SoftKey Inc. and Fleet
             Bank of Massachusetts, N.A. to Credit Agreement dated as of September 30, 1994(9)

 10.12    -- Fifth Amendment dated as of October 4, 1996 by and among SoftKey Inc. and Fleet
             National Bank, as successor in interest to Fleet Bank of Massachusetts, to Credit
             Agreement dated as of September 30, 1994(12)

 10.13    -- Employment Agreement dated March 1, 1994 by and between SoftKey Software Products
             Inc. and Robert Gagnon(13)*

 10.14    -- Amendment No. 1 dated as of March 1, 1995, to Employment Agreement dated as of
             February 1, 1994 by and between R. Scott Murray and the Company(13)*

 10.15    -- Sublease Agreement dated as of January 5, 1995 by and between Mellon Financial
             Services Corporation #1 and SoftKey Inc.(13)

 10.16    -- Continuing Guaranty of Lease dated as of January 5, 1995 by the Company in favor
             of Mellon Financial Services Corporation #1(13)

 10.17    -- 1990 Long Term Equity Incentive Plan, as amended and restated through October 31,
             1996*

 10.18    -- Form of Stock Option Agreement under 1990 Long Term Equity Incentive Plan(9)*

 10.19    -- 1996 Stock Option Plan, as amended and restated through October 31, 1996*
</TABLE>
 
                                       48
<PAGE>   51
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                          DESCRIPTION
-------                                         -----------
 <C>      <C><S>
 10.20    -- Form of Stock Option Agreement under 1996 Stock Option Plan(9)*

 10.21    -- Form of Standstill Agreement by and between the Company and Tribune Company(5)

 11.1     -- Statement Re: Computation of Per Share Earnings

 21.1     -- Subsidiaries of the Company

 23.1     -- Written Consent of Coopers & Lybrand L.L.P.
</TABLE>
 
---------------
  *  Denotes management contract or compensatory plan or arrangement.
 
 (1) Incorporated by reference to schedules included in the Company's definitive
     Joint Management Information Circular and Proxy Statement dated December
     27, 1993.
 
 (2) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended July 6, 1996.
 
 (3) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended September 30, 1995.
 
 (4) Incorporated by reference to exhibits filed with the Company's Registration
     Statement on Form S-3 (Reg . No. 333-145) filed January 26, 1996.
 
 (5) Filed as exhibits to the Agreement and Plan of Merger dated November 30,
     1995 by and among the Company, Cubsco I, Inc., Cubsco II, Inc., Tribune
     Company, Compton's NewMedia, Inc. and Compton's Learning Company,
     incorporated by reference to exhibits filed with the Company's Current
     Report on Form 8-K dated December 11, 1995.
 
 (6) Incorporated by reference to exhibits filed with the Company's Current
     Report on Form 8-K dated December 11, 1995.
 
 (7) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended July 2, 1994.
 
 (8) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended April 2, 1994.
 
 (9) Incorporated by reference to exhibits filed with the Company's Annual
     Report on Form 10-K for the year ended January 6, 1996.
 
(10) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended October 1, 1994.
 
(11) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended July 1, 1995.
 
(12) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended October 5, 1996.
 
(13) Incorporated by reference to exhibits filed with the Company's Annual
     Report on Form 10-K for the year ended December 31, 1994.
 
  (b) Reports on Form 8-K
 
     The registrant filed a Current Report on Form 8-K reporting that, effective
October 24, 1996, it had changed its name to The Learning Company, Inc.
 
                                       49
<PAGE>   52
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
 
                                          THE LEARNING COMPANY, INC.
 
                                          By:        /s/ MICHAEL PERIK
                                            ------------------------------------
                                                       Michael Perik
                                                Chief Executive Officer and
                                                   Chairman of the Board
                                               (principal executive officer)
 
Date: April 3, 1997
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated as of April 3, 1997.
 
<TABLE>
<CAPTION>
                  SIGNATURE                                        TITLE
                  ---------                                        -----
<C>                                            <S>
 
              /s/ MICHAEL PERIK                Director, Chief Executive Officer and Chairman
---------------------------------------------    of the Board of Directors
                Michael Perik                  
 
              /s/ ROBERT GAGNON                Director
---------------------------------------------
                Robert Gagnon
 
              /s/ KEVIN O'LEARY                Director and President
---------------------------------------------
                Kevin O'Leary
 
             /s/ ROBERT RUBINOFF               Director
---------------------------------------------
               Robert Rubinoff
 
              /s/ MICHAEL BELL                 Director
---------------------------------------------
                Michael Bell
 
             /s/ SCOTT SPERLING                Director
---------------------------------------------
               Scott Sperling
 
              /s/ JAMES DOWDLE                 Director
---------------------------------------------
                James Dowdle
 
             /s/ LAMAR ALEXANDER               Director
---------------------------------------------
               Lamar Alexander
 
             /s/ CHARLES PALMER                Director
---------------------------------------------
               Charles Palmer
 
             /s/ R. SCOTT MURRAY               Executive Vice President and Chief
---------------------------------------------    Financial Officer (principal financial
               R. Scott Murray                   officer and principal accounting officer)
                                               
</TABLE>
 
                                       50
<PAGE>   53
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
EXHIBIT                                                                                    PAGE
NUMBER                                      DESCRIPTION                                   NUMBER
-------                                     -----------                                   ------
 <C>      <C><S>                                                                          
  2.1     -- Amended and Restated Combination Agreement by and among WordStar
             International Incorporated, SoftKey Software Products Inc., Spinnaker
             Software Corporation and SSC Acquisition Corporation dated as of August
             17, 1993, as amended(1)

  3.1     -- Restated Certificate of Incorporation, as amended(2)

  3.2     -- Bylaws of the Company, as amended(2)

  4.1     -- Indenture dated as of October 16, 1995 between the Company and State
             Street Bank and Trust Company, as Trustee, for 5 1/2% Senior Convertible
             Notes due 2000 (the "Indenture")(3)

  4.2     -- First Supplemental Indenture to the Indenture, dated as of November 22,
             1995, by and between the Company and State Street Bank and Trust Company,
             as Trustee(4)

  4.3     -- Note Resale Registration Rights Agreement dated as of October 23, 1995 by
             and between the Company, on the one hand, and the Initial Purchasers set
             forth therein, on the other hand (the "Registration Rights Agreement")(4)

  4.4     -- Letter Agreement dated November 22, 1995 amending the Registration Rights
             Agreement(4)

  4.5     -- Form of Securities Resale Registration Rights Agreement by and among the
             Company and Tribune Company(5)

  4.6     -- Form of Indenture between the Company and State Street Bank and Trust
             Company, as Trustee, for 5 1/2% Senior Convertible/Exchangeable Notes Due
             2000(6)

 10.1     -- Employment Agreement dated March 5, 1997 by and between the Company and
             Tony Bordon*

 10.2     -- Employment Agreement dated May 27, 1994 by and between the Company and
             Michael Perik(7)*

 10.3     -- Employment Agreement dated May 27, 1994 by and between the Company and
             Kevin O'Leary(7)*

 10.4     -- Employment Agreement dated February 1, 1994 by and between the Company
             and R. Scott Murray(8)*

 10.5     -- Employment Agreement dated October 8, 1993 by and between SoftKey
             Software Products Inc. and David E. Patrick(8)*

 10.6     -- 1994 Non-Employee Director Stock Option Plan, as amended and restated
             effective February 5, 1996(9)*

 10.7     -- Form of Stock Option Agreement under 1994 Non-Employee Director Stock
             Option Plan(9)*

 10.8     -- Credit Agreement dated as of September 30, 1994 between SoftKey Inc. and
             Fleet Bank of Massachusetts, N.A.(10)

 10.9     -- Second Amendment dated as of May 17, 1995 by and between SoftKey Inc. and
             Fleet Bank of Massachusetts, N.A. to Credit Agreement dated as of
             September 30, 1994(11)

 10.10    -- Third Amendment dated as of December 22, 1995 by and among SoftKey Inc.
             and Fleet Bank of Massachusetts, N.A. to Credit Agreement dated as of
             September 30, 1994(9)

 10.11    -- Fourth Amendment dated as of February 28, 1996 by and among SoftKey Inc.
             and Fleet Bank of Massachusetts, N.A. to Credit Agreement dated as of
             September 30, 1994(9)

 10.12    -- Fifth Amendment dated as of October 4, 1996 by and among SoftKey Inc. and
             Fleet National Bank, as successor in interest to Fleet Bank of
             Massachusetts, N.A., to Credit Agreement dated as of September 30,
             1994(12)

 10.13    -- Employment Agreement dated March 1, 1994 by and between SoftKey Software
             Products Inc. and Robert Gagnon(13)

 10.14    -- Amendment No. 1 dated as of March 1, 1995, to Employment Agreement dated
             as of February 1, 1994 by and between R. Scott Murray and the
             Company(13)*
</TABLE>
 
                                       51
<PAGE>   54
 
<TABLE>
<CAPTION>
EXHIBIT                                                                                    PAGE
NUMBER                                      DESCRIPTION                                   NUMBER
------                                      -----------                                   ------
 <S>     <C> <C>                                                                          <C>
 10.15    -- Sublease Agreement dated as of January 5, 1995 by and between Mellon
             Financial Services Corporation #1 and SoftKey Inc.(13)
 
 10.16    -- Continuing Guaranty of Lease dated as of January 5, 1995 by the Company
             in favor of Mellon Financial Services Corporation #1(13)

 10.17    -- 1990 Long Term Equity Incentive Plan, as amended and restated through
             October 31, 1996*

 10.18    -- Form of Stock Option Agreement under 1990 Long Term Equity Incentive
             Plan(9)*

 10.19    -- 1996 Stock Option Plan, as amended and restated through October 31, 1996*

 10.20    -- Form of Stock Option Agreement under 1996 Stock Option Plan(9)*

 10.21    -- Form of Standstill Agreement by and between the Company and Tribune
             Company(5)

 11.1     -- Statement Re: Computation of Per Share Earnings

 21.1     -- Subsidiaries of the Company

 23.1     -- Written Consent of Coopers & Lybrand L.L.P.
</TABLE>
 
---------------
 
  *  Denotes management contract or compensatory plan or arrangement.
 
 (1) Incorporated by reference to schedules included in the Company's definitive
     Joint Management Information Circular and Proxy Statement dated December
     27, 1993.
 
 (2) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended July 6, 1996.
 
 (3) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended September 30, 1995.
 
 (4) Incorporated by reference to exhibits filed with the Company's Registration
     Statement on Form S-3 (Reg . No. 333-145) filed January 26, 1996.
 
 (5) Filed as exhibits to the Agreement and Plan of Merger dated November 30,
     1995 by and among the Company, Cubsco I, Inc., Cubsco II, Inc., Tribune
     Company, Compton's NewMedia, Inc. and Compton's Learning Company,
     incorporated by reference to exhibits filed with the Company's Current
     Report on Form 8-K dated December 11, 1995.
 
 (6) Incorporated by reference to exhibits filed with the Company's Current
     Report on Form 8-K dated December 11, 1995.
 
 (7) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended July 2, 1994.
 
 (8) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended April 2, 1994.
 
 (9) Incorporated by reference to exhibits filed with the Company's Annual
     Report on Form 10-K for the year ended January 6, 1996.
 
(10) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended October 1, 1994.
 
(11) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended July 1, 1995.
 
(12) Incorporated by reference to exhibits filed with the Company's Quarterly
     Report on Form 10-Q for the quarterly period ended October 5, 1996.
 
(13) Incorporated by reference to exhibits filed with the Company's Annual
     Report on Form 10-K for the year ended December 31, 1994.
 
                                       52