SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------

FORM 10-K/A
AMENDMENT NO. 1
TO
(Mark One)

[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1996

[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period to

Commission File Number: 0-25916

YES! ENTERTAINMENT CORPORATION

(Exact name of Registrant as specified in its charter)

Delaware 94-3165290
----------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) (Identification No.)

3875 Hopyard Road, Suite 375, Pleasanton, California 94588
(Address of principal executive offices and zip code)

Registrant's telephone number, including area code: (510) 847-9444
------------------

Securities registered pursuant to Section 12(b) of the Act: None

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

Common Stock, no par value
(Title of Class)

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 the voting stock held by non affiliates of the
Registrant, based upon the closing sale price of the Common Stock on March 14,
1997 on the Nasdaq National Market was

approximately $42,846,228. Shares of Common Stock held by each officer and
director and by each person who owns 5% or more of the outstanding Common Stock
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.

The number of shares outstanding of the Registrant's Common Stock as of March
14, 1997 was 14,043,432.

DOCUMENTS INCORPORATED BY REFERENCE

Certain sections of the Registrant's definitive Proxy Statement for the 1997
Annual Meeting of Shareholders to be held on May 20, 1997 are incorporated by
reference in Part III of this Form 10-K/A to the extent stated herein.

PART I

ITEM 1. BUSINESS

GENERAL

YES! Entertainment Corporation ("YES!" or the "Company") develops,
manufactures and markets toys and other entertainment products, including a
variety of interactive products. YES! applies innovative technology available in
other industries to design products that are fun for children and build on their
natural creativity. Most of YES!'s products target children between the ages of
two and twelve, a market of over 45 million in North America alone.

YES! has introduced several lines of products since being founded in
December 1992. A substantial portion of the Company's current products are
marketed under the YES! Gear brand. YES! Gear is principally comprised of the
Company's Yak Bak, Mega and T.R.A.P.S. lines of products. These products, which
include both children's electronic and audio products, are designed to appeal to
kids six to twelve years of age with their high impact design and unique play
activities. The Company also markets Power Penz, a line of pens that incorporate
toys and activities. In 1996, the Company also launched a line of food activity
products with the Mrs. Fields Baking Factory, a toy cookie oven using mixes
developed in conjunction with the Mrs. Fields Development Corporation, and V-
Link, a new line of communication products designed to be a short-range, toll-
free radiophone system that includes voice-messaging, conference call and
private conversation features.

In 1997, the Company expects to introduce a number of new products and
product lines. These include the Baskin-Robbins Ice Cream Maker, a toy ice cream
maker with which children can prepare ice cream for their family using delicious
mixes developed in conjunction with Baskin-Robbins USA, Co., Air Vectors, a line
of small vehicles for boys that transform and launch flying objects, such as
airplanes or missiles, YES! Pre-School, a line of pre-school products which
incorporate popular features from YES!'s highly successful Yak Bak line, YES!
Girl, a line of electronic toys and activities specially for girls, Disgusting
Designs, a ghoulish new art activity center for boys, and Radical Air, a line of
toy guns that shoot foam balls that expand to three times their original size in
the air.

YES! was incorporated in California in September 1992 and began operations
in November 1992. The Company changed its state of incorporation from California
to Delaware in October 1996. The Company had net revenues of $69.7 million,
$55.7 million, $36.4 million and $25.9 million in 1996, 1995, 1994 and 1993,
respectively. The Company incurred operating losses from its inception through
the quarter ended June 30, 1995, incurred a net loss of approximately $12.6
million in 1996, and had an accumulated deficit of approximately $52.7 million
at December 31, 1996.

The Company's initial public offering of Common Stock occurred in June 1995
at which time the Company's Common Stock and Redeemable Common Stock Purchase
Warrants issued in connection with the initial public offering ("IPO Warrants")
commenced trading on the Nasdaq SmallCap Market. The Company's Common Stock and
IPO Warrants were included on the Nasdaq National Market in November 1995. All
of the outstanding IPO Warrants were exercised in December 1995 and January 1996
at an exercise price of $4.00 per share. Pursuant to the exercise of the IPO
Warrants, the Company raised approximately $19.8 million.

YES!, YAK BAK and COMES TO LIFE BOOKS are registered trademarks and YES!
GEAR, POWER PENZ, AIR VECTORS, YES! PRE-SCHOOL, YES! GIRL, DISGUSTING DESIGNS,
RADICAL AIR WEAPONS, T.R.A.P.S., YAK BAK WARP'R, YAK BAK SFX, YAK BAKWARDS, YAK
MANIAK, MEGA MIKE, MIGHTY MEGA MOUTH SPORTS, SECRETS, CODER, LASER SHOTS, QUICK
FLIPS, PEN PHONE, HANDY CANDY, V-LINK, MONSTER MARKER HAND, MOLDY BODY PARTS,
PET TOONIES, GIZMOS, MUSIC GIZMOS, INSTRUMENT GISMOS, DANCE STUDIO, YES!
EXTREME, STROBES, YAK BAK BALLS, SFX BALLS, YES! GAMES and SLAP TRAP are
trademarks of YES! Entertainment Corporation. All rights reserved. MRS. FIELDS
is a registered trademark of the Mrs. Fields Development Corporation. BASKIN 31
ROBBINS is a registered trademark of the Baskin-Robbins USA, Co. NICKELODEON is
a registered trademark of Nickelodeon, a programing service of Viacom
International, Inc.

PRODUCTS

YES!'s product lines span major markets for children's and teen products.
These include educational and licensed products, children's electronics and
publishing, activity products, and electronic learning products, as well as new
product categories that YES!'s innovative approach to product development is
helping to create, such as audio recording and distortion products, functional
toys (i.e. toys that work as other types of products, such as pens) and
children's and teen communications. The majority of the Company's products
target children ages two to twelve, although the Company's V-Link product
targets consumers between the ages of ten and seventeen.

The Company introduced a number of new product lines in 1996 and expects to
introduce several new product lines in 1997. The Company expects that the 1997
product lines, certain of which are technically complex, will place great
demands on management and other Company resources. There can be no assurance
that the products under development will be successfully developed, or if
successfully developed, that they will achieve market acceptance. In addition,
if the Company is not able to complete successful development, tooling,
manufacture and marketing of its 1997 product lines, the Company's operating
results and financial condition will be materially adversely affected.

YES! GEAR

The Company's current line of YES! Gear products comprises over 30 SKUs.
All of these products are designed around the idea of combining technical
innovation in a low cost product that provides children with opportunity for
creative expression. YES! Gear is principally comprised of the Company's Yak
Bak, Mega and T.R.A.P.S. lines of products.

Yak Bak. The Yak Bak line of products combines solid state recording,
playback and sound effects technology in colorful, highly stylized micro-sized
recorders that permit children to record and play back their customized
messages. Designed to fit comfortably into a child's hand and pocket, each of
the Yak Bak products is available in a number of different colors. All Yak Bak
packaging is designed to achieve maximum impact in a retail store and allow
customers to test the product before purchasing it.

YES! launched its YES! Gear product line in December 1994 with the
introduction of Yak Bak, a simple, highly stylized six-second recording and
playback device. Since then, the Company has introduced a number of extensions
to the Yak Bak product, including Yak Bak Warp'r, a more fully featured version
of the original Yak Bak product, which includes a voice pitch modulator, that
alters the voice recording to permit the recorder to play back the recording in
new ways; Yak Bak SFX, which incorporates built-in sound effects and extended
recording features that allow a child to create a wide variety of messages and
custom recordings; and Yak Bakwards, a Yak Bak device that permits the user to
play back a recorded message in reverse (thereby creating a whole new language
for children). The Company has also extended the recordability features of the
Yak Bak into other formats appealing to children, including balls, wristwatches,
motion detectors and a variety of pens that include the Yak Warp'r, Yak Bak SFX
and Yak Bakwards features.

In 1997, the Company expects to extend the Yak Bak line further with the
introduction of Yak Maniak, a Yak Bak device that incorporates echo, reverb and
tremolo capability to permit kids to make new and exciting recordings. The
Company also expects to launch a line of Yak Bak SFX products themes for girls
under the Ms. Yak mark.

Mega Products. In 1996, the Company introduced a line of voice
amplification products. In 1997, the Company will continue these types of
products with its Mega Mike and Mighty Mega Mouth Sports products. Mega Mike is
a voice amplification device that clips to the user's belt, attached to which is
a microphone into which children can speak. With the addition of applause,
booing, laughter and rim shot sound effects, Mega Mike transforms children into
one-man stand-up comedians. Mighty Mega Mouth Sports is a high sound volume
device that let's kids blast their voice and add popular sports sound effects
sounds.

T.R.A.P.S. In 1996, the Company introduced a line of remote activated
pranks and effects products marketed under the name Techno Remote Activated
Pranks (or T.R.A.P.S.). Each of the T.R.A.P.S. is activated by a radio frequency
transponder that allows the user to initiate his or her prank or effect from a
hidden or remote location. The remote control device activates all four
T.R.A.P.S., which include a squirt cannon, a water or air balloon popper, a
sound effects generator and a bug drop, which releases plastic bugs from a
ceiling location.

POWER PENZ.

In December 1995, the Company began shipping a new line of functional toys
under the Power Penz mark. Power Penz are a series of activity toys that take
form in a fully functional ball-point pen. In 1995, the Company introduced four
mechanical Power Penz, consisting of a dart launcher, a helicopter, a miniature
race car launcher, and a combination telescope, microscope and rear view mirror,
and two electrical Power Penz, consisting of a sound effects toy and a mini
directional amplifier. In 1996, the Company expanded the Power Penz line to
include Secrets and Coder, pens that wrote in (and illuminated with a built-in
UV light) invisible ink, Laser Shots, pens that fire and sense beams of infrared
light that allow kids to aim and fire at each other's pens, Quick Flips, pens
that house grooming and cosmetic devices for girls and spy activities for boys
that flip out of the body of the pen, and Rimshot, pens that house a basketball
hoop and launch miniature basketballs.

The Company expects to expand the Power Penz line in 1997 to include Pen
Phone, pens that work as short range infrared walkie talkies, Handy Candy
candy dispensing pens, FM radio pens, drumming pens, and many other new and
exciting activities in a pen.

LICENSED FOOD

Mrs. Fields Baking Factory. In 1996, the Company entered the children's
food products market with the introduction of the Mrs. Fields Baking Factory, a
toy oven that permits children to bake cookies, muffins and brownies for their
families and friends, using recipes developed in conjunction with the Mrs.
Fields Development Corporation. Each oven displays the familiar Mrs. Fields red
and white color scheme and logo and comes complete with a set of baking pans and
utensils. The mixes, which come with the oven and are also sold separately, are
designed to taste like the real Mrs. Fields cookies available at any one of the
hundreds of Mrs. Fields cookie outlets throughout the United States.

Baskin-Robbins Ice Cream Maker. In 1997, the Company expects to build on
the success of the Mrs. Fields Baking Factory when it launches the Baskin-
Robbins Ice Cream Maker, which makes real ice cream using Baskin-Robbins mixes,
including some that have been developed exclusively for YES!. Like the Mrs.
Fields Baking Factory, the

Baskin-Robbins Ice Cream Maker will be sold with a variety of mixes, and refills
will be available in a number of different flavors.

COMMUNICATIONS

In late 1996, the Company introduced V-Link, a new communications product
marketed principally to teens ages ten to seventeen. V-Link is designed to
permit teens to communicate with each other within up to a 1,000 foot radius
(such as in a school or at a shopping mall) without any toll or monthly charges.
V-Link also includes voice mail and messaging capabilities, together with the
ability to have private conversations or talk on a party line.

V-Link is a complicated consumer electronics product, and the Company has
incurred substantial expense in completing the development and tooling for its
manufacture. In 1996, the Company also devoted a substantial portion of its
marketing budget to the introduction of V-Link, which occurred later than
anticipated. The Company's 1996 financial results were materially adversely
impacted as the result of delays in the introduction of V-Link, as well as in
obtaining formal regulatory approval for the sale of V-Link. If the Company is
unable to effectively market V-Link in 1997, or if V-Link is not well-received
by teen consumers in 1997, the Company will be unable to recover its investment
in the development and manufacturing of inventory of V-Link, which may have a
material adverse effect on the Company's 1997 financial results.

NEW CATEGORIES FOR 1997

The Company has or is in the process of developing a number of new lines of
products for 1997 that will significantly expand the breadth of YES!'s product
offerings. Specifically, the Company will move into new categories of products,
including vehicles, pre-school, girls items, foam products and electronic games.

Vehicles. Air Vectors is YES!'s initial foray into the popular toy vehicle
category. YES! is attempting to enter this category with a new and exciting
feature -- Air Vectors cars will race ahead, then transform and launch planes or
missiles from the vehicles superstructure, which continue their forward motion
in flight. The Company's initial vehicles will be themed as racing cars,
military vehicles and off-road vehicles. The Company is currently developing the
Air Vectors line which it expects will be shipped late in the 1997 selling
season.

YES! PreSchool. At Toy Fair 1997, the Company introduced a new line of pre-
school electronic products to address the growing three to six year old market.
These products include Yakkins, a line of molded plastic characters into which
children can record sounds and messages for playback, Pet Toonies,a line of
animals that play popular kids songs in that animal's own sounds, and Music
Gizmos and Instrument Gizmos, a line of highly stylistic devices that play pre-
set tunes and musical sounds in a variety of different ways depending on how a
child "builds" their gizmo.

YES! Girl. The Company in 1997 expects to expand into the girls category
with a new line of YES! Girl products, themed especially for creative girls. The
Company's entree into this category is Dance Studio, a portable dance instructor
that calls out dance steps to little girls. Girls can dance to preset routines,
or create their own, and can vary the pace and beat of their new dances.

YES! Extreme. The Company also is creating a new category of action sports
and play activities. These will include three new product lines.

Strobes

In 1997, the Company expects to introduce a line of high bounce balls that
contain impact activated strobing lights. Bounce the ball and brilliant red
lights begin to flash inside, creating a whole new dynamic of day and night ball
play.

Radical Air Weapons (R.A.W.)

The Company is developing and expects to introduce in 1997 a line of toy
guns that shoot expanding foam balls. Unlike other foam guns, these balls expand
quickly to more than three times their compacted size as they fly through the
air.

Yak Balls and SFX Balls

Finally, the Company expects to extend both the recording and sound effects
features of the Yak Bak and Yak Bak SFX products into a line of miniature
baseballs and footballs under the Yak Bak Balls and SFX Balls names.

Activities. The Company expects to introduce in 1997 Disgusting Designs, a
ghoulish new painting and arts design center for young boys. The design center
is comprised of a Zombie head and finger that incorporates all sorts of painting
activities, including paint filled brains, crayon teeth, eyeballs that are
brushes, sponge tongues and stamp and fingers. Other accessories sold separately
include a Monster Marker Hand and a Moldy Body Parts molding kit, which lets
kids mold their own creepy sculptures that they can then decorate.

YES! Games. In 1997, the Company expects to introduce a product into the
electronic games category. Slap Trap is an electronic game module that contains
four different game plays that challenge user's memory and reaction time. Slap
Trap is designed for family fun.

PRODUCT DESIGN AND DEVELOPMENT

The Company's product development combines the use of independent outside
designers with internal development to develop new product lines.

INDEPENDENT DESIGNERS

The Company continually evaluates new product ideas generated by a number
of outside independent designers with whom the Company communicates on a regular
basis. When the Company decides to develop a product based upon an idea
presented

by an independent designer, the Company enters into a license agreement with the
designer. These license agreements typically provide for the payment of
royalties based on net sales of the new product. Such arrangements exist for
most of the Company's lines of products.

INTERNAL DEVELOPMENT

A substantial portion of the Company's internal development efforts focus
primarily on further development of ideas originally submitted by independent
designers. Product design and development is a joint effort between the
Company's product development, marketing, sales and engineering groups. Each
group brings its unique expertise, allowing the creation of ideas which combine
the latest technologies, current trends and strongest consumer and retailer
demands.

The Company tests product concepts and prototypes through consumer market
research techniques, including focus groups and in-home use tests. The also
meets with a number of retailers across the country to preview prototype
products, determine levels of interest and help refine details of the product
lines prior to production. In addition, the Company frequently previews
advertising plans, public relations plans, point-of-purchase displays, packaging
and other matters with retailers prior to production.

In 1996, 1995 and 1994, the Company incurred research and development
expenses of approximately $4.6 million, $2.8 million and $4.9 million,
respectively. Substantially all of the Company's research and development
expense is spent on new product development.

MANUFACTURING, PRODUCTION AND DISTRIBUTION

The Company's present strategy is to contract for substantially all of its
manufacturing requirements. Most of the Company's product lines are manufactured
overseas by unaffiliated contract manufacturers which have facilities in Hong
Kong and the People's Republic of China. Certain of the Company's products and
components of products are manufactured in the United States.

The Company chooses manufacturers based on price, quality of merchandise,
reliability and ability to meet the Company's timing requirements for delivery.
Manufacturing commitments are made on a purchase order basis. The Company is
generally required to post a letter of credit prior to shipment.

The Company has not entered into any long-term contracts with any of its
manufacturers.

The Company has a group of employees located in California and Hong Kong
whosupervise the Company's manufacturing contractors. These employees'
responsibilities include the establishment and ongoing development of close
relationships with the manufacturers, setting product and manufacturing
standards,

performing production planning and quality assurance functions including
inspection at various stages, tracking costs, performing and/or working with
manufacturing engineering, and oversight of the manufacturing processes. In
order to source a variety of raw materials and components, provide quality
control, and administer contracts with manufacturers on location, the Company
established a subsidiary in Hong Kong, Entertainment Products, Ltd.

Management believes that its strategy to contract for substantially all
manufacturing requirements provides the Company with financial flexibility and
the most efficient use of its capital. However, since the Company does not have
its own manufacturing facilities, it is dependent on close working relationships
with its contract manufacturers for the supply and quality of its products.
These manufacturers are based in Hong Kong with manufacturing facilities located
in the People's Republic of China. The Company expects to continue to use a
limited number of contract manufacturers and accordingly will continue to be
highly dependent upon sources outside the Company for timely production and
quality workmanship. Given the highly seasonal nature of the Company's business,
any unusual delay or quality control problems of suchmanufacturers, or delays in
product deliveries, delays in locating or providing new tooling to acceptable
substitute manufacturers or delays in increasing the production of alternative
manufacturers, would have a material adverse effect on the Company's operating
results and financial condition. Foreign manufacturing is subject to a number of
risks, including transportation delays and interruptions, political and economic
disruptions, labor strikes, the imposition of tariffs and import and export
controls, changes in governmental policies, and fluctuations in currency
exchange rates, the occurrence of which could have a material adverse effect on
the Company's business. The Company is working with its manufacturers to ensure
timely delivery of the Company's product. However, there can be no assurance
that the manufacturers will be able to meet the Company's production schedules.
In addition, manufacturing in Hong Kong and the People's Republic of China
entails certain more specific risks, including the return of Hong Kong to
governance by the People's Republic of China in June 1997 and recent political
tensions between the People's Republic of China and the Republic of China
(Taiwan). There can be no assurance that these events will not result in
disruptions to the Company's production schedules.

The Company maintains a quality control and quality assurance program and
has established process controls, inspection and test criteria for each of its
products. These methods are applied by the Company or its agents regularly to
product samples in each manufacturing location prior to shipment and each
shipment must pass quality control inspection. Once the products arrive in the
United States, samples are subject to spot inspection to ensure quality. The
Company's international distributors also maintain quality control programs,
typically relying on an inspection agent who certifies the quality of the
products prior to their shipment from Hong Kong to the international
distributor.

10.

The Company has identified certain components in its products which its
contract manufacturers are allowed to purchase only from designated approved
suppliers in order to ensure quality. Each manufacturer submits samples from
early production runs to independent testing laboratories to determine whether
the manufacturer is producing to certified safety and product standards. On an
ongoing basis, random samples are drawn from each manufacturer for full-scale
testing.

The Company's products are shipped from the point of manufacture by sea and
air transport to the Company's California distribution facility. As a result,
delivery may be subject to labor disruptions, particularly in the maritime
shipping industry, as well as to limitations on the availability of air cargo
space for the shipment of items in certain circumstances. To date, the Company
has not been materially affected by any such disruptions or constraints. In
addition, extensive reliance on air shipment is expensive and may adversely
impact the Company's profitability.

At the Company's California distribution facility, the Company performs
inventory planning and management, takes delivery of products, inspects,
warehouses and ships products to its retailers' distribution points. Truck
transport is used for delivery from the Company's distribution facility to the
retailers' distribution points or designated retail locations.

MARKETING AND SALES

YES!'s marketing budget is primarily expended for television advertising
and point-of-purchase display programs. The Company has expended a majority of
its advertising for national television spots and the production of television
commercials which support the majority of YES!'s product lines. In conjunction
with television advertising and public relations and promotions programs, the
Company also uses point-of-purchase displays to serve as the final link in a
marketing chain that educates consumers and motivates them to purchase YES!
products.

Additionally, many of the Company's products benefit from the strong market
identification of its licensed characters and brands. The Company has contracts
for the licensing right to use various well-known children's characters and
consumer brands and will continue to negotiate contracts for rights for future
products. Most of these character licenses provide for advances against future
royalties, minimum guaranteed payments and a royalty based on net sales.

The Company's products are sold throughout the United States primarily by
the Company's direct sales force to toy retailers, toy distributors, catalog
showrooms, mass merchants, department stores and discount stores. Retailers of
YES! products in 1996, 1995 and 1994 included toy retailers, such as Toys "R"
Us, Inc. ("TRU") and Kay Bee Toy Stores, and general retailers, such as Wal-Mart
Stores, Inc. ("Wal-Mart"), Target Stores, K-Mart, Service Merchandise Co., Inc.
and Hills Stores Company, Inc. The Company also uses sales representative
organizations typically either to address less concentrated

11.

markets or in connection with certain of the Company's products, including V-
Link, that sell outside normal toy retail channels.

The Company's ten largest customers accounted for approximately 85%, 87%
and 68% of sales for the years ending December 31, 1996, 1995 and 1994,
respectively. For the year ended December 31, 1996, the Company's two largest
customers, TRU and Wal-Mart, accounted for 21% and 20% of net sales,
respectively. For the year ended December 31, 1995, TRU and Wal-Mart each
accounted for approximately 27% of net sales and for the year ended December 31,
1994, the same two customers accounted for 14% and 21% of net sales,
respectively. While the Company intends to expand distribution to new accounts,
the Company expects to continue to depend on a relatively small number of
customers for a significant percentage of its sales. Significant reductions in
sales to any one or more of the Company's largest customers would have a
material adverse effect on the Company's operating results. Because orders in
the toy industry are generally cancelable at any time without penalty, there can
be no assurance that present or future customers will not terminate their
purchase arrangements with the Company or significantly change, reduce or delay
the amount of products ordered from the Company. Any such termination of a
significant customer relationship or change, reduction or delay in significant
orders could have a material adverse effect on the Company's operating results.

In connection with the introduction of new products, many companies in the
toy industry discount prices of existing products, provide for certain
advertising allowances and credits or give other sales incentives to their
customers. In addition, in order to address such issues as working capital
requirements, sales of inventory and changes in marketing trends, many toy
companies allow retailers to return slow-moving products for credit, or if the
manufacturer lowers the prices of its products, to provide price adjustments for
inventories on hand at the time the price change occurs. The Company has made
such accommodations in the past, and expects to make accommodations such as
stock balancing, returns, other allowances or price protection adjustments in
the future. Any such accommodations by the Company in the future could have a
material adverse effect on the Company's operating results. Furthermore, in the
past certain of the Company's retail customers have delayed payment beyond the
date such payment is due. There can be no assurance that retail customers will
not delay payments in the future which would materially impact the Company's
ability to predict its cash flow, often to the detriment of the Company's
business.

INTERNATIONAL OPERATIONS

International net sales were approximately $14.9 million, $3.8 million and
$10.4 million in 1996, 1995 and 1994, respectively, and accounted for
approximately 21%, 7% and 29% of the Company's revenue in those respective
years. International net sales were substantially lower in 1995 primarily as the
result of weakness in the international economy.

12.

The Company's international products are based on the Company's products
developed for the domestic market, so that international product development
costs are minimized. In 1996, the Company introduced the YES! Gear line of
products internationally, where they were well-received, particularly in Japan.
In 1997, the Company expects to introduce all of its domestic 1996 and early
1997 products internationally, with a particular emphasis on expanding European
sales.

The Company sells its products internationally through a network of leading
toy distributors in their local markets. The Company believes it has and is
continuing to develop strong relationships with its key distributors, and that
such distributors have a good reputation in, and knowledge of, the markets they
serve. The Company believes that by leveraging the distributors' local
expertise, the Company is able to generate substantially greater international
retail sales than if the Company attempted to obtain such sales directly. In
addition, because local market distributors typically pay for the Company's
products on a letter of credit and take delivery of such product in Hong Kong,
and because the distributors are responsible for the warehousing and promotion
of the Company's products in the local market, the Company is able to minimize
risks associated with a direct international effort as well as the Company's
capital commitments in advance of manufacture of the product, and can maintain a
leaner staff requiring fewer resources to support the Company's international
operations. The Company also has engaged a sales and marketing company to
coordinate sales of the Company's products in Europe; this agency receives a
commission on all sales to European countries.

Substantially all international sales are conducted through the Company's
Hong Kong subsidiary, Entertainment Products, Ltd. and are denominated in U.S.
dollars and therefore the Company has not to date experienced any adverse impact
from currency fluctuations. To the extent future sales are not denominated in
US dollars, currency exchange fluctuations in the countries where the Company
does business could materially adversely affect the Company's business,
financial conditions and results of operations.

Although the Company's international sales division works closely with its
foreign distributors, the Company cannot directly control such distributors'
sales and marketing activities and, accordingly, cannot manage the Company's
product sales in foreign markets. While the Company believes the distributors to
whom the Company has granted foreign market rights are highly qualified, all of
these distributors also distribute, either on behalf of themselves or other toy
manufacturers, other product lines of toys, including product lines of toys that
may be competitive with those of the Company. There can be no assurance that
these distributors will manage effectively the sale of the Company's products
worldwide or that their marketing efforts will prove effective. In addition,
although the Company attempts to structure its international sales in U.S.
dollar denominated transactions only, certain transactions may

13.

be denominated in the local currency. Accordingly, the Company's international
sales may be disrupted by currency fluctuations or other events beyond the
Company's control, including political or regulatory changes. In addition, the
Company's international distributors are also subject to local rules and
regulations which can substantially affect the profitability or ability of the
Company or its international distributors to sell the Company's products
internationally.

PATENTS AND LICENSES

Certain of the Company's product lines also incorporate concepts or
technologies created by outside designers, some of which are patented. In
addition, many of the Company's products incorporate other intellectual property
rights, such as characters or brand names, that are proprietary to third
parties. The Company typically enters into a license agreement to acquire the
rights to the concepts, technologies or other rights for use with the Company's
products. Substantially all of these licenses are exclusive for the children's
and youth markets. These license agreements typically provide for the retention
of ownership of the technology, concepts or other intellectual property by the
licensor and the payment of a royalty to the licensor. Such royalty payments
generally are based on the net sales of the licensed product for the duration of
the license and, depending on the revenues generated from the sale of the
licensed product, may be substantial. In addition, such agreements often provide
for an advance payment of royalties and may require the Company to guarantee
payment of a minimum level of royalties that may exceed the actual royalties
generated from net sales of the licensed product. Some of these agreements have
fixed terms and may need to be renewed or renegotiated prior to their expiration
in order for the Company to continue to sell the licensed product. Certain of
the Company's licenses require that certain minimum performance goals be met in
order for the Company to renew or extend its licenses. The termination or non-
renewal of a key license would materially adversely affect the Company's
operating results and financial condition.

In addition to rights licensed from third parties, the Company also relies
on a combination of patents, copyright, trademark and trade secret protection,
non-disclosure agreements and work-for-hire arrangements to establish and
protect the proprietary rights it has in its products. There can be no assurance
that the Company's competitors will not independently develop or acquire
patented or other proprietary technologies that are substantially equivalent or
superior to those of the Company. There also can be no assurance that the
measures adopted by the Company to protect its proprietary rights will be
adequate to do so or that the Company's products do not infringe on third party
intellectual property rights, including patents. Reverse engineering and grey
market production of successful toy products is common in the industry. The
ability of the Company's competitors to acquire technologies or other
proprietary rights equivalent or superior to those of the Company or the
inability of the Company to enforce its proprietary rights would have a material
adverse effect on the Company's operating results and financial condition.

14.

Intellectual property matters are frequently litigated on allegations that
third party proprietary rights have been infringed. Such litigation can be
expensive and time-consuming to prosecute or defend against and, if decided
adversely to the Company, may preclude the Company from enjoining competitors
from utilizing technology or designs the Company considers proprietary or
prevent the Company from selling its products or require that the Company pay
significant and unanticipated royalties. The Company has defended two such
lawsuits and, although the Company prevailed in each instance, each lawsuit was
expensive and time-consuming to defend. In addition, such lawsuits could have
the effect of causing the Company's customers to delay or cancel purchase orders
until they are resolved.

COMPETITION

The Company's product lines span major segments both within and beyond the
scope of the traditional toy industry. Accordingly, the Company's products
compete in a number of different markets with a number of different competitors.
Market leaders from which the Company faces competition include Mattel, Inc.,
Hasbro, Inc., Tyco Toys, Inc. (which recently merged with Mattel, Inc.), Tiger
Electronics and Video Technology Industries, Inc. Product innovation, quality,
product identity through marketing and promotion, and strong distribution
capabilities are all important attributes of successful companies in the toy
industry. The Company believes that it is generally competitive with other toy
companies on these factors.

In recent years, leading toy retailers have gained significant market
share. They generally feature a large selection of toys, some at discount
prices, and maintain lean inventories to reduce their inventory risk. Continued
consolidation among discount-oriented retailers can be expected to require toy
companies such as the Company to keep prices competitive and to implement and
maintain production and inventory control methods permitting these toy companies
to respond quickly to changes in demand.

The toy industry is highly competitive. Many of the Company's competitors
have substantially greater assets and resources than those of the Company. Other
competitors market non-promoted products that compete with the Company on the
basis of price. Some of these products are competitive with those of the
Company, which supports sales with advertising and therefore necessitates higher
price points. The relatively low barriers to entry into the toy industry and the
limited proprietary nature of many toy products also permit new competitors to
enter the industry easily. As a result, successful new products or product
concepts often are duplicated and offered to the Company's customers and through
other channels of distribution at lower prices than the Company may be required
to charge to recapture product development and marketing expenses. Certain
companies have already introduced, and the Company anticipates other companies
will introduce toys and published products that compete with the Company's
existing and new products. Such competition has forced

15.

in the past, and may force in the future, price reductions, which would
adversely affect the Company's operating results and financial condition.

GOVERNMENT AND INDUSTRY REGULATION (p. 10)

The Company is subject to the provisions of the Federal Hazardous
Substances Act and the Federal Consumer Product Safety Act. Those laws empower
the Consumer Product Safety Commission to protect children from hazardous toys
and other articles. The Consumer Product Safety Commission has the authority to
exclude from the market articles which are found to be hazardous and can require
a manufacturer to repurchase such toys under certain circumstances. In the pre-
production stages and periodically thereafter, the Company sends sample toys to
independent laboratories to test for compliance with the Consumer Product Safety
Commission's rules and regulations, as well as with the voluntary product
standards of the Toy Manufacturers of America. Similar laws exist in specific
jurisdictions within the United States as well as in certain foreign countries.
The Company designs its products to exceed the highest safety standards imposed
either by government or industry regulatory authorities. In the event that the
Company violates any such rule or regulation, sale of the offending product
could be enjoined. To date, the Company has not experienced any material
governmental or voluntary safety compliance problems with respect to its
products. In the event that the Company violates any such rule or regulation,
sale of the offending product could be enjoined.

Certain of the Company's products may also be subject to other government
rules and regulations. For instance, the Company's V-Link product is subject to
Federal Communications Commission ("FCC") rules and regulations. On December 13,
1996, the Company voluntarily ceased shipments of its V-Link products pending
receipt of final marketing approval from the FCC to sell V-Link, which the
Company had inadvertently not obtained prior to commencing V-Link sales. While
the Company did obtain such approval, the Company was required to pay a $31,000
fine to the FCC as a result of its failure to obtain FCC marketing approval and
take certain other remedial steps to help ensure that the Company meets its FCC
obligations in the future. There can be no assurance that the Company may not be
required to obtain government approval for other products in the future, that
such approval can be obtained, or that seeking such approvals will not result in
delays in product introductions.

EMPLOYEES

As of February 28, 1997, the Company had a total of 123 employees, of whom
74 were based in the United States and 49 were based in Hong Kong. The Company
is staffed in the functions necessary to operate a successful business in the
toy industry, including product development, marketing, sales, management of
outside functions and internal operations. The Company intends to keep overhead
low and utilize outside resources whenever practical.

16.

None of the Company's employees is represented by a collective bargaining
arrangement, nor has the Company ever experienced any work stoppage. The Company
believes that its relations with its employees are good.

ITEM 2. PROPERTIES

The Company leases all of its facilities, including executive offices of
17,335 square feet in Pleasanton, California, warehouse space of 84,000 square
feet in Hayward, California, manufacturing facilities of 6,700 square feet in
Carson, California and a showroom of 8,300 square feet in New York, New York.
The Company's wholly-owned Hong Kong subsidiary leases approximately 4,500
square feet of office space in Kowloon, Hong Kong. The Company believes that
suitable space will be available on reasonable terms should the Company require
additional space. In 1996, the Company's total rent expense was $1.2 million.

The Company's management information system is based on an IBM AS400
computer and personal computers running commercially available software. The
Company believes this information system is adequate to meet the Company's
business needs for the foreseeable future, as enhanced by available technology.

ITEM 3. LEGAL PROCEEDINGS

The Company is involved from time to time in litigation incidental to
its business. The Company believes that none of its pending litigation matters,
individually or in the aggregate, will have a material adverse effect on the
Company's operating results or financial condition.

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

There were no matters submitted to a vote of security holders during the
fourth quarter of fiscal 1996.

17.

PART II

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

The Company's Common Stock is quoted on the Nasdaq National Market under
the trading symbol "YESS." The Company's Common Stock is not listed or quoted on
any other quotation system or securities exchange. The following table sets
forth the range of quarterly low, high and closing sale prices of the Common
Stock on the Nasdaq SmallCap Stock Market from the Company's initial public
offering on June 7, 1995 until November 1995, and as quoted on the Nasdaq
National Market since November 1995. The Company has not paid cash dividends and
has no present plans to do so. At March 14, 1997, there were approximately 230
holders of record of the Company's Common Stock.

PRICE RANGE OF
COMMON STOCK
------------------------
LOW HIGH CLOSE
---- ---- -----

Fiscal year 1997:
First quarter (through March 14, 1997)................................ $4 5/8 $7 3/16 $5 7/16
Fiscal year 1996:
First Quarter......................................................... 6 10 1/4 9 3/8
Second Quarter........................................................ 9 1/8 16 7/8 14 3/4
Third Quarter......................................................... 9 3/8 15 3/8 14 1/4
Fourth Quarter........................................................ 5 5/8 15 6 7/16
Fiscal year 1995:
Second Quarter (from June 7, 1995).................................... 5 5 1/4 5
Third Quarter......................................................... 5 6 1/4 5 7/8
Fourth Quarter........................................................ 5 3/4 6 5/8 6 5/8

On March 14, 1997, the last sale price for the Common Stock reported on the
Nasdaq National Market was $5 7/16 per share.

18.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following selected statement of operations data for each of the five
years in the period ended December 31, 1996 are derived from financial
statements of the Company.

YEAR ENDED DECEMBER 31, PERIOD FROM
------------------------------------------- SEPTEMBER 14, 1992
(INCEPTION) THROUGH
1996 1995 1994 1993 DECEMBER 31, 1992
-------- ------- -------- -------- -------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

STATEMENT OF OPERATIONS
DATA:
Net sales................ $ 69,699 $55,673 $ 36,379 $ 25,931 $ --
Operating income
(loss).................. (11,688) 4,989 (19,920) (20,472) (674)
Net income (loss)........ (12,571) 3,478 (21,927) (20,964) (672)
Pro forma net loss per
share(1)(2)............. -- -- $ (5.08) -- --
Net income (loss) per
share(1)(2)............. (0.91) $ 0.41 -- --
Shares used in comput-
ing pro forma net
loss per share(1)....... -- -- 4,319 -- --
Shares used in comput-
ing net income (loss)
per share(1)........... 13,890 8,534 -- -- --
BALANCE SHEET DATA:
Cash and cash equiva-
lents(3)................ $ 1,572 $ 2,987 $ 2,558 $ 2,462 $ 6
Working capital.......... 25,934 25,671 5,083 8,529 (438)
Total assets............. 61,451 48,870 29,657 29,591 725
Redeemable convertible
preferred stock......... -- -- 49,339 30,469 --
Total shareholders'
equity (deficit)........ $ 30,065 $28,584 $(42,570) $(21,028) (79)

- ------------
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the number of shares used in computing per share amounts. The loss per share
data in 1993 and 1992 is not presented as the periods were prior to the
Company's initial public offering.

(2) The Company has not paid any cash dividends in any of the years presented.

(3) Excludes approximately $1.3 million and $5.4 million of restricted cash
which collateralized outstanding trade letters of credit at December 31, 1994
and 1993, respectively. At December 31, 1996 and 1995, there was no restricted
cash collateralizing outstanding letters of credit.

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

This Management's Discussion and Analysis of Financial Condition and
Results of Operations includes certain forward looking statements about the
Company that are based on current expectations. Actual results may differ
materially as a result of any one or more of the risks identified in this
section, as well as in the section captioned "Business Factors."

19.

OVERVIEW

YES! Entertainment Corporation was founded in September 1992 to develop,
manufacture and market a variety of toys and other children's entertainment
products, including a variety of interactive products. The Company's strategy is
to use innovative technology to design products that are fun for children and
build on their natural creativity.

The Company has achieved cumulative net sales of approximately $188 million
through December 31, 1996, although it had an accumulated deficit as of December
31, 1996 of approximately $52.7 million. Management believes that delays in
obtaining financing in 1993 and 1994 resulted in lost sales opportunities,
including opportunities for reorders, and also required the Company to incur
higher than normal shipment and advertising expenses to expedite product
delivery and create consumer demand in a shortened holiday selling period. In
1995, the Company was able to secure financing to ensure that its products were
introduced in time to take advantage of the holiday selling season. In 1996, the
Company's financial results were adversely affected by a number of issues,
including a weak retail environment which caused retailers to defer orders and a
delivery delay in the Company's V-Link product, compounded in part by the
voluntary suspension of V-Link shipments pending resolution of market approval
issues from the FCC.

The production and shipment of the Company's 1997 products is subject to a
number of risks, and there can be no assurance that the Company will be able to
complete the development, tooling, manufacture or successful marketing of its
1997 products. This risk is compounded by the large number of new products the
Company is introducing in 1997, including many additions to the YES! Gear line
of products (such as Yak Maniak and several new Power Penz), the Baskin-Robbins
Ice Cream Maker, Air Vectors and R.A.W., each of which is still in the
developmental stage and which also involve complicated development and tooling
issues. Air Vectors and R.A.W. are not expected to ship until late in the third
quarter, and in the event there is a delay in the final development, tooling,
production or transport of these products, they may not ship until even later in
the year, if at all.

The Company constantly evaluates the toy markets and its development and
manufacturing schedules. As the year progresses, the Company may elect to reduce
the number of products it currently plans on shipping in 1997 for a variety of
reasons, which include but are not limited to more accurate evaluation of
demand, supply and manufacturing difficulties, or competitive considerations.
Similarly, the Company may add products to its 1997 line either by accelerating
development schedules or strategic acquisitions of current product lines.
Reducing or adding products from and to the Company's line may have an impact on
the Company's financial performance depending on, among other things, the price
points, advertising and promotional

20.

support for and development, tooling and manufacturing costs of such products,
relative to products they replace or are replaced by, as the case may be, if at
all.

In 1995, the Company adopted a financial strategy to maintain a low break-
even point and to focus on profitability rather than sales growth. Management
believes that this financial strategy was instrumental in achieving
profitability in 1995. While the Company attempted to maintain this strategy in
1996, the revenue shortfall realized in 1996 was much more significant than the
Company had expected. The Company expects to continue to focus on controlling
fixed expenses in 1997, although there is no guarantee that a revenue shortfall
in 1997 would not materially adversely affect the Company's financial
performance.

The Company also expects to consider opportunities to enhance revenue
growth as well as profitability through acquisitions or other strategic business
relationships in 1997.

RESULTS OF OPERATIONS

The following table sets forth certain items from the Company's statement
of operations for the years ended December 31, 1996, 1995 and 1994, and the
relevant percentage of net sales represented by certain income and expense
items:

YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
1996 1995 1994
------------------ ---------------- -------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- ------- ------- ------- -------- --------
(DOLLARS IN THOUSANDS)

Net sales................. $ 69,699 100.0% $55,673 100.0% $ 36,379 100.0%
Cost of sales............. 42,624 61.2 26,623 47.8 25,012 68.8
-------- ------ ------- ------ -------- -----
Gross profit.............. 27,075 38.8 29,050 52.2 11,367 31.2
Operating expenses
Marketing, advertising
&amp; promotion......... 13,192 18.9 6,423 11.5 11,013 30.3
Selling, distribution
&amp; administrative.... 25,571 36.7 17,638 31.7 20,274 55.7
-------- ------ ------- ------ -------- -----
Total operating
expenses............. 38,763 55.6 24,061 43.2 31,287 86.0
======== ====== ======= ====== ======== =====
Operating income (loss). (11,688) (16.8) 4,989 9.0 (19,920) (54.8)
Interest income........ 264 0.4 69 0.1 129 0.4
Interest expense....... $ (1,039) (1.5) (1,321) (2.4) (785) (2.2)
Other expense, net..... $ (108) (0.1) (74) (0.1) (1,351) (3.7)
-------- ------ ------- ------ -------- -----
Income (loss) before
provision of income
taxes................. $(12,571) (18.0) 3,633 6.5 (21,927) (60.3)
Provision for income
taxes................. $ -- -- 185 0.3 -- --
-------- ------ ------- ------ -------- -----
Net income (loss).... $(12,571) (18.0)% $ 3,478 6.2% $(21,927) (60.3)%
======== ====== ======= ====== ======== =====

The Company's unanticipated fourth quarter loss was principally the result
of a revenue shortfall from the Company's V-Link product line and the failure of
------
the Company's customers to place reorders for the Company's other products after
the Thanksgiving holiday. The Company began shipments of the V-Link products in
------
mid-November, 1997, and indications were that the product would be well
received. In particular, after the Company had sponsored an MTV program
featuring V-Link in October, the Company received more calls to its 800 number
------
inquiring about the product and where consumers could purchase it than it had
received for any of its prior products. The Company had also received support
from its retail customers regarding the product and its potential for the
Christmas season. The Company therefore believed that the V-Link product line
------
would be in great demand at retail and the Company would receive additional
orders from customers for pre-Christmas sales and restocking orders for the
beginning of 1997. The Company's expectations for V-Link are reflected in the
------
Company's aggressive manufacture of the V-Link product. The unexpected sales
------
shortfall relative to expectations is reflected in the Company's year-end
inventory levels.

At the time it began shipment of V-Link to retailers, the Company was not
------
aware of the requirement that V-Link receive formal FCC approval prior to
------
shipment, in part because of the mistaken belief that verification by an
independent testing lab (which the Company had obtained) was sufficient to
permit the Company to begin shipments to its vendors. The Company in turn did
not anticipate that it would have to cease shipment of V-Link at any time in
------
December. The Company only became aware of that requirement in response to a
reporter's inquiry of the Company on or about December 11, which formed the
basis of an article published in the San Francisco Chronicle on December 12.
-----------------------
The Company voluntarily ceased shipping V-Link products on December 13, pending
------
resolution of all issues with the FCC. The Company resumed shipment on December
18, after having reached an agreement with the FCC and obtained formal FCC
certification. Nevertheless, actual demand for V-Link fell far short of the
------
Company's expectations. In addition to weak demand, the announcement of the
stop-ship may also have caused many retailers to avoid placing new or restocking
orders.

The Company also did not anticipate that it would not obtain reorders of
its other products. The Company had strong sales in the third quarter, which did
not include the Company's V-Link product. The Company therefore believed the
------
Company's non V-Link products would be available at retail and would begin to
------
sell through in advance of the Thanksgiving holiday weekend from November 28 to
December 1, 1997. (The Thanksgiving weekend traditionally marks the start of
the busy pre-Christmas retail selling season). Sell-through data available to
the Company in early November were consistent with this belief, as were recent
trends indicating substantial increases in revenue from the comparable quarter
in the prior year. However, the Company's customers did not place reorders in
the quantities expected and sell-through data available in early December were
less than expected. The Company believes this was a phenomenon experienced
generally by the toy industry. The effect of this was exacerbated by retailers'
increased reliance on just-in-time inventory practices which shifts risk of weak
sales substantially to the manufacturer, which must produce inventory prior to
actual sales results.

The Company expects its business will remain highly seasonal, and difficult
to predict.

NET SALES

The Company's worldwide net sales were $69.7 million in 1996, $55.7 million
in 1995 and $36.4 million in 1994. Products introduced in 1994 accounted for 9%,
35% and 38% of worldwide sales in 1996, 1995 and 1994, respectively. Products
introduced in 1995 accounted for 35% and 45% of worldwide sales in 1996 and
1995, respectively. Products introduced in 1996 accounted for 54% of the
Company's worldwide sales in 1996. In 1996, net sales of products introduced in
1996 were $37.8 million, and sales of

21.

products introduced before 1996 declined from $55.7 million in 1995 to $31.9
million. In 1995, net sales of products introduced in 1995 were $25.1 million
and sales of products introduced before 1995 declined from $36.4 million in 1994
to $30.6 million. The Company expects that newly introduced products will
continue to account for a significant percentage of sales in the year they are
introduced as the result both of expanding sales and the decline in sales of
earlier products due to the relatively short life cycles of many products in the
toy industry.

Domestic net sales were $54.8 million in 1996, compared to $51.9 million in
1995 and $26.0 million in 1994. The slight increase in 1996 over 1995 was
attributable to the introduction of a number of new product lines in 1996,
including the Mrs. Fields Baking Factory and V-Link, together with the addition
of a number of new products to the Company's YES! Gear and Power Penz
categories. This increase was offset in part by lower than expected domestic
sales in the fourth quarter of 1996, and the decrease in unit sales and average
selling price of the Company's older product lines. The increase in 1995
domestic net sales over 1994 was primarily the result of the introduction of Yak
Bak and Nickelodeon products in 1995.

The Company's Yak Bak and Power Penz product lines together accounted for a
significant percentage of the Company's sales in 1996 and 1995, comprising 72%
and 50% thereof, respectively. Yak Bak accounted for 4% of the Company's 1994
net sales, the year in which Yak Bak was first shipped. In 1996 and 1995, the
Company's Yak Bak items accounted for approximately 46% and 47% of the Company's
sales, respectively. The Company's Power Penz products accounted for 22% and 3%
of the Company's sales in 1996 and 1995, respectively, following the
introduction of the Power Penz in 1995. In addition, in 1996 the Company sold a
number of Yak Bak and Power Penz products together; these sales accounted for
approximately 4% of the Company's 1996 net sales. No other product line
accounted for more than 10% of the Company's sales in 1996, although one product
line, Comes To Life Books, accounted for 17% and 47% of the Company's sales in
1995 and 1994, respectively. Although the Company expects that its revenue base
will be less concentrated on any one line of products in 1997 as compared to
previous years, the Company expects that YES! Gear, in particular the Yak Bak
items, and the Power Penz and Mrs. Fields lines of product will continue to
account for a substantial portion of the Company's revenues in 1997.

International net sales were $14.9 million in 1996 compared with $3.8 in
1995 and $10.4 million in 1994. International sales were substantially higher in
1996 than 1995 due to the increased emphasis the Company placed on expanding
international sales in conjunction with the introduction of the Company's YES!
Gear line of product internationally beginning in 1996. Sales to distributors in
Pacific Rim countries comprised a substantial portion of the Company's 1996
international sales, although the Company expects that sales to Europe will
expand substantially in 1997. International net sales in 1995 were lower than in
1994 primarily as the result of weakness in the

22.

international economy. International sales represented 21% of worldwide sales in
1996, and 7% and 29% of worldwide sales in 1995 and 1994, respectively.

The Company is dependent on a relatively small number of customers, in
particular TRU and Wal-Mart, for a significant percentage of its sales.
Significant reductions in sales to any one or more of the Company's largest
customers would have a material adverse effect on the Company's operating
results. Because orders in the toy industry are generally cancelable at any time
without penalty, there can be no assurance that present or future customers will
not terminate their purchase agreements with the Company or significantly
change, reduce or delay the amount of products ordered from the Company. Any
termination of a significant customer relationship or change, reduction or delay
in significant orders would have a material adverse effect on the Company's
operating results.

The Company relies exclusively on foreign distributors to market and sell
the Company's products outside the United States. Although the Company's
international sales personnel work closely with its foreign distributors, the
Company cannot directly control such entities' sales and marketing activities
and, accordingly, cannot directly manage the Company's product sales in foreign
markets. In addition, the Company's international sales may be disrupted by
currency fluctuations or other events beyond the Company's control, including
political or regulatory changes.

COST OF SALES

Cost of sales were approximately $42.6 million, $26.6 million and $25.0
million in 1996, 1995 and 1994, respectively. Cost of sales were approximately
61% and 48% of net sales in 1996 and 1995, respectively. The increase in cost of
sales in absolute dollars in 1996 was $16.0 million. The increase in cost of
sales in 1996, in absolute dollars, was the result of increased sales volume
($14.2 million), an increase in inventory write-downs, primarily as a result of
lower than expected sales in the fourth quarter of 1996 ($2.3 million), and an
increase in other costs of sales ($463,000) offset by lower product costs ($1.0
million). In addition to the foregoing, the increase in cost of sales as a
percentage of sales in 1996 from 1995 was also due to an increase in the
provision for sales returns and allowances in relation to sales as a result of
lower than expected retail sales in the fourth quarter, reduced selling prices,
and a higher percentage of international sales, which have lower associated
gross margins as a result of product prices which are lower than domestic prices
due to lower operating expenses and competitive factors.

The increase in cost of sales in 1995 from 1994 was the result of increased
volume ($7.7 million), offset by lower product costs ($516,000), a decrease in
inventory write-downs ($4.8 million) and a decrease in other costs of sales
($719,000).

23.

also due to a decrease in sales returns and allowances reserves in relation to
sales ($3.2 million).

FOURTH QUARTER ADJUSTMENTS

During the fourth quarter of 1996, the Company recorded write downs of
inventory of $2.9 million and recorded additional sales returns and allowance
reserves of $2.3 million as a result of less than expected sales in the quarter

OPERATING EXPENSES

YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
1996 1995 1994
------------------ -------------------- ------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ ------- ------ -------
(DOLLARS IN THOUSANDS)

Marketing, advertising &
promotion................... $13,192 18.9% $ 6,423 11.5% $11,013 30.3%
Selling, distribution &
administrative.............. 25,571 36.7 17,638 31.7 20,274 55.7
------- ---- ------- ----- ------- ----
Total operating expenses..... $38,763 55.6% $24,061 43.2% $31,287 86.0%

Operating expenses increased by $14.7 million in 1996 from 1995. Operating
expenses in 1995 decreased by $7.2 million from 1994. The increase in 1996 was
primarily the result of higher variable expenses associated with higher sales
and higher fixed and marketing expenses required to support new product
introductions and expected higher sales volume. Operating expenses as a
percentage of net sales increased to 56% in 1996 from 43% in 1995, but were less
than the 86% for 1994. The increase in 1996 was primarily the result of a
significant shortfall in expected net sales in the fourth quarter of 1996. The
decrease in 1995 in operating expenses both in absolute terms and as a
percentage of sales as compared to 1994 was primarily the result of the
Company's strategy to maintain a low break-even level.

A significant portion of the Company's operating expenses are fixed and do
not vary with sales. Consequently, if sales volumes fall below expectations,
the Company's financial results are likely to be materially adversely affected,
particularly where, as in 1996, this shortfall is not anticipated until late in
the fourth quarter. The Company expects that fixed expenses will increase in
1997.

MARKETING, ADVERTISING AND PROMOTION. Marketing, advertising and promotional
expenses increased $6.8 million in 1996 from 1995 to a total of $13.2 million,
to promote retail sales of the Company's products at expected volumes that
substantially exceeded actual sales in the fourth quarter. In order to obtain
the most competitive prices, advertising commitments, in particular for fourth
quarter advertising, must be made in advance and cannot be canceled in the event
of product shipment delays, as occurred with V-Link. Marketing, advertising and
promotional expenses decreased $4.6 million in 1995 from 1994. This decrease
resulted primarily

24.

from a reduction in advertising expense, which was occasioned in part by the
need for additional advertising in late 1994 to compensate for late delivery of
product.

SELLING, DISTRIBUTION AND ADMINISTRATIVE.

Selling, distribution and administrative expenses increased $7.9 million in
1996 from 1995 to a total of $25.6 million, and increased as a percentage of
sales to 37% from 32% for the comparable periods. The increase in absolute
dollars resulted from higher variable expenses associated with higher sales
volume, including an increase of $319,000 for outbound freight, $1.5 million for
royalty expense, and $356,000 for customer service and distribution, in addition
to higher costs required to support expected higher sales volumes, including
increases of $669,000 for operations support, $1.8 million for product
development, $1.3 million for sales expense, and $1.4 million for general and
administrative expenses. The increase as a percentage of sales was due to higher
fixed expenses incurred in anticipation of greater sales volume in the fourth
quarter of 1996 than occurred, offset in part by the Company's ongoing efforts
to maintain low fixed expenses. Selling, distribution and administrative
expenses decreased $2.6 million in 1995 from 1994, and decreased as a percentage
of net sales to 32% in 1995 from 56% in 1994. This decrease resulted from
reduced headcount in operations support of approximately $300,000 and product
development of approximately $500,000, and from significantly reduced spending
in operations support of approximately $442,000, product development of
approximately $1.6 million, and general and administrative expense of
approximately $668,000. These decreases were partially offset by higher royalty
expense of approximately $1.3 million associated with the increase in revenue.

INTEREST EXPENSE

The following table shows interest expense and interest income for the
applicable periods:

YEARS ENDED DECEMBER 31,
--------------------------------------------------
1996 1995 1994
--------------- --------------- ---------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ ------- ------ -------
(DOLLARS IN THOUSANDS)

Interest income.............. $ 264 0.4% $ 69 0.1% $ 129 0.4%
Interest expense............. $(1,039) (1.5)% $(1,321) (2.4)% $(785) (2.2)%

Interest expense decreased by $282,000 in 1996 from 1995. This decrease was
primarily the result of decreased borrowing under the Company's credit facility
for working capital purposes, due in part to the higher cash balance the Company
maintained during the first half of 1996. Interest expense increased by
approximately $536,000 in 1995 from 1994. This increase was largely due to
higher borrowings against the Company's credit facilities as the result of
increasing sales volume and purchase commitments. The Company expects interest
expense to increase in 1997 due to increased reliance on borrowings under the
Company's credit facility and the issuance in March 1997 of convertible
debentures in the aggregate principal amount of

25.

$1,566,000. As part of the March 1997 transaction, the Company also issued
85,000 shares of convertible Series A Preferred Stock. This preferred stock has
a cumulative semi-annual dividend of 6.5% per annum, which will not be accounted
for as interest expense, and which may be paid either in common stock or cash,
at the Company's option.

OTHER EXPENSE, NET

The decrease in other expense, net in 1995 and 1996 from 1994 was primarily
the result of a charge against earnings taken in 1994 for unreconciled
intercompany balances, offset in part by miscellaneous income. The Company has
implemented procedures to ensure that future intercompany accounts are promptly
cleared.

INCOME TAXES

The Company had no income tax provision for 1996 as the Company had a pre-
tax loss of $12.6 million. The Company's provision for income tax for 1995 of
$185,000 represented an effective tax rate of five percent and, due to the
utilization of net operating loss carryforwards, was solely attributable to
federal and state minimum taxes and foreign income taxes. There was no provision
for income taxes in 1994 as the Company had a pre-tax losses of $22 million. The
Company anticipates that its effective tax rate will increase in 1997 due, in
part, to anticipated taxable income, offset in part by potential restrictions on
the utilization of net operating loss carryforwards, discussed below.

At December 31, 1996, the Company had net operating loss carryforwards for
federal and California tax purposes of approximately $36.5 million and $17.0
million, respectively. The federal losses will expire in the years 2007 though
2011, and the state losses will expire in the years 1999 through 2001, if not
utilized. Utilization of the net operating loss carryovers may be subject to a
substantial annual limitation if it should be determined that there has been a
change in the ownership of more than 50 percent of the value of the Company's
stock, pursuant to Section 382 of the Internal Revenue Code of 1986 and similar
state provisions. The annual limitation may result in the expiration of net
operating loss carryovers before utilization. See Note 11 of Notes to
Consolidated Financial Statements.

SEASONALITY

The Company's business continues to be highly seasonal, with a majority of
shipments to retailers occurring during the last five months of the year. The
Company's operating results have varied significantly in the past, and are
expected to vary in the future, from quarter to quarter. The Company expects
that a majority of its product will ship in the third and fourth quarters, and a
substantial portion of its accounts receivable will be collected in the fourth
and first quarters. The effect of seasonality, common in the toy industry, has
been exaggerated in the Company's case because of the

26.

introduction of the Company's new product lines which represented a significant
portion of the Company's net sales in the third and fourth quarters of 1996,
1995 and 1994. In 1996, seasonality was compounded by the poor retail
environment during the 1996 holiday season that caused retailers to not place
reorders in the quantities expected.

The following table shows the net sales of the Company for each of the past
twelve quarters:

NET SALES BY QUARTER

March 31..................... $ 8.9 13% $ 5.7 10% $ 2.3 6%
June 30...................... 11.6 17 4.7 9 4.5 12
September 30................. 29.6 42 18.6 33 16.3 45
December 31.................. 19.6 28 26.7 48 13.3 37
----- ----- ----- --- ----- ---
Total....................... $69.7 100% $55.7 100% $36.4 100%
===== ===== ===== === ===== ===

Because of the highly seasonal nature of the Company's business, the
Company may not be able to accurately predict retailer order trends, given that
many retailers make final reorder decisions in the fourth quarter, and often
after the date by which the Company must make manufacturing commitments to build
inventory in anticipation of retailer demand. This accounted for the percentage
decrease in fourth quarter shipments in 1996 from 1995.

In addition, most of the Company's most significant customers have adopted
inventory management systems to track sales of particular products and rely on
reorders being filled rapidly by suppliers, rather than maintaining large on-
hand inventories to meet consumer demand. While these systems reduce a
retailer's investment in inventory, they increase pressure on suppliers like the
Company to fill orders promptly and shift a significant portion of inventory
risk to the supplier. The Company may also be required to incur substantial
additional expense to fill late reorders in order to ensure the product is
available at retail prior to Christmas; these may include drop-shipment expense
and higher advertising allowances which would otherwise be borne by the
Company's customers.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 1996, the Company had cash and cash equivalents of
approximately $1.6 million, a decrease of $1.4 from approximately $3.0 million
at December 31, 1995. This decrease in cash and cash equivalents was due to
$16.2 million

27.

used in operating activities and $3.6 million used in investing activities,
offset in part by $18.4 million provided by financing activities.

Cash used in operating activities was primarily the result of the Company's
net loss of $12.6 million, an increase in inventory of $15.2 million, and an
increase in prepaid expenses and other current assets of $3.1 million, offset in
part by an increase in accounts payable of $7.1 million, and decreases in
accounts receivable of $4.3 million, depreciation and amortization of $2.5
million, and advertising expenses funded by inventory of $1.0 million.

Cash used in investing activities was primarily for the acquisition of
tooling and other equipment of $3.5 million.

Cash provided by financing activities was due primarily to the proceeds
from the issuance of common stock and common warrants of $13.0 million, net
proceeds from loans payable of $6.6 million and proceeds from stockholders'
notes receivable of $842,000, offset in part by principal payments on
convertible notes payable of $2.0 million.

Since its inception, the Company's internally generated cash flow has not
been sufficient to finance trade receivables, inventory, capital equipment
requirements and new product development, or to support operations. The Company
has met its capital requirements to date primarily through the initial public
offering of the Company, which generated net proceeds to the Company of
approximately $10.9 million, the exercise of IPO Warrants which generated
approximately $19.7 million, the private sales of approximately $50.0 million of
equity securities, borrowings of $2.0 million of long-term convertible
subordinated notes (now repaid), borrowings under short term loans from certain
stockholders, borrowings under bank loans guaranteed by shareholders, borrowings
under a factoring agreement with a group of banks, borrowings under a Loan and
Security Agreement with Congress Financial Corporation (Western), and borrowings
under an Accounts Receivable Management and Security Agreement entered into with
BNY Financial Corporation in July 1995, as amended (the "ARM Agreement"). In
addition, in the first quarter of 1997, the Company raised net proceeds of
approximately $9.5 million from the sale of convertible debentures, preferred
stock and warrants.

To meet seasonal working capital requirements during the balance of 1997,
the Company anticipates borrowing substantial amounts under the ARM Agreement.
The terms of the ARM Agreement, as amended, provide that BNY Financial
Corporation may advance YES! up to $30 million on the basis of the Company's
accounts receivable, inventory and product being imported on a letter of credit
basis. Loans to the Company are fully secured by all of the Company's assets,
including intellectual property, and BNY acquired ownership of all of the
Company's trade receivables. The Company is required to remain in compliance
with certain financial and other covenants under the

28.

ARM Agreement. A monthly quick ratio of 1:1 is required under the Loan and
Security Agreement. The ratio at December 31, 1996 was .99:1 and the Copmpany
obtained a waiver through March 31, 1997 with regard to the quick ratio
requirement. Since the month ended December 31, 1996, the Company has been in
compliance with this requirement. A ratio of earnings calculated before
interest, taxes, depreciation and amortization to total interest expense of 5:1
on a rolling four quarter basis is required under the Loan and Security
Agreement. The Company recorded a loss before interest, taxes, depreciation and
amortization for the four quarters ended December 31, 1996, March 31, 1997, and
June 30, 1997. The Company has obtained a waiver from BNY with regard to this
covenant through December 31, 1997. The ARM Agreement also restricts the ability
of the Company to obtain working capital in the form of indebtedness, other than
indebtedness incurred in the ordinary course of the Company's business, to grant
security interests in the assets of the Company or to pay dividends on the
Company's securities. As of December 31, 1996, the Company had borrowings of
$16.7 million under the ARM Agreement.

Primarily as the result of less than anticipated revenues in the fourth
quarter of 1996, the Company's inventory increased to $26.2 million on December
31, 1996 from $12.1 million on December 31, 1995. The Company believes that
appropriate write-downs have been taken and that adequate reserves have been
established in connection with this level of inventory. However, there can be
no assurance that the Company will be able to market and sell the excess
inventory at prices above its carrying value or that gross margins will not be
affected by a reduction in its realizable value.

The Company's working capital needs will depend upon numerous factors,
including the extent and timing of acceptance of the Company's products in the
market, the Company's operating results, the cost of increasing the Company's
sales and marketing activities and the status of competitive products, none of
which can be predicted with certainty. The Company has experienced severe
working capital shortfalls in the past, which have restricted the Company's
ability to conduct its business as anticipated. As a result of seasonality in
the toy industry, the timing of new product introductions and the Company's
planned growth, there can be no assurance that the Company will not require
additional funding. There can be no assurance that any additional financing will
be available to the Company on acceptable terms, if at all, when required by the
Company. The inability to obtain such financing would have a material adverse
effect on the Company's operating results.

BUSINESS FACTORS

Because of the variety and uncertainty of the factors affecting the
Company's operating results, past financial performance and historic trends may
not be a reliable indicator of future performance. These factors, as well as
other factors affecting the Company's operating performance, and the fact that
the Company participates in a highly dynamic industry, may result in significant
volatility in the Company's common stock price. The Company's business

29.

is subject to a number of risks and the Company's forward looking statements
should be considered in light of the business factors set forth below.

Limited Operating History. The Company has a short operating history,
having commenced operation in November 1992 and shipped its first product in
July 1993. Future profitability is dependent upon the Company's ability to
successfully and timely introduce, finance and manufacture its new products,
successfully market its existing products and collect trade receivables in a
timely manner.

History of Losses; Accumulated Deficit. The Company incurred operating
--------------------------------------
losses of $21.0, $21.9 and $12.6 million for the years ended December 31, 1993,
1994, and 1996, respectively. In 1996, the Company had a net cash outflow of
$1.4 million. As a result of losses, the Company has incurred indebtedness to
finance its operations. See "Dependence on Restricted Facility." In the event
the Company continues to incur operating losses and is unable to obtain
additional financing on favorable terms, or at all, in the future, its operating
results and financial condition would be materially adversely affected.

Dependence on 1997 Products. In 1997, the Company has introduced and
expects to commence sales of a number of new product lines in new product
categories, such as the Baskin-Robbins Ice Cream Maker, Air Vectors, YES!
Extreme, YES! Games, and YES! PreSchool. In addition, the Company also expects
to expand its existing product lines in 1996, particularly its YES! Gear and
Power Penz line of products. Manufacturing of certain of these items in
commercial quantities has not commenced or is just commencing. The Company
expects that completing the development and the manufacture of its 1997 product
lines will place great demands on management and other Company resources. If the
Company is not able to complete the development, tooling, manufacture and
successful marketing of its 1997 product lines, the Company's operating results
and financial condition would be materially adversely affected.

Dependence on YES! Gear and Power Penz. The majority of the Company's
current product lines are sold under the YES! Gear and Power Penz brands. The
Yes! Gear brand accounted for 55.0% and 60.7% of the Company's sales in 1995
and 1996, respectively. The Power Penz brand accounted for 3.1% and 22.0% of
the Company's sales in 1995 and 1996 respectively. The Company expects YES!
Gear, and in particular the Yak Bak, and the Power Penz product lines to
continue to account for a substantial percentage of the Company's business,
but there can be no assurance that the Company will be able to sustain Yak Bak
and Power Penz sales at 1996 levels or such level as may be necessary to
maintain its overall sales and revenues. In addition, the Company is aware
that a number of toy manufacturers have attempted to duplicate the Company's
success in this area of product by introducing similar lines of products in
1996 and for 1997. While the Company believes it will compete favorably with
these new products on the basis of styling, quality, product depth and
promotional support, there can be no assurance that

30.

the sale of these competitive products will not impact the sale of the YES! Gear
or Power Penz product lines, particularly on the basis of price.

Just in Time Inventory; Compressed Sales Cycles. Most of the Company's most
significant customers have adopted inventory management systems to track sales
of particular products and rely on reorders being filled rapidly by suppliers,
rather than maintaining large on-hand inventories to meet consumer demand. While
these systems reduce a retailer's investment in inventory, they increase
pressure on suppliers like the Company to fill orders promptly and shift a
significant portion of inventory risk to the supplier. The limited inventory
carried by the Company's customers may also reduce or delay consumer sell-
through which in turn could impair the Company's ability to obtain reorders of
its product in quantities necessary to permit the Company to achieve planned
sales and income growth. In addition, the Company may be required to incur
substantial additional expense to fill late reorders in order to ensure the
product is available at retail prior to Christmas; these may include drop-
shipment expense and higher advertising allowances which would otherwise be
borne by the Company's customers. In the event that anticipated reorders do not
materialize, the Company may incur increased inventory carrying costs.

Changes in 1997 Product Line. The Company constantly evaluates the toy
markets and its development and manufacturing schedules. As the year progresses,
the Company may elect to reduce the number of products it currently plans on
shipping in 1997 for a variety of reasons, which include but are not limited to
more accurate evaluation of demand, supply and manufacturing difficulties, or
competitive considerations. Similarly, the Company may add products to its 1997
line either by accelerating development schedules or strategic acquisitions of
current product lines. Reducing or adding products from and to the Company's
line may have an impact on the Company's financial performance depending on,
among other things, the price points, advertising and promotional support for
and development, tooling and manufacturing costs of such products, relative to
products they replace or are replaced by, as the case may be, if at all.

Sales Concentration Risk. The Company's ten largest customers accounted for
approximately 85%, 87% and 68% of sales for the years ending December 31, 1996,
1995 and 1994, respectively. For the year ended December 31, 1996, the Company's
two largest customers, TRU and Wal-Mart, accounted for 21% and 20% of net sales,
respectively. For the year ended December 31, 1995, the same two customers each
accounted for approximately 27% of net sales and for the year ended December 31,
1994, TRU and Wal-Mart accounted for 14% and 21% of net sales, respectively.
While the Company intends to expand distribution to new accounts, the Company
expects to continue to depend on a relatively small number of customers for a
significant percentage of its sales. Significant reductions in sales to any one
or more of the Company's largest customers would have a material adverse effect
on the Company's operating results. Because orders in the toy industry are
generally cancelable at any

31.

time without penalty, there can be no assurance that present or future customers
will not terminate their purchase arrangements with the Company or significantly
change, reduce or delay the amount of products ordered from the Company. Any
such termination of a significant customer relationship or change, reduction or
delay in significant orders could have a material adverse effect on the
Company's operating results.

Price Protection; Stock Balancing; Reliance of Timely Payment. In
connection with the introduction of new products, many companies in the toy
industry discount prices of existing products, provide for certain advertising
allowances and credits or give other sales incentives to their customers,
particularly their most significant customers. In addition, in order to address
working capital requirements, sales of inventory, changes in marketing trends
and other issues, many companies in the toy industry allow retailers to return
slow-moving products for credit, or if the manufacturer lowers the prices of its
products, to provide price adjustments for inventories on hand at the time the
price change occurs. The Company has made such accommodations in the past, and
expects to make accommodations such as stock balancing, returns, other
allowances or price protection adjustments in the future. Any such
accommodations by the Company in the future could have a material adverse effect
on the Company's operating results. In addition, in the past certain of the
Company's retail customers have delayed payment beyond the date such payment is
due. Delays in payments from retail customers in the future could materially
impact the Company's anticipated cash flow to the detriment of the Company's
business. Delays or reductions in payment have, in the past, increased the
Company's reliance on other sources of capital, including bank lines of
credit, which has increased the Company's interest expense and, in the case of
payment reductions, reduced profitability, or increased loss, by an amount
equivalent to such reductions. Delays or reductions in payment in the future
would have the same or similar effect.

Seasonality. Sales of toys traditionally have been highly seasonal, with
a majority of retail sales occurring during the December holiday season.
Accordingly, the Company expects that its operating results will vary
significantly from quarter to quarter, particularly in the third and fourth
quarters, when the majority of products are shipped, and the first quarter,
when a disproportionate amount of receivables are collected and trade credits
are negotiated. In addition, although indications of interest are provided by
retailers early in the year for product shipments for the December holiday
season, committed orders are not placed until later in the year and, even when
placed, such orders generally are cancelable at any time without penalty.
Accordingly, the Company generally must enter into tooling, manufacturing,
media and advertising commitments prior to having firm orders. As a result,
there can be no assurance that the Company can maintain sufficient flexibility
with respect to its working capital needs or its ability to manufacture
products and obtain supplies of raw materials, tools and components to be able
to minimize the adverse effects of an unanticipated shortfall or increase in
demand. Failure to accurately predict and respond to consumer demand may cause
the Company to produce excess inventory which could materially adversely
affect the

32.

Company's operating results and financial condition. Conversely, if a product
achieves greater success than anticipated, the Company may not have sufficient
inventory to meet retail demand, which could adversely impact the Company's
relations with its customers.

Short Product Cycles. Consumer preferences in the toy industry are
continuously changing and are difficult to predict. Few products achieve market
acceptance, and even when they do achieve commercial success, products typically
have short life cycles. There can be no assurance that (i) new products
introduced by the Company will achieve any significant degree of market
acceptance, (ii) acceptance, if achieved, will be sustained for any significant
amount of time, or (iii) such products' life cycles will be sufficient to permit
the Company to recover development, manufacturing, marketing and other costs
associated therewith. In addition, sales of the Company's existing product lines
are expected to decline over time, and may decline faster than expected unless
existing products are enhanced or new product lines are introduced. Failure of
new product lines to achieve or sustain market acceptance would have a material
adverse effect on the Company's operating results and financial condition. Any
or all products within the Yes! Gear and Power Penz categories, which
categories account for a majority of the Company's overall product sales, will
experience relatively short life cycles.

International Business Risk.

The Company will rely in 1997 principally on foreign distributors to market
and sell the Company's products outside the United States. Although the
Company's international sales personnel work closely with its foreign
distributors, the Company cannot directly control such entities' sales and
marketing activities and, accordingly, cannot directly manage the Company's
product sales in foreign markets. The percentage of total sales constituting
foreign sales for 1994, 1995 and 1996 are 29%, 7% and 21%, respectively. In
addition, the Company's international sales may be disrupted by currency
fluctuations or other events beyond the Company's control, including political
or regulatory changes. To date, substantially all of the Company's international
sales have been denominated in US dollars and therefore the Company has not to
date experiences any adverse impact from currency fluctuations. To the extent
future sales are not denominated in U.S. dollars, currency exchange fluctuations
in the countries where the Company does business could materially adversely
affect the Company's business, financial condition and results of operations.

Dependence on Manufacturing Facilities Based in People's Republic of
China. The Company contracts for the manufacture of substantially all of its
products with entities based in Hong Kong whose manufacturing facilities are
located in the People's Republic of China. In 1997, Hong Kong will become a
sovereign territory of the People's Republic of China. While the People's
Republic of China has provided assurances that Hong Kong will be allowed to
maintain critical economic and tax policies, there can be no assurance that
political or social tensions will not develop in Hong Kong that would disrupt
this process. In addition, recent tensions between the Peoples Republic of
China

33.

and the Republic of China (Taiwan), and the United States' involvement
therein, could result either in a disruption in manufacturing in the China
mainland or in the imposition of tariffs or duties on Chinese manufactured
goods. Either event would have an adverse impact on the Company's ability to
obtain its products or on the cost of these products, respectively, such that
its operating results and financial condition would be materially adversely
affected.

Dependence on Restrictive Facility. The Company is dependent on the ARM
Agreement with BNY Financial Corporation to meet its financial needs during
1997, due in large part to the seasonality of the Company's business whereby
the Company is required to finance the manufacture of a substantial portion of
its products in the summer and autumn but does not collect on the sale of
these products until the fourth quarter of that year and the first quarter of
the following year. Under the terms of the ARM Agreement, BNY Financial
Corporation has taken a first priority security interest in substantially all
of the Company's assets, including its intellectual property. The ARM
Agreement also contains a number of restrictive covenants and events of
default, including a provision specifying that it shall be an event of default
if either Donald Kingsborough or Sol Kershner, the Company's Chief Executive
Officer and Chief Financial Officer, respectively, is not active in the
management of the Company and is not replaced within ninety (90) days with a
suitable individual of comparable experience and capability. In the event the
Company falls out of compliance with the ARM Agreement, and BNY Financial
Corporation does not provide financing, the Company would not be able to
finance its operations as contemplated, and its operating results and
financial condition would be materially adversely affected.

Dependence on Key Personnel. The Company's future success will depend to
a significant extent on the efforts of the key management personnel, including
Donald D. Kingsborough, the Company's Chairman and Chief Executive Officer,
and other key employees. The loss of one or more of these employees could have
a material adverse effect on the Company's business. In addition, the Company
believes that its future success wiwll depend in large part on its ability to
attract and retain highly qualified management, operations and sales
personnel. There can be no assurance that the Company will be able to attract
and retain the employees it needs in order to ensure its success.

34.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following consolidated financial statements of the YES! Entertainment
Corporation are filed as a part of this report:

PAGE
----

Report of Ernst &amp; Young LLP, Independent Auditors..................... F-1

Consolidated Balance Sheets at December 31, 1996 and December 31, 1995.... F-2

Consolidated Statements of Operations for the three years ended
December 31, 1996....................................................... F-3

Consolidated Statements of Stockholders' Equity (Deficit) for the three
years ended December 31, 1996........................................... F-4

Consolidated Statements of Cash Flows for the three years ended
December 31, 1996....................................................... F-5

Notes to Consolidated Financial Statements................................ F-7

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

None.

35.

PART III

Certain information required by Part III is omitted from this Report in
that the Company will have filed a definitive proxy statement pursuant to
Regulation 14A (the "Proxy Statement") for its 1996 Annual Meeting of
Shareholders with 120 days after the end of the fiscal year covered by this
Report, and certain information included therein is incorporated herein by
reference.

ITEM 10. EXECUTIVE OFFICERS OF THE REGISTRANT

EXECUTIVE OFFICERS OF THE COMPANY

The following sets forth certain information regarding the executive
officers of the Company, who are elected by and serve at the discretion of the
Board of Directors:

NAME AGE POSITION
---- --- --------

Donald Kingsborough.............. 50 Chairman of the Board and Chief
Executive Officer

Tim Bender....................... 36 Senior Vice President, Sales

Bruce Bower...................... 35 Executive Vice President, Business
Development, General Counsel and
Secretary

Sharon Duncan.................... 45 Executive Vice President, International

Tom Fritz........................ 37 Vice President, Marketing
Chief Financial and Chief Operating

Sol Kershner..................... 68 Officer

William Radin.................... 66 Executive Vice President, Operations
Executive Vice President, Product

Patricia Root.................... 38 Development

The Company's executive officers are appointed annually by, and serve at
the discretion of, the Board of Directors. Each executive officer is a full time
employee of the Company. There is no family relationship between any executive
officer or director of the Company.

Donald Kingsborough founded the Company in September 1992 and has served as
Chairman of the Board and Chief Executive Officer since that time. From May 1989
to November 1992, Mr. Kingsborough was Chief Executive Officer of Intelligy
Corporation, a developer of educational and child development products,
including software. In February 1985, Mr. Kingsborough founded Worlds of Wonder,
Inc., and served as its Chief Executive Officer until April 1988.

Tim Bender joined the Company in October 1994 as National Accounts Manager.
Mr. Bender was promoted to Senior Vice President, Sales in February 1997. From
1984 until he joined the Company, Mr. Bender was employed by Lego Systems
Inc., a toy manufacturer, most recently as Senior National Accounts Manager.

Bruce Bower joined the Company in March 1994 as Executive Vice President,
General Counsel and Secretary. In January 1996, Mr. Bower was also named
Executive Vice President, Business Development. From November 1989 until March
1994, Mr.

36.

Bower was associated with the law firm of Wilson Sonsini Goodrich &amp; Rosati
in Palo Alto, California.

Sharon Duncan joined the Company in July 1996 as Executive Vice President,
International. From January 1990 to January 1992, she was Director of
International Sales and Marketing for Galoob Toys, Inc., a toy company. She
was promoted to Vice President, International Sales and Marketing for Galoob
in January of 1992 and held that position through June 1996.

Tom Fritz joined the Company in November 1993 as Director of Marketing and
was promoted to Vice President, Marketing in September 1995. From 1991 until
he joined the Company, Mr. Fritz was employed by Nestle Beverage Corporation,
most recently as Business Director, Nestea.

Sol Kershner was appointed Chief Financial Officer and Chief Operating
Officer in July 1995. Mr. Kershner served as the Company's first Chief Financial
Officer and was a founder of the Company. From September 1994 until July 1995,
Mr. Kershner consulted with the Company on a full-time basis. From 1989 to 1992
Mr. Kershner was Executive Vice President and Chief Financial Officer of
Intelligy Corporation, a children's educational products company. From 1987 to
1989, Mr. Kershner served as the Chief Financial Officer of Centigram
Corporation, a telecommunications company.

William Radin joined the Company in June 1993 as Senior Vice President,
R&amp;D, and was promoted to Executive Vice President, Operations in July 1994.
From January 1990 to December 1992, he was Vice President and Managing Director
of Galco, the Hong Kong division of Lewis Galoob Toys, Inc., a toy manufacturer,
and from December 1992 to April 1993, he was Managing Director of Arco, Ltd.,
the Hong Kong division of Mattel, Inc., a toy manufacturer. From June 1983 to
December 1990, Mr. Radin was Vice President and Managing Director for Tonka
Kenner Parker Far East, a toy manufacturer.

Patricia Root joined the Company at inception as Executive Vice President,
Product Development. From June 1989 to September 1992, Ms. Root was Director of
Product Development of Intelligy Corporation, a developer of educational and
child development products, including software.

The information required by this Item regarding the directors of the
Company is incorporated by reference to the information set forth in the section
entitled "Proposal No. 1: Election of Directors" in the Company's Proxy
Statement for the 1997 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission within 120 days after the end of the
Company's fiscal year ended December 31, 1996.

37.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item regarding executive compensation is
incorporated by reference to the information set forth in the section entitled
"Executive Officer Compensation" in the Company's Proxy Statement for the 1997
Annual Meeting of Stockholders to be filed with the Commission within 120 days
after the end of the Company's fiscal year ended December 31, 1996.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item regarding security ownership of
certain beneficial owners and management is incorporated by reference to the
information set forth in the section entitled "Other Information--Share
Ownership by Principal Stockholders and Management" in the Company's Proxy
Statement for the 1997 Annual Meeting of Stockholders to be filed with the
Commission within 120 days after the end of the Company's fiscal year ended
December 31, 1996.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item regarding certain relationships and
related transactions is incorporated by reference to the information set forth
in the section entitled "Certain Transactions" in the Company's Proxy
Statement for the 1997 Annual Meeting of Stockholders to be filed with the
Commission within 120 days after the end of the Company's fiscal year ended
December 31, 1996.

38.

PART IV

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

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

(1) Consolidated Financial Statements. The consolidated financial
statements of YES! Entertainment Corporation are listed at Item 8
and attached hereto beginning at page F-1.

(2) Financial Statement Schedules. The following financial statement
schedule of the Company is filed as part of this report and should
be read in conjunction with the consolidated financial statements,
and related notes thereto, of the Company.

PAGE
----

Schedule II -- Valuation and Qualifying Accounts.................... S-1

Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is included in the
financial statements or notes thereto.

(3) Exhibits.

EXHIBIT
NUMBER DESCRIPTION
- ------- -----------

3.1(1) Certificate of Incorporation of Registrant, as amended.

3.2(1) Bylaws of Registrant.

4.1(1) Form of Registrant's Common Stock Certificate.

4.2(1) Form of Convertible Subordinated Debenture dated March 18, 1997.

4.3(1) Form of Warrant dated March 18, 1997.

10.1(1)(2) Form of Indemnification Agreement entered into by Registrant with
each of its directors and executive officers.

10.2(1)(2) 1992 Stock Option Plan and related agreements.

10.3(1)(2) 1995 Profit Sharing Plan.

10.4(1)(2) 1995 Stock Option Plan and related agreements.

10.5(1)(2) 1995 Director Option Plan.

10.6(1)(2) Form of Founder Stock Purchase Agreement dated as of December 21,
1992 by and between the Registrant and each Purchaser (as defined
therein).

10.7(1) Acquisition Agreement dated as of December 31, 1992 by and between
the Registrant and Intelligy Corporation.

10.8(1) Amendment to Acquisition Agreement dated as of December 31, 1992 by
and between the Registrant and Intelligy Corporation dated as of
January 21, 1993.

10.9(1) Series B Stock Purchase Agreement dated as of January 27, 1993 by
and among the Registrant and the Purchasers (as defined therein).

39.

EXHIBIT
NUMBER DESCRIPTION
- ------- -----------

10.10(1) Amendment to Series B Stock Purchase Agreement dated as of January
27, 1993 by and among the Registrant and the Purchasers (as defined
therein) dated as of February 5, 1993.

10.11(1) Preferred Stock Purchase Agreement dated as of March 29, 1993 by
and between the Registrant and Capital Cities Capital, Inc.

10.12(1) Note and Warrant Purchase Agreement dated as of June 4, 1993 by and
among the Registrant and the Purchasers (as defined therein).

10.13(1) Series D Stock Purchase Agreement dated as of July 16, 1993 by and
among the Registrant and the Purchasers (as defined therein).

10.14(1) Series D. Stock Purchase Agreement dated as of July 16, 1993 by and
among the Registrant and the Purchasers (as defined therein), as
amended through October 4, 1993.

10.15(1) Convertible Subordinated Note Purchase Agreement dated as of
September 30, 1993 by and among the Registrant and the Purchasers
(as defined therein).

10.16(1) Congress Financial Guarantee Financing and Warrant Agreement dated
as of August 15, 1994 by and among the Registrant and the Investors
(as defined therein).

10.17(1) Series F Preferred Stock Purchase Agreement dated as of September
16, 1994 by and among the Registrant and the Purchasers (as defined
therein).

10.18(1) Amended and Restated Registration Rights Agreement dated as of June
17, 1994 by and among the Registrant and Holders (as defined
therein).

10.19(1) Amended Shareholders Agreement dated as of June 17, 1994 by and
among the Registrant and the Purchasers (as defined therein).

10.20(1) Loan and Security Agreement dated as of June 15, 1994 by and between
Congress Financial Corporation (Western) and the Registrant (the
"Loan and Security Agreement").

10.21(1) First Amendment to the Loan and Security Agreement dated as of
August 15, 1994.

10.22(1) Second Amendment to the Loan and Security Agreement dated as of
December 1994.

10.23(1) Third Amendment to the Loan and Security Agreement dated as of
January 27, 1995.

10.24(1) Fourth amendment to the Loan and Security Agreement dated as of
March 31, 1995.

10.25(1) Bank Guarantee, Note Financing and Warrant Agreement dated as of
February 18, 1994 by and among the Registrant and the Investors
(as defined therein).

10.26(1) Form of Reimbursement Agreement for Letters of Guarantee dated as of
February 18, 1994 by and between the Registrant and each Guarantor
(as defined therein).

10.27(1)(3) Asset Purchase Agreement dated as of December 18, 1992 between the
Registrant and Microsonics International, Inc.

10.28(1)(3) License Agreement dated as of May 11, 1994 between the Registrant
and the Disney Publishing Group.

10.29(1)(3) Product Development Agreement dated as of June 28, 1994 by and among
the Registrant and the Licensors (as defined therein).

10.30(1)(3) Agreement dated as of January 31, 1994 between the Registrant and
Liu Concept Designs &amp; Associates.

10.31(1) Lease Agreement between the Registrant and Chawin Property, Inc.,
dated as of March 1, 1993, for the facility located at 3875 Hopyard
Road, Pleasanton, California.

10.32(1) Lease Agreement between the Registrant and Lincoln Hayward VI, dated
as of May 17, 1993, for the facility located at 1039-1055 Whipple
Road, Hayward, California.

10.33(1) Guarantee Conversion Agreement dated as of March 31, 1995 by and
among the Registrant and the Guarantors (as defined therein), as
amended.

40.

EXHIBIT
NUMBER DESCRIPTION
- ------- -----------

10.34(1) Form of Subscription Documents dated as of April 1995 by and
between the Registrant and each Investor (as defined therein).

10.35(1) License Agreement dated as of January 13, 1993 by and between the
Registrant and Shoot the Moon Products, Inc.

10.36(1)(3) Nickelodeon Merchandise License Agreement dated as of April 26,
1995 by and between the Registrant and MTV Networks.

10.37(1) Second Amendment to Lease between the Registrant and Chawin
Property, Inc., dated as of May 1, 1995, for the facility located at
2875 Hopyard Road, Pleasanton, California.

10.38(1) Form of Bridge Note issued in the Registrant's April 1995 Bridge
Financing.

10.39(1) Accounts Receivable Management and Security Agreement by and
between the Registrant and BNY Financial Corporation.

10.40(1)(3) License Agreement dated as of April 26, 1995 by and between the
Registrant and Machina, Inc.

10.41(1)(2) Employment Agreement by and between the Registrant and Sol
Kershner.

10.42(1)(2) Employment Agreement by and between the Registrant and William
Radin.

10.43(3) Product Development and License Agreement by and between
Registrant and Machina, Inc. dated September 7, 1995.

10.44(3) Development and License Agreement by and between Registrant and
Machina, Inc. dated April 26, 1995.

10.45(3) Product Development and License Agreement by and between Registrant
and Machina, Inc. dated June 16,1995, as amended.

10.46(3) Product Development and License Agreement by and between Registrant
and Machina, Inc. dated June 27, 1995.

10.47(3) Accounts Receivable Management and Security Agreement by and between
Registrant and BNY Financial Corporation dated July 31, 1995.

10.48(3) Product Development and License Agreement by and between Registrant
and Machina, Inc. dated August 31, 1995.

10.49(3) License Agreement by and between Registrant and Skyline Products,
Inc. dated September 27, 1995.

10.50(3) License Agreement by and between Registrant and Mrs. Fields
Development Corporation dated September 30, 1995.

10.51(3) License Agreement by and among Registrant, Kiscom, Inc., and Greg
Hyman Associates dated November 18, 1995.

10.52(3) Royalty Agreement by and between Registrant and Shoot The Moon,
Inc. dated December 27, 1995.

10.53(2) 1996 Profit Sharing Plan.

10.54(2) 1996 Executive Profit Sharing Plan.

10.55(1) Third Amendment to Lease Agreement between Registrant and Lincoln
Hayward VI dated May 17, 1996 for the facility located at 1006
Whipple Road, Hayward, California.

10.56(1) Third Amendment to Lease Agreement between Registrant and Chawin
Property, Inc. dated May 1, 1996 for the facility located at 3875
Hopyard Road, Pleasanton, Califonia.

10.57(1) Amended and Restated Convertible Debenture and Convertible Preferred
Stock Purchase Agreement dated as of March 18, 1997 among Infinity
Investors Limited, Fairway Capital Limited and Registrant.

10.58(1) Amended and Restated Registration Rights Agreement dated as of March
18, 1997 among Infinity Investors Limited, Fairway Capital Limited
and Registrant.

41.

EXHIBIT
NUMBER DESCRIPTION
- ------- -----------

11.1(4) Statement of computation of earnings per share.

21.1(1) Subsidiaries of the Registrant.

23.1 Consent of Ernst & Young LLP, Independent Auditors.

27.1(4) Financial Data Schedule for the year ended December 31, 1996.

- --------
(1) Incorporated by reference to Exhibits filed with the following: Registration
Statement on Form S-1 (File No. 33-91408), which became effective on June 7,
1995; Quarterly Report on Form 10-Q for the quarter ended June 30, 1995,
filed with the Securities and Exchange Commission on August 15, 1995;
Quarterly Report on Form 10-Q for the quarter ended September 30, 1995,
filed with the Securities and Exchange Commission on October 31, 1995;
Annual Report on Form 10-K for the year ended on December 31, 1995;
Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, filed
with the Securities and Exchange Commission on August 2, 1996; Registration
Statement on Form 8-B, filed with Securities and Exchange Commission on
October 31, 1996, which became effective on November 5, 1996; Post-Effective
Amendment No. 4 on Form S-3 to the Registration Statement on Form S-1 (File
No. 33-91408), which became effective on November 20, 1996; Current Report
on Form 8-K filed with the Securities and Exchange Commission on February
11, 1997; Current Report on Form 8-K filed with the Securities and Exchange
Commmission on March 25, 1997; Registration Statement on Form S-3 (File No.
33-91408 ), which became effective on March 25, 1997.

(2) Indicates management compensatory plan, contract or arrangement.

(3) Confidential treatment has been previously granted for certain portions of
these exhibits.

(4) Previously filed on the 10-K for the fiscal year ended December 31, 1996
with the Securities and Exchange Commission.

42.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this Form 10-K/A to be signed on its
behalf by the undersigned, thereunto duly authorized in the City of
Pleasanton, State of California, on this 24th day of October 1997.

YES! Entertainment Corporation

By: /s/ Donald D. Kingsborough
-----------------------------------
Donald D. Kingsborough
Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Form 10-K/A has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated:

SIGNATURE TITLE DATE
--------- ----- ----
/s/ DONALD D. KINGSBOROUGH Chairman of the Board and Chief October 24, 1997
- -------------------------- Executive Officer (Principal
Donald D. Kingsborough Executive Officer)

/s/ Mark C. Shepherd Chief Financial Officer October 24, 1997
- -------------------------- (Principal Financial and
Mark C. Shepherd Accounting Officer) and
Secretary

* Director October 24, 1997
- --------------------------
David C. Costine

* Director October 24, 1997
- --------------------------
Esmond T. Goei

* Director October 24, 1997
- --------------------------
Michael J. Marocco

Director October 24, 1997
- --------------------------
Anthony Miadich

*By: /s/ Donald D. Kingsborough
--------------------------
Donald D. Kingsborough,
Attorney-in-Fact

43.

REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders
YES! Entertainment Corporation

We have audited the accompanying consolidated balance sheets of YES!
Entertainment Corporation as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity (deficit), and
cash flows for each of the three years in the period ended December 31, 1996.
Our audits also included the financial statement schedule listed in the index
at Item 14(a). These financial statements and schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
YES! Entertainment Corporation at December 31, 1996 and 1995, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

/s/ ERNST & YOUNG LLP

February 26, 1997,
except as to Note 16,
as to which the date is
March 18, 1997

F-1

YES! ENTERTAINMENT CORPORATION

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

DECEMBER 31,
-----------
1996 1995
---- ----
ASSETS

Current assets:
Cash and cash equivalents............................................... $ 1,572 $ 2,987
Accounts receivable, net of allowance for doubtful accounts
of $465 in 1996 and $432 in 1995....................................... 21,956 26,260
Inventories............................................................. 26,194 12,050
Prepaid royalties....................................................... 4,045 2,071
Prepaid expenses........................................................ 1,868 1,903
Other current assets.................................................... 1,671 560
------- -------
Total current assets..................................................... 57,306 45,831
Property and equipment, net.............................................. 3,869 2,769
Intangibles and deposits, net............................................ 276 270
------- -------
Total assets............................................................. $61,451 $48,870
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Convertible notes payable............................................... $ -- $ 2,000
Loans payable........................................................... 16,712 10,125
Accounts payable........................................................ 12,565 5,484
Accrued royalties....................................................... 1,018 1,267
Accrued liabilities..................................................... 879 1,012
Capital lease obligations due within one year........................... 16 87
Income taxes payable.................................................... 182 185
------- -------
Total current liabilities................................................ 31,372 20,160
Capital lease obligations................................................ 14 29
Other liabilities........................................................ -- 97

Stockholders' equity:
Undesignated preferred stock, $0.001 par value:
Authorized shares--2,000,000 at December 31, 1996 and 1995.............
Issued and outstanding shares--none issued at December 31,
1996 and 1995......................................................... -- --
Common stock, $0.001 par value:
Authorized shares--48,000,000 at December 31, 1996
Issued and outstanding shares--14,044,422 in 1996 and
10,738,710 in 1995.................................................... 14 69,511
Additional paid-in capital.............................................. 82,707 --
Accumulated deficit..................................................... (52,656) (40,085)
Less amounts receivable from stockholders............................... -- (842)
------- -------
Total stockholders' equity............................................... 30,065 28,584
------- -------
Total liabilities and stockholders' equity............................... $61,451 $48,870
======= =======

See accompanying notes.

F-2

YES! ENTERTAINMENT CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

YEARS ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
--------- --------- ---------

Net sales...................................................... $ 69,699 $ 55,673 $ 36,379
Cost of sales.................................................. 42,624 26,623 25,012
-------- -------- --------
Gross profit................................................... 27,075 29,050 11,367
Operating expenses:
Marketing, advertising, and promotion......................... 13,192 6,423 11,013
Selling, distribution, and administrative..................... 25,571 17,638 20,274
-------- -------- --------
Total operating expenses....................................... 38,763 24,061 31,287
-------- -------- --------
Operating income (loss)........................................ (11,688) 4,989 (19,920)
Interest income................................................ 264 69 129
Interest expense............................................... (1,039) (1,321) (785)
Other expense, net............................................. (108) (74) (1,351)
-------- -------- --------
Income (loss) before provision for income taxes................ (12,571) 3,663 (21,927)
Provision for income taxes..................................... -- 185 --
-------- -------- --------
Net income (loss).............................................. $(12,571) $ 3,478 $(21,927)
======== ======== ========
Net income (loss) per share.................................... $ (0.91) $ 0.41 $ --
======== ======== ========
Shares used in computing net income (loss) per share........... 13,890 8,534 --
======== ======== ========
Pro forma net loss per share................................... $ (5.08)
========
Shares used in computing pro forma net loss per
share.......................................................... 4,319
========

See accompanying notes.

F-3

YES! ENTERTAINMENT CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)

SERIES A NOTES AND
CONVERTIBLE AMOUNTS TOTAL
PREFERRED STOCK COMMON STOCK ADDITIONAL RECEIVABLE STOCKHOLDERS'
---------------- ----------------- PAID-IN ACCUMULATED FROM EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT STOCKHOLDERS (DEFICIT)
------ ------ ------ ------ --------- ----------- ------------ -------------

Balance at December 31,
1993...................... 1,800 $ 594 380 $ 57 $ $(21,636) $ (43) $(21,028)
Repurchase of common
stock..................... -- -- (1) -- -- -- -- -- --
Common stock issued for
services.................. -- -- 21 342 -- -- -- 342
Repayment of notes
receivable................ -- -- -- -- -- -- 43 43
Net loss................... -- -- -- -- -- (21,927) -- (21,927)
----- ----- ------ -------- ------- -------- ----- --------
Balance at December 31,
1994...................... 1,800 594 400 399 -- (43,563) -- (42,570)
Exercise of stock
options................... -- -- 19 33 -- -- -- 33
Issuance of common
stock..................... -- -- 3,196 12,015 -- -- -- 12,015
Issuance of common
stock warrants............ -- -- -- 320 -- -- -- 320
Exercise of common
stock warrants............ -- -- 1,703 6,812 -- -- (842) 5,970
Conversion of Series A
convertible preferred
stock to common stock..... (1,800) (594) 120 594 -- -- -- --
Conversion of
redeemable convertible
preferred stock to
common stock.............. -- -- 5,301 49,338 -- -- -- 49,338
Net income................. -- -- -- -- -- 3,478 -- 3,478
----- ----- ------ -------- ------- -------- ----- --------
Balance at December 31,
1995...................... -- -- 10,739 69,511 -- (40,085) (842) 28,584
Reincorporation in the
state of Delaware......... -- -- -- (69,500) 69,500 -- -- --
Exercise of stock
options................... -- -- 47 -- 160 -- -- 160
Exercise of common
stock warrants............ -- -- 3,242 3 12,883 -- -- 12,886
Issuance of common stock
related to Company's
401(k) plan............... -- -- 16 -- 164 -- -- 164
Payments of stockholder
notes receivable.......... -- -- -- -- -- -- 842 842
Net loss................... -- -- -- -- -- (12,571) -- (12,571)
----- ----- ------ -------- ------- -------- ----- --------
Balance at December 31,
1996...................... -- $ -- 14,044 $ 14 $82,707 $(52,656) $ -- $ 30,065
===== ===== ====== ======== ======= ======== ===== ========

See accompanying notes.

F-4

YES! ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

YEARS ENDED DECEMBER 31,
---------------------------
1996 1995 1994
------ ------ ------

OPERATING ACTIVITIES
Net income (loss).................................... $(12,571) $ 3,478 $(21,927)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation....................................... 2,370 2,127 2,078
Amortization....................................... 87 56 59
Advertising expense funded by issuance of
redeemable preferred stock........................ -- -- 2,741
Advertising expenses funded by inventory........... 1,022 893 --
Employer contribution to 401(k) plan funded with
common stock...................................... 164 -- --
Changes in operating assets and liabilities:
Accounts receivable.............................. 4,304 (17,744) 467
Inventories...................................... (15,166) 333 (4,673)
Prepaid expenses and other current assets........ (3,050) (4,320) 9
Accounts payable................................. 7,081 (5,463) (3,860)
Accrued liabilities.............................. (382) 158 (364)
Income taxes payable............................. (3) -- --
Other long-term liabilities...................... (97) 58 (45)
-------- -------- --------
Net cash used in operating activities................ (16,241) (20,424) (25,515)
INVESTING ACTIVITIES
Acquisition of property and equipment................ (3,470) (1,397) (2,798)
Decrease (increase) in intangibles and deposits...... (93) 18 (21)
-------- -------- --------
Net cash used in investing activities................ (3,563) (1,379) (2,819)
FINANCING ACTIVITIES
Decrease (increase) in restricted cash............... -- 1,251 4,168
Principle payments on convertible notes payable...... (2,000) -- --
Net proceeds from loans payable...................... 6,587 4,121 7,403
Principal payments on capital lease obligations...... (86) (77) (54)
Proceeds from bridge loans........................... -- -- 2,092
Proceeds from issuance of redeemable convertible
preferred stock, net of issuance costs.............. -- -- 14,778
Proceeds from issuance of common stock and common
warrants, net of issuance costs..................... 13,046 16,937 --
Proceeds from stockholders' notes receivable......... 842 -- 43
-------- -------- --------
Net cash provided by financing activities............ 18,389 22,232 28,430
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents......................................... (1,415) 429 96
Cash and cash equivalents at beginning at period..... 2,987 2,558 2,462
-------- -------- --------
Cash and cash equivalents at end of period........... $ 1,572 $ 2,987 $ 2,558
======== ======== ========

See accompanying notes.

F-5

YES! ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(IN THOUSANDS)

YEARS ENDED DECEMBER 31,
---------------------------
1996 1995 1994
------ ------ ------

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid........................................ $ 1,105 1,404 $ 685
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Series C and F redeemable convertible preferred
stock issued in exchange for advertising............ -- -- $ 2,000
Series F redeemable convertible preferred stock
issued in exchange for bridge loans................. -- -- 2,092
Equipment acquired under capital lease financings.... -- -- 7
Common stock issued in exchange for extinguishment
of trade accounts payable........................... -- -- $ 342
Amounts receivable from stockholders upon exercise
of warrants......................................... -- $ 842 --
Conversion of notes payable into common stock........ -- $ 1,400 --

See accompanying notes.

F-6

See accompanying notes.
YES! ENTERTAINMENT CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1996

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

YES! Entertainment Corporation (the Company) develops, manufactures, and
markets a variety of toys and other children's products, including a variety
of interactive products. The Company markets its products through domestic and
international retailers and distributors.

Basis of Presentation

The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated. During 1996, the Company
reincorporated in the state of Delaware.

Use of Estimates

The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

Revenue Recognition

The Company recognizes revenue upon shipment of product and computes net
sales by concurrently deducting a provision for sales returns and allowances,
including allowances for defective returns, price protection, mark downs, and
other returns. Sales allowances may vary as a percentage of gross sales due to
changes in the Company's product mix, defective product allowances, or other
sales allowances. Revenue from licensing and royalties is recognized at the
time payment for the same is received. Revenue from licensing and royalties
has not, to date, constituted a significant portion of the Company's total
revenues.

Advertising Expense

The cost of production related to advertising is expensed upon the first
showing of the advertising and the cost associated with media time is expensed
as incurred. The Company incurred approximately $10,033,000, $3,295,000, and
$6,892,000 in advertising costs during 1996, 1995, and 1994, respectively. At
December 31, 1996 and 1995, the Company had $2,583,000 and $2,176,000,
respectively, of prepaid advertising related to future advertising.

Research and Development

Research and development expenses of approximately $4,586,000, $2,768,000,
and $4,850,000 for the years ended December 31, 1996, 1995, and 1994,
respectively, have been included in general and administrative expenses for
financial statement purposes.

F-7

Cash and Cash Equivalents

The Company considers all highly liquid investments with original
maturities of three months or less at the time of purchase to be cash
equivalents.

Under Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" (FAS 115), management
classifies investments as available-for-sale or held-to-maturity at the time
of purchase and periodically reevaluates such designation. Debt securities are
classified as held-to-maturity when the Company has the positive intent and
ability to hold the securities to maturity. Held-to-maturity securities are
stated at amortized cost with corresponding premiums or discounts amortized to
interest income over the life of the investment. Debt securities not
classified as held-to-maturity are classified as available-for-sale and are
reported at fair value. Unrecognized gains or losses on available-for-sale
securities are included, net of tax, in shareholders' equity until their
disposition. Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale securities are included in interest
income. The cost of securities sold is based on the specific identification
method. The Company had no short-term investments at December 31, 1996 or
1995.

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or
market. Inventories are as follows:

DECEMBER 31,
------------------
1996 1995
------- -------
(IN THOUSANDS)

Raw materials................................................ $ 2,940 $ 1,904
Work-in-process.............................................. 974 575
Finished goods............................................... 22,280 9,571
------- -------
$26,194 $12,050
======= =======

The Company's inventory valuation process is done on a part-by-part basis.
Lower of cost to market adjustments, specifically identified on a part-by-part
basis, reduce the carrying value of the related inventory and take into
consideration reductions in sales prices, excess inventory levels, and obsolete
inventory. Once established, these adjustments are considered permanent and are
not reversed until the related inventory is sold or disposed.

F-8

Property and Equipment

Property and equipment are stated at cost. Depreciation is computed on a
straight-line basis over the assets' estimated useful lives of one to five
years. Equipment under capital leases and leasehold improvements are amortized
over the shorter of the estimated useful lives or the lease term.

DECEMBER 31,
1996 1995
------- ------
(IN THOUSANDS)

Equipment......................................................................... $ 1,766 $1,373
Tooling........................................................................... 6,169 3,763
Furniture and fixtures............................................................ 2,113 1,467
Leasehold improvements............................................................ 332 376
Film.............................................................................. 412 356
Software.......................................................................... 479 466
------- ------
11,271 7,801
Accumulated depreciation.......................................................... 7,402 5,032
------- ------
$ 3,869 $2,769
======= ======

Intangible Assets

Intangible assets consist primarily of product technology rights, patents,
and trademarks. Intangibles are amortized on a straight-line basis over the
estimated lives of the related assets of two to six years. Accumulated
amortization as of December 31, 1996 and 1995 was $248,524 and $161,417,
respectively.

Net Income (Loss) Per Share

Net loss per share in 1996 is computed using the weighted average number of
shares of common stock outstanding during the year.

The 1995 net income per share is calculated using the weighted average
number of common shares and common equivalent shares outstanding during the
period. The 1994 net loss per share is calculated using the weighted average
number of common shares outstanding during the period. Common equivalent
shares are excluded from the calculation as the effect is antidilutive.
Pursuant to the Securities and Exchange Commission Staff Accounting Bulletins,
common and common equivalent shares issued by the Company at prices below the
initial public offering price during the twelve-month period prior to the
offering have been included in the calculation of the 1995 net income per
share as if they were outstanding for all periods presented prior to the
offering date (using the treasury stock method or the modified treasury stock
method when applicable and the initial public offering price). Net loss per
share for 1994 calculated on this basis was $(44.03).

In 1994, pro forma net loss per share, which is disclosed on the statement
of operations, has been computed as described above and also gives effect,
even if antidilutive, to common equivalent shares from redeemable convertible
preferred stock that converted upon the closing of the Company's initial
public offering (using the if-converted method).

F-9

2. ADVERTISING CREDITS

During 1996 and 1995, the Company entered into various transactions whereby
it exchanged $987,000 and $2,796,000 of inventory, respectively, for advertising
credits to be used toward the purchase of media time. These transactions are
reported at the estimated fair market value of the inventory exchanged, which
approximated cost. The agreements allow the Company to use the advertising
credits in lieu of up to 25% of the cost of media purchased. The credits expire
in August 2000. During 1996 and 1995, the Company utilized $1,022,000 and
$893,000, respectively, of these credits for advertising.

At December 31, 1996 and 1995, the Company had advertising credits in the
amount of $1,868,000 and $1,904,000, respectively, which were included in
prepaid assets. The Company expects to fully utilize the credits in 1998.

3. RECLASSIFICATIONS

Certain reclassifications in the Statements of Operations for fiscal 1995 have
been made to prior amounts reported to conform with the presentation adopted by
the Company to report its 1996 financial results.

4. CONCENTRATIONS OF CREDIT RISK

Financial instruments that subject the Company to concentrations of credit
risk are cash equivalents and trade receivables. Cash equivalents consist
principally of short-term money market funds and certificates of deposit. These
instruments are short-term in nature and bear minimal risk. To date, the Company
has not experienced losses on these investments.

The Company manufactures and sells its products primarily to major toy
retailers in the United States. Credit is extended based on an evaluation of the
customers' financial condition, and generally collateral is not required. Credit
losses are provided for in the consolidated financial statements and, to date,
have been within management's expectations. Reserves are maintained for
potential credit losses.

F-10

5. CERTAIN OTHER RISKS

Stock Balancing, Price Protection, and Advertising Allowances

Many companies in the toy industry allow retailers to return slow-moving
products for credit/replacement (referred to as stock balancing), discount
prices of existing products, provide for certain advertising allowances and
credits, or give other sales incentives to customers. The Company has made such
accommodations in the past, including significant accommodations in fiscal 1996
with regard to slow-moving products. Due to the nature of the industry,
including the volatility of consumer acceptance of product introductions, there
can be no assurance that the Company will not make such accommodations in the
future. Such accommodations could have a material adverse effect on the
Company's operating results and financial condition.

Seasonality of Sales

Sales of toys have historically been highly seasonal with a majority of the
sales occurring late in the fiscal year. Failure to accurately predict and
respond to consumer demand may cause the Company to produce excess inventory
which could materially adversely affect the Company's operating results and
financial condition. Conversely, if a product achieves greater success than
anticipated, the Company may not have sufficient inventory to meet retail
demand, which could adversely impact the Company's relations with its customers.

Off-Shore Manufacturing

As the Company does not have its own manufacturing facilities, it is
dependent on close working relationships with its contract manufacturers for the
supply and quality of its product. These manufacturers are based in Hong Kong
with manufacturing facilities in the People's Republic of China. The Company
expects to continue to use a limited number of contract manufacturers and,
accordingly, will continue to be highly dependent upon sources outside the
Company for timely production. Given the highly seasonal nature of the Company's
business, any unusual delays or quality control problems could have a material
adverse effect on the Company's operating results and financial condition.

Customer Concentration

A limited number of customers historically have accounted for a substantial
portion of the Company's revenues.

The Company's sales to significant customers as a percent of net sales were
as follows:

YEARS ENDED
DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----

Toys R Us..................................................... 21% 27% 14%
Wal-Mart...................................................... 20 27 21
Tomy.......................................................... 11 * 12%
Kmart......................................................... 11% * *
Kay-Bee....................................................... * 12% *

- --------
* Sales to these customers were less than 10% of net sales in the years
indicated.

F-11

The Company expects to continue to depend on a relatively small number of
customers for a significant percentage of its sales. Significant reductions in
sales to any one or more of the Company's largest customers would have a
material adverse effect on the Company's operating results and financial
condition. Because orders in the toy industry are generally cancelable at any
time without penalty, there can be no assurance that present or future customers
will not terminate their purchase arrangements with the Company or significantly
change, reduce, or delay the amount of products ordered from the Company. With
respect to its larger customers, any such termination of a customer relationship
or change, reduction, or delay in orders could have a material adverse effect on
the Company's operating results and financial condition.

Dependence on 1997 Product Introductions

The Company has introduced and expects to commence sales of new product
lines during the current year. The Company expects that the 1997 product lines
will place great demands on management and other Company resources. There can be
no assurance that the products under development by the Company will be
successfully developed or, if they are successfully developed, that they will
achieve market acceptance. If the Company is not able to complete development,
tooling, manufacture, and successful marketing of these product lines, the
Company's operating results and financial condition could be materially
adversely affected.

Dependence on Key Personnel

The Company believes its success will depend, to a significant extent, on
the efforts and abilities of certain of its senior management. Additionally, the
Company's line of credit agreement required employment of certain key personnel.
The Company has entered into employment agreements with these individuals;
however, the loss of such key personnel could have a material adverse effect on
the Company's operating results and financial condition.

F-12

6. NOTES PAYABLE AND FINANCING ARRANGEMENTS

The Company has $30,000,000 available under the accounts receivable
management and security agreement that expires July 30, 1999. Borrowings under
the agreement are based on 70% of defined eligible accounts receivable and 30%
of defined eligible inventories and are subject to specified letter of credit
and inventory sublimits. Borrowings bear interest at 3% above the institution's
reference rate (the higher of the prime rate or the Federal Funds Rate plus
1/2%). The interest rate was 11-1/4% at December 31, 1996. Borrowings under the
line of credit can be applied to the issuance of letters of credit up to
$16,000,000. At December 31, 1996, borrowings were $16,712,000, and the Company
had approximately $4,223,000 of letters of credit outstanding. The amounts
available under the line of credit at December 31, 1996 was approximately
$22,111,000. Borrowings are collateralized by substantially all of the Company's
assets, and the Company is subject to significant charges for early termination
by the Company. In addition, the Loan and Security Agreement entered into with
BNY Financial Corporation limits the Company's ability to pay dividends without
the lender's consent. The agreement contains covenants that require the Company
to maintain a minimum tangible net worth and meet certain other financial
ratios. The Company was not in compliance with the quick ratio and profitability
covenants at December 31, 1996 and has obtained a waiver from the financial
institution with regard to these covenants for the year ended December 31, 1996.

During August 1994, the Company entered into a $2,500,000 supplemental loan
agreement with the financial institution then providing its line of credit. In
connection with the loan, certain stockholders provided letters of credit or
certificates of deposit as collateral for the loan. In exchange, the
stockholders were issued warrants to purchase 166,760 shares of common stock at
an exercise price of $7.50 per share. One stockholder elected to convert
$1,100,000 of collateral for Series F convertible preferred stock at $7.50 per
share, and the proceeds were used to pay down the loan to $1,400,000. The
related warrants issued in conjunction with this collateral were then canceled.
In exchange for an extension to the loan maturity date, the participating
stockholders were granted additional warrants to purchase 93,247 shares of
common stock at $7.50 per share. In April 1995, the Company issued an aggregate
of $1,400,000 principal amount of conversion notes to the participating
stockholders in full satisfaction of the Company's obligation to repay such
investors for draws against the letters of credit and cash collateral accounts
posted by such investors. The notes bear interest at 10% per annum. In
connection with the Company's initial public offering, the notes were converted
into 320,729 shares of common stock, and the note holders were issued redeemable
common stock warrants to purchase an additional 320,729 shares of common stock
at an exercise price of $4.00 per share.

In April 1995, the Company issued an aggregate of $3,000,000 bridge notes
and warrants to purchase 1,500,000 shares of the Company's common stock. The
bridge notes bore interest at a rate of 10% per annum and were repaid from the
proceeds of the Company's initial public offering in June 1995.

7. CONVERTIBLE NOTES PAYABLE

As of December 31, 1995, $2,000,000 in principal amount of 10% convertible
subordinated notes payable was outstanding. The notes were issued on September
30, 1993 and matured on September 30, 1996. In October 1996, all amounts
outstanding under these notes were paid.

F-13

8. ROYALTIES

The Company has acquired certain product rights and technologies from
product designers and developers as well as the rights to certain well-known
children's characters. These agreements generally provide for an advance royalty
payment and subsequent royalty payments based on net sales of products utilizing
the related technology or characters. Royalty expense under these agreements
totaled $4,586,000, $3,065,000, and $1,757,000 in 1996, 1995 and 1994,
respectively. Future minimum royalty commitments under these agreements are
approximately $2,727,000 at December 31, 1996.

The Company has a license agreement with Shoot the Moon Products, Inc.
(STM) pursuant to which the Company pays royalties for the use of the technology
incorporated in one of the Company's products, T.V. Teddy. Prior to founding the
Company, Donald D. Kingsborough, the Company's Chairman and Chief Executive
Officer, was a shareholder of STM. In consideration of Mr. Kingsborough's
contribution to the capital of STM of all of his shares, STM entered into an
agreement with Mr. Kingsborough pursuant to which he is entitled to receive 15%
of the royalties received by STM for three products, including T.V. Teddy. The
amount to be paid to Mr. Kingsborough is based upon royalties paid on sales of
the T.V. Teddy hardware and excludes sales of the encoded videotapes. During
1996, 1995, and 1994, royalty payments to STM for sales of T.V. Teddy hardware
approximated $7,700, $335,000, and $383,000, respectively.

9. CAPITAL LEASE OBLIGATIONS

The Company leases certain equipment under noncancelable lease agreements
that are accounted for as capital leases. As of December 31, 1996 and 1995,
equipment under capital lease arrangements included in property and equipment,
aggregated approximately $348,599 and $346,000. Accumulated amortization
totaled $318,823 and $247,000 at December 31, 1996, and 1995, respectively.

Future minimum lease payments under capital lease obligations at December
31, 1996, are as follows (in thousands):

1997................................. $18
1998................................. 15
1999................................. --
---
Total minimum payments............... 33
Less amounts representing interest... 3
Less current portion................. 16
---
$14
===

F-14

10. OPERATING LEASE COMMITMENTS

The Company leases its operating facilities under noncancelable operating
leases expiring at various dates through 2000. The lease agreements contained
scheduled rent increases over the terms of the lease, and rental expense is
charged to operations on a straight-line basis over the lease term. The leases
are secured by deposits of $210,000 and $103,000 at December 31, 1996 and 1995,
respectively, which are included in other assets.

Future minimum operating lease payments, net of sublease income, at
December 31, 1996 are as follows (in thousands):

1997.............................. $1,302
1998.............................. 982
1999.............................. 660
2000.............................. 219
2001 and beyond................... 657
------
$3,820
======

Total rental expense was approximately $1,187,000, $1,345,000, and
$1,243,000, in 1996, 1995, and 1994, respectively. The Company subleased a
portion of its Hong Kong subsidiary's facility under a noncancelable operating
lease that expired in 1995. As such, the 1995 and 1994 rental expense was offset
by approximately $186,000 and $156,000 of sublease income, respectively.

11. INCOME TAXES

The Company provides for income taxes as required under Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes." The
components of the provision for income taxes consist of the following (in
thousands):

YEAR ENDED
DECEMBER 31,
1995
------------

Current:
Federal................... $110
State..................... 25
Foreign................... 50
----
Total....................... $185
====

There was no provision for income taxes in either 1996 or 1994, as the
Company incurred pre-tax book losses of approximately $12,500,000 and
$22,000,000, respectively. The Company's provision for income taxes for 1995 is
solely attributable to federal and state minimum taxes and foreign income taxes.

F-15

The total provision for income taxes differs from the amount computed by
applying the federal statutory income tax rate (34%) to income (loss) before
taxes as follows (in thousands):

YEARS ENDED DECEMBER 31,
------------------------
1996 1995 1994
------ ------ ------

Income tax (benefit) computed at the federal
statutory rate.................................. $(4,274) $ 1,294 $(7,674)
State taxes...................................... -- 25 --
Foreign taxes.................................... -- 50 --
Temporary differences and net operating losses
with no current tax benefit (benefited)......... 4,274 (1,184) 7,674
------- ------- -------
Provision for income taxes....................... $ -- $ 185 $ --
======= ======= =======

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets are as follows (in thousands):

DECEMBER 31,
----------------
1996 1995
------- -------

Deferred tax assets:
Allowance for returns....................................................... $ 1,807 $ 772
Capitalized research and development........................................ 2,505 2,526
Net operating loss carryforwards............................................ 13,453 9,517
Reserves and accrued expenses............................................... 1,846 2,312
------- ------
Total deferred tax assets.................................................... 19,611 15,127
Valuation allowance.......................................................... (19,611) (15,127)
------- --------
Net deferred tax assets...................................................... $ -- $ --
======= ========

Realization of deferred tax assets is dependent on future earnings, the
amount and timing of which are uncertain. Accordingly, a valuation allowance,
in an amount equal to the net deferred tax assets as of December 31, 1996 and
1995 has been established to reflect these uncertainties. The change in the
valuation allowance was an increase of $4,484,000 and $7,780,000 in 1996 and
1994, respectively, and a decrease of $993,000 in 1995.

At December 31, 1996, the Company had net operating loss carryforwards for
federal and California tax purposes of approximately $36,500,000 and
$17,000,000, respectively. The federal losses will expire in the years 2007
through 2011, and the state losses will expire in the years 1999 through 2001,
if not utilized. Utilization of the net operating loss carryovers may be subject
to a substantial annual limitation if it should be determined that there has
been a change in the ownership of more than 50% of the value of the Company's
stock, pursuant to Section 382 of the Internal Revenue Code of 1986 and similar
state provisions. The annual limitation may result in the expiration of net
operating loss carryovers before utilization.

F-16

12. STOCKHOLDERS' EQUITY

Warrants

In April and May 1995, in connection with the bridge notes described in
Note 6, the Company issued warrants to purchase an aggregate of 1,500,000 shares
of the Company's common stock. The warrants are exercisable for a five-year
period from the date of grant at $4.00 per share.

In connection with the Company's initial public offering in June 1995, the
Company issued redeemable common stock purchase warrants (IPO Warrants) at $0.10
per share. In addition, the Company issued to the underwriter of the initial
public offering an option to purchase an additional 250,000 shares of common
stock and an option to purchase 250,000 warrants. Each IPO Warrant entitles the
holder to purchase one share of common stock for $4.00 during the five-year
period beginning June 7, 1995. Additionally, the Company issued 320,729 IPO
Warrants in connection with the conversion of approximately $1,400,000 of
convertible subordinated promissory notes.

All IPO Warrants, the warrants issued in April and May 1995 in connection
with the bridge notes, and any warrants issued upon the exercise of the
underwriter's purchase option were redeemable by the Company at a price of $0.01
per warrant if the last price of the common stock had been at least $6.50 per
share for twenty consecutive trading days. The warrants became redeemable on
December 14, 1995, and the Company called all warrants for redemption at which
point various warrants were exercised. At December 31, 1996, 3,241,956 warrants
had been exercised.

In addition to the warrants described above, the Company periodically
outstanding to purchase common stock at December 31, 1996:

NUMBER OF PRICE PER EXPIRATION
SHARES SHARE DATE
--------- --------- ----------

37,252 $16.32 November 1998
35,990 $12.60 December 1998
348,729 $15.30 July 1998
217,265 $16.32 February 1999
454,852 $ 7.50 August 1999

Stock Option Plans

Under the Company's 1992 Stock Option Plan (1992 Plan), the Board of
Directors may grant incentive stock options to employees, directors, and
consultants to purchase up to 500,000 shares of common stock.

In July 1995, the Board of Directors adopted the 1995 Stock Option Plan
(1995 Plan) and reserved 500,000 shares of common stock for issuance thereunder.
In October 1995, the Board of Directors increased the total number of shares
reserved for issuance to 1,000,000. In July

F-17

1996, the Board of Directors increased the total number of shares reserved
for issuance under the 1995 Stock Option Plan by 1,500,000 shares.

The 1992 Plan and the 1995 Plan provide for the granting of incentive stock
options and nonstatutory stock options to employees, directors, and consultants
of the Company at prices ranging from 85% to 110% (depending on the type of
grant) of the fair market value of the common stock on the date of grant as
determined by the Board of Directors. The options generally vest at a rate of
25% after one year from the date of grant and 1/48 each month thereafter. The
vesting and exercise provisions of the option grants are determined by the Board
of Directors, and the options are nontransferable. The Company may offer to
repurchase the outstanding options at any time under terms and conditions to be
determined by the Board of Directors.

In July 1995, the Company adopted the 1995 Director Option Plan (Director
Plan) and reserved 120,000 shares of common stock for issuance thereunder. Under
the Director Plan, automatic option grants are made upon appointment as a
director and on each anniversary date thereafter to eligible nonemployee members
of the Board of Directors. One hundred percent of the shares subject to the
initial option granted to each director become fully vested one year after the
date of the grant. One forty-eighth of the shares subject to subsequent options
granted to each director become exercisable each month after the option grant.

Stock option activity under the 1992 Plan and 1995 Plan was as follows:
(in thousands, except per share data)

OPTIONS OUTSTANDING
----------------------
WEIGHTED
AVAILABLE NUMBER AVERAGE
FOR OF PRICE PER
GRANT SHARES SHARE
--------- -------- ---------

Balance at December 31, 1993...... 87 129 $ 1.71
Granted......................... (67) 67 $ 2.25
Canceled........................ 40 (40) $ 1.90
----- -----
Balance at December 31, 1994...... 60 156 $ 1.90
Options authorized.............. 1,404 $ --
Granted......................... (1,243) 1,243 $ 4.86
Exercised....................... -- (19) $ 1.84
Canceled........................ 71 (71) $ 2.02
----- -----
Balance at December 31, 1995...... 292 1,309 $ 4.70
Options authorized.............. 1,500 -- $ --
Granted......................... (1,218) 1,218 $13.07
Exercised....................... -- (47) $ 3.40
Canceled........................ 64 (64) $ 6.45
------ -----
Balance at December 31, 1996...... 638 2,416 $ 9.11
====== =====

At December 31, 1996 and 1995, approximately 554,000 and 175,000 options,
respectively, were exercisable under the plans.

F-18

At December 31, 1996, options outstanding were as follows:

OPTIONS
OUTSTANDING OPTIONS EXERCISABLE
----------- ------------------------
NUMBER WEIGHTED NUMBER
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
AS OF REMAINING AVERAGE AS OF AVERAGE
DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 1996 LIFE PRICE 1996 PRICE
- --------------- ------ ---------- -------- ----------- --------

$ 1.50 -- 2.25........................................... 193,295 7.82 $ 2.17 174,331 $ 2.17
5.25 -- 6.50........................................... 1,022,772 8.71 5.58 373,945 5.78
7.50 -- 10.69.......................................... 185,100 9.56 10.49 26 9.13
11.13 -- 13.88.......................................... 1,014,512 9.78 13.70 5,884 11.98
--------- ---- ----- ------- -----
$ 1.50 -- $13.88......................................... 2,415,679 9.15 $9.09 554,186 $4.71

The Company has elected to follow Accounting Principle Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB Opinion No. 25) and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under the
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (FAS 123), requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB Opinion No. 25,
because the exercise price of the Company's employee stock options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized.

Pro forma information regarding net income(loss) and earnings(loss) per
share is required by FAS 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of FAS 123.
For options granted prior to the initial public offering in June 1995, the fair
value for these options was estimated at the date of grant using the Minimum
Value option pricing method with the following assumption for 1995: a risk-free
interest rate of 6.37%; a dividend yield of 0%; and an expected life of options
of five years. For options granted subsequent to the initial public offering,
the fair value for these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions: a risk-free interest rate of 6.23% and 6.37% for 1996 and 1995,
respectively; a dividend yield of 0%; a volatility factor of the expected market
price of the Company's common stock of .342 and .269 for 1996 and 1995,
respectively; and a weighted average expected life of the option of five years.
The weighted average fair value of these options granted were $1.84 and $5.37
for 1996 and 1995, respectively.

The Minimum Value option valuation method may be used by nonpublic
companies to value an award. The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options which have no
vesting restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions, including the

F-19

expected stock price volatility. Because the Company's employee stock options
have characteristics significantly different from those of traded options and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.

Had compensation costs for the Company's stock-based compensation plans
been determined on the fair value at the grant dates for awards under those
plans consistent with the method of FAS 123, the Company's net income(loss) and
earnings(loss) per share would have been reduced to the pro forma amounts
indicated below:

YEARS ENDED DECEMBER 31,
------------------------
1996 1995
------ ------

Pro forma net income (loss)........................ $(13,477,000) $3,314,000
Pro forma earnings (loss) per share................ $ (0.97) $ 0.39

Because FAS 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1999.

Undesignated Preferred Stock

The Board of Directors may issue up to 2,000,000 shares of undesignated
preferred stock in one or more series and may fix the rights, privileges and
restrictions granted to or imposed upon any wholly unissued series of
undesignated preferred stock, as well as to fix the number of shares
constituting any series and designations of such series, without any further
voter action by the stockholders.

Common Stock Reserved for Future Issuance

Authorized shares of common stock reserved, are as follows (in thousands):

DECEMBER 31,
1996
------------

Stock option plans, including the 1992 Stock Option Plan, the
1995 Stock Option Plan, and the 1995 Director Option Plans..... 3,054
Issued and outstanding warrants................................. 1,354
Undesignated preferred stock.................................... 2,000
-----
Total common stock reserved for future issuance................. 6,408
=====

F-20

13. INDUSTRY AND GEOGRAPHIC INFORMATION

The Company operates in a single industry segment. The Company markets its
products in the United States and in foreign countries through its sales
personnel, independent sales representatives, and distributors.

The Company's geographic sales as a percent of net product sales were as
follows:

YEARS ENDED
DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- ----

United States................................................ 79% 93% 71%
Export:
Europe...................................................... 3 2 17
Far East.................................................... 11 2 4
Other....................................................... 7 3 8
---- ---- ----
100% 100% 100%
==== ==== ====

14. LITIGATION

The Company is involved from time to time in litigation incidental to its
business. The Company believes that none of its pending litigation matters,
individually or in the aggregate, will have a material adverse effect on the
Company's operating results or financial condition.

15. EMPLOYEE BENEFIT PLAN

In July 1996, the Company restated the YES! Entertainment 401(k) Savings
Plan (the Plan) to accommodate a matching contribution in the form of employer
stock. As allowed under Section 401(k) of the Internal Revenue Code, the Plan
provides tax deferred salary deductions for eligible employees. Eligible
employees include persons employed by YES! Entertainment Corporation on a
substantially full-time basis for a period of at least one month. Participants
in the Plan may make deferrals not less than 1% and not more than 20% of their
annual compensation, limited by the maximum dollar amount allowed by the
Internal Revenue Code. The Company, at its discretion, may elect to make
contributions to the Plan on behalf of its eligible participants. If the Company
elects to do so, it will match 50% of employee contributions at the end of each
quarter in the form of company stock. During 1996, the Company made
contributions in the form of company stock in the amount of $163,702.

F-21

16. SUBSEQUENT EVENT

During March 1997, the Company issued $1,566,667 in convertible debentures
and 85,000 shares of Series A convertible preferred stock at a par value of
$0.001 per share for $100 per share to a series of investors for a total of
$8,500,000.

Holders of the Series A convertible preferred stock shall be entitled to
receive, when and as declared by the Board of Directors out of legally available
funds, cumulative dividends at a rate of 6 1/2% per annum, payable in cash or
shares of common stock, semi-annually in arrears, but in no event later than the
date of conversion. The Series A convertible preferred stock has no voting
rights, has a liquidation preference of $100 per share plus all accrued but
unpaid dividends, subject to adjustment, and is convertible at the option of the
holder, into shares of common stock, at the lowest of (a) $5.313, (b) the
average of the lowest per share market value for any five consecutive trading
days during the sixty trading days immediately following January 28, 1997, or
(c) 82 1/2% of the average per share market value for the five trading days
immediately preceding the conversion date. Beginning January 28, 1998 the
Company can force conversion of the preferred stock to common stock at the then
applicable conversion rate. The Series A convertible preferred stock is
redeemable, in cash, at the option of the Company at a redemption price equal to
the sum of (i) the average per share market value for the five days immediately
preceding (1) the 20th trading day after the date of redemption notice or (2)
the date of payment in full by the Company, whichever is greater, and (ii) the
conversion ratio calculated on the 20th trading day after the redemption notice.
The Series A convertible preferred stock is mandatorily redeemable on January
28, 2000, if not previously converted or redeemed. Any redemption payments must
be approved by BNY, the financial institution with which the Company has its
current accounts receivable management agreement.

The convertible debentures earn interest at 5% per annum, are due January
28, 2000, and are convertible any time after January 28, 1998, at the option of
the holder, at a conversion price similar to that of the Series A convertible
preferred stock. The convertible debentures are subordinated to the bank
financing agreement.

In connection with the issuance of convertible debt and preferred stock,
the Company issued warrants for the purchase of 300,000 shares of common stock
at an exercise price per share equal to the lesser of (a) $7.875 or (b) 125% of
the average of the lowest per share market value for any five consecutive
trading days during the sixty trading days following March 18, 1997. The
warrants expire March 18, 2002.

The Company will record approximately $260,000 in interest expense and
$1,480,000 in dividends related to this transaction during the first quarter of
fiscal 1997.

F-22

SCHEDULE II

YES! ENTERTAINMENT CORPORATION

VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)

BALANCE AT CHARGED TO
BEGINNING OF COSTS AND BALANCE AT
PERIOD EXPENSES DEDUCTIONS END OF PERIOD
------ -------- ---------- -------------

Year ended December 31, 1994:
Allowance for doubtful accounts...... $ 140 $ 140 $ 21 $ 259
Allowance for sales returns
and allowances...................... 6,877 8,844 8,063 7,658
------ ------- ------- ------
7,017 8,984 8,084 7,917
====== ======= ======= ======
Year ended December 31, 1995:
Allowance for doubtful accounts...... 259 232 59 432
Allowance for sales returns
and allowances...................... 7,658 6,523 11,575 2,606
------ ------- ------- ------
7,917 6,755 11,634 3,038
------ ------- ------- ------
Year ended December 31, 1996:
Allowance for doubtful accounts....... 432 192 159 465
Allowance for sales returns
and allowances....................... 2,606 9,939 7,365 5,180
------ ------- ------- ------
$3,038 $10,131 $ 7,524 $5,645
====== ======= ======= ======

F-23