ETOYS INC, 10-K, 2000-06-02

ETOYS INC
10-K, 2000-06-02
HOBBY, TOY & GAME SHOPS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-K
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(MARK ONE)

<TABLE>
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/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>

FOR THE FISCAL YEAR ENDED MARCH 31, 2000
OR

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/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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COMMISSION FILE NUMBER: 000-25709

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ETOYS INC.

(Exact name of registrant as specified in its charter)

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DELAWARE 95-4633006
(State or other jurisdiction (I.R.S. Employer
of Identification No.)
incorporation or organization)
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3100 OCEAN PARK BLVD., SUITE 300
SANTA MONICA, CALIFORNIA 90405
(Address of principal executive offices, zip code)

Registrant's telephone number, including area code: (310) 664-8100

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

None

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

Common Stock, par value $.0001 per share

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. / /

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Aggregate market value of voting stock held by
non-affiliates of the registrant
as of May 31, 2000........................................ $499,287,575
Number of shares of common stock outstanding as of May 31,
2000...................................................... 121,574,168
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DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III of this Report, to the extent not set
forth herein, is incorporated herein by reference from the registrant's
definitive proxy statement relating to the annual meeting of stockholders to be
held in 2000, which definitive proxy statement shall be filed with the
Securities and Exchange Commission within 120 days after the end of the fiscal
year to which this Report relates.

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ETOYS INC.

FORM 10-K

FOR THE FISCAL YEAR ENDED MARCH 31, 2000

INDEX

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PAGE
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PART I

Item 1. Business.................................................... 3
Item 2. Properties.................................................. 32
Item 3. Legal Proceedings........................................... 33
Item 4. Submission of Matters to a Vote of Security Holders......... 33

PART II

Item 5. Market for Registrant's Common Stock and Related Stockholder
Matters................................................... 33
Item 6. Selected Financial Data..................................... 34
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 35
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 45
Item 8. Financial Statements and Supplementary Data................. 46
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................. 90

PART III

Item 10. Directors and Executive Officers of the Registrant.......... 90
Item 11. Executive Compensation...................................... 90
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 90
Item 13. Certain Relationships and Related Transactions.............. 90

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K....................................................... 90
Signatures.............................................................. 93
</TABLE>

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PART I

ITEM 1. BUSINESS

THIS ANNUAL REPORT ON FORM 10-K AND THE DOCUMENTS INCORPORATED HEREIN BY
REFERENCE CONTAIN FORWARD-LOOKING STATEMENTS BASED ON CURRENT EXPECTATIONS,
ESTIMATES AND PROJECTIONS. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
EXPRESSED IN FORWARD-LOOKING STATEMENTS. SEE "ITEM 7. MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--FORWARD-LOOKING
STATEMENTS."

GENERAL

eToys Inc. (the "Company" or "we") is a leading Web-based retailer focused
exclusively on children's products, including toys, video games, books,
software, videos, music and baby-oriented products. Our online store, located at
www.etoys.com, offers an extensive selection of competitively priced children's
products, with over 100,000 SKUs. Through our wholly-owned subsidiary,
BabyCenter, we offer Webby-award winning content and community for new and
expectant parents and an online store with an extensive selection of
baby-oriented products and supplies. In October 1999, we launched eToys.co.uk,
which incorporates our technology and online store design and offers consumers
in the United Kingdom over 5,000 SKUs of children's toys, software, videos and
video games tailored to this market. In addition, in November 1999, we began
offering services to all provinces of Canada through our eToys.com store, and in
March 2000 we launched the BabyCenter brand in the United Kingdom, offering a
content and community site for parents and expectant parents located at
www.babycentre.co.uk. As of March 31, 2000, we had sold children's products to
approximately 1.9 million customers.

By combining our expertise in children's products and our commitment to
excellent customer service with the benefits of Internet retailing, we are able
to deliver a unique shopping experience to consumers, the key components of
which include the following:

CONVENIENT SHOPPING EXPERIENCE. Our online store provides customers with an
easy-to-use Web site. It is available 24 hours a day, seven days a week and may
be reached from the shopper's home or office. Our online store enables us to
deliver a broad selection of products to customers in rural or other locations
that do not have convenient access to physical stores. We also make the shopping
experience convenient by categorizing our products into easy-to-shop
departments. These include toys, video games, books, software, videos, music and
baby. Our advanced search technology makes it easy for consumers to locate
products efficiently based on pre-selected criteria depending upon the
department. For example, by using a quick keyword search or a sophisticated
product search in our toy department, a customer can search by any combination
of age, category, keyword or price. We also make it easy to find age appropriate
products through our shop by age feature.

EXTENSIVE PRODUCT SELECTION AND INNOVATIVE MERCHANDISING. We offer a broad
selection of children's products that would be economically or physically
impractical to stock in a traditional store. We provide consumers with a
comprehensive selection of both traditional, well-known brands, such as Mattel,
Hasbro and LEGO, and specialty toy brands, such as BRIO, Discovery Toys and
Learning Curve. In addition, we offer a broad selection of children's video
games, books, software, videos, music and baby-oriented products. We strive to
merchandise our store in a way that makes it as easy as possible for consumers
to locate products. As a result, we have added numerous specialty boutiques
designed to appeal to specific consumer interests such as hobbies, dolls and
trains. We have also added a series of seasonal boutiques to enable consumers to
easily locate seasonal specific items such as Halloween costumes and school
supplies. In addition, the unique environment of the Internet enables us to
dynamically adjust our merchandising strategy and product mix to respond to
changing customer demand.

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HELPFUL AND USEFUL SHOPPING SERVICES. Through our online store, we offer
helpful and useful services to assist our customers, who are generally adults
purchasing for children. Many of these services are also designed to inform and
involve children in the shopping experience. Our services include:

- PRODUCT REVIEWS AND RECOMMENDATIONS. To assist customers in selecting
appropriate products, we provide regularly updated product recommendations
through our FAVORITES BY AGE, FANTASTIC FINDS and our 200 TREASURES UNDER $20
recommended list of affordable toys. In addition, we feature product reviews
and lists of award-winning products from prominent parenting and family
publications as well as from organizations solely dedicated to children's
products.

- MY ETOYS. Through My eToys, we personalize the customer's shopping experience
by offering the following services:

- BIRTHDAY REMINDERS, in which we notify shoppers of a child's birthday
three weeks in advance via e-mail and offer age-appropriate gift
recommendations;

- WISH LISTS, in which parents and children can e-mail friends and family a
list of a child's most desired toys, video games, books, software, videos,
music and baby-oriented products;

- GIFT REGISTRY, like a wedding registry, in which customers can purchase
gifts without duplicating the purchases of other friends and family; and

- ADDRESS BOOK, in which we record the addresses of people to whom our
customers send gifts so they do not need to re-enter the same addresses
multiple times.

- IN-STOCK NOTIFICATION. If a product is out of stock, our customers can request
that we e-mail them when the product is back in stock. We believe this service
helps customers avoid extended store-to-store searches for hard-to-find
products.

- PRE-ORDER SERVICE. Our pre-order service gives consumers the opportunity to be
one of the first to receive newly released video games, children's videos and
music. Pre-order allows customers to place orders for new and highly sought
after items on a first-come, first-served basis.

- PRODUCT NEWS. Our free monthly e-mail newsletters deliver updates about new
products and services and special offers to our customers.

EXCELLENT CUSTOMER SERVICE. We provide free pre- and post-sales support via
both e-mail and toll-free telephone service during extended business hours. Once
an order is made, customers can view order-tracking information on our Web site
or contact our customer service department to obtain the status of their orders
and, when necessary, resolve order and product questions. Furthermore, the
customer service area of our Web site contains extensive information for
first-time and repeat visitors. These include helpful hints in searching for,
shopping for, ordering and returning our products. Through our East and West
Coast distribution centers, we also strive to provide a high level of
fulfillment services.

BUSINESS STRATEGY

Our objective is to be the world's leading online retailer of children's
products. Key elements of our strategy include the following:

FOCUS ON ONLINE RETAILING OF CHILDREN'S PRODUCTS. We intend to become the
primary place for consumers to purchase children's products by enhancing our
current product offerings and expanding into additional categories. For example,
in 2000, we plan to launch party goods and hobby stores as well as create new
and distinct content areas focused on topics of interest to parents and
children.

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BUILD STRONG BRAND RECOGNITION. We use online and offline marketing
strategies to enhance our brand recognition. We focus our efforts primarily
towards mothers, who we believe are the principal decision-makers for purchases
of children's products.

PURSUE WAYS TO INCREASE NET SALES. We intend to pursue new opportunities to
increase our net sales by opening new departments, increasing product selection,
adding more helpful and useful shopping services, and acquiring complementary
businesses, products or technologies.

PROMOTE REPEAT PURCHASES. We intend to maximize the number of repeat
purchases by our customers by targeting existing customers through direct
marketing techniques, building features unique to each individual customer and
enhancing our customer service.

EXPAND INTO ADDITIONAL INTERNATIONAL MARKETS. We currently offer children's
products in the United States and Canada through our eToys.com online store and
in the United Kingdom through our eToys.co.uk online store. We also offer
content and community to parents and expectant parents through BabyCentre.co.uk.
Our European operations are conducted through a Netherlands subsidiary, and we
are exploring opportunities to separately finance its operations and plan to
continue expanding internationally in a manner consistent with the availability
and extent of such financing opportunities.

MAINTAIN OUR TECHNOLOGY FOCUS AND EXPERTISE. We intend to enhance our
service offerings to take advantage of the unique characteristics of online
retailing. We plan to increase the efficiency of our relationships with product
vendors and manufacturers and our distribution operations.

CORPORATE INFORMATION

We were incorporated as Toys.com in Delaware in November 1996. In May 1997,
we changed our name to eToys.com Inc., and in June 1997, we changed our name to
eToys Inc. Our corporate offices are located at 3100 Ocean Park Blvd.,
Suite 300, Santa Monica, CA 90405. Our telephone number at that location is
(310) 664-8100.

Information contained on our Web sites is not part of this Annual Report on
Form 10-K.

THE ETOYS ONLINE RETAIL STORE

We designed our online retail store to be the primary place for consumers to
purchase children's products. We believe our attractive, easy-to-use, online
store offers consumers a unique and enjoyable shopping experience as compared to
traditional store-based retailers. The look-and-feel of our Web site is playful
and entertaining, and navigation is consistent throughout. A consumer shopping
on our Web site can, in addition to ordering products, browse the different
departments of our store, conduct targeted searches, view recommended products,
visit our Gift Center, participate in promotions and check order status. In
contrast to a traditional retail store, the consumer can shop in the comfort and
convenience of his or her home or office.

OUR STORE DEPARTMENTS

We categorize products into different departments, including toys, video
games, books, software, videos, music and baby. Within each department, products
are organized by brand, such as Mattel and Hasbro, by category, such as games,
plush toys and dolls, and by our recommendations, such as bestsellers and
favorites. The following is a summary of each of these departments:

TOYS. Since inception, we have focused on becoming the leading online
retailer of quality children's toys. We believe that we offer the largest
selection of toys available on the Internet. We provide a comprehensive
selection of both traditional, well-known brands, such as Mattel, Hasbro

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and LEGO, and specialty toy brands, such as BRIO, Discovery Toys and Learning
Curve. We individually select and test many of our toys before adding them to
our online store collection to ensure quality.

VIDEO GAMES. Through our video game department, we offer an extensive
selection of game titles, including bestsellers and new releases, for the
popular Sega Dreamcast, Sony PlayStation, Nintendo 64 and Game Boy platforms. We
provide both Entertainment Software Rating Board ratings and our own ratings for
each video game with respect to content, language and level of violence. In
addition, we sell video game hardware and recommended accessories.

BOOKS. Through our children's book department, we offer more than 80,000
titles at competitive prices. We categorize books by age, favorite character,
series, subject, author and our recommendations. We attempt to bring the books
to life by providing thorough content descriptions and in many instances actual
sample pages. Additionally, just like the neighborhood book store, we offer
author interviews and autographed books from some of the most popular children's
authors.

SOFTWARE. Through our children's software department, we offer a wide
selection of software with an emphasis on educational titles. We organize our
software into easy-to-use and understandable categories.

VIDEOS. Through our children's video department, we offer videos for
children that are organized into easy-to-shop categories. We feature a variety
of well-known titles from popular television series, as well as award-winning
independent releases.

MUSIC. Through our children's music department, we offer an extensive
assortment of children's music in both cassette and CD format. Unlike most
retailers, we organize our children's music into different categories by
subject. We feature a variety of popular children's music categories, including
books on tape, educational, holiday, lullabies and bedtime, rock for kids,
soundtracks, storytelling and Sesame Street. We also carry music from artists
associated with independent labels. We listen to many of our music products in
order to create helpful product descriptions and recommendations.

BABY. Through our BabyCenter site, we offer a broad assortment of products,
including car seats, baby carriers, clothes, bottles, nursery decor and
maternity gear. We provide expectant mothers and mothers both traditional,
well-known and specialty brands.

SHOPPING AT OUR STORE

We believe that the sale of children's products over the Web can offer
attractive benefits to consumers. These include enhanced selection, convenience,
ease-of-use, depth of content and information, and competitive pricing. Key
features of our online store include:

BROWSING. Our Web site offers visitors a variety of highlighted subject
areas and special features arranged in a simple, easy-to-use format intended to
enhance product search, selection and discovery. By clicking on the permanently
displayed department names, the consumer moves directly to the home page of the
desired department and can quickly view promotions and featured products.
Customers can use a quick keyword search in order to locate a specific product.
They can also execute more sophisticated searches based on pre-selected criteria
depending upon the department. In addition, customers can browse our online
store by hot-linking to specially designed pages dedicated to products from key
national and specialty brands. Customers can also hot-link to pages featuring
key product categories such as construction toys, just-for-girls software and
movie soundtrack music.

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GETTING PRODUCT ANSWERS. One of the unique advantages of an Internet retail
store is the ability to provide product information and editorial content. On
our Web site customers can find detailed product information, including product
descriptions, manufacturers' and merchants' age recommendations, product
packaging, battery requirements, a list of accessories and related products that
are available, product awards and customer reviews. We also provide editorial
content for our customers through regularly updated product recommendations,
including FAVORITES BY AGE, FANTASTIC FINDS and 200 TREASURES UNDER $20.
Furthermore, on our Web site we highlight award-winning products from prominent
parenting and family publications as well as from organizations solely dedicated
to children's products.

FINDING A GIFT. Through our gift services, consumers can obtain gift
recommendations by age and obtain information on a variety of child-appropriate
gift wrap styles and personalized message cards to accompany the gift. In
addition, we offer a birthday reminder service, in which we notify shoppers of a
child's birthday three weeks in advance via e-mail and proactively offer age-
appropriate recommendations to help our busy shoppers. We also provide a
children's wish list service, in which parents and children can e-mail friends
and family a list of a child's most desired gifts, and a gift registry service,
which is similar to our wish list service but helps friends and families avoid
duplicate purchases. We also sell electronic gift certificates, which typically
arrive within 24 hours of placing an order.

SELECTING A PRODUCT AND CHECKING OUT. To purchase products, customers
simply click on the "add to cart" button to add products to their virtual
shopping cart. Customers can add and subtract products from their shopping cart
as they browse around our store, prior to making a final purchase decision, just
as in a physical store. Because we maintain a fully-integrated inventory system
and stock each item we sell, we are able to notify customers in real-time
whether a selected product is currently in stock. To execute orders, customers
click on the "checkout" button and, depending upon whether the customer has
previously shopped with us, are prompted to supply shipping details online. We
also offer customers a variety of gift wrapping and shipping options during the
checkout process. Prior to finalizing an order by clicking the "submit" button,
customers are shown their total charges along with the various options chosen at
which point customers still have the ability to change their order or cancel it
entirely.

PAYING. To pay for orders, a customer must use a credit card, which is
authorized during the checkout process, but which is charged when we ship the
customer's items from our distribution facilities. Our Web site uses a security
technology that works with the most common Internet browsers and makes it
virtually impossible for unauthorized parties to read information sent by our
customers. Our system automatically confirms receipt of each order via e-mail
within minutes and notifies the customer when we ship the order. We also offer
our customers a money-back return policy.

GETTING HELP. From every page of our Web site, a customer can click on a
"help" button to go to our customer service area. The customer service area of
our Web site contains extensive information for first-time and repeat visitors.
In this area, we assist customers in searching for, shopping for, ordering and
returning our products as well as provide information on our low price
guarantee, shipping charges and other policies. We also offer our customers a
guided tour of our site to help them learn how to shop our store. In addition,
we provide customers with answers to the most frequently asked questions and
encourage our visitors to send us feedback and suggestions via e-mail.
Furthermore, customer service agents are available to answer questions about
products and the shopping process during extended business hours via our
toll-free number, which is displayed in the customer service area of our Web
site.

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OTHER WEB SITES OPERATED BY ETOYS

BABYCENTER.COM. On July 1, 1999, eToys acquired BabyCenter, a Web-based
business that offers a wide variety of information, products and interactive
forums focused on and serving expectant mothers and new parents. Visitors to the
BabyCenter Web site can read health articles and parenting news, interact online
with other families and purchase a wide selection of baby-oriented products and
supplies. BabyCenter is one of the Web's most complete resources on
preconception, pregnancy, babies and toddlers. BabyCenter generally begins to
develop relationships with expectant parents before the baby is born by
providing informative and valuable content from world-renowned organizations and
expert individuals on one of life's most important decisions. During pregnancy
and once the child is born, BabyCenter deepens its relationship with expectant
parents and parents by providing weekly e-mail newsletters that highlight
articles dealing with issues and questions that are relevant to the mother's
stage of pregnancy or the age of her baby. In order to ensure the reliability of
all content produced on the BabyCenter Web site, BabyCenter has set up a medical
advisory board to review all content prior to its usage.

In February 2000, we announced that we were uniting our baby businesses,
which then consisted of BabyCenter and the Baby Store at eToys, under the
BabyCenter brand. As part of this initiative, we have directed all eToys
customers seeking baby-related content and commerce to the BabyCenter.com site.
In addition, in order to enhance operating efficiencies, we will move all
BabyCenter commerce functions, such as distribution and customer service, from
San Francisco to Southern California. The transition, which is expected to be
completed during the summer of 2000, will reduce overlapping positions at
BabyCenter and relocate other positions to eToys.

In January 2000, we completed the sale of substantially all of the assets
and related liabilities of BabyCenter's Consumer Health Interactive division for
approximately $20 million in a combination of cash and registrable securities.
CHI is a resource for health plans looking to use the Internet to attract and
retain members.

INTERNATIONAL. In October 1999, we launched eToys.co.uk, which incorporates
our technology and online store design and offers consumers in the United
Kingdom over 5,000 SKUs of toys, software, videos and video games. In addition,
in November 1999, we began serving all provinces of Canada through our eToys.com
store, and in March 2000 we launched the BabyCenter brand in the United Kingdom,
offering a content and community site for parents and expectant parents located
at www.babycentre.co.uk.

MERCHANDISING

We believe that the breadth and depth of our product selection, together
with the flexibility of our online store and our range of helpful and useful
shopping services, enable us to pursue a unique merchandising strategy. We
provide an extensive selection of children's products. These include traditional
mass market toys, specialty toys and a broad selection of related children's
products, including video games, books, software, videos, music and
baby-oriented products, that would be economically impractical to stock in a
traditional store. We focus exclusively on children's products and we
individually select and test many of the products in our online store to ensure
quality. This level of product evaluation enables us to deliver valuable
additional product information to our shoppers. For example, we are able to
develop detailed and helpful descriptions and our own recommendations by age for
many of the products in our online store.

Unlike store-based retail formats, our online store provides us significant
flexibility with regard to the organization and presentation of our product
selection. Our easy-to-use Web site allows customers to browse our product
selection by brand, age, product category and price, as well as by combinations
of these attributes. For example, a customer can easily search for
science-oriented toys designed for eight-year-old children or view all Barbie
dolls and related accessories without

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consulting store personnel or walking multiple aisles within one or more
traditional stores. Our online store enables us to dynamically adjust our
product mix to respond to changing customer demand. In addition, our online
store gives us flexibility in featuring or promoting specific toys without
having to alter the physical layout of a store.

We strive to merchandise our store in a way that makes it as easy as
possible for consumers to locate products. As a result, we have added numerous
specialty boutiques designed to appeal to specific consumer interests such as
hobbies, dolls and trains. We have also added a series of seasonal boutiques to
enable consumers to easily locate seasonal specific items such as Halloween
costumes and our Summer Shop. In addition, we entered into an agreement with
Discovery Toys, a premier direct seller of children's developmental products, to
become the exclusive online distributor of their educational toys. Through our
Discovery Toys boutique, parents can easily find products by age, developmental
benefits, bestsellers and award winners.

To encourage purchases, we feature various promotions on a rotating basis
throughout the store and continually update our online recommendations. We also
actively create and maintain pages that are artistically designed to highlight
the most prominent product brands we sell in our different departments. We
believe this content-based merchandising provides us with an excellent
opportunity to cross-sell a brand across our departments and promote impulse
purchases by customers. Finally, our range of helpful and useful shopping
services such as our Gift Center, our "Birthday Gifts Made Easy", our
recommendations and our 200 TREASURES UNDER $20 feature enable us to display and
promote our product selection in a flexible and targeted manner.

We believe that our merchandising strategy provides a unique selling
opportunity for our vendors. We are able to offer all our vendors access to
purchasers of children's products regardless of the size or influence of the
individual vendor.

MARKETING AND PROMOTION

Our marketing and promotion strategy is designed to:

- build brand recognition;

- increase consumer traffic to our store;

- add new customers;

- build strong customer loyalty;

- maximize repeat purchases; and

- develop additional ways to increase our net sales.

Through our advertising and promotions, we target adult purchasers of
children's products, with a focus on mothers. We believe that mothers are the
principal decision-makers in purchases of children's products and strongly
influence children's products purchases by family and friends. We use offline
and online marketing strategies to maximize customer awareness and enhance brand
recognition. Our marketing agreements generally provide for us to be the
preferred online toy retailer on the sites of these providers. We also generally
have the right to place banner advertisements and integrated links to our store
on specified children-related or other particular pages or through keyword
searches. In addition, we advertise on the sites of major online portals.

Pursuant to a marketing agreement with AOL, the leading Internet online
service provider, entered into in August 1999, we are a premiere AOL provider of
children's products featured on the AOL Network, with "anchor" positions in such
shopping areas as toys, educational toys, kid and infant gear and electronic
games. Furthermore, under the agreement, AOL has committed that AOL users will
access the online areas promoting eToys a specified number of times. Over the
3-year

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term of the agreement, we are obligated to make quarterly payments of
$1.5 million to AOL, or a total of $18 million during the term of the agreement.
In addition, to the extent new customers arriving from AOL exceed 1,800,000, we
are required to pay $10 for each new customer arriving from AOL. We have also
agreed to offer for sale a substantial selection of children's products, to
offer special deals to AOL users through the AOL online area, and to manage,
operate and support such children's toy products. The agreement with AOL expires
in August 2002; however, AOL may terminate the agreement earlier in the event we
materially breach the agreement, if we are acquired by a competitor of AOL or in
the event of bankruptcy or insolvency or similar adverse financial events
specified in the agreement.

We use traditional offline advertising, including television advertising,
print advertising and billboard advertising in major markets. In
September 1999, we initiated a new national television, print and billboard
advertising campaign under the slogan, "eToys. Where Great Ideas Come to You,"
which is intended to communicate our role as a parents' ally and to underscore
the ease and convenience of online shopping. It also demonstrates to consumers
our focus on kids and the Internet.

We seek to enter into strategic promotional initiatives with highly
recognized family-oriented brand names as a way to build brand recognition.
During the second half of calendar 1999, we entered into such relationships with
Rosie O'Donnell, McDonald's, Lego, GapKids and babyGap, Visa U.S.A. and the
Marine Corps' Toys for Tots program. Through our relationship with
Rosie O'Donnell, we created Rosie's Readers, a literacy initiative that is
intended to promote kids' interests in books and serve as a fundraising platform
for Ms. O'Donnell's "For All Kids Foundation," a children's-oriented charity. In
connection with the program, Ms. O'Donnell makes four book selections each
month, which are regularly featured on "The Rosie O'Donnell Show" and the eToys
Web site, and we donate the profits generated from Rosie's selections to her
charity. We also entered into an in-store and online cross-promotion with
GapKids and babyGap for the 1999 holiday season and in connection with our
summer 2000 advertising campaign which offers customers of GapKids and babyGap
stores and Web sites a $10 eToys gift certificate with any purchase of $75 or
more. Similarly, customers who spend $75 or more at our store receive a $10 gift
certificate for GapKids and babyGap stores and Web sites.

We use our in-house newsletters to alert customers to important developments
at our store. We currently produce three newsletters each month. Our main
newsletter is "Now Playing at eToys", which notifies customers about new helpful
and useful shopping services, new products and special offers. We offer our
customers the option of choosing a child's age and gender for this e-mail so
that we can make appropriate product recommendations. Our second newsletter is
"Reading Adventures", which delivers recommendations for children's books based
on age and reading level. Our final newsletter, "The Gamer's Bulletin", keeps
our video game customers up-to-date on new video games by platform.

To direct traffic to our Web site, we have created inbound links that
connect directly to our Web site from other sites. Potential customers can
simply click on these links to become connected to our Web site from search
engines and community and affinity sites. In addition, in order to increase
exposure on the Internet and directly generate sales, we have an affiliates
program. Under this program, we pay our registered affiliates a referral fee for
each new customer who makes a purchase at our Web site.

OPERATIONS

We obtain products from a network of large and small vendors, manufacturers
and distributors. We carry inventory of the products available for sale on our
Web site. We currently conduct our distribution operations through five
facilities operated by us, consisting of an

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approximately 105,000 square foot facility in Commerce, California; an
approximately 438,500 square foot facility in Pittsylvania County, Virginia; an
approximately 272,000 square foot facility in Greensboro, North Carolina; an
approximately 75,000 square foot facility in San Francisco, California; and an
approximately 46,000 square foot facility in Swindon, England. Commencing in the
fall of 2000, we also plan to conduct distribution operations from an
approximately 763,000 square foot facility in Ontario, California that is
currently being developed, to augment our Virginia facility with an additional
715,000 square foot facility adjacent to the existing facility, and to cease
distribution operations at the San Francisco facility described above. We have
also entered into a lease for an approximately 108,000 square foot distribution
facility in Belgium. We send orders from our Web sites to our distribution
facilities over secure connections and warehouse management systems that
optimize the pick, pack and ship process. The warehouse management system
provides the Web site with data on inventory receiving, shipping, inventory
quantities and inventory location, which enables us to display information about
the availability of the products on our Web site. The management system also
enables us to offer a variety of gift wrap choices, custom gift cards and custom
to/from labels for each individual gift. In addition, we offer an order tracking
service for our customers on our Web site.

We offer three levels of shipping service in the United States: standard,
premium and express. We have developed relationships with United Parcel Service,
the United States Postal Service and Federal Express to maximize our overall
service level to all 50 states. Priority orders are flagged and expedited
through our distribution processes. These capabilities are required due to the
time-sensitive nature of the gifts that we deliver to our customers.

Our operations functions, including inventory purchasing, distribution
fulfillment functions, customer service functions and other related activities,
are conducted through our distribution subsidiary, eToys Distribution, LLC.

CUSTOMER SERVICE

We believe that a high level of customer service and support is critical to
retaining and expanding our customer base. Our customer service representatives
are available 24 hours a day, seven days a week to provide assistance via e-mail
or telephone. We strive to answer all customer inquiries within 24 hours. Our
customer service representatives handle questions about orders, assist customers
in finding desired products and register customers' credit card information over
the telephone. Our customer service representatives are a valuable source of
feedback regarding user satisfaction. Our customer service operations consist of
both our internal, self-operated customer service department and certain
third-party service providers. We also use BizRate, an online market research
company, to obtain monthly customer feedback. Our Web site also contains a
customer service page that outlines store policies and provides answers to
frequently asked questions.

OPERATIONS AND TECHNOLOGY

We have implemented a broad array of scaleable site management, search,
customer interaction, distribution services and systems that we use to process
customers' orders and payments. These services and systems use a combination of
our own technologies and commercially available, licensed technologies. The
systems that we use to process customers' orders and payments are integrated
with our accounting and financial systems. We focus our internal development
efforts on creating and enhancing specialized software that is unique to our
business. We use a set of applications for:

- accepting and validating customer orders;

- organizing, placing and managing orders with suppliers;

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- receiving product and assigning it to customer orders; and

- managing shipment of products to customers based on various ordering criteria.

Our systems have been designed based on industry standard architectures and
have been designed to reduce downtime in the event of outages or catastrophic
occurrences. Our systems provide 24-hour-a-day, seven-day-a-week availability.
Our system hardware is hosted at third-party facilities in Sunnyvale,
California, and Herndon, Virginia, which provide redundant communications lines
and emergency power backup. We have implemented load balancing systems and our
own redundant servers to provide for fault tolerance. We have also created a
Network Operations Center through which we continually test and monitor the
operation of our Web site in order to promptly identify any deficiency or
failure in our systems.

Web site and technology expenses were $3.6 million and $43.4 million in the
fiscal years ended March 31, 1999 and 2000, respectively. The market in which we
compete is characterized by rapidly changing technology, evolving industry
standards, frequent new service and product announcements and enhancements and
changing customer demands. Accordingly, our future success will depend on our
ability to:

- adapt to rapidly changing technologies;

- adapt our services to evolving industry standards; and

- continually improve the performance, features and reliability of our service
in response to competitive service and product offerings and evolving demands
of the marketplace.

GOVERNMENT REGULATION

We are subject to federal, state and local regulations pertaining to
consumer protection (such as the Federal Trade Commission's Mail and Telephone
Order Rule), electronic commerce and online privacy (such as the Children's
Online Privacy Protection Act) and general business regulations. Furthermore,
because of the increasing popularity of the Internet, it is likely that a number
of additional laws and regulations will be adopted with respect to the Internet.
These laws may cover issues such as user privacy, freedom of expression,
pricing, content and quality of products and services, taxation, advertising,
intellectual property rights and information security. Further, the growth of
electronic commerce may prompt calls for more stringent consumer protection
laws. The Federal Trade Commission and several states have proposed legislation
to limit the uses of personal user information gathered online or require online
services to establish privacy policies. The Federal Trade Commission has also
initiated action against at least one online service regarding the manner in
which personal information is collected from users and provided to third
parties. The adoption of additional consumer protection laws could create
uncertainty in Web usage and reduce the demand for our products and services. In
addition, any failure by us to comply with the rules and regulations promulgated
by the Federal Trade Commission or other governmental authorities could result
in action being taken against us that could have a material adverse effect on
our business and results of operations.

We are not certain how our business may be affected by the application of
existing laws governing issues such as property ownership, copyrights,
encryption and other intellectual property issues, taxation, libel, obscenity
and export or import matters. The vast majority of such laws were adopted prior
to the advent of the Internet. As a result, they do not contemplate or address
the unique issues of the Internet and related technologies. Changes in laws
intended to address such issues could create uncertainty in the Internet market
place. Such uncertainty could reduce demand for our services or increase the
cost of doing business as a result of litigation costs or increased service
delivery costs.

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In addition, because our services are available over the Internet in
multiple states and foreign countries, other jurisdictions may claim that we are
required to qualify to do business in each such state or foreign country. We are
qualified to do business only in California. Our failure to qualify in a
jurisdiction where we are required to do so could subject us to taxes and
penalties. It could also hamper our ability to enforce contracts in such
jurisdictions. The application of laws or regulations from jurisdictions whose
laws do not currently apply to our business could have a material adverse effect
on our business, results of operations and financial condition.

COMPETITION

The online commerce market is new, rapidly evolving and intensely
competitive. We expect competition to intensify in the future. Increased
competition is likely to result in price reductions, reduced gross margins and
loss of market share, any of which could seriously harm our net sales and
results of operations. Current and new competitors can enter our market with
little difficulty and can launch new Web sites at a relatively low cost. In
addition, the children's products industries, including toys, video games,
software, video, books, music and baby-oriented products, are intensely
competitive.

We currently or potentially compete with a variety of other companies,
including:

- other online companies that include children's and baby products as part of
their product offerings, such as Amazon.com, Barnesandnoble.com, CDnow,
Beyond.com, Reel.com, iBaby, BabyCatalog.com, iVillage and Women.com;

- traditional store-based toy and children's and baby product retailers such as
Toys R Us, FAO Schwarz, Zany Brainy, babyGap, GapKids, Gymboree, KB Toys, The
Right Start and Babies R Us;

- major discount retailers such as Wal-Mart, Kmart and Target;

- online efforts of these traditional retailers, including the online stores
operated by Toys R Us, Wal-Mart, FAO Schwarz, babyGap, GapKids, KB Toys (i.e.,
KB Kids) and Gymboree;

- physical and online stores of entertainment entities that sell and license
children's and baby products, such as The Walt Disney Company and Warner
Bros.;

- catalog retailers of children's and baby products and products for toddlers
and expectant mothers;

- vendors or manufacturers of children's and baby products that currently sell
some of their products directly online, such as Mattel and Hasbro;

- Internet portals and online service providers that feature shopping services,
such as AOL, Yahoo!, Excite and Lycos; and

- various smaller online retailers of children's and baby products, such as
Smarterkids.com.

We believe that the following are principal competitive factors in our
market:

- brand recognition;

- selection;

- convenience;

- price;

- speed and accessibility;

- customer service;

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- quality of site content; and

- reliability and speed of order shipment.

Many traditional store-based and online competitors have longer operating
histories, larger customer or user bases, greater brand recognition and
significantly greater financial, marketing and other resources than we do. Many
of these competitors can devote substantially more resources to Web site
development than we can. In addition, larger, well-established and well-financed
entities may join with online competitors or publishers or suppliers of
children's products, including toys, video games, software, videos, books, music
and baby-oriented products, as the use of the Internet and other online services
increases.

Our competitors may be able to secure products from vendors on more
favorable terms, fulfill customer orders more efficiently and adopt more
aggressive pricing or inventory availability policies than we can. Traditional
store-based retailers also enable customers to see and feel products in a manner
that is not possible over the Internet. Some of our competitors such as Toys R
Us and Wal-Mart have significantly greater experience in selling children's
toys, video games, software, videos and music products.

Our online competitors are particularly able to use the Internet as a
marketing medium to reach significant numbers of potential customers. Finally,
new technologies and the expansion of existing technologies, such as price
comparison programs, may increase competition.

INTELLECTUAL PROPERTY

We rely on various intellectual property laws and contractual restrictions
to protect our proprietary rights in products and services. These include
confidentiality, invention assignment and nondisclosure agreements with our
employees, contractors, suppliers and strategic partners. Despite these
precautions, it may be possible for a third party to copy or otherwise obtain
and use our intellectual property without our authorization. In addition, we
pursue the registration of our trademarks and service marks in the U.S. and
internationally. However, effective intellectual property protection may not be
available in every country in which our services are made available online.

We have licensed various proprietary rights to third parties. We attempt to
ensure that these licensees maintain the quality of our brand. However, these
licensees may nevertheless take actions that materially adversely affect the
value of our proprietary rights or reputation. We also rely on technologies that
we license from third parties. These licenses may not continue to be available
to us on commercially reasonable terms in the future. As a result, we may be
required to obtain substitute technology of lower quality or at greater cost,
which could materially adversely affect our business, results of operations and
financial condition.

We expect that participants in our markets will be increasingly subject to
infringement claims as the number of services and competitors in our industry
segment grows. Any such claim, with or without merit, could be time-consuming,
result in costly litigation, cause service upgrade delays or require us to enter
into royalty or licensing agreements. Such royalty or licensing agreements might
not be available on terms acceptable to us or at all. As a result, any such
claim of infringement against us could have a material adverse effect upon our
business, results of operations and financial condition.

EMPLOYEES

As of March 31, 2000, we had 940 full-time employees. None of our employees
are represented by a labor union. We have not experienced any work stoppages and
consider our employee relations to be good.

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Our future performance depends in significant part upon the continued
service of our key technical, sales and senior management personnel, none of
whom are bound by an employment agreement requiring service for any defined
period of time. The loss of services of one or more of our key employees could
have a material adverse effect on our business, financial condition and results
of operations. Our future success also depends in part upon our continued
ability to attract, hire, train and retain highly qualified technical, sales and
managerial personnel. Competition of such personnel is intense and there can be
no assurance that we can retain our key personnel in the future.

ADDITIONAL FACTORS THAT MAY AFFECT RESULTS

THE RISKS AND UNCERTAINTIES DESCRIBED BELOW AND THE OTHER INFORMATION IN
THIS ANNUAL REPORT SHOULD BE CAREFULLY CONSIDERED. THE RISKS AND UNCERTAINTIES
DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS AND
UNCERTAINTIES NOT PRESENTLY KNOWN TO US OR THAT WE CURRENTLY DEEM IMMATERIAL MAY
ALSO IMPAIR OUR BUSINESS OPERATIONS. IF ANY OF THE FOLLOWING RISKS ACTUALLY
OCCUR, OUR BUSINESS, FINANCIAL CONDITION OR OPERATING RESULTS COULD BE
MATERIALLY ADVERSELY AFFECTED.

OUR LIMITED OPERATING HISTORY MAKES FUTURE FORECASTING DIFFICULT.

We were incorporated in November 1996. We began selling products on our Web
site in October 1997. As a result of our limited operating history, it is
difficult to accurately forecast our net sales and we have limited meaningful
historical financial data upon which to base planned operating expenses. We base
our current and future expense levels on our operating plans and estimates of
future net sales, and our expenses are to a large extent fixed. Sales and
operating results are difficult to forecast because they generally depend on the
volume and timing of the orders we receive. As a result, we may be unable to
adjust our spending in a timely manner to compensate for any unexpected revenue
shortfall. This inability could cause our net losses in a given quarter to be
greater than expected.

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WE ANTICIPATE FUTURE LOSSES AND NEGATIVE CASH FLOW.

We expect operating losses and negative cash flow to continue for the
foreseeable future. Among other things, the sources of such losses will include
costs and expenses related to:

- brand development, marketing and other promotional activities;

- the expansion of our inventory management and distribution operations;

- the continued development of our Web site and consumer-driven technology,
transaction processing systems and our computer network;

- the expansion of our product offerings and Web site content;

- development of relationships with strategic business partners;

- international expansion of our operations; and

- assimilation of operations and personnel acquired with BabyCenter

As of March 31, 2000, we had an accumulated deficit of $220.5 million. We
incurred net losses of $48.4 million for the quarter ended March 31, 2000 and
$189.6 million for the year ended March 31, 2000.

Also, as a result of our acquisition of BabyCenter, we have recorded a
significant amount of goodwill, the amortization of which will significantly
reduce our earnings and profitability for the foreseeable future. The recorded
goodwill of approximately $189.0 million is being amortized over a five-year
period. To the extent we do not generate sufficient cash flow to recover the
amount of the investment recorded, the investment may be considered impaired and
could be subject to earlier write-off. In such event, our net loss in any given
period could be greater than anticipated.

Our ability to become profitable depends on our ability to generate and
sustain substantially higher net sales while maintaining reasonable expense
levels. If we do achieve profitability, we cannot be certain that we would be
able to sustain or increase profitability on a quarterly or annual basis in the
future. For more details, see Item 6., "Selected Financial Data" and Item 7.,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

ANY FAILURE BY US TO SUCCESSFULLY EXPAND OUR DISTRIBUTION OPERATIONS WOULD
HAVE A MATERIAL ADVERSE EFFECT ON US.

Any failure by us to successfully expand our distribution operations to
accommodate increases in demand and customer orders would have a material
adverse effect on our business prospects, financial condition and operating
results. Under such circumstances, the material adverse effects may include,
among other things, an inability to increase net sales in accordance with the
expectations of securities analysts and investors; increases in costs that we
may incur to meet customer expectations; increases in fulfillment expenses if we
are required to rely on more expensive fulfillment systems than anticipated or
incur additional costs for balancing merchandise inventories among multiple
distribution facilities; loss of customer loyalty and repeat business from
customers if they become dissatisfied with our delivery services; and damage to
our reputation and brand image arising from uncertainty with respect to our
distribution operations. These risks are greatest during the fourth calendar
quarter of each year, when our sales increase substantially relative to other
quarters and the demand on our distribution operations increases
proportionately. In addition, consistent with industry practice for online
retailers, we notify our customers via our Web site that we cannot guarantee all
products ordered after a specified date in December will be delivered by
Christmas day, which may deter potential customers from purchasing from us
following that date. Since our limited operating history makes it difficult to
accurately estimate the number of orders that may be received during the fourth
calendar quarter, we may experience either

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inadequate or excess fulfillment capacity during this quarter, either of which
could have a material adverse impact on us. The occurrence of one or more of
these events would be likely to cause the market price of our securities to
decline.

We currently conduct our distribution operations through five facilities
operated by us, consisting of an approximately 105,000 square foot facility in
Commerce, California; an approximately 438,500 square foot facility in
Pittsylvania County, Virginia; an approximately 272,000 square foot facility in
Greensboro, North Carolina; an approximately 75,000 square foot facility in San
Francisco, California; and an approximately 46,000 square foot facility in
Swindon, England. Commencing in the fall of 2000, we also plan to conduct
distribution operations from an approximately 763,000 square foot facility in
Ontario, California that is currently being developed, to augment our Virginia
facility with an additional 715,000 square foot facility adjacent to the
existing facility, and to cease distribution operations at the San Francisco
facility described above. We have also entered into a lease for an approximately
108,000 square foot distribution facility in Belgium. On March 31, 2000, we
terminated our relationship with Fingerhut Business Services, Inc., a third-
party provider of distribution services. We have in the past and continue to
devote substantial resources to the expansion of our distribution operations.
This expansion may cause disruptions in our business as well as unexpected
costs. We are not experienced with coordinating and managing distribution
operations in geographically distant locations. This may result in increased
costs as we seek to meet customers' expectations, balance merchandise
inventories among our distribution facilities and take other steps that may be
necessary to meet the demands placed on our distribution operations,
particularly during the fourth calendar quarter of the year. Despite the fact
that we devote substantial resources to the expansion and refinement of our
distribution operations, there can be no assurance that our existing or future
distribution operations will be sufficient to accommodate increases in demand
and customer orders.

IF WE EXPERIENCE PROBLEMS IN OUR DISTRIBUTION OPERATIONS, WE COULD LOSE
CUSTOMERS.

We rely upon third-party carriers for product shipments, including shipments
to and from our distribution facilities. We are therefore subject to the risks,
including employee strikes and inclement weather, associated with such carriers'
ability to provide delivery services to meet our shipping needs. In addition,
failure to deliver products to our customers in a timely and accurate manner
would damage our reputation and brand. We also depend upon temporary employees
to adequately staff our distribution facilities, particularly during the holiday
shopping season. If we do not have sufficient sources of temporary employees, we
could lose customers.

OUR OPERATING RESULTS ARE VOLATILE AND DIFFICULT TO PREDICT. IF WE FAIL TO
MEET THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS AND INVESTORS, THE MARKET
PRICE OF OUR SECURITIES MAY DECLINE SIGNIFICANTLY.

Our annual and quarterly operating results have fluctuated in the past and
may fluctuate significantly in the future due to a variety of factors, many of
which are outside of our control. Because our operating results are volatile and
difficult to predict, we believe that quarter-to-quarter comparisons of our
operating results are not a good indication of our future performance. It is
likely that in some future quarter our operating results may fall below the
expectations of securities analysts and investors. In this event, the trading
price of our securities may decline significantly.

Factors that may harm our business or cause our operating results to
fluctuate include the following:

- our inability to obtain new customers at reasonable cost, retain existing
customers, or encourage repeat purchases;

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- decreases in the number of visitors to our Web site or our inability to
convert visitors to our Web site into customers;

- the mix of children's products, including toys, video games, books, software,
videos, music and baby-oriented products sold by us;

- seasonality;

- our inability to manage inventory levels or control inventory shrinkage;

- our inability to manage our distribution operations;

- our inability to adequately maintain, upgrade and develop our Web site, the
systems that we use to process customers' orders and payments or our computer
network;

- the ability of our competitors to offer new or enhanced Web sites, services or
products;

- price competition;

- an increase in the level of our product returns;

- fluctuations in the demand for children's and baby products associated with
movies, television and other entertainment events;

- our inability to obtain popular children's products, including toys, video
games, books, software, videos, music and baby-oriented products from our
vendors;

- fluctuations in the amount of consumer spending on children's products,
including toys, video games, books, software, videos, music and baby-oriented
products;

- the termination of existing or failure to develop new marketing relationships
with key business partners;

- the extent to which we are not able to participate in cooperative advertising
campaigns with major brand names as we have done in the past;

- increases in the cost of online or offline advertising;

- the amount and timing of operating costs and capital expenditures relating to
expansion of our operations, including international expansion;

- unexpected increases in shipping costs or delivery times, particularly during
the holiday season;

- technical difficulties, system downtime or Internet brownouts;

- government regulations related to use of the Internet for commerce or for
sales and distribution of children's products, including toys, video games,
books, software, videos, music and baby-oriented products; and

- economic conditions specific to the Internet, online commerce and the
children's and baby products industries.

A number of factors will cause our gross margins to fluctuate in future
periods, including the mix of children's products, including toys, video games,
books, software, videos, music and baby-oriented products sold by us, inventory
management, inbound and outbound shipping and handling costs, the level of
product returns and the level of discount pricing and promotional coupon usage.
Any change in one or more of these factors could reduce our gross margins in
future periods. For more details, see Item 7., "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

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BECAUSE WE EXPERIENCE SEASONAL FLUCTUATIONS IN OUR NET SALES, OUR QUARTERLY
RESULTS WILL FLUCTUATE AND OUR ANNUAL RESULTS COULD BE BELOW EXPECTATIONS.

We have historically experienced and expect to continue to experience
seasonal fluctuations in our net sales. These seasonal patterns will cause
quarterly fluctuations in our operating results. In particular, a
disproportionate amount of our net sales have been realized during the fourth
calendar quarter and we expect this trend to continue in the future.

In anticipation of increased sales activity during the fourth calendar
quarter, we hire a significant number of temporary employees to bolster our
permanent staff and we significantly increase our inventory levels. For this
reason, if our net sales were below seasonal expectations during this quarter,
our annual operating results could be below the expectations of securities
analysts and investors.

Due to our limited operating history, it is difficult to predict the
seasonal pattern of our sales and the impact of such seasonality on our business
and financial results. In the future, our seasonal sales patterns may become
more pronounced, may strain our personnel and warehousing and order shipment
activities and may cause a shortfall in net sales as compared to expenses in a
given period. For more details, see the Item 7., "Management's Discussion and
Analysis of Financial Condition and Results of Operations".

WE FACE SIGNIFICANT INVENTORY RISK BECAUSE CONSUMER DEMAND CAN CHANGE FOR
PRODUCTS BETWEEN THE TIME THAT WE ORDER PRODUCTS AND THE TIME THAT WE
RECEIVE THEM.

We carry a significant level of inventory. As a result, the rapidly changing
trends in consumer tastes in the market for children's products, including toys,
video games, books, software, videos, music and baby-oriented products, subject
us to significant inventory risks. It is critical to our success that we
accurately predict these trends and do not overstock unpopular products. The
demand for specific products can change between the time the products are
ordered and the date of receipt. We are particularly exposed to this risk
because we derive a majority of our net sales in the fourth calendar quarter of
each year. Our failure to sufficiently stock popular toys and other products in
advance of such fourth calendar quarter would harm our operating results for the
entire fiscal year.

In the event that one or more products do not achieve widespread consumer
acceptance, we may be required to take significant inventory markdowns, which
could reduce our net sales and gross margins. This risk may be greatest in the
first calendar quarter of each year, after we have significantly increased
inventory levels for the holiday season. We believe that this risk will increase
as we open new departments or enter new product categories due to our lack of
experience in purchasing products for these categories. In addition, to the
extent that demand for our products increases over time, we may be forced to
increase inventory levels. Any such increase would subject us to additional
inventory risks. For more details, see Item 7., "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

BECAUSE WE DO NOT HAVE LONG-TERM OR EXCLUSIVE VENDOR CONTRACTS, WE MAY NOT
BE ABLE TO GET SUFFICIENT QUANTITIES OF POPULAR CHILDREN'S PRODUCTS IN A
TIMELY MANNER. AS A RESULT, WE COULD LOSE CUSTOMERS.

If we are not able to offer our customers sufficient quantities of toys or
other products in a timely manner, we could lose customers and our net sales
could be below expectations. Our success depends on our ability to purchase
products in sufficient quantities at competitive prices, particularly for the
holiday shopping season. As is common in the industry, we do not have long-term
or exclusive arrangements with any vendor or distributor that guarantee the
availability of toys

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or other children's products for resale. Therefore, we do not have a predictable
or guaranteed supply of toys or other products.

TO MANAGE OUR GROWTH AND EXPANSION, WE NEED TO IMPROVE AND IMPLEMENT
FINANCIAL AND MANAGERIAL CONTROLS AND REPORTING SYSTEMS AND PROCEDURES. IF
WE ARE UNABLE TO DO SO SUCCESSFULLY, OUR RESULTS OF OPERATIONS WILL BE
IMPAIRED.

Our rapid growth in personnel and operations has placed, and will continue
to place, a significant strain on our management, information systems and
resources. In addition, with the acquisition of BabyCenter, we added over 160
new employees, including managerial, technical and operations personnel, and
have been required to assimilate substantially all of BabyCenter's operations
into our operations. Further, during 1999 and 2000, we continued to expand our
distribution operations, which now include five facilities operated by us,
consisting of an approximately 105,000 square foot facility in Commerce,
California; an approximately 438,500 square foot facility in Pittsylvania
County, Virginia; an approximately 272,000 square foot facility in Greensboro,
North Carolina; an approximately 75,000 square foot facility in San Francisco,
California; and an approximately 46,000 square foot facility in Swindon,
England. Commencing in the fall of 2000, we also plan to conduct distribution
operations from an approximately 763,000 square foot facility in Ontario,
California that is currently being developed, to augment our Virginia facility
with an additional 715,000 square foot facility adjacent to the existing
facility, and to cease distribution operations at the San Francisco facility
described above. We have also entered into a lease for an approximately 108,000
square foot distribution facility in Belgium. This expansion may cause
disruptions in our business as well as unexpected costs. We are not experienced
with coordinating and managing distribution operations in geographically distant
locations.

In order to manage this growth effectively, we need to continue to improve
our financial and managerial controls and reporting systems and procedures. If
we continue to experience a significant increase in the number of our personnel
and expansion of our distribution operations, our existing management team may
not be able to effectively train, supervise and manage all of our personnel or
effectively oversee all of our distribution operations. In addition, our
existing information systems may not be able to handle adequately the increased
volume of information and transactions that would result from increased growth.
Our failure to successfully implement, improve and integrate these systems and
procedures would cause our results of operations to be below expectations.

RISK OF INTERNATIONAL EXPANSION

In October 1999, we launched eToys.co.uk, which serves customers in the
United Kingdom, and in November 1999, we began serving all provinces of Canada
through our eToys.com store. We also offer content and community to parents and
expectant parents through BabyCentre.co.uk. Our European operations are
conducted through a Netherlands subsidiary, and we are exploring opportunities
to separately finance its operations and will continue to expand our presence in
foreign markets in a manner consistent with the availability and extent of such
financing opportunities.

We have relatively little experience in purchasing, marketing and
distributing products or services for these markets and may not benefit from any
first-to-market advantages. It will be costly to establish international
facilities and operations, promote our brand internationally, and develop
localized Web sites and stores and other systems. We may not succeed in our
efforts in these countries. If net sales from international activities do not
offset the expense of establishing and maintaining foreign operations, our
business prospects, financial condition and operating results will suffer.

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As the international online commerce market continues to grow, competition
in this market will likely intensify. In addition, governments in foreign
jurisdictions may regulate Internet or other online services in such areas as
content, privacy, network security, encryption or distribution. This may affect
our ability to conduct business internationally.

WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY AGAINST CURRENT AND FUTURE
COMPETITORS.

The online commerce market is new, rapidly evolving and intensely
competitive. Increased competition is likely to result in price reductions,
reduced gross margins and loss of market share, any of which could seriously
harm our net sales and results of operations. We expect competition to intensify
in the future because current and new competitors can enter our market with
little difficulty and can launch new Web sites at a relatively low cost. In
addition, the children's products industries, including toy, video game, books,
software, video, music and baby-oriented products, are intensely competitive.

We currently or potentially compete with a variety of other companies,
including:

- other online companies that include toys and children's and baby products as
part of their product offerings, such as Amazon.com, Barnesandnoble.com,
CDnow, Beyond.com, Reel.com, iBaby, BabyCatalog.com, iVillage and Women.com;

- traditional store-based toy and children's and baby products retailers such as
Toys R Us, FAO Schwarz, Zany Brainy, babyGap, GapKids, Gymboree, KB Toys, The
Right Start and Babies R Us;

- major discount retailers such as Wal-Mart, Kmart and Target;

- online efforts of these traditional retailers, including the online stores
operated by Toys R Us, Wal-Mart, FAO Schwarz, babyGap, GapKids, KB Toys (i.e.,
KB Kids) and Gymboree;

- physical and online stores of entertainment entities that sell and license
children and baby products, such as The Walt Disney Company and Warner Bros.;

- catalog retailers of children's and baby products as well as products for
toddlers and expectant mothers;

- vendors or manufacturers of children's and baby products that currently sell
some of their products directly online, such as Mattel and Hasbro;

- Internet portals and online service providers that feature shopping services,
such as AOL, Yahoo!, Excite and Lycos; and

- various smaller online retailers of children's and baby products, such as
Smarterkids.com.

Many traditional store-based and online competitors have longer operating
histories, larger customer or user bases, greater brand recognition and
significantly greater financial, marketing and other resources than we do. Many
of these competitors can devote substantially more resources to Web site
development than we can. In addition, larger, well-established and well-financed
entities may join with online competitors or suppliers of children's products,
including toys, video games, books, software, video, music and baby-oriented
products as the use of the Internet and other online services increases.

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IF WE ENTER NEW BUSINESS CATEGORIES THAT DO NOT ACHIEVE MARKET ACCEPTANCE,
OUR BRAND AND REPUTATION COULD BE DAMAGED AND WE COULD FAIL TO ATTRACT NEW
CUSTOMERS.

Any new department or product category that is launched or acquired by us,
such as BabyCenter, which is not favorably received by consumers could damage
our brand or reputation. This damage could impair our ability to attract new
customers, which could cause our net sales to fall below expectations. The
expansion of our business to include BabyCenter or any other new department or
product category will require significant additional expenses, and strain our
management, financial and operational resources. This type of expansion would
also subject us to increased inventory risk. We may choose to expand our
operations by developing other new departments or product categories, promoting
new or complementary products, expanding the breadth and depth of products and
services offered or expanding our market presence through relationships with
third parties. In addition, we may pursue the acquisition of other new or
complementary businesses, products or technologies.

IF WE DO NOT SUCCESSFULLY EXPAND OUR WEB SITE AND THE SYSTEMS THAT PROCESS
CUSTOMERS' ORDERS, WE COULD LOSE CUSTOMERS AND OUR NET SALES COULD BE
REDUCED.

If we fail to rapidly upgrade our Web site in order to accommodate increased
traffic, we may lose customers, which would reduce our net sales. Furthermore,
if we fail to rapidly expand the computer systems that we use to process and
ship customer orders and process payments, we may not be able to successfully
distribute customer orders. As a result, we could lose customers and our net
sales could be reduced. In addition, our failure to rapidly upgrade our Web site
or expand these computer systems without system downtime, particularly during
the fourth calendar quarter, would further reduce our net sales. We may
experience difficulty in improving and maintaining such systems if our employees
or contractors that develop or maintain our computer systems become unavailable
to us. We have experienced periodic systems interruptions, which we believe will
continue to occur, while enhancing and expanding these computer systems.

OUR FACILITIES AND SYSTEMS ARE VULNERABLE TO NATURAL DISASTERS AND OTHER
UNEXPECTED PROBLEMS. THE OCCURRENCE OF A NATURAL DISASTER OR OTHER
UNEXPECTED PROBLEM COULD DAMAGE OUR REPUTATION AND BRAND AND REDUCE OUR NET
SALES.

We are vulnerable to natural disasters and other unanticipated problems that
are beyond our control. Our office facilities in Southern California, Northern
California and London, England, house substantially all of our product
development and information systems. Our third-party Web site hosting facilities
located in Sunnyvale, California and Herndon, Virginia, house substantially all
of our computer and communications hardware systems. Our distribution facilities
located in California, North Carolina, Virginia and England house substantially
all of our product inventory. A natural disaster, such as an earthquake, or
harsh weather or other comparable problems that are beyond our control could
cause interruptions or delays in our business and loss of data or render us
unable to accept and fulfill customer orders. Any such interruptions or delays
at these facilities would reduce our net sales. In addition, our systems and
operations are vulnerable to damage or interruption from fire, flood, power
loss, telecommunications failure, break-ins, earthquakes and similar events. We
have no formal disaster recovery plan and our business interruption insurance
may not adequately compensate us for losses that may occur. In addition, the
failure by the third-party facilities to provide the data communications
capacity required by us, as a result of human error, natural disaster or other
operational disruptions, could result in interruptions in our service. The
occurrence of any or all of these events could damage our reputation and brand
and impair our business.

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OUR NET SALES COULD DECREASE IF OUR ONLINE SECURITY MEASURES FAIL.

Our relationships with our customers may be adversely affected if the
security measures that we use to protect their personal information, such as
credit card numbers, are ineffective. If, as a result, we lose many customers,
our net sales could decrease. We rely on security and authentication technology
that we license from third parties. With this technology, we perform real-time
credit card authorization and verification with our bank. We cannot predict
whether events or developments will result in a compromise or breach of the
technology we use to protect a customer's personal information.

Furthermore, our servers may be vulnerable to computer viruses, physical or
electronic break-ins, denial of service attacks and similar disruptions. We may
need to expend significant additional capital and other resources to protect
against a security breach or to alleviate problems caused by any breaches. We
cannot assure that we can prevent all security breaches.

OUR NET SALES AND GROSS MARGINS WOULD DECREASE IF WE EXPERIENCE SIGNIFICANT
CREDIT CARD FRAUD.

A failure to adequately control fraudulent credit card transactions would
reduce our net sales and our gross margins because we do not carry insurance
against this risk. We have developed technology to help us to detect the
fraudulent use of credit card information. Nonetheless, to date, we have
suffered losses as a result of orders placed with fraudulent credit card data
even though the associated financial institution approved payment of the orders.
Under current credit card practices, we are liable for fraudulent credit card
transactions because we do not obtain a cardholder's signature.

WE FACE THE RISK OF INVENTORY SHRINKAGE.

If the security measures we use at our distribution facilities do not reduce
or prevent inventory shrinkage, our gross profit margin may decrease. We have
undertaken a number of measures designed to address inventory shrinkage,
including the installation of enhanced security measures at our distribution
facilities. These measures may not successfully reduce or prevent inventory
shrinkage in future periods. Our failure to successfully improve the security
measures we use at our distribution facilities may cause our gross profit
margins and results of operations to be significantly below expectations in
future periods.

IF WE DO NOT RESPOND TO RAPID TECHNOLOGICAL CHANGES, OUR SERVICES COULD
BECOME OBSOLETE AND WE COULD LOSE CUSTOMERS.

If we face material delays in introducing new services, products and
enhancements, our customers may forego the use of our services and use those of
our competitors. To remain competitive, we must continue to enhance and improve
the functionality and features of our online store. The Internet and the online
commerce industry are rapidly changing. If competitors introduce new products
and services embodying new technologies, or if new industry standards and
practices emerge, our existing Web site and proprietary technology and systems
may become obsolete.

To develop our Web site and other proprietary technology entails significant
technical and business risks. We may use new technologies ineffectively or we
may fail to adapt our Web site, our transaction processing systems and our
computer network to meet customer requirements or emerging industry standards.

INTELLECTUAL PROPERTY CLAIMS AGAINST US CAN BE COSTLY AND COULD IMPAIR OUR
BUSINESS.

Other parties may assert infringement or unfair competition claims against
us. In the past, a toy distributor using a name similar to ours sent us notice
of a claim of infringement of proprietary rights, which claim was subsequently
withdrawn. We have also received a claim from the holders of

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<PAGE>
a home shopping video catalog patent and a remote query communication system
patent that our Internet marketing program and Web site operations,
respectively, infringe such patents, and BabyCenter has received a claim from
the holder of an automated registry patent that its Web site infringes such
patent. We expect to receive other notices from other third parties in the
future. We cannot predict whether third parties will assert claims of
infringement against us, or whether any past or future assertions or
prosecutions will harm our business. If we are forced to defend against any such
claims, whether they are with or without merit or are determined in our favor,
then we may face costly litigation, diversion of technical and management
personnel, or product shipment delays. As a result of such a dispute, we may
have to develop non-infringing technology or enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may be
unavailable on terms acceptable to us, or at all. If there is a successful claim
of product infringement against us and we are unable to develop non-infringing
technology or license the infringed or similar technology on a timely basis, it
could impair our business.

IF THE PROTECTION OF OUR TRADEMARKS AND PROPRIETARY RIGHTS IS INADEQUATE,
OUR BRAND AND REPUTATION COULD BE IMPAIRED AND WE COULD LOSE CUSTOMERS.

The steps we take to protect our proprietary rights may be inadequate. We
regard our copyrights, service marks, trademarks, trade dress, trade secrets and
similar intellectual property as critical to our success. We rely on trademark
and copyright law, trade secret protection and confidentiality or license
agreements with our employees, customers, partners and others to protect our
proprietary rights. We currently hold registered trademarks for "eToys" and
"BabyCenter". Effective trademark, service mark, copyright and trade secret
protection may not be available in every country in which we will sell our
products and services online. Furthermore, the relationship between regulations
governing domain names and laws protecting trademarks and similar proprietary
rights is unclear. Therefore, we may be unable to prevent third parties from
acquiring domain names that are similar to, infringe upon or otherwise decrease
the value of our trademarks and other proprietary rights.

THE LOSS OF THE SERVICES OF ONE OR MORE OF OUR KEY PERSONNEL, OR OUR FAILURE
TO ATTRACT, ASSIMILATE AND RETAIN OTHER HIGHLY QUALIFIED PERSONNEL IN THE
FUTURE, COULD DISRUPT OUR OPERATIONS AND RESULT IN A REDUCTION IN NET SALES.

The loss of the services of one or more of our key personnel could seriously
interrupt our business. We depend on the continued services and performance of
our senior management and other key personnel, particularly Edward C. Lenk, our
President, Chief Executive Officer and Chairman of the Board. Our future success
also depends upon the continued service of our executive officers and other key
sales, marketing and support personnel as well as the successful integration of
BabyCenter's management with our senior management team. None of our officers or
key employees is bound by an employment agreement for any specific term. Our
relationships with these officers and key employees are at will. We do not have
"key person" life insurance policies covering any of our employees.

THERE ARE RISKS ASSOCIATED WITH THE BABYCENTER MERGER AND OTHER POTENTIAL
ACQUISITIONS. AS A RESULT, WE MAY NOT ACHIEVE THE EXPECTED BENEFITS OF THE
BABYCENTER MERGER AND OTHER POTENTIAL ACQUISITIONS.

We may not realize the anticipated benefits from the BabyCenter merger.

In February 2000, we announced that we were uniting our baby businesses,
which then consisted of BabyCenter and the Baby Store at eToys, under the
BabyCenter brand. As part of this initiative, we have directed all eToys
customers seeking baby-related content and commerce to the BabyCenter.com site.
In addition, we will move all BabyCenter commerce functions, such as
distribution and customer service, from San Francisco to Southern California.
The transition, which

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<PAGE>
is expected to be completed during the summer of 2000, will reduce overlapping
positions at BabyCenter and relocate other positions to eToys.

We may not be able to successfully assimilate BabyCenter's additional
personnel, operations, acquired technology and products into our business. The
merger may further strain our existing financial and managerial controls and
reporting systems and procedures. In addition, key BabyCenter personnel may
decide not to work for us. These difficulties could disrupt our ongoing
business, distract management and employees or increase our expenses. Further,
the physical expansion in facilities that has occurred as a result of this
merger may result in disruptions that seriously impair our business. In
particular, we have operations in multiple facilities in geographically distant
areas. We are not experienced in managing facilities or operations in
geographically distant areas.

If we are presented with appropriate opportunities, we intend to make other
investments in complementary companies, products or technologies. We may not
realize the anticipated benefits of any other acquisition or investment. If we
buy another company, we will likely face the same risks, uncertainties and
disruptions as discussed above with respect to the BabyCenter merger.
Furthermore, we may have to incur debt or issue equity securities to pay for any
additional future acquisitions or investments, the issuance of which would be
dilutive to us or our existing securityholders and could affect the price of our
securities.

IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US EVEN IF DOING SO WOULD
BE BENEFICIAL TO OUR SECURITYHOLDERS.

Provisions of our Amended and Restated Certificate of Incorporation, our
Bylaws and Delaware law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our securityholders.

We are subject to Section 203 of the Delaware General Corporation Law, which
regulates corporate acquisitions. In general, Section 203 prohibits a publicly
held Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years following the date the
person became an interested stockholder, unless:

- the Board of Directors approved the transaction in which such stockholder
became an interested stockholder prior to the date the interested stockholder
attained such status;

- upon consummation of the transaction that resulted in the stockholder's
becoming an interested stockholder, he or she owned at least 85% of the voting
stock of the corporation outstanding at the time the transaction commenced,
excluding shares owned by persons who are directors and also officers; or

- on or subsequent to such date the business combination is approved by the
Board of Directors and authorized at an annual or special meeting of
stockholders.

A "business combination" generally includes a merger, asset or stock sale,
or other transaction resulting in a financial benefit to the interested
stockholder. In general, an "interested stockholder" is a person who, together
with affiliates and associates, owns, or within three years prior to the
determination of interested stockholder status, did own, 15% or more of a
corporation's voting stock.

Our Amended and Restated Certificate of Incorporation and Bylaws do not
provide for the right of stockholders to act by written consent without a
meeting or for cumulative voting in the election of directors. In addition, our
Amended and Restated Certificate of Incorporation permits the Board of Directors
to issue preferred stock with voting or other rights without any stockholder
action. Commencing on the record date for our first annual meeting of
stockholders on which we have at least 800 stockholders, which is expected to be
the record date for our annual meeting held in 2000, our Amended and Restated
Certificate of Incorporation provides for the Board of Directors to be divided
into three classes, with staggered three-year terms. As a result, only one

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<PAGE>
class of directors will be elected at each annual meeting of stockholders. Each
of the two other classes of directors will continue to serve for the remainder
of its respective three-year term. These provisions, which require the vote of
stockholders holding at least a majority of the outstanding common stock to
amend, may have the effect of deterring hostile takeovers or delaying changes in
our management.

IF WE ARE UNABLE TO ACQUIRE THE NECESSARY WEB DOMAIN NAMES, OUR BRAND AND
REPUTATION COULD BE DAMAGED AND WE COULD LOSE CUSTOMERS.

We may be unable to acquire or maintain Web domain names relating to our
brand in the United States and other countries in which we may conduct business.
As a result, we may be unable to prevent third parties from acquiring and using
domain names relating to our brand. Such use could damage our brand and
reputation and take customers away from our Web site. We currently hold various
relevant domain names, including the "eToys.com" domain name. The acquisition
and maintenance of domain names generally is regulated by governmental agencies
and their designees. The regulation of domain names in the United States and in
foreign countries is subject to change in the near future. Such changes in the
United States are expected to include the creation of additional top-level
domains. Governing bodies may establish additional top-level domains, appoint
additional domain name registrars or modify the requirements for holding domain
names.

WE MAY NEED TO CHANGE THE MANNER IN WHICH WE CONDUCT OUR BUSINESS IF
GOVERNMENT REGULATION INCREASES.

The adoption or modification of laws or regulations relating to the Internet
could adversely affect the manner in which we currently conduct our business. In
addition, the growth and development of the market for online commerce may lead
to more stringent consumer protection laws, both in the United States and
abroad, that may impose additional burdens on us. Laws and regulations directly
applicable to communications or commerce over the Internet are becoming more
prevalent. The United States Congress recently enacted Internet laws regarding
children's privacy, copyrights, taxation and the transmission of sexually
explicit material, and the Federal Trade Commission's Children's Online Privacy
Protection Act became effective April 21, 2000. The European Union recently
enacted its own privacy regulations. In addition, we are subject to existing
federal, state and local regulations pertaining to consumer protection, such as
the Federal Trade Commission's Mail and Telephone Order Rule. The law of the
Internet, however, remains largely unsettled, even in areas where there has been
some legislative action. It may take years to determine whether and how existing
laws such as those governing intellectual property, privacy, libel and taxation
apply to the Internet. Any failure by us to comply with rules and regulations
applicable to our business could result in action being taken against us that
could have a material adverse effect on our business and results of operations.

In order to comply with new or existing laws regulating online commerce, we
may need to modify the manner in which we do business, which may result in
additional expenses. For instance, we may need to spend time and money revising
the process by which we fulfill customers' orders to ensure that each shipment
complies with applicable laws. We may need to hire additional personnel to
monitor our compliance with applicable laws. We may also need to modify our
software to further protect our customers' personal information.

WE MAY BE SUBJECT TO LIABILITY FOR THE INTERNET CONTENT THAT WE PUBLISH.

As a publisher of online content, we face potential liability for
defamation, negligence, copyright, patent or trademark infringement, or other
claims based on the nature and content of materials that we publish or
distribute. In particular, our BabyCenter Web site offers a variety of content
for new and expectant parents, including content relating to pregnancy,
fertility and

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infertility, nutrition, child rearing and related subjects. If we face
liability, then our reputation and our business may suffer. In the past,
plaintiffs have brought these types of claims and sometimes successfully
litigated them against online services. Although we carry general liability
insurance to cover claims of these types, there can be no assurance that such
insurance will be adequate to indemnify us for all liability that may be imposed
on us.

OUR NET SALES COULD DECREASE IF WE BECOME SUBJECT TO SALES AND OTHER TAXES.

If one or more states or any foreign country successfully asserts that we
should collect sales or other taxes on the sale of our products, our net sales
and results of operations could be harmed. We do not currently collect sales or
other similar taxes for physical shipments of goods into states other than
California. However, one or more local, state or foreign jurisdictions may seek
to impose sales tax collection obligations on us. In addition, any new operation
in states outside California could subject our shipments in such states to state
sales taxes under current or future laws. If we become obligated to collect
sales taxes, we will need to update our system that processes customers' orders
to calculate the appropriate sales tax for each customer order and to remit the
collected sales taxes to the appropriate authorities. These upgrades will
increase our operating expenses. In addition, our customers may be discouraged
from purchasing products from us because they have to pay sales tax, causing our
net sales to decrease. As a result, we may need to lower prices to retain these
customers.

WE MAY BE UNABLE TO MEET OUR FUTURE CAPITAL REQUIREMENTS.

We cannot be certain that additional financing will be available to us on
favorable terms when required, or at all. If we raise additional funds through
the issuance of equity, equity-related or debt securities, such securities may
have rights, preferences or privileges senior to those of the rights of our
outstanding securities and our stockholders will experience additional dilution.
We require substantial working capital to fund our business. Since our
inception, we have experienced negative cash flow from operations and expect to
experience significant negative cash flow from operations for the foreseeable
future. Significant volatility in the stock markets, particularly with respect
to Internet stocks, may increase the difficulty of raising additional capital.
Although we believe that current cash, cash equivalents and cash that may be
generated from operations will be sufficient to meet our anticipated cash needs
through March 31, 2001, there can be no assurance to that effect.

THE MARKET PRICES OF OUR SECURITIES MAY BE VOLATILE, WHICH COULD RESULT IN
SUBSTANTIAL LOSSES FOR INDIVIDUAL SECURITYHOLDERS.

The market prices for our securities have been and are likely to continue to
be highly volatile and subject to wide fluctuations in response to factors
including the following, some of which are beyond our control:

- actual or anticipated variations in our quarterly operating results;

- announcements of technological innovations, increased cost of operations or
new products or services by us or our competitors;

- changes in financial estimates by securities analysts;

- conditions or trends in the Internet and/or online commerce industries;

- changes in the economic performance and/or market valuations of other
Internet, online commerce or retail companies;

- volatility in the stock markets, particularly with respect to Internet stocks,
and decreases in the availability of capital for Internet-related businesses;

- announcements by us or our competitors of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;

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<PAGE>
- additions or departures of key personnel;

- release of lock-up or other transfer restrictions on our outstanding shares of
common stock or sales of additional shares of common stock; and

- potential litigation.

From May 20, 1999 (the first day of public trading of our common stock)
through March 31, 2000, the high and low sales prices for our common stock
fluctuated between $84.50 and $8.84. On May 30, 2000, the closing sale price of
our common stock was $5.06. See Item 5. "Market for Registrant's Common Stock
and Related Stockholder Matters" for additional information regarding the
trading prices of our common stock.

In the past, following periods of volatility in the market price of their
securities, many companies have been the subject of securities class action
litigation. If we were sued in a securities class action, it could result in
substantial costs and a diversion of management's attention and resources and
would cause the prices of our securities to fall.

AS A RESULT OF THE ISSUANCE OF OUR CONVERTIBLE NOTES, WE HAVE A SIGNIFICANT
AMOUNT OF DEBT AND MAY HAVE INSUFFICIENT CASH FLOW TO SATISFY OUR DEBT
SERVICE OBLIGATIONS. IN ADDITION, THE AMOUNT OF OUR DEBT COULD IMPEDE OUR
OPERATIONS AND FLEXIBILITY.

As a result of the issuance of $150 million of our 6.25% Convertible
Subordinated Notes due December 1, 2004, we have a significant amount of debt
and debt service obligations. If we are unable to generate sufficient cash flow
or otherwise obtain funds necessary to make required payments on the notes,
including from cash and cash equivalents on hand, we will be in default under
the terms of the indenture which could, in turn, cause defaults under our other
existing and future debt obligations. For more details regarding our ability to
make payments on the notes, see Item 7., "Management's Discussion and Analysis
of Financial Condition and Results of Operations" under the heading "Liquidity
and Capital Resources."

Even if we are able to meet our debt service obligations, the amount of debt
we have could adversely affect us in a number of ways, including by:

- limiting our ability to obtain any necessary financing in the future for
working capital, capital expenditures, debt service requirements or other
purposes;

- limiting our flexibility in planning for, or reacting to, changes in our
business;

- placing us at a competitive disadvantage relative to our competitors who have
lower levels of debt;

- making us more vulnerable to a downturn in our business or the economy
generally;

- requiring us to use a substantial portion of our cash flow from operations to
pay principal and interest on our debt, instead of contributing those funds to
other purposes such as working capital and capital expenditures; and

- requiring us to maintain specific financial ratios and comply with other
restrictive covenants in our existing and future agreements governing our debt
obligations.

To be able to meet our debt service requirements we must successfully
implement our business strategy. We cannot assure you that we will successfully
implement our business strategy or that we will be able to generate sufficient
cash flow from operating activities to meet our debt service obligations and
working capital requirements. Our ability to meet our obligations will be
dependent upon our future performance, which will be subject to prevailing
economic conditions and to financial, business and other factors.

To implement our business strategy, we will need to seek additional
financing. If we are unable to obtain such financing on terms that are
acceptable to us, we could be forced to dispose of assets to make up for any
shortfall in the payments due on our debt under circumstances that

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<PAGE>
might not be favorable to realizing the highest price for those assets. A
substantial portion of our assets consist of intangible assets, the value of
which will depend upon a variety of factors, including without limitation, the
success of our business. As a result, we cannot assure you that our assets could
be sold quickly enough, or for amounts sufficient, to meet our obligations,
including our obligations under the notes.

WE MAY BE UNABLE TO REPURCHASE THE NOTES UPON THE OCCURRENCE OF A CHANGE OF
CONTROL.

Upon the occurrence of a change of control of eToys, we are required to
offer to repurchase all outstanding notes. Although the indenture governing the
notes allows us, subject to satisfaction of certain conditions, to repurchase
the notes using shares of our common stock, if a change of control were to
occur, our ability to repurchase the notes with cash will depend on the
availability of sufficient funds and compliance with the terms of any debt
ranking senior to the notes. Our failure to repurchase tendered notes upon a
change of control would constitute an event of default under the indenture,
which could result in the acceleration of the maturity of the notes and all of
our other outstanding debt. These repurchase requirements may also delay or make
it harder for others to obtain control of us.

CLAIMS BY HOLDERS OF THE NOTES WILL BE SUBORDINATED TO CLAIMS BY HOLDERS OF
OUR SENIOR DEBT.

The notes rank behind all of our existing and future senior debt and
effectively behind all existing and future liabilities (including trade
payables) of our subsidiaries. As a result, if we declare bankruptcy, liquidate,
reorganize, dissolve or otherwise wind up our affairs or are subjected to
similar proceedings, we must repay all senior debt before we will be able to
make any payments on the notes. Likewise, upon a default in payment with respect
to any of our debt or an event of default with respect to this debt resulting in
its acceleration, our assets will be available to pay the amounts due on the
notes only after all senior debt has been paid in full. In addition, we have
located all of our inventory purchasing, distribution fulfillment functions,
customer service functions and other related activities in our distribution
subsidiary, eToys Distribution, LLC. The effect of this will be to increase the
amount of our subsidiary liabilities, especially during the third and fourth
calendar quarters. We may not have sufficient assets remaining to pay amounts
due on any or all of the notes then outstanding. The indenture does not prohibit
us or our subsidiaries from incurring additional senior debt, other debt or
other liabilities. Our ability to pay our obligations on the notes could be
adversely affected if we or our subsidiaries incur more debt.

As of March 31, 2000, we had outstanding $16.6 million of senior debt and
$23.5 million of subsidiary liabilities (of which $4.6 million also qualifies as
senior debt) to which the notes are subordinated. Both we and our subsidiaries
expect that from time to time we will incur additional debt to which the notes
will be subordinated.

SUBSTANTIAL SALES OF OUR COMMON STOCK COULD CAUSE OUR STOCK PRICE AND THE
PRICE OF THE NOTES TO FALL.

If our stockholders sell substantial amounts of our common stock, including
shares issued upon the exercise of outstanding options, the market prices of the
notes and our common stock could fall. Such sales also might make it more
difficult for us to sell equity or equity-related securities in the future at a
time and price that we deem appropriate. As of March 31, 2000, we had
outstanding 121,214,105 shares of common stock and 22,463,321 options to acquire
common stock, of which 4,119,590 options were vested and exercisable. As of
March 31, 2000, of the shares that are currently outstanding, 47,848,398 are
freely tradeable in the public market and 73,365,707 are tradeable in the public
market subject to the restrictions, if any, applicable under Rule 144 and

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<PAGE>
Rule 145 of the Securities Act. All shares acquired upon exercise of options
will be freely tradeable in the public market.

In general, under Rule 144 as currently in effect, a person who has
beneficially owned restricted securities for at least one year would be entitled
to sell within any three-month period a number of shares that does not exceed
the greater of (a) one percent of the number of shares of common stock then
outstanding (which for eToys was 1,212,141 shares as of March 31, 2000) or (b)
the average weekly trading volume of the common stock during the four calendar
weeks preceding the sale. Sales under Rule 144 are also subject to requirements
with respect to manner of sale, notice, and the availability of current public
information about us. Under Rule 144(k), a person who is not deemed to have been
our affiliate at any time during the three months preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years, is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144. Although the
holders of a substantial amount of our common stock are subject to selling
restrictions contained in Rule 144, sales by such stockholders of a substantial
amount of our common stock could adversely affect the market price of our
securities.

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth specific information regarding our executive
officers and directors as of May 31, 2000:

<TABLE>
<CAPTION>
NAME AGE POSITION(S)
---- -------- -----------------------------------------------------
<S> <C> <C>
Edward C. Lenk.................... 38 President, Chief Executive Officer and Chairman of
the Board
Theodore F. Augustine............. 53 Senior Vice President and Chief Logistics Officer
Janine Bousquette................. 39 Senior Vice President of Marketing
David F. Gatto.................... 38 Senior Vice President
Frank C. Han...................... 36 Senior Vice President of Product Development
John R. Hnanicek.................. 36 Senior Vice President and Chief Information Officer
Steven J. Schoch.................. 41 Senior Vice President and Chief Financial Officer
Louis V. Zambello III............. 42 Senior Vice President of Operations
Peter C.M. Hart................... 49 Director
Tony A. Hung...................... 32 Director
Michael Moritz.................... 45 Director
Daniel J. Nova.................... 38 Director
</TABLE>

EDWARD C. LENK founded eToys and has served as our President, Chief
Executive Officer and a Director since June 1997. In December 1998, he was
appointed Chairman of the Board. Prior to founding eToys, from May 1994 to July
1996, Mr. Lenk was employed as Vice President of Strategic Planning at The Walt
Disney Company, where he was responsible for strategic planning and new business
development of Worldwide Attractions and Resorts. From May 1991 to May 1994, he
was a Director of Strategic Planning at The Walt Disney Company. Mr. Lenk
received a Bachelor of Arts SUMMA CUM LAUDE from Bowdoin College and a Masters
in Business Administration, with distinction, from Harvard Business School.

THEODORE F. AUGUSTINE has served as our Senior Vice President and Chief
Logistics Officer since April 14, 2000. Prior to joining us, Mr. Augustine was
Vice President, Global Logistics of Gateway Inc., a computer manufacturer, from
October 1998 to April 2000. From May 1996 to October 1998, he was Vice
President, Global Logistics and Distribution of Tech Data Corp., a wholesale
distributor of computer related products, and from March 1995 to May 1996, he
was President of M-Group Logistics, a logistics consulting group. Mr. Augustine
received a Masters in Business Administration from Loyola College, Baltimore,
Maryland.

30
<PAGE>
JANINE BOUSQUETTE has served as our Senior Vice President of Marketing since
May 1999. Prior to joining us, from 1995 to May 1999, Ms. Bousquette worked at
PepsiCo Inc., a manufacturer of soft drinks, juices and snackfoods, serving most
recently as Vice President of Marketing and also serving as Vice President of
Marketing for the Flavor Brands. From 1982 to 1995, Ms. Bousquette worked in
brand management at The Procter & Gamble Company, a manufacturer of consumer
products, serving most recently as Senior Marketing Director. Ms. Bousquette
received a Bachelor of Arts PHI BETA KAPPA from the University of Michigan.

DAVID F. GATTO has served as our Senior Vice President since December 27,
1999. Prior to joining us, Mr. Gatto was Chairman and Chief Executive Officer of
L.A. Gear, Inc., an athletic footwear manufacturer and licensor, from June 1997
to December 1999 and its Executive Vice President from September 1991 to
June 1996. From June 1996 to June 1997, Mr. Gatto was Chief Operating Officer of
Syncronys Softcorp, a desktop utility software manufacturer and distributor.
Mr. Gatto received a Bachelor of Science in Industrial Engineering and Nuclear
Engineering from the University of California, Berkeley, and a Master of Science
from M.I.T.'s Sloan School of Management.

FRANK C. HAN has served as our Senior Vice President of Product Development
since January 1999. From February 1997 to January 1999, Mr. Han was our Chief
Operating Officer and Vice President of Finance. Prior to joining us, Mr. Han
worked at Union Bank of California, serving as Vice President of Interactive
Markets from January 1995 to February 1997 and as Director of Strategic Planning
from 1993 to 1995. Mr. Han received a Bachelor of Science CUM LAUDE from Yale
University and a Masters in Business Administration from the Stanford Graduate
School of Business.

JOHN R. HNANICEK has served as our Chief Information Officer since
December 1998. Prior to joining us, from October 1996 to December 1998, he was
employed as Senior Vice President of Information Systems for Hollywood
Entertainment, Inc., a nationwide retail video chain. From January 1996 to
October 1996, Mr. Hnanicek served as Chief Information Officer for
Homeplace, Inc., a home furnishings chain. From 1990 to 1995, he served as
Senior Vice President of Information Systems and Logistics at OfficeMax, Inc., a
retail office supply outlet. Mr. Hnanicek holds a Bachelor of Science in
Computer Science and Accounting from Cleveland State University.

STEVEN J. SCHOCH has served as our Chief Financial Officer since
January 1999. Prior to joining us, from December 1995 to January 1999,
Mr. Schoch was Vice President and Treasurer of Times Mirror Company, a newspaper
and magazine publishing company. He also served as Chief Executive Officer and
President of a wholly owned subsidiary of Times Mirror Company dedicated to the
reduction and containment of costs of the parent company. From March 1991 to
October 1995, Mr. Schoch worked at The Walt Disney Company, most recently as
Vice President, Treasurer--Euro Disney S.C.A. Mr. Schoch received a Bachelor of
Science from Tufts University and a Masters in Business Administration from the
Amos Tuck School of Business Administration at Dartmouth College.

LOUIS V. ZAMBELLO III has served as our Senior Vice President of Operations
since December 1998. Prior to joining us, from 1984 to 1998, he held a variety
of positions at L.L. Bean, Inc., an outdoor retailer. Most recently,
Mr. Zambello served as Senior Vice President of Operations and Creative from
June 1998 to December 1998, as Senior Vice President of Operations from
December 1993 to June 1998, as Vice President of Merchandise Services and
Manufacturing from December 1991 to August 1993 and in a variety of other
positions since 1984. Mr. Zambello received a Bachelor of Arts MAGNA CUM LAUDE
from Cornell University and a Masters in Business Administration from Harvard
Business School.

PETER C.M. HART has served as a Director of eToys since October 1997. Since
January 1999, Mr. Hart has been a Managing Partner of Wildkin LLC, a distributor
of toys. Since November 1997, he has served as a business advisor to EdUsa, a
company that provides language instruction over

31
<PAGE>
the Internet. From 1983 to 1997, he held a variety of positions at Ross
Stores, Inc., an apparel retailer, most recently as a Senior Vice President
managing warehousing, distribution and MIS operations. Previously, Mr. Hart was
a Business Systems Analyst at Joseph Magnin Department Store in San Francisco
and at Rediffusion in Buckinghamshire, England. Mr. Hart is a member of the
Audit Committee of the Board of Directors.

TONY A. HUNG has served as a Director of eToys since December 1997. He has
been a General Partner of DynaFund Ventures, a venture capital partnership,
since November 1999 and prior thereto a Vice President of Dynafund Ventures
since 1997. Previously, Mr. Hung held a variety of positions at The Walt Disney
Company, serving as Manager of Corporate Strategic Planning from 1996 to 1997,
as Manager of Television and Telecommunications from 1995 to 1996, and as Senior
Analyst in the Corporate Treasury department from 1992 to 1995. Mr. Hung serves
on the boards of directors of a number of private companies. Mr. Hung holds a
Bachelor of Arts from Harvard University and a Masters in Business
Administration from The Anderson School at University of California at Los
Angeles. Mr. Hung is a member of the Audit Committee of the Board of Directors.

MICHAEL MORITZ has served as a Director of eToys since June 1998. He has
been a general partner of Sequoia Capital, a venture capital firm, since 1986.
Mr. Moritz serves as a director of Agile Software, Saba Software, Webvan,
PlanetRx, Yahoo! Inc. and Flextronics International Ltd., as well as several
private companies. Mr. Moritz received a Master of Arts degree from Oxford
University and a Masters in Business Administration from the Wharton School at
the University of Pennsylvania. Mr. Moritz is a member of the Compensation
Committee of the Board of Directors.

DANIEL J. NOVA has served as a Director of eToys since June 1998. Since
August 1996, Mr. Nova has served as a general partner of Highland Capital
Partners, a venture capital firm. Previously, he was a general partner of
CMG@Ventures from January 1995 to August 1996 and a Senior Associate at Summit
Partners from June 1991 to January 1995. Mr. Nova is a director of Lycos, Inc.,
an online portal, and several private companies. Mr. Nova received a Bachelor of
Science in Computer Science and Marketing with honors from Boston College and a
Masters in Business Administration from Harvard Business School. Mr. Nova is a
member of the Audit and Compensation Committees of the Board of Directors.

Our executive officers serve at the discretion of the Board of Directors.
There are no family relationships among any of our directors or executive
officers.

ITEM 2. PROPERTIES

Our corporate offices are located in Santa Monica, California, where we
lease approximately 60,000 square feet under a lease that expires in July 2003,
approximately 45,000 square feet under a lease that expires in October 2002 and
approximately 25,000 square feet under a lease that expires in January 2002. In
October 2000 we intend to relocate our corporate offices to a new location in
Santa Monica pursuant to a 11 year lease that we signed in December 1999. Under
the lease agreement we have leased a 151,000 square foot building which is
currently being developed. In addition, BabyCenter's corporate offices consist
of approximately 28,400 square feet located in San Francisco, California under a
lease that expires as to 24,000 square feet on September 1, 2004 and as to 4,400
square feet on December 31, 2004. In connection with our European operations, we
maintain corporate offices consisting of approximately 37,000 square feet
located in London, England under a lease that expires in 2010 (with an option to
extend to 2015) and approximately 9,000 square feet located in Munich, Germany
under a lease that expires in June 2005.

In connection with our distribution operations, we lease approximately
105,000 square feet in Commerce, California under a lease that expires in
August 2003; approximately 763,000 square feet in Ontario, California under a
lease that expires in June 2005 (with an option to extend an additional six
months with respect to 193,000 square feet); approximately 438,500 square feet
in Pittsylvania County, Virginia under a lease that expires in July 2004;
approximately 272,000 square feet in

32
<PAGE>
Greensboro, North Carolina under a lease that expires in June 2003;
approximately 75,000 square feet in San Francisco, California under a lease that
expires as to 23,000 square feet on August 31, 2000 and as to 52,000 square feet
on December 31, 2000; and approximately 46,000 square feet in Swindon, England
under a lease that expires as to 26,000 square feet in August 2000 and as to
20,000 square feet in January 2001. Commencing in the fall of 2000, we also
expect to augment our Virginia facility with an additional 715,000 square foot
facility adjacent to the existing facility and to cease using the San Francisco
facility described above. We have also entered into a lease for an approximately
108,000 square foot distribution facility in Belgium under a lease with an
expiration date of May 2003.

ITEM 3. LEGAL PROCEEDINGS

From time to time, we are involved in legal proceedings relating to claims
arising out of our ordinary course of business, including employment related
claims and claims of alleged infringement of trademarks, copyrights and other
intellectual property. We are currently not aware of any such legal proceedings
that we believe will have, individually or in the aggregate, a material adverse
effect on our business, prospects, financial condition or operating results.

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

No matters were submitted for a vote of our stockholders during the fourth
quarter of the year ended March 31, 2000.

PART II

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

MARKET INFORMATION

Our common stock trades on The Nasdaq National Market under the symbol
"ETYS." The following table sets forth high and low sales prices for our common
stock for the periods indicated, as reported by The Nasdaq National Market.

<TABLE>
<CAPTION>
HIGH LOW
-------- --------
<S> <C> <C>
Fiscal Year ended March 31, 2000:
First Quarter (from May 20, 1999(1))...................... $77.00 $37.50
Second Quarter............................................ $66.50 $30.00
Third Quarter............................................. $84.50 $25.56
Fourth Quarter............................................ $25.63 $ 8.84
</TABLE>

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

(1) The date of our initial public offering of our common stock.

HOLDERS

As of March 31, 2000, there were 942 record stockholders of record of our
common stock.

DIVIDENDS

We have never declared or paid cash dividends on our capital stock. We
currently intend to retain all available funds and any future earnings for use
in the operation and expansion of our business and do not anticipate paying any
cash dividends in the foreseeable future.

RECENT SALES OF UNREGISTERED SECURITIES

On March 23, 2000, we issued a warrant to acquire up to 1,500 shares of our
common stock with an exercise price of $11.375 per share to Kinka Usher, the
director of certain of our television commercials. The warrant was fully vested
upon issuance and has a term of one year. The issuance of the warrant was exempt
from the registration requirements of the Securities Act of 1933 pursuant to
Section 4(2) thereof.

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<PAGE>
ITEM 6. SELECTED FINANCIAL DATA

The following selected financial and operating data set forth below should
be read in conjunction with Item 7., "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our consolidated financial
statements and the notes included elsewhere in this Annual Report. The
consolidated results of operations are not necessarily indicative of future
results.

<TABLE>
<CAPTION>
FISCAL YEAR ENDED
MARCH 31,
---------------------------------------
2000 1999 1998
----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales.............................................. $ 151,036 $ 29,959 $ 687
Cost of sales.......................................... 121,973 24,246 568
---------- ---------- ----------
Gross profit........................................... 29,063 5,713 119
Operating expenses:
Marketing and sales.................................. 120,460 20,719 1,290
Web site and technology.............................. 43,429 3,608 421
General and administrative........................... 16,665 4,352 676
Goodwill amortization................................ 27,835 319 --
Deferred compensation amortization................... 13,701 5,814 2
---------- ---------- ----------
Total operating expenses....................... 222,090 34,812 2,389
---------- ---------- ----------
Operating loss......................................... (193,027) (29,099) (2,270)
Interest income, net................................... 3,401 542 3
---------- ---------- ----------
Loss before taxes...................................... (189,626) (28,557) (2,267)
Provision for taxes.................................... (1) (1) (1)
---------- ---------- ----------
Net loss............................................... $ (189,627) $ (28,558) $ (2,268)
========== ========== ==========
Basic and diluted net loss per share................... $ (1.78) $ (0.85) $ (0.09)
========== ========== ==========
Shares used to compute basic and diluted net loss per
share................................................ 106,597 33,428 25,130
========== ========== ==========
</TABLE>

<TABLE>
<CAPTION>
MARCH 31,
------------------------------------
2000 1999 1998
---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.............................. $ 139,627 $ 20,173 $ 1,552
Working capital........................................ 164,985 21,821 1,456
Total assets........................................... 425,158 30,666 2,927
Total debt............................................. 166,561 707 --
Total stockholders' equity (deficit)................... 215,386 (24,098) (1,345)

OTHER FINANCIAL DATA:
Ratio of loss to fixed charges(a)...................... -- -- --
</TABLE>

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

(a) Loss consists of pre-tax loss from continuing operations, plus fixed
charges. Fixed charges consist of interest expense, including amortization
of debt financing costs, and the interest component of rent expenses on
operating leases. As a result of the loss incurred for the years ended
March 31, 2000, 1999 and 1998, the ratio coverage was less than 1:1 as the
Company was unable to cover the indicated fixed charges. The Company must
generate additional earnings of $189,626, $28,557 and $2,267 for the years
ended March 31, 2000, 1999 and 1998, respectively, to achieve a coverage
of 1:1.

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

THIS ANNUAL REPORT ON FORM 10-K AND THE FOLLOWING "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" INCLUDES
"FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT AND SECTION 21E OF THE EXCHANGE ACT. ALL STATEMENTS OTHER THAN STATEMENTS OF
HISTORICAL FACT ARE "FORWARD-LOOKING STATEMENTS" FOR PURPOSES OF THESE
PROVISIONS, INCLUDING ANY PROJECTIONS OF EARNINGS, REVENUES OR OTHER FINANCIAL
ITEMS, ANY STATEMENTS OF THE PLANS AND OBJECTIVES OF MANAGEMENT FOR FUTURE
OPERATIONS, ANY STATEMENTS CONCERNING PROPOSED NEW PRODUCTS OR SERVICES, ANY
STATEMENTS REGARDING FUTURE ECONOMIC CONDITIONS OR PERFORMANCE, AND ANY
STATEMENT OF ASSUMPTIONS UNDERLYING ANY OF THE FOREGOING. IN SOME CASES,
FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED BY THE USE OF TERMINOLOGY SUCH AS
"MAY", "WILL", "EXPECTS", "PLANS", "ANTICIPATES", "ESTIMATES", "POTENTIAL", OR
"CONTINUE" OR THE NEGATIVE THEREOF OR OTHER COMPARABLE TERMINOLOGY. ALTHOUGH WE
BELIEVE THAT THE EXPECTATIONS REFLECTED IN THE FORWARD-LOOKING STATEMENTS
CONTAINED HEREIN ARE REASONABLE, THERE CAN BE NO ASSURANCE THAT SUCH
EXPECTATIONS OR ANY OF THE FORWARD-LOOKING STATEMENTS WILL PROVE TO BE CORRECT,
AND ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED OR ASSUMED IN
THE FORWARD-LOOKING STATEMENTS. OUR FUTURE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS, AS WELL AS ANY FORWARD-LOOKING STATEMENTS, ARE SUBJECT TO INHERENT
RISKS AND UNCERTAINTIES, INCLUDING BUT NOT LIMITED TO THE RISK FACTORS SET FORTH
ABOVE UNDER "BUSINESS--ADDITIONAL FACTORS THAT MAY AFFECT RESULTS" AND FOR THE
REASONS DESCRIBED ELSEWHERE IN THIS REPORT. ALL FORWARD-LOOKING STATEMENTS AND
REASONS WHY RESULTS MAY DIFFER INCLUDED IN THIS REPORT ARE MADE AS OF THE DATE
HEREOF, AND WE ASSUME NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENT
OR REASON WHY ACTUAL RESULTS MIGHT DIFFER.

Currently, Accounting Standard Setters are reviewing the financial statement
classification of distribution and fulfillment costs and other items by a number
of e-commerce companies, including the Company. We define distribution and
fulfillment costs as primary recurring costs incurred for the operation of our
distribution centers and customer service centers, and have classified such
costs in marketing and sales expenses. These costs are primarily composed of
distribution facility expenses, including equipment and supplies, payroll and
travel expenses for personnel engaged in distribution activities, and
third-party fulfillment fees. These costs represent the facility costs necessary
for warehousing inventory as well as costs incurred to pick and pack a customer
order and the related packaging supplies. The Accounting Standard Setters may
decide to require that certain distribution center costs be classified as cost
of sales. Should this occur, we will reclassify any distribution and fulfillment
costs as required and our gross profit will be correspondingly affected.
However, such reclassification will not impact our sales, operating profit or
loss, net profit or loss, or cash flows.

AS USED BELOW, "FISCAL 1999", "FISCAL 1998" AND "FISCAL 1997" REFER TO THE
FISCAL YEARS ENDED MARCH 31, 2000, 1999 AND 1998, RESPECTIVELY.

OVERVIEW

We are a leading Web-based retailer focused exclusively on children's
products, including toys, video games, books, software, videos, music and
baby-oriented products. Through our wholly-owned subsidiary, BabyCenter, we
offer Webby-award winning content and community for new and expectant parents
and an online store with an extensive selection of baby-oriented products and
supplies. We currently offer an extensive selection of competitively priced
children's products consisting of over 100,000 SKUs.

We were incorporated in November 1996 and began offering products for sale
on our Web site and entered into a marketing agreement with AOL on October 1,
1997. For the period from inception through October 1, 1997, we had no sales and
our operating activities related primarily to

35
<PAGE>
the development of the necessary computer infrastructure and initial planning
and development of our Web site and operations. Since launching our online
store, we have continued these operating activities and have also focused on
building sales momentum, expanding our product offerings, establishing vendor
relationships, promoting our brand name and establishing distribution and
customer service operations. Our cost of sales and operating expenses have
increased significantly since inception. This trend reflects the costs
associated with our formation as well as increased efforts to promote our brand,
build market awareness, attract new customers, recruit personnel, build
operating infrastructure and develop our Web site and associated systems that we
use to process customers' orders and payments.

We have grown rapidly since launching our online store in October 1997.
During the fall of 1998, we launched our redesigned Web site and added video
game, software, video and music departments to our online store. In June 1999,
we began selling baby-oriented products through our baby department and in July
1999 we launched our children's book department which offers more than 80,000
children's book titles. In addition, we have added numerous specialty boutiques
designed to appeal to specific consumer interests, such as hobbies, dolls and
trains. We have also added a series of seasonal boutiques to enable consumers to
easily locate seasonal specific items, such as Halloween costumes and school
supplies.

On July 1, 1999, we completed the acquisition of BabyCenter. BabyCenter is a
Web-based business that offers a wide variety of content, community and products
focused on and serving expectant mothers and new parents. Visitors to the
BabyCenter Web site can read health articles and parenting news, interact online
with other families and purchase a wide selection of baby-oriented products and
supplies. BabyCenter derives its net sales principally from product sales and
sales of advertisement space as well as sponsorships with various companies. In
connection with the acquisition of BabyCenter, we recorded goodwill of
approximately $189.0 million, which is being amortized over a five-year period.
In January 2000, we completed the sale of substantially all of the assets and
related liabilities of BabyCenter's Consumer Health Interactive division for
approximately $20 million in a combination of cash and registrable securities.
CHI is a resource for health plans looking to use the Internet to attract and
retain members.

In October 1999, we launched eToys.co.uk, which incorporates our technology
and online store design and offers consumers in the United Kingdom over 5,000
SKUs of children's toys, software, videos and video games. In addition, in
November 1999, we began offering services to all provinces of Canada through our
eToys.com store, and in March 2000 we launched the BabyCenter brand in the
United Kingdom, offering a content and community site for parents and expectant
parents located at www.babycentre.co.uk.

The markets in which we compete are highly seasonal. A disproportionate
amount of our net sales have been realized during the fourth calendar quarter
and we expect this trend to continue in future periods. In addition, since a
disproportionate amount of our net sales are realized during the fourth calendar
quarter, we significantly increase our purchases of inventory during the third
and fourth calendar quarters. Accordingly, our accounts payable are at their
highest levels during the fourth calendar quarter. Our gross margin will
fluctuate in future periods based on factors such as product mix, inventory
management, inbound and outbound shipping costs, the level of product

36
<PAGE>
returns, and the level of discount pricing and promotional coupon usage.
However, we expect to improve gross margin through changes in product mix
(including higher margin private label products), additional non-fulfillment
revenues such as sponsorship fees, improved purchasing terms with higher volume
purchasing and reduced shipping costs as a result of our bi-coastal distribution
centers.

Since inception, we have incurred significant losses and, as of the end of
Fiscal 1999, had an accumulated deficit of $220.5 million. We expect operating
losses and negative cash flow to continue for the foreseeable future. We expect
to incur additional costs and expenses related to brand development, marketing
and other promotional activities; the expansion of our inventory management and
distribution operations; the continued development of our Web site, systems that
we use to process customers' orders and payments and our computer network; the
expansion of our product offerings and Web site content; and development of
relationships with strategic business partners.

We have a limited operating history on which to base an evaluation of our
business and prospects. You must consider our prospects in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development, particularly companies in new and rapidly evolving markets
such as online commerce. Such risks for us include, but are not limited to, an
evolving and unpredictable business model, management of growth and the
availability of capital to fund our growth. To address these risks, we must,
among other things, maintain and expand our customer base, implement and
successfully execute our business and marketing strategy, continue to develop
and upgrade our technology and systems that we use to process customers' orders
and payments, improve our Web site, provide superior customer service, respond
to competitive developments, raise additional capital to enable us to implement
our business plan and attract, retain and motivate qualified personnel. We
cannot assure you that we will be successful in addressing such risks, and our
failure to do so could have a material adverse effect on our business,
prospects, financial condition and results of operations.

RESULTS OF OPERATIONS

We commenced offering products for sale on our Web site on October 1, 1997,
and, accordingly, Fiscal 1997 only includes a period of six months during which
we were generating net sales and incurring expenses. Consequently, our net sales
and expenses for Fiscal 1998 increased due to a full year of net sales generated
and expenses incurred during such period as compared to six months of net sales
and expenses incurred during Fiscal 1997.

NET SALES

<TABLE>
<CAPTION>
FISCAL FISCAL FISCAL
1999 CHANGE 1998 CHANGE 1997
--------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net sales....................................... $151,036 404% $29,959 4,261% $ 687
</TABLE>

FISCAL 1999 VERSUS FISCAL 1998

Net sales consist of product sales to customers and charges to customers for
outbound shipping and handling and gift wrapping and are net of product returns,
promotional discounts and coupons. Net sales increased to $151.0 million for
Fiscal 1999 from $30.0 million for Fiscal 1998, reflecting a significant
increase in units sold due to the growth of our customer base, repeat purchases
from our existing customers and growth in our non-toy categories at baby and
book stores that were launched in 1999. Cumulative customer accounts increased
to 1.9 million at the end of Fiscal 1999 from 365,000 at the end of Fiscal 1998.

37
<PAGE>
INTERNATIONAL SALES--FISCAL 1999

International sales were $2.5 million, or 1.7% of net sales for Fiscal 1999.
In October 1999, we launched eToys.co.uk, expanding into the international
market for the first time. Accordingly, no international sales are reported for
prior periods.

FISCAL 1998 VERSUS FISCAL 1997

Net sales increased to $30.0 million for Fiscal 1998 from $0.7 million for
Fiscal 1997 as a result of the significant growth of our customer base and an
increase in repeat purchases from our existing customers, reflecting the
relaunch of our Web site and the addition of new departments to our online store
during the fall of 1998.

GROSS PROFIT

<TABLE>
<CAPTION>
FISCAL FISCAL FISCAL
1999 CHANGE 1998 CHANGE 1997
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Gross Profit...................................... $29,063 409% $5,713 4,701% $ 119
Percentage of net sales........................... 19.2% 19.1% 17.3%
</TABLE>

FISCAL 1999 VERSUS FISCAL 1998

Gross profit is net sales less cost of sales, which consists of the costs of
products sold to customers, outbound and inbound shipping and handling costs,
and gift wrapping costs. Gross profit increased in absolute dollars to $29.1
million for Fiscal 1999 versus $5.7 million for Fiscal 1998, reflecting our
increased sales volume. Our gross profit increased as a percentage of net sales
by approximately 0.1% for Fiscal 1999 as compared to Fiscal 1998. The increase
in gross profit as a percentage of net sales is primarily attributable to better
purchasing efficiencies from our toy category in Fiscal 1999 versus Fiscal 1998
as well as higher margins in our baby business, partially offset by increased
sales of lower-margin video games and book products as well as the impact of
shipping margins. Shipping margins were adversely impacted in Fiscal 1999 due to
the level of split shipments and shipping upgrades generated as a result of our
third-party fulfillment operations. In addition, shipping margins in Fiscal 1999
and 1998 were adversely impacted by the location of our distribution centers
principally in the western United States. This resulted in increased shipping
costs as we shipped cross-country to the majority of our customer base located
in the eastern United States. We expect that our new distribution center
location in Danville, Virginia will allow us to reduce the costs incurred from
shipping since it is located closer to the majority of our customers.

The loss from shipping, which represents shipping revenues less outbound
shipping and handling costs included in cost of sales, was $5.8 million and $0.6
million in Fiscal 1999 and Fiscal 1998, respectively. We believe that providing
our customers with superior customer service is an essential component of our
business strategy. Accordingly, we may incur additional costs in order to meet
customer expectations, which could decrease gross profit. Over time, we intend
to expand our operations by adding product categories and by expanding the
breadth and depth of our product or service offerings. In subsequent periods, we
expect to improve gross margin through changes in product mix (including higher
margin private label products), additional non-fulfillment revenues such as
sponsorship fees, improved purchasing terms with higher volume purchasing and
reduced shipping costs as a result of our bi-coastal distribution centers.

38
<PAGE>
FISCAL 1998 VERSUS FISCAL 1997

Gross profit increased to $5.7 million for Fiscal 1998 versus $0.1 million
for Fiscal 1997. Our gross profit increased as a percentage of net sales by
approximately 2% for Fiscal 1998 as compared to Fiscal 1997. This increase was
primarily due to greater sales of higher margin products as a percentage of our
overall net sales and improved purchasing.

The loss from shipping, which represents shipping revenues less outbound
shipping and handling costs included in cost of sales, was $0.6 million in
Fiscal 1998. In Fiscal 1997, the gross profit from shipping was $5,000.

MARKETING AND SALES

<TABLE>
<CAPTION>
FISCAL FISCAL FISCAL
1999 CHANGE 1998 CHANGE 1997
--------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Marketing and sales............................ $120,460 481% $20,719 1,506% $1,290
Percentage of net sales........................ 79.8% 69.2% 187.8%
</TABLE>

FISCAL 1999 VERSUS FISCAL 1998

Marketing and sales expenses consist of advertising expense, fulfillment,
customer service and credit card fees, and other marketing and sales expense,
including personnel and general overhead. Marketing and sales expenses increased
to $120.5 million for Fiscal 1999 from $20.7 million for Fiscal 1998. This $99.8
million increase was primarily attributable to increases in our advertising
expenditures incurred to promote the holiday shopping season, increased payroll
and related costs for fulfilling the higher level of customer demand, and
additional costs incurred in the expansion of our distribution facilities.
Marketing and sales expenses increased as a percentage of net sales during
Fiscal 1999 due to increased advertising expenditures incurred to promote the
holiday shopping season as well as additional costs incurred in the expansion of
our distribution facilities.

During Fiscal 1999, advertising expense was $55.5 million or 37% of net
sales. Although we intend to continue to devote a substantial amount of our
capital resources to the pursuit of an aggressive branding and marketing
campaign, we expect advertising expense to decrease significantly as a
percentage of net sales in future periods.

During Fiscal 1999, fulfillment, customer service and credit card fees were
$50.3 million or 33% of net sales. Although we expect the expansion and
refinement of our distribution facilities to accommodate increases in sales
volume, coupled with costs incurred to meet customer expectations, to result in
continued increases in these expenses, we believe these expenses will decline
significantly as a percentage of net sales and will not materially exceed our
gross profits during the fiscal year ending March 31, 2001. During the fiscal
year ending March 31, 2002, we expect our gross profits to exceed these
expenses. We plan to reduce fulfillment, customer service and credit card fees
as a percentage of net sales through increased productivity arising from greater
automation and operating experience in fulfilling customer orders, as well as
through higher utilization of our distribution centers as revenues increase and
seasonality decreases.

On March 31, 2000, we ceased receiving fulfillment services from our
third-party vendor, Fingerhut Business Services, and since that time we have
relied solely on our own distribution centers located in California, North
Carolina and Virginia for domestic fulfillment operations and in Swindon,
England for international fulfillment operations. We expect the transition of
inventory from Fingerhut facilities to be completed during the summer of 2000.
Costs incurred to date associated with this transition have not been material
and the remaining costs expected to be incurred this upcoming year to complete
the transition are also not expected to be material. We expect to incur

39
<PAGE>
expenses associated with the continued development and enhancement of our own
distribution operations and from our efforts to meet customer expectations with
respect to timely and accurate order fulfillment.

FISCAL 1998 VERSUS FISCAL 1997

Marketing and sales expenses increased to $20.7 million for Fiscal 1998 from
$1.3 million for Fiscal 1997. This $19.4 million increase was primarily
attributable to the expansion of our online and offline advertising, including a
comprehensive print and television advertising campaign, as well as increased
personnel and related expenses required to implement our marketing strategy. In
addition, due to a significant increase in our sales volume, we experienced
higher distribution and customer service expenses, including an increased level
of temporary staffing during the holiday season. Marketing and sales expenses
decreased significantly as a percentage of net sales during Fiscal 1998 due to
the significant increase in net sales during such period.

WEB SITE AND TECHNOLOGY

<TABLE>
<CAPTION>
FISCAL FISCAL FISCAL
1999 CHANGE 1998 CHANGE 1997
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Web site and technology........................... $43,429 1,104% $3,608 757% $ 421
Percentage of net sales........................... 28.8% 12.0% 61.3%
</TABLE>

FISCAL 1999 VERSUS FISCAL 1998

Web site and technology expenses consist primarily of payroll and related
expenses for merchandising, development, and systems and telecommunications
personnel, and infrastructure costs related to systems and telecommunications.
Web site and technology also includes costs related to the development of
internal-use software. All development costs incurred in the preliminary project
stage, as well as maintenance and training, are expensed as incurred. Certain
plans of development are so uncertain that it is not probable that they will be
completed and are therefore expensed when incurred. Once the development project
has completed the preliminary project stage and it is deemed probable that the
project will be completed and used as intended, the project is considered to
have moved into the application development stage. All costs incurred for the
development or purchase of internal-use software that are incurred in the
application development stage are capitalized as incurred within property and
equipment and amortized over their estimated useful lives.

Web site and technology expenses increased to $43.4 million for Fiscal 1999
from $3.6 million for Fiscal 1998. This $39.8 million increase was primarily
attributable to increased staffing of systems and telecommunication personnel,
increased costs incurred in the preliminary development stage for projects
intended to enhance the features, content and functionality of our Web site and
transaction-processing systems, as well as increased investment in systems and
telecommunications infrastructure. Web site and technology expenses increased as
a percentage of net sales during Fiscal 1999 primarily due to increased
investments in systems and telecommunication infrastructure. We believe that
continued investment in Web site and technology is critical to attaining our
strategic objectives. In addition to ongoing investments in our online stores
and infrastructure, we intend to increase investments in product, service and
international expansion. As a result, we expect Web site and technology expenses
to increase significantly in absolute dollars.

40
<PAGE>
FISCAL 1998 VERSUS FISCAL 1997

Web site and technology expenses increased to $3.6 million for Fiscal 1998
from $0.4 million for Fiscal 1997. This $3.2 million increase was primarily
attributable to increased staffing and associated costs related to enhancing the
features, content and functionality of our online store and increasing the
capacity of our systems that we use to process customers' orders and payments.
Website and technology expenses decreased significantly as a percentage of net
sales during Fiscal 1998 due to the significant increase in net sales during
such period.

GENERAL AND ADMINISTRATIVE

<TABLE>
<CAPTION>
FISCAL FISCAL FISCAL
1999 CHANGE 1998 CHANGE 1997
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
General and administrative........................ $16,665 283% $4,352 542% $ 678
Percentage of net sales........................... 11.0% 14.5% 98.7%
</TABLE>

FISCAL 1999 VERSUS FISCAL 1998

General and administrative expenses consist of payroll and related expenses
for executive and administrative personnel, facilities expenses, professional
services expenses, travel and other general corporate expenses. General and
administrative expenses increased to $16.7 million for Fiscal 1999 from
$4.4 million for Fiscal 1998. This $12.3 million increase was primarily due to
increased headcount and associated costs, professional fees, facilities and
other related costs. General and administrative expenses decreased in Fiscal
1999 as a percentage of net sales due to the significant increase in net sales
in such period. We expect general and administrative expenses to increase in
absolute dollars as we expand our staff and incur additional costs related to
the growth of our business and international expansion.

FISCAL 1998 VERSUS FISCAL 1997

General and administrative expenses increased to $4.4 million for
Fiscal 1998 from $0.7 million for Fiscal 1997. This $3.7 million increase was
primarily attributable to increased headcount and related expenses associated
with the hiring of additional personnel and increased professional services
expenses. General and administrative expenses decreased significantly as a
percentage of net sales during Fiscal 1998 due to the significant increase in
net sales during such period.

GOODWILL AND INTANGIBLE ASSETS AMORTIZATION

<TABLE>
<CAPTION>
FISCAL FISCAL FISCAL
1999 CHANGE 1998 CHANGE 1997
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Goodwill and intangible assets amortization......... $27,835 8,626% $319 N/M $ --
Percentage of net sales............................. 18.4% 1.1% 0.0%
</TABLE>

FISCAL 1999 VERSUS FISCAL 1998

Goodwill represents the excess of the purchase price over the fair value of
the net tangible assets acquired in a business combination. As a result of the
acquisition of BabyCenter on July 1, 1999, we recorded goodwill of approximately
$189.0 million, which is to be amortized over five years. As such, goodwill
amortization for Fiscal 1999 of $27.8 million reflects amortization of goodwill
from the BabyCenter purchase, in addition to amortization of goodwill recorded
from a previous acquisition. In January 2000, we completed the sale of
substantially all of the assets and related liabilities of BabyCenter's Consumer
Health Interactive division for approximately $20 million

41
<PAGE>
in a combination of cash and registrable securities. As a result of the sale,
goodwill amortization will decrease in amounts proportionate to the sale
proceeds in future periods due to the reduction of goodwill related to CHI. To
the extent that we do not generate additional sufficient cash flow to recover
the amount of the investment recorded, the investment may be considered impaired
or be subject to earlier write-off. In such event, our net loss in any given
period could be greater than anticipated.

FISCAL 1998 VERSUS FISCAL 1997

At the end of Fiscal 1997 and Fiscal 1998, goodwill resulting from an
acquisition was $956,000 and is being amortized on a straight-line basis over
three years. The acquisition was completed in March 1998 and therefore goodwill
amortization for Fiscal 1998 reflects a full year of goodwill amortization.

DEFERRED COMPENSATION AMORTIZATION

<TABLE>
<CAPTION>
FISCAL FISCAL FISCAL
1999 CHANGE 1998 CHANGE 1997
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Deferred compensation amortization................ $13,701 136% $5,814 N/M $ 2
Percentage of net sales........................... 9.1% 19.4% 0.3%
</TABLE>

FISCAL 1999 VERSUS FISCAL 1998

In Fiscal 1999, we recorded total deferred stock compensation of
$13.8 million in connection with stock options granted during the period.
Deferred stock compensation is amortized to expense over the vesting periods of
the applicable options, resulting in $13.7 million for Fiscal 1999. These
amounts represent the difference between the exercise price of stock option
grants and the deemed fair value of our common stock at the time of such grants.

Amortization of deferred compensation for each of the next four fiscal years
is expected to be as follows:

<TABLE>
<CAPTION>
AMOUNTS
IN
YEAR ENDED THOUSANDS
---------- ---------
<S> <C>
March 31, 2001.............................................. $13,645
March 31, 2002.............................................. 13,639
March 31, 2003.............................................. 9,534
March 31, 2004.............................................. 264
</TABLE>

FISCAL 1998 VERSUS FISCAL 1997

In Fiscal 1998, we recorded total deferred stock compensation of
$44.7 million in connection with stock options granted during the period,
including approximately $0.3 million which represents the fair value of options
granted to non-employees during this period. Such amount is amortized to expense
over the vesting periods of the applicable options, resulting in $5.8 million
for Fiscal 1998. These amounts represent the difference between the exercise
price of stock option grants and the deemed fair value of our common stock at
the time of such grants.

42
<PAGE>
INTEREST INCOME AND EXPENSE

<TABLE>
<CAPTION>
FISCAL FISCAL FISCAL
1999 CHANGE 1998 CHANGE 1997
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest income...................................... $7,409 1,158% $589 3,172% $18
Interest expense..................................... $4,008 8,428% $ 47 213% $15
</TABLE>

FISCAL 1999 VERSUS FISCAL 1998

Interest income consists of earnings on our cash and cash equivalents.
Interest income increased to $7.4 million for Fiscal 1999 from $0.6 million for
Fiscal 1998. The $6.8 million increase was due to higher cash balances resulting
from the proceeds of our initial public offering of common stock and proceeds
from the issuance of $150 million of convertible notes. Interest expense
consists primarily of interest from the issuance of the convertible notes, the
amortization of debt financing costs related to the convertible notes as well as
interest on asset acquisitions financed through notes payable and capital
leases. Interest expense increased to $4.0 million for Fiscal 1999 from $47,000
for Fiscal 1998 due to interest on the convertible notes and additional asset
acquisitions financed through notes payable and capital lease obligations.

FISCAL 1998 VERSUS FISCAL 1997

Interest income increased to $0.6 million for Fiscal 1998 from $18,000 for
Fiscal 1997. This $0.6 million increase was primarily attributable to earnings
on higher average cash and cash equivalent balances during Fiscal 1998. Interest
expense increased to $47,000 for Fiscal 1998 as compared to $15,000 for
Fiscal 1997. The increase in interest expense is attributable to interest paid
on bridge loan financing obtained, and subsequently repaid through a combination
of preferred stock issuance and cash payments, during Fiscal 1998.

INCOME TAXES

We have not generated any taxable income to date and therefore have not paid
any federal income taxes since inception. Utilization of our net operating loss
carryforwards, which begin to expire in 2012, may be subject to certain
limitations under Section 382 of the Internal Revenue Code of 1986, as amended.
We have provided a full valuation allowance on the deferred tax asset,
consisting primarily of net operating loss carryforwards, because of uncertainty
regarding its realizability.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 2000, the Company's principal source of liquidity consisted of
$139.6 million of cash and cash equivalents compared to $20.2 million of cash
and cash equivalents at March 31, 1999.

Net cash used in operating activities was $174.4 million and $23.9 million
for Fiscal 1999 and Fiscal 1998, respectively. Net operating cash flows were
primarily attributable to net losses, reduced by noncash charges of depreciation
and amortization, as well as increases in inventories, prepaid expenses and
other, which were offset by increases in accounts payable and accrued expenses.

Net cash used in investing activities was $26.8 million for Fiscal 1999 and
consisted of purchases of fixed assets and other assets, partially offset by
proceeds from the sale of fixed assets and investments, and cash received from
the acquisition of BabyCenter and the sale of CHI. Cash available for investment
purposes increased substantially in Fiscal 1999 as a result of the proceeds from
the issuance of common stock in our initial public offering and proceeds from
the issuance of

43
<PAGE>
$150 million of our convertible notes. Net cash used in investing activities for
Fiscal 1998 was $2.7 million and consisted of purchases of fixed assets and
other assets.

Net cash provided by financing activities of $320.9 million for the fiscal
year ended March 31, 2000 resulted from net proceeds from the issuance of common
stock in our initial public offering and proceeds from the issuance of the
convertible notes, offset by debt financing costs incurred as a result of the
issuance of the convertible notes and payments on notes payable and capital
leases. Net cash provided by financing activities for Fiscal 1998 was
$45.3 million and resulted from net proceeds from the issuance of redeemable
convertible preferred stock and proceeds from bridge loan financing, offset by
payments on the bridge loan.

As of March 31, 2000, our principal commitments consisted of the
$150 million of convertible notes outstanding, operating lease obligations,
notes payable and capital lease obligations incurred to finance fixed asset
acquisitions and future advertising commitments. Our total commitments for
operating leases, capital leases and notes payable obligations is $22.0 million
for the year ended March 31, 2001. During Fiscal 1999, we entered into a number
of commitments for online, print and broadcast advertising. As of March 31,
2000, future advertising commitments were $11.4 million, $7.9 million and
$2.2 million for the years ended March 31, 2001, 2002 and 2003, respectively.

The convertible notes, issued in December 1999, are unsecured and are
subordinated to our existing and future senior debt as defined in the indenture
pursuant to which the convertible notes were issued. The principal amount of the
convertible notes will be due on December 1, 2004 and will bear interest at an
annual rate of 6.25%, payable twice a year, on June 1 and December 1, beginning
June 1, 2000, until the principal amount of the convertible notes is fully
repaid. The convertible notes may be converted into our common stock at the
option of the holder at any time prior to December 1, 2004, unless the
convertible notes have been previously redeemed or repurchased by us. The
conversion rate, subject to adjustment in certain circumstances, is 13.5323
shares of our common stock for each $1,000 principal amount of convertible
notes, which is equivalent to a conversion price of approximately $73.90 per
share. Additionally, on or after December 1, 2002, we may redeem all or a
portion of the convertible notes, that have not been previously redeemed or
repurchased, at any time at redemption prices set forth in the indenture
pursuant to which the convertible notes were issued, plus any accrued and unpaid
interest to the redemption date.

In December 1999, we entered into an eleven year lease agreement to relocate
our corporate offices. The lease begins in October 2000. In connection with the
lease commitment, we delivered a letter of credit to the lessor in the amount of
$7.5 million, which we have cash collateralized. Additionally, pursuant to the
lease agreement, in April 2000 we delivered a second letter of credit in the
amount of $7.5 million, which we have also cash collateralized. The letters of
credit will be held as security during the initial lease term.

We believe that current cash and cash equivalents and cash that may be
generated from operations will be sufficient to meet our anticipated cash needs
through March 31, 2001. However, any projections of future cash needs and cash
flows are subject to substantial uncertainty. If current cash, cash equivalents
and cash that may be generated from operations are insufficient to satisfy our
liquidity requirements, we will likely seek to sell additional equity or debt
securities or to obtain a line of credit. The sale of additional equity or
equity-related securities would result in additional dilution to our
stockholders. In addition, we will, from time to time, consider the acquisition
of or investment in complementary businesses, products, services and
technologies, which might impact our liquidity requirements or cause us to issue
additional equity or debt securities. There can be no assurance that financing
will be available in amounts or on terms acceptable to us, if at all.

44
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are subject to market risk related to changes in foreign currency
exchange rates and interest rates. We do not use derivative financial
instruments.

FOREIGN CURRENCY RISK. We currently have wholly-owned subsidiaries with
operations in the United Kingdom and Europe. All sales and expenses incurred by
the foreign subsidiaries are denominated in the British pound and Euro, which
are considered the functional currencies of the respective subsidiaries. As
such, we are exposed to foreign currency risk which arises in part from funding
denominated in British pounds and Euros provided to the foreign subsidiaries and
from the translation of the foreign subsidiaries' financial results into U.S.
dollars during consolidation. As exchange rates vary, our results from
operations and profitability may be adversely impacted. As of March 31, 2000,
the effect of the foreign currency exchange rate fluctuations has not been
material.

INTEREST RATE RISK. We maintain a portfolio of highly liquid cash
equivalents maturing in three months or less as of the date of purchase. Given
the short-term nature of these investments, we believe we are not subject to
significant interest rate risk with respect to these investments. Additionally,
we are subject to interest rate risk related to the $150 million of convertible
notes, combined with our notes payable and capital lease obligations. Our notes
payable and capital lease obligations bear interest at fixed rates, and their
carrying amount approximates fair value based on borrowing rates currently
available to us. As such, we believe that market risk arising from our notes
payable and capital lease obligations is not material. The convertible notes,
issued in December 1999, are unsecured and are subordinated to our existing and
future senior debt as defined in the indenture pursuant to which the convertible
notes were issued. The principal amount of the convertible notes will be due on
December 1, 2004 and will bear interest at an annual rate of 6.25%, payable
twice a year, on June 1 and December 1, beginning June 1, 2000, until the
principal amount of the convertible notes is fully repaid. The convertible notes
may be converted into our common stock at the option of the holder at any time
prior to December 1, 2004, unless the convertible notes have been previously
redeemed or repurchased by us. The conversion rate, subject to adjustment in
certain circumstances, is 13.5323 shares of our common stock for each $1,000
principal amount of convertible notes, which is equivalent to a conversion price
of approximately $73.90 per share. As of March 31, 2000, the carrying value of
the convertible notes was $150 million. As of March 31, 2000, the fair value of
the convertible notes was $58.5 million based upon the closing market price as
of that date. The difference between the carrying value and the fair value of
the convertible notes as of March 31, 2000 is primarily due to declines in the
price of our common stock and the favorable interest rate of the convertible
notes as compared to current interest rates.

45
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
eTOYS INC.
Report of Ernst & Young LLP, Independent Auditors........... 47
Consolidated Balance Sheets................................. 48
Consolidated Statements of Operations....................... 49
Consolidated Statements of Stockholders' Equity (Deficit)... 50
Consolidated Statements of Cash Flows....................... 51
Notes to Consolidated Financial Statements.................. 52

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
Unaudited Pro Forma Condensed Combined Statements of
Operations................................................ 68
Unaudited Pro Forma Condensed Combined Balance Sheet........ 70
Notes to Unaudited Pro Forma Condensed Combined Financial
Information............................................... 71

BABYCENTER, INC.
Report of Independent Auditors.............................. 74
Balance Sheets.............................................. 75
Statements of Operations.................................... 76
Statements of Shareholders' Equity (Deficit)................ 77
Statements of Cash Flows.................................... 78
Notes to Financial Statements............................... 79
</TABLE>

46
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders

eToys Inc.

We have audited the accompanying consolidated balance sheets of eToys Inc.
as of March 31, 2000 and 1999, and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for the three years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of eToys Inc. as
of March 31, 2000 and 1999, and the consolidated results of its operations and
its cash flows for the years then ended, in conformity with accounting
principles generally accepted in the United States.

/s/ Ernst & Young LLP

Los Angeles, California
April 26, 2000

47
<PAGE>
ETOYS INC.

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>
MARCH 31,
---------------------
2000 1999
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $139,627 $ 20,173
Inventories............................................... 60,309 5,067
Prepaids and other current assets......................... 14,350 1,577
-------- ---------
Total current assets........................................ 214,286 26,817
Property and equipment, net................................. 54,488 2,136
Goodwill (net of accumulated amortization of $25,786 and
$319 at March 31, 2000 and 1999, respectively)............ 142,828 637
Other assets................................................ 13,556 1,076
-------- ---------
Total assets................................................ $425,158 $ 30,666
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 32,422 $ 4,236
Accrued expenses.......................................... 10,789 530
Current portion of long-term notes payable and capital
lease obligations....................................... 6,090 230
-------- ---------
Total current liabilities................................... 49,301 4,996
Long-term notes payable and capital lease obligations....... 10,471 477
Long-term convertible subordinated notes.................... 150,000 --
Redeemable Convertible Preferred Stock, 19,593,089 shares
authorized:
Series A Preferred Stock; $.0001 par value; none and
7,023,645 shares issued and outstanding at March 31,
2000 and 1999, respectively........................... -- 4,355
Series B Preferred Stock, $.0001 par value, none and
11,886,649 shares issued and outstanding at March 31,
2000 and 1999, respectively........................... -- 24,952
Series C Preferred Stock, $.0001 par value, none and
666,666 shares issued and outstanding at March 31,
2000 and 1999, respectively........................... -- 19,984
Commitments and contingencies
Stockholders' equity:
Common Stock, $.0001 par value, 600,000,000 shares
authorized; 121,214,105 and 34,535,415 shares issued and
outstanding at March 31, 2000 and 1999, respectively.... 12 3
Additional paid-in capital................................ 476,529 45,837
Receivables from stockholders............................. (1,817) (138)
Deferred compensation..................................... (37,082) (38,974)
Accumulated other comprehensive loss...................... (1,803) --
Accumulated deficit....................................... (220,453) (30,826)
-------- ---------
Total stockholders' equity (deficit)........................ 215,386 (24,098)
-------- ---------
Total liabilities and stockholders' equity.................. $425,158 $ 30,666
======== =========
</TABLE>

See accompanying notes.

48
<PAGE>
ETOYS INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-------------------------------
2000 1999 1998
--------- -------- --------
<S> <C> <C> <C>
Net sales................................................... $ 151,036 $ 29,959 $ 687
Cost of sales............................................... 121,973 24,246 568
--------- -------- -------
Gross profit................................................ 29,063 5,713 119
Operating expenses:
Marketing and sales....................................... 120,460 20,719 1,290
Web site and technology................................... 43,429 3,608 421
General and administrative................................ 16,665 4,352 676
Goodwill amortization..................................... 27,835 319 --
Deferred compensation amortization........................ 13,701 5,814 2
--------- -------- -------
Total operating expenses................................ 222,090 34,812 2,389
--------- -------- -------
Operating loss.............................................. (193,027) (29,099) (2,270)
Other income (expense):
Interest income........................................... 7,409 589 18
Interest expense.......................................... (4,008) (47) (15)
--------- -------- -------
Loss before provision for taxes............................. (189,626) (28,557) (2,267)
Provision for taxes......................................... (1) (1) (1)
--------- -------- -------
Net loss.................................................... $(189,627) $(28,558) $(2,268)
========= ======== =======
Basic and diluted net loss per share........................ $ (1.78) $ (0.85) $ (0.09)
========= ======== =======
Shares used to compute basic and diluted net loss per
share..................................................... 106,597 33,428 25,130
========= ======== =======
</TABLE>

See accompanying notes.

49
<PAGE>
ETOYS INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>

COMMON STOCK ADDITIONAL RECEIVABLES
----------------------- PAID-IN FROM DEFERRED
SHARES AMOUNT CAPITAL STOCKHOLDERS COMPENSATION
----------- --------- ------------ --------------- ----------------
<S> <C> <C> <C> <C> <C>
Balance at April 1, 1997.................. -- $ -- $ -- $ -- $ --
Issuance of Common Stock................ 26,569,275 3 917 -- --
Restricted stock issued................. 6,080,001 -- 30 (30) --
Exercise of stock options............... 150,000 -- 1 -- --
Deferred compensation................... -- -- 55 -- (55)
Amortization of deferred compensation... -- -- -- -- 2
Comprehensive loss:
Net loss.............................. -- -- -- -- --
Comprehensive loss......................
----------- ------ -------- -------- ---------

Balance at March 31, 1998................. 32,799,276 3 1,003 (30) (53)
Restricted stock issued................. 525,000 -- 35 (140) --
Exercise of stock options............... 1,211,139 -- 32 -- --
Issuance of warrants.................... -- -- 32 -- --
Deferred compensation................... -- -- 44,735 -- (44,735)
Amortization of deferred compensation... -- -- -- -- 5,814
Repayment of receivables from
stockholders.......................... -- -- -- 32 --
Comprehensive loss:
Net loss.............................. -- -- -- -- --
Comprehensive loss......................
----------- ------ -------- -------- ---------

Balance at March 31, 1999................. 34,535,415 3 45,837 (138) (38,974)
Proceeds from initial public offering,
net of $2,606 issuance costs.......... 9,568,000 1 175,836 -- --
Conversion of Redeemable Convertible
Preferred Stock into Common Stock..... 58,779,267 6 49,296 -- --
Exercise of stock options and
warrants.............................. 2,702,116 -- 1,932 -- --
Common Stock issued for acquisition of
BabyCenter............................ 16,003,095 2 190,456 -- --
Issuance of Common Stock under Employee
Stock Purchase Plan................... 53,712 -- 1,042 -- --
Purchase of restricted stock............ (427,500) -- (2) -- --
Issuance of warrants.................... -- -- 323 -- --
Deferred compensation, net.............. -- -- 11,809 -- (11,809)
Amortization of deferred compensation... -- -- -- -- 13,701
Assumption of receivables from
stockholders.......................... -- -- -- (1,862) --
Repayment of receivables from
stockholders.......................... -- -- -- 183 --
Comprehensive loss:
Net loss.............................. -- -- -- -- --
Net unrealized loss on investments.... -- -- -- -- --
Foreign currency translation loss..... -- -- -- -- --
Comprehensive loss......................
----------- ------ -------- -------- ---------

Balance at March 31, 2000................. 121,214,105 $ 12 $476,529 $ (1,817) $ (37,082)
=========== ====== ======== ======== =========

<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE ACCUMULATED
LOSS DEFICIT TOTAL
------------------ --------------- ---------
<S> <C> <C> <C>
Balance at April 1, 1997.................. $ -- $ -- $ --
Issuance of Common Stock................ -- -- 920
Restricted stock issued................. -- -- --
Exercise of stock options............... -- -- 1
Deferred compensation................... -- -- --
Amortization of deferred compensation... -- -- 2
Comprehensive loss:
Net loss.............................. -- (2,268) (2,268)
---------
Comprehensive loss...................... (2,268)
------- ---------- ---------
Balance at March 31, 1998................. -- (2,268) (1,345)
Restricted stock issued................. -- -- (105)
Exercise of stock options............... -- -- 32
Issuance of warrants.................... -- -- 32
Deferred compensation................... -- -- --
Amortization of deferred compensation... -- -- 5,814
Repayment of receivables from
stockholders.......................... -- -- 32
Comprehensive loss:
Net loss.............................. -- (28,558) (28,558)
---------
Comprehensive loss...................... (28,558)
------- ---------- ---------
Balance at March 31, 1999................. -- (30,826) (24,098)
Proceeds from initial public offering,
net of $2,606 issuance costs.......... -- -- 175,837
Conversion of Redeemable Convertible
Preferred Stock into Common Stock..... -- -- 49,302
Exercise of stock options and
warrants.............................. -- -- 1,932
Common Stock issued for acquisition of
BabyCenter............................ -- -- 190,458
Issuance of Common Stock under Employee
Stock Purchase Plan................... -- -- 1,042
Purchase of restricted stock............ -- -- (2)
Issuance of warrants.................... -- -- 323
Deferred compensation, net.............. -- -- --
Amortization of deferred compensation... -- -- 13,701
Assumption of receivables from
stockholders.......................... -- -- (1,862)
Repayment of receivables from
stockholders.......................... -- -- 183
Comprehensive loss:
Net loss.............................. -- (189,627) (189,627)
Net unrealized loss on investments.... (1,641) -- (1,641)
Foreign currency translation loss..... (162) -- (162)
---------
Comprehensive loss...................... (191,430)
------- ---------- ---------
Balance at March 31, 2000................. $(1,803) $ (220,453) $ 215,386
======= ========== =========
</TABLE>

See accompanying notes.

50
<PAGE>
ETOYS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-------------------------------
2000 1999 1998
--------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss.................................................... $(189,627) $(28,558) $(2,268)
Adjustments to reconcile net loss to net cash used in
operating activities:
Noncash interest.......................................... -- 70 15
Nonemployee stock compensation............................ -- -- 33
Deferred compensation amortization related to stock
options................................................. 13,701 5,814 2
Depreciation.............................................. 5,700 411 18
Amortization of intangibles............................... 28,597 319 --
Other, net................................................ -- 6 --
Changes in operating assets and liabilities:
Inventories............................................. (53,622) (4,843) (198)
Prepaids and other current assets....................... (10,751) (1,542) (35)
Accounts payable........................................ 25,611 3,890 297
Accrued expenses........................................ 5,956 503 9
--------- -------- -------
Net cash used in operations................................. (174,435) (23,930) (2,127)

INVESTING ACTIVITIES:
Capital expenditures for property and equipment............. (44,252) (2,119) (178)
Proceeds from sale of property and equipment................ 5,419 475 --
Acquisition of Toys.com..................................... -- -- (270)
Net cash received from acquisition of BabyCenter, net of
acquisition costs......................................... 2,571 -- --
Net cash proceeds from the sale of Consumer Health
Interactive division...................................... 14,296 -- --
Proceeds from the sale of investments....................... 1,492 -- --
Other, net.................................................. (6,368) (1,076) --
--------- -------- -------
Net cash used in investing activities....................... (26,842) (2,720) (448)

FINANCING ACTIVITIES:
Proceeds from bridge loan................................... -- 5,000 --
Payments on bridge loan..................................... -- (2,238) --
Proceeds from the issuance of Common Stock and exercise of
stock options............................................. 178,821 32 225
Proceeds from the issuance of Redeemable Convertible
Preferred Stock and exercise of warrants.................. -- 42,469 3,007
Proceeds from the issuance of convertible
notes..................................................... -- -- 895
Proceeds from the issuance of convertible subordinated
notes..................................................... 150,000 -- --
Debt financing costs........................................ (4,810) -- --
Payments on notes payable and capital leases................ (3,301) (24) --
Proceeds from receivables from stockholders................. 183 32 --
--------- -------- -------
Net cash provided by financing activities................... 320,893 45,271 4,127
Effect of foreign exchange rate changes on cash............. (162) -- --
--------- -------- -------
Net increase in cash and cash equivalents................... 119,454 18,621 1,552
Cash and cash equivalents at beginning of period............ 20,173 1,552 --
--------- -------- -------
Cash and cash equivalents at end of period.................. $ 139,627 $ 20,173 $ 1,552
========= ======== =======
</TABLE>

See accompanying notes.

51
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SIGNIFICANT ACCOUNTING POLICIES

GENERAL

eToys Inc. (the Company) was incorporated in November 1996 in the state of
Delaware. Prior to June 1997, the Company had no operations or activities. In
June 1997, initial issuances of Common Stock occurred. The Company launched its
Web site in October 1997. The Company is a Web-based retailer focused
exclusively on children's products, including toys, video games, software,
videos, music and baby-related products.

The accompanying financial statements have been prepared on the basis that
the Company will continue as a going concern. The Company has incurred
significant operating losses since inception of operations and has limited
working capital. Management believes that the existing working capital in
addition to revenue generated from product sales will support the Company's
operations through March 31, 2001.

ESTIMATES AND ASSUMPTIONS

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

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All intercompany balances and transactions
have been eliminated.

RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to the current
year presentation.

CASH AND CASH EQUIVALENTS

All highly liquid investments with maturities of three months or less at the
date of purchase are considered to be cash equivalents and are carried at cost
plus accrued interest, which approximates fair value.

INVENTORIES

Inventories are stated at the lower of cost (using the first in-first out
method) or market and consist primarily of finished goods.

PROPERTY AND EQUIPMENT

Property and equipment is stated at cost. Depreciation and amortization is
provided using the straight-line method based upon estimated useful lives, which
range from three to five years. Assets acquired under lease and leasehold
improvements are amortized using the straight-line method over the shorter of
the estimated life of the asset or the remaining term of the lease.

Costs incurred for the purchase or development of internal use software,
including web site development costs, are also included within property and
equipment. All costs incurred in the

52
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
preliminary project stage, as well as maintenance and training, are expensed as
incurred. Once the development project has completed the preliminary project
stage and it is deemed probable that the project will be completed and used as
intended, the project is considered to have moved into the application
development stage. All costs incurred for the development or purchase of
internal-use software that are incurred in the application development stage are
capitalized as incurred. All capitalized costs are then amortized over their
estimated useful lives, which is typically three years.

GOODWILL

Goodwill represents the excess of the purchase price over the estimated fair
market value of net assets acquired in a business combination. Goodwill is
amortized on a straight-line basis over three to five years.

LONG-LIVED ASSETS

The Company reviews for the impairment of long-lived assets and certain
identifiable intangibles whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. An impairment loss
would be recognized when estimated future cash flows expected to result from the
use of the asset and its eventual disposition is less than its carrying amount.
No such impairment losses have been identified by the Company.

INCOME TAXES

Income taxes are accounted for under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under SFAS 109,
deferred tax assets and liabilities are determined based on differences between
financial reporting and tax basis of assets and liabilities, and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.

FOREIGN CURRENCY TRANSLATION

The functional currency of the Company's foreign subsidiaries is the local
currency. Assets and liabilities of the foreign subsidiaries are translated into
U.S. dollars at the period end exchange rates, and revenues and expenses are
translated at average rates prevailing during the periods presented. Translated
adjustments are included in accumulated other comprehensive loss, a separate
component of stockholders' equity. Transaction gains or losses arising from
transactions denominated in a currency other than the functional currency of the
entity involved, which have been insignificant, are included in the consolidated
statements of operations.

COMPREHENSIVE LOSS

As of April 1, 1999, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income", which establishes standards
for the reporting and display of comprehensive loss and its components in the
financial statements. Comprehensive loss is composed of net loss, net unrealized
losses on investments and foreign currency translation adjustments.

53
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET LOSS PER SHARE

Net loss per share is computed using the weighted average number of shares
of Common Stock outstanding. Shares associated with stock options and the
Redeemable Convertible Preferred Stock are not included for the years ended
March 31, 2000, 1999 and 1998 because they are antidilutive. Effective upon the
closing of the Company's initial public offering in May 1999, the shares of the
Redeemable Convertible Preferred Stock automatically converted into Common Stock
and are included in the calculation of weighted average number of shares as of
that date.

The following table sets forth the computation of basic and diluted net loss
per share for the periods indicated:

<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
------------------------------------------
2000 1999 1998
------------- ------------ -----------
<S> <C> <C> <C>
Numerator:
Net loss....................................... $(189,627,000) $(28,558,000) $(2,268,000)
============= ============ ===========
Denominator:
Weighted average shares........................ 106,597,242 33,427,908 25,129,888
------------- ------------ -----------
Denominator for basic and diluted
calculation.................................. 106,597,242 33,427,908 25,129,888
============= ============ ===========
Basic and diluted net loss per share............. $ (1.78) $ (0.85) $ (0.09)
============= ============ ===========
</TABLE>

REVENUE RECOGNITION

The Company recognizes revenue from product sales, net of any discounts,
when the products are shipped to customers. Outbound shipping and handling
charges are included in net sales. The Company provides an allowance for sales
returns in the period of sale, based upon historical experience. Additionally,
revenues provided from the sale of banner advertisements and sponsorship
advertising contracts are recognized ratably in the period in which the
advertising is displayed, provided that no significant Company obligations
remain and collections of the resulting receivable is probable.

ADVERTISING COSTS

The Company expenses advertising costs as incurred. For the years ended
March 31, 2000, 1999 and 1998, the Company incurred advertising costs of
$55.5 million, $10.8 million and $0.9 million, respectively.

ACCOUNTING FOR STOCK-BASED COMPENSATION

Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," ("SFAS 123") requires that stock awards granted
subsequent to January 1, 1995, be recognized as compensation expense based on
their fair value at the date of grant. Alternatively, a company may use
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," ("APB 25") and disclose pro forma income amounts which would have
resulted from recognizing such awards at their fair value. The Company has
elected to account for stock-based

54
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
compensation expense under APB 25 and make the required pro forma disclosures
for compensation (see Note 7).

CONCENTRATIONS OF CREDIT RISK

The Company is potentially subject to concentrations of credit risk arising
principally from its holdings of cash and cash equivalents. The Company's credit
risk is managed by investing its cash in high quality money market instruments
and securities of the U.S. government and its agencies, foreign governments and
high quality corporate issuers. The Company believes it had no significant
concentrations of credit risk as of March 31, 2000 and 1999.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts for the Company's cash and cash equivalents, notes
receivable, accounts payable and accrued liabilities approximate fair value due
to the relatively short maturity of these instruments. Notes payable and capital
lease obligation carrying amounts approximate fair value based upon borrowing
rates currently available to the Company. The fair value of the Company's fixed
rate long-term debt is based upon the closing market price (see Note 5).

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). Subsequently, Statement of Financial
Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of FASB Statement No. 133" ("SFAS
137") was issued, which deferred the effective date of SFAS 133 for one year.
SFAS 133, as amended by SFAS 137, is effective for all fiscal quarters for all
fiscal years beginning after June 15, 2000. SFAS 133 requires all derivative
instruments to be recorded as assets or liabilities at fair value. Gains or
losses resulting from changes in the values of those derivatives would be
accounted for depending on the use of the derivatives and whether it qualifies
for hedge accounting. The Company does not believe the effects of adoption will
be material to its financial position or results of operations as the Company
does not currently hold any derivative instruments.

In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB No. 101"), which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements. SAB No. 101 did not impact the
Company's revenue recognition policies.

2. ACQUISITIONS AND DISPOSALS

The acquisition has been accounted for as a purchase and the acquisition
costs of $190.0 million have been allocated to the assets acquired and the
liabilities assumed based upon

55
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. ACQUISITIONS AND DISPOSALS (CONTINUED)
estimates of their respective fair values. A total of $189.0 million,
representing the excess of the purchase price over the fair value of the net
tangible assets acquired, has been allocated to intangible assets and is being
amortized over five years.

The Company's consolidated results of operations incorporates BabyCenter's
results of operations commencing upon the July 1, 1999 acquisition date. The
unaudited pro forma combined information below presents the combined results of
operations of the Company as if the acquisition had occurred at the beginning of
the respective periods presented. The unaudited pro forma combined information,
based upon the historical consolidated financial statements of the Company and
BabyCenter, is based on an acquisition cost of $190.0 million and assumes that
an estimated $189.0 million excess of acquisition cost over the book value of
BabyCenter's net tangible assets is allocated to intangible assets with a useful
life of five years.

<TABLE>
<CAPTION>
YEARS ENDED
MARCH 31,
---------------------
2000 1999
--------- ---------
(IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C>
Revenues................................................ $ 153.1 $ 34.7
Net loss................................................ $(206.2) $(70.9)
Net loss per share(1)................................... $ (1.87) $(1.43)
</TABLE>

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

(1) Net loss per share is calculated using the weighted average number of common
shares outstanding, including the effects of the automatic conversion of the
Company's Redeemable Convertible Preferred Stock into Common Stock effective
upon the closing of the Company's initial public offering, and the issuance
of approximately 16.0 million shares to stockholders of BabyCenter as if
such events had occurred on April 1, 1998.

The unaudited pro forma combined information is not necessarily indicative
of the results of operations of the combined company had the acquisition
occurred at the beginning of the periods presented, nor is it necessarily
indicative of future results.

In March 1998, the Company acquired certain assets and assumed certain
liabilities and obligations of one of its online competitors, Toys.com,
including $25,000 in toy inventories and assumed certain advertising liabilities
in the amount of $48,000, and the assumption of future contingent advertising
contracts. The acquisition was accounted for under the purchase method of
accounting and included a cash payment of approximately $0.3 million and the
issuance of 2,340,000 shares of Common Stock with an estimated deemed fair value
of approximately $0.7 million. Goodwill resulting from the acquisition was
approximately $1.0 million. Subsequent to the acquisition, Toys.com ceased
operations as a separate entity.

On January 18, 2000, BabyCenter Inc., a wholly-owned subsidiary of the
Company, completed its sale of substantially all of the assets and related
liabilities of its Consumer Health Interactive ("CHI") division. In connection
with the sale, the Company received proceeds in a combination of cash and
registrable securities of approximately $20.0 million. The revenues and
operating results of CHI were not significant to the consolidated financial
results of the Company. The net book value of CHI's assets and related
liabilities approximated the sale price of $20.0 million as of the date of sale.

56
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

3. PROPERTY AND EQUIPMENT

Property and equipment, at cost, consist of the following:

<TABLE>
<CAPTION>
MARCH 31,
-------------------
2000 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Computers, equipment and software......................... $15,556 $1,393
Furniture and fixtures.................................... 909 10
Leasehold improvements.................................... 2,765 371
Leased assets............................................. 16,460 731
Construction in progress.................................. 25,027 --
------- ------
60,717 2,505
Less accumulated depreciation and amortization............ (6,229) (369)
------- ------
Property and equipment, net........................... $54,488 $2,136
======= ======
</TABLE>

4. INCOME TAXES

As a result of the net operating losses, the provision for income taxes
consists solely of minimum state taxes. The following is a reconciliation of the
statutory federal income tax rate to the Company's effective income tax rate:

<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
------------------------------------
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Statutory federal income tax expense (benefit)....... (34)% (34)% (34)%
State income tax expense (benefit)................... (3) (6) (6)
Valuation allowance.................................. 30 24 40
Non-deductible stock compensation.................... 2 15 --
Non-deductible goodwill amortization................. 5 1 --
--- --- ---
-- % -- % -- %
=== === ===
</TABLE>

The components of the deferred tax assets and related valuation allowance at
March 31, 2000 and 1999, are as follows:

<TABLE>
<CAPTION>
MARCH 31,
-------------------
2000 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Reserves............................................... $ 2,964 $ --
Other.................................................. 1,023 792
Net operating loss carryforwards....................... 69,445 9,731
-------- --------
Deferred tax assets.................................... 73,432 10,523
Valuation allowance.................................... (73,432) (10,523)
-------- --------
$ -- $ --
======== ========
</TABLE>

57
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

4. INCOME TAXES (CONTINUED)
Due to the uncertainty surrounding the timing of realizing the benefits of
its favorable tax attributes in future tax returns, the Company has placed a
valuation allowance against its otherwise recognizable deferred tax assets.

The Company has net operating losses for both federal and state tax purposes
of approximately $177.4 million and $103.6 million, respectively, expiring
beginning in the years 2012 for federal and 2005 for state. The net operating
losses can be carried forward to offset future taxable income. Approximately
$14.7 million and $7.3 million of the federal and state net operating losses,
respectively, relate to stock option deductions, which, if realized will be
credited to additional paid-in capital. Utilization of the above carryforwards
may be subject to utilization limitations, which may inhibit the Company's
ability to use carryforwards in the future.

5. DEBT

In December 1999, the Company issued $150 million principal amount of 6.25%
convertible subordinated notes (the "Convertible Notes") due December 1, 2004.
In connection with the issuance of the Convertible Notes, the Company incurred
financing costs of $4.8 million, resulting in net proceeds to the Company of
$145.2 million. The Convertible Notes are unsecured and are subordinated to
existing and future senior debt as defined in the indenture pursuant to which
the Convertible Notes were issued. The principal amount of the Convertible Notes
will be due on December 1, 2004 and will bear interest at an annual rate of
6.25%, payable twice a year, on June 1 and December 1, beginning June 1, 2000,
until the principal amount of the Convertible Notes is fully repaid. The
Convertible Notes may be converted into the Company's Common Stock at the option
of the holder at any time prior to December 1, 2004, unless the Convertible
Notes have been previously redeemed or repurchased by the Company. The
conversion rate, subject to adjustment in certain circumstances, is 13.5323
shares of the Company's Common Stock for each $1,000 principal amount of the
Convertible Notes, which is equivalent to a conversion price of approximately
$73.90 per share. Additionally, on or after December 1, 2002, the Company may
redeem all or a portion of the Convertible Notes, that have not been previously
redeemed or repurchased, at any time at redemption prices set forth in the
indenture pursuant to which the Convertible Notes were issued, plus any accrued
and unpaid interest to the redemption date.

In February 2000, the Company filed a shelf registration statement with the
Securities and Exchange Commission covering resales of the $150 million of
Convertible Notes and Common Stock issuable upon conversion of the Convertible
Notes. The shelf registration statement is expected to be declared effective in
June 2000.

In accordance with Statement of Financial Accounting Standards No. 107,
"Disclosure about Fair Value of Financial Instruments," a reasonable estimate of
the fair value of the Convertible Notes outstanding at March 31, 2000 was $58.5
million. This is based upon the closing market price of the Convertible Notes on
that date.

During the year ended March 31, 1998, the Company received $0.9 million in
proceeds from the issuance of 6.07% convertible notes. The notes were
automatically converted into Series A Redeemable Convertible Preferred Stock due
to certain conditions as specified within the initial note agreement. As a
result of the conversion, the initial proceeds from the convertible notes of
$0.9 million, plus $15,000 of accrued interest, were converted into 1,468,018
shares of Series A Redeemable Convertible Preferred Stock.

58
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

5. DEBT (CONTINUED)
In conjunction with the issuance of the 6.07% convertible notes, the Company
issued to the purchasers of the 6.07% convertible notes, 721,757 stock warrants
for the purchase of Series A Redeemable Convertible Preferred Stock at $.62 per
share. As of March 31, 2000, all warrants have been exercised. No value has been
allocated to the warrants as the amount is not deemed to be significant.

On May 6, 1998, the Company entered into a $5.0 million bridge financing
agreement with a group of investors. The bridge financing was in the form of
Convertible Subordinated Promissory Notes (the Notes) which were payable on
demand after May 6, 1999 accruing interest at a rate of 8% per annum until paid
and compounded annually. In July 1998, $2.8 million of the Notes plus interest
were converted into 1,331,235 shares of Series B Redeemable Convertible
Preferred Stock. The remaining balance of the Notes of $2.2 million plus accrued
interest was repaid in cash to the investors in June 1998.

Effective upon the closing date of the Company's initial public offering,
all Redeemable Convertible Preferred Stock, including all shares purchased from
the exercise of warrants, were converted into Common Stock.

6. CAPITAL STRUCTURE

REDEEMABLE CONVERTIBLE PREFERRED STOCK

On March 19, 1999, the Company amended its Certificate of Incorporation to,
among other matters, increase the authorized number of shares of Preferred Stock
to 19,593,089.

In conjunction with this amendment, the Company authorized 666,666 shares of
Series C Redeemable Convertible Preferred Stock (Series C). In December 1997,
the issuance of Series A Redeemable Convertible Preferred Stock (Series A)
resulted in proceeds of $3.0 million, representing 4,849,999 shares issued and
outstanding at $0.62 per share. In conjunction with this offering, $0.9 million
of convertible notes, plus related accrued interest of $15,000, were converted
into 1,468,018 shares of Series A (see Note 5). In June 1998, the issuance of
Series B resulted in proceeds of $25.0 million representing 11,886,649 shares
issued and outstanding at $2.1032 per share. In March 1999, the Company issued
Series C which resulted in proceeds of approximately $20.0 million, representing
666,666 shares issued and outstanding at $30 per share. Each share of Redeemable
Convertible Preferred Stock is convertible, at the stockholder's option, into
such number of fully paid and nonassessable shares of Common Stock as is
determined by dividing $0.62 in the case of Series A, $2.1032 in the case of
Series B and $30 in the case of Series C by the Conversion Price, as defined.

Upon the closing of the Company's initial public stock offering, all
Redeemable Convertible Preferred Stock, including stock warrants exercised for
the purchase of 721,757 shares of Series A Redeemable Convertible Preferred
Stock, was converted into an aggregate of 58,779,267 shares of Common Stock.

COMMON STOCK

In March 1999, the Company's Board of Directors declared a stock split of
three shares for every one share of Common Stock then outstanding. The stock
split was effective May 24, 1999, the date the Company's public offering of
Common Stock closed. Accordingly, the accompanying

59
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

6. CAPITAL STRUCTURE (CONTINUED)
financial statements and footnotes have been restated to reflect the stock
split. The par value of the shares of Common Stock to be issued in connection
with the stock split was credited to Common Stock and a like amount charged to
additional paid-in capital.

The following table is presented to summarize the Common Stock authorized at
March 31, 2000:

<TABLE>
<CAPTION>
COMMON
SHARES ISSUED
DESCRIPTION OF INSTRUMENT OR RESERVED
------------------------------------------------------------ -------------
<S> <C>
Common Stock outstanding 121,214,105
1997 Employee Incentive Stock Option Plan 17,400,000
1999 Employee Incentive Stock Option Plan 24,800,000
1997 BabyCenter, Inc. Stock Option Plan 2,716,905
1999 Employee Stock Purchase Plan 1,000,000
1999 Directors Stock Option Plan 600,000
Convertible subordinated notes 2,029,845
Common Stock warrants 4,000
-----------
Common Stock issued or reserved 169,764,855
-----------
Common Stock available 430,235,145
===========
</TABLE>

RECEIVABLES FROM STOCKHOLDERS

Receivables from stockholders, totaling $0.1 million at March 31, 1999,
represent interest bearing notes from certain stockholders issued to finance the
purchase of 6,605,001 and 50,000 shares of the Company's Common and Series B,
respectively. The notes bear interest rates between 6.0% and 8.0% per year with
interest due upon payment of the notes. The notes outstanding as of March 31,
1999 were fully repaid during the year ended March 31, 2000.

Receivables from stockholders as of March 31, 2000 of $1.8 million represent
the outstanding balance of $1.8 million on interest bearing notes from certain
BabyCenter stockholders issued to finance the purchase of BabyCenter common
stock. These notes were assumed by the Company in connection with the
acquisition of BabyCenter. As a result of the assumption of the notes, the
issued notes are financing the purchase of 1,395,022 shares of the Company's
Common Stock. The notes bear interest rates between 4.77% and 5.21% per year
with interest due upon payment of the notes. The notes are payable on different
dates ranging from March 3, 2003 to April 12, 2003, or upon termination of
employment or transfer or any purchased shares.

DEFERRED COMPENSATION

The Company recorded deferred compensation, net of option cancellations, of
$11.8 million, $44.7 million and $0.1 million for the years ended March 31,
2000, 1999 and 1998, respectively. The amounts recorded represent the difference
between the grant price and the deemed fair value of the Company's Common Stock
for shares subject to options granted. The amortization of deferred compensation
will be charged to operations over the vesting period of the options, which is
typically four years. Total amortization recognized was $13.7 million,
$5.8 million and $2,000 for the years ended March 31, 2000, 1999 and 1998,
respectively.

60
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

6. CAPITAL STRUCTURE (CONTINUED)
The following table shows the amounts of deferred compensation amortization
that would have been recorded under the following income statement categories
had deferred compensation amortization not been separately stated in the
consolidated statements of operations:

<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
------------------------------
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Marketing and sales............................ $ 3,541 $ 1,503 $ --
Web site and technology........................ 4,489 1,905 --
General and administrative..................... 5,671 2,406 2
------- ------- -------
$13,701 $ 5,814 $ 2
======= ======= =======
</TABLE>

7. STOCK OPTION PLANS

The Company adopted the 1997 Stock Option Plan, as amended June 1998 (the
Plan), which provides for the granting of options for purchases up to
17,400,000 shares of the Company's Common Stock. Under the terms of the Plan,
options may be granted to employees, nonemployees, directors or consultants at
prices not less than the fair value at the date of grant. Options granted to
nonemployees are recorded at the value of negotiated services received. Options
vest over four years, 25% for the first year and ratably over the remaining
three years and generally expire ten years from the date of grant.

In February 1999, the Board of Directors adopted the 1999 Stock Option Plan,
the 1999 Directors' Stock Option Plan and the 1999 Employee Stock Purchase Plan.
In March 1999 the stockholders approved these plans. The 1999 Stock Option Plan
provides for 24,800,000 shares of Common Stock to be granted under terms similar
to the 1997 Stock Plan. The 1999 Directors' Stock Option Plan reserves a total
of 600,000 shares of Common Stock for grants of options to nonemployee
directors. The 1999 Employee Stock Purchase Plan reserves a total of 1,000,000
shares of Common Stock for limited purchases by employees through payroll
deductions, with a purchase price equal to 85% of the fair market value of the
Common Stock.

In connection with the BabyCenter acquisition, the Company assumed the
outstanding options issued under the BabyCenter, Inc. 1997 Stock Option Plan.
Upon closing of the merger, options outstanding under the BabyCenter plan became
options to purchase an aggregate of 2,716,905 shares of the Company's Common
Stock. The terms of the BabyCenter options are similar to the terms of options
issuable under the 1999 Stock Option Plan, except that if the Company were
acquired, such options would terminate if not assumed, or equivalent options
substituted, by the Company's acquiror.

61
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

7. STOCK OPTION PLANS (CONTINUED)

The following table summarizes the Company's stock option activity:

<TABLE>
<CAPTION>
NUMBER OF PRICE WEIGHTED AVERAGE
SHARES PER SHARE EXERCISE PRICE
---------- ----------------- -----------------
<S> <C> <C> <C>
Outstanding at March 31, 1997............... --
Granted................................... 4,407,000 $0.005 to $ 0.033 $ 0.010
Exercised................................. (150,000) 0.005 to 0.005 0.005
Canceled.................................. -- --
----------

Outstanding at March 31, 1998............... 4,257,000 0.005 to 0.033 0.010
Granted................................... 14,116,650 0.033 to 9.000 1.695
Exercised................................. (1,736,136) 0.005 to 3.333 0.037
Canceled.................................. (1,709,838) 0.005 to 3.333 0.053
----------

Outstanding at March 31, 1999............... 14,927,676 0.005 to 9.000 1.595
Granted and assumed(1).................... 11,645,147 0.040 to 73.875 19.819
Exercised................................. (2,546,725) 0.005 to 20.000 0.724
Canceled.................................. (1,562,777) 0.033 to 66.563 10.397
----------

Outstanding at March 31, 2000............... 22,463,321 $0.005 to $73.875 $10.467
==========
</TABLE>

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

(1) Includes the assumption of 2,716,905 outstanding options issued under the
BabyCenter, Inc. 1997 Stock Option Plan assumed by the Company in connection
with the BabyCenter acquisition.

Options outstanding at March 31, 2000, 1999 and 1998 were exercisable for
4,119,590, 535,944 and 321,000 shares of Common Stock, respectively. Common
Stock available for future grants at March 31, 2000, 1999 and 1998 were
18,620,723, 22,786,188 and 4,165,500 shares, respectively.

Additional information with respect to the outstanding options as of
March 31, 2000 is as follows:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- ---------------------
WEIGHTED WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
NUMBER OF EXERCISE CONTRACTUAL NUMBER OF EXERCISE
SHARES PRICE LIFE SHARES PRICE
---------- -------- ---------------- ---------- --------
<S> <C> <C> <C> <C> <C>
RANGE OF EXERCISE PRICES
$ 0.005 to $ 0.140................ 2,562,307 $ 0.055 7.92 631,364 $ 0.062
0.143 to 0.143................ 5,450,613 0.143 8.56 1,627,754 0.143
0.150 to 3.333................ 3,306,646 2.405 8.79 814,128 2.440
3.830 to 10.520................ 2,605,700 8.784 9.22 379,403 8.499
11.000 to 11.580................ 2,406,907 11.121 9.10 17,749 11.000
14.063 to 19.750................ 3,049,391 16.677 9.86 970 19.750
20.000 to 43.500................ 2,212,628 32.267 9.42 640,772 26.087
49.850 to 62.625................ 552,484 60.182 9.51 7,450 59.750
66.563 to 66.563................ 314,050 66.563 9.50 -- --
73.875 to 73.875................ 2,595 73.875 9.58 -- --
---------- ---------
$ 0.005 to $73.875................ 22,463,321 $10.467 8.97 4,119,590 $ 5.549
========== =========
</TABLE>

62
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

7. STOCK OPTION PLANS (CONTINUED)
Pro forma information regarding the net loss and net loss per share is
required by SFAS 123. This information is required to be determined as if the
Company had accounted for its employee stock option grants under the fair value
method of that statement. The Company calculated the minimum fair value of each
option grant on the date of the grant using the minimum value option pricing
model as prescribed by SFAS 123 through May 20, 1999. The fair value of the
options granted subsequent to May 20, 1999 have been estimated at the date of
grant using the Black-Scholes option pricing model. The following weighted
average assumptions were used:

<TABLE>
<CAPTION>
YEARS ENDED
MARCH 31,
------------------------------
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Risk-free interest rates................................. 6.1% 5.14% 6.0%
Expected lives (in years)................................ 4 4 5
Dividend yield........................................... 0% 0% 0%
Expected volatility...................................... 90% 0% 0%
</TABLE>

Had compensation cost for the Company's stock option plan been determined
consistent with the fair value method as required by SFAS 123, the Company's net
loss and net loss per share would have been as indicated below:

<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
------------------------------------------
2000 1999 1998
----------- ---------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Net loss:
As reported......................................... $ (189,627) $ (28,558) $ (2,268)
Pro forma........................................... (214,787) (28,686) (2,268)
Basic and diluted net loss per share:
As reported......................................... $ (1.78) $ (0.85) $ (0.09)
Pro forma........................................... (2.01) (0.86) (0.09)
</TABLE>

8. COMMITMENTS AND CONTINGENCIES

LEASES AND NOTES PAYABLE OBLIGATIONS

The Company leases its office and warehouse facilities under long-term
noncancelable operating leases. The Company had a letter of credit outstanding
relating to building leases in the amount of $7.5 million as of March 31, 2000.
For the years ended March 31, 2000, 1999 and 1998, total rent expense incurred
related to these leases amounted to $6.3 million, $0.6 million and
$0.1 million, respectively.

63
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8. COMMITMENTS AND CONTINGENCIES (CONTINUED)
At March 31, 2000, future lease and notes payable commitments are as follows
(in thousands):

<TABLE>
<CAPTION>
NOTES
PAYABLE
AND
OPERATING CAPITAL
LEASES LEASES
--------- --------
<S> <C> <C>
2001........................................................ $ 14,505 $ 7,452
2002........................................................ 15,676 7,243
2003........................................................ 15,543 4,148
2004........................................................ 13,049 362
2005........................................................ 10,852 --
Thereafter.................................................. 58,390 --
-------- -------
$128,015 19,205
========
Less amounts representing interest.......................... (2,644)
-------
$16,561
=======
</TABLE>

EQUIPMENT FINANCING ARRANGEMENT

During December 1998, the Company entered into a line of credit arrangement
with a leasing institution that provides for sale and leaseback transactions of
capital equipment up to a maximum of $2.0 million. Under this agreement,
$1.3 million was available for future financing transactions at March 31, 1999.
During the year ended March 31, 2000, the remaining financing available under
the agreement was fully utilized. In addition, the agreement provided the
leasing institution warrants, with value equal to approximately $0.1 million
with the number of shares to be determined pursuant to a formula, as defined, at
the time of issuance. Such warrants were issued on January 31, 1999 and
subsequently exercised in March 2000.

ADVERTISING COMMITMENTS

During 1999 and the first part of 2000, the Company entered into a number of
commitments for online, print and broadcast advertising. At March 31, 2000,
future advertising commitments were as follows: $11.4 million in 2001,
$7.9 million in 2002 and $2.2 million in 2003.

LEGAL PROCEEDINGS

From time to time, the Company is involved in legal proceedings relating to
claims arising out of the ordinary course of business, including employment
related claims and claims of alleged infringement of trademarks, copyrights and
other intellectual property. The Company currently is not aware of any such
legal proceedings that it believes will have, individually or in the aggregate,
a material adverse effect on its business, prospects, financial condition or
operating results.

9. RETIREMENT PLAN

The Company maintains a defined contribution 401(k) plan under which its
employees are eligible to participate. Participants may make, within certain
limitations, voluntary contributions based upon a percentage of their
compensation. The Company may make voluntary contributions to the Plan.
Participants are fully vested in the Company's contributions after a specified
number of

64
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9. RETIREMENT PLAN (CONTINUED)
years of service, as defined under the plan. No Company contributions had been
made to date under the plan.

10. SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION

<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-------------------------------
2000 1999 1998
--------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Income taxes paid........................................... $ 1 $ 1 $ 1
Interest paid............................................... $ 706 $ 9 $ --
Notes payable and capital lease obligations incurred........ $ 17,143 $ 731 $ --
Conversion of outstanding notes into Series A and Series B
Redeemable Convertible Preferred Stock.................... $ -- $ 2,800 $ 910
Issuance of stock in connection with the Toys.com
acquisition............................................... $ -- $ -- $ 663
Issuance of notes receivables for Common Stock and
Redeemable Convertible Preferred Stock.................... $ -- $ 140 $ 30
Acquisition of BabyCenter:
Fair value of assets acquired (including goodwill)........ $ 197,634 $ -- $ --
Liabilities assumed....................................... (9,017) -- --
Stock issued.............................................. (189,987) -- --
Assumption of stockholders' receivable.................... 1,862 -- --
--------- ------- -----
Cash paid................................................... 492 -- --
Cash acquired............................................... (3,063) -- --
--------- ------- -----
Net cash received from acquisition of BabyCenter............ $ 2,571 $ -- $ --
========= ======= =====
</TABLE>

11. SUBSEQUENT EVENTS (UNAUDITED)

In May 2000, the Company increased the number of shares eligible to be
granted under the 1999 Stock Plan to 28,455,005 and the number of shares
available for purchase under the 1999 Employee Stock Purchase Plan to 1,609,167.

12. QUARTERLY RESULTS (UNAUDITED)

The following tables contain selected unaudited Statement of Operations
information for each quarter of 2000 and 1999. The Company believes that the
following information reflects all normal

65
<PAGE>
ETOYS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

12. QUARTERLY RESULTS (UNAUDITED) (CONTINUED)
recurring adjustments necessary for a fair presentation of the information for
the periods presented. The operating results for any quarter are not necessarily
indicative of results for any future period.

<TABLE>
<CAPTION>
YEAR ENDED MARCH 31, 2000
--------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net sales......................................... $ 7,975 $ 13,306 $106,751 $ 23,004
Gross profit...................................... 1,518 2,554 20,284 4,707
Net loss.......................................... (20,783) (44,944) (75,487) (48,413)
Basic and diluted loss per share.................. $ (0.32) $ (0.38) $ (0.63) $ (0.40)
======== ======== ======== ========
Shares used in computation of basic and diluted
loss per share.................................. 65,959 119,374 119,716 120,608
======== ======== ======== ========
</TABLE>

<TABLE>
<CAPTION>
YEAR ENDED MARCH 31, 1999
--------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net sales......................................... $ 381 $ 608 $ 22,910 $ 6,059
Gross profit...................................... 70 112 4,709 821
Net loss.......................................... (2,171) (3,383) (9,822) (13,182)
Basic and diluted loss per share.................. $ (0.07) $ (0.10) $ (0.29) $ (0.38)
======== ======== ======== ========
Shares used in computation of basic and diluted
loss
per share....................................... 32,838 32,893 33,731 34,240
======== ======== ======== ========
</TABLE>

66
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

The following unaudited pro forma condensed combined financial information
for the Company consists of the Unaudited Pro Forma Condensed Combined
Statements of Operations for the years ended March 31, 2000 and 1999 and the
Unaudited Pro Forma Condensed Combined Balance Sheet as of March 31, 1999.

On July 1, 1999, the Company completed its acquisition of BabyCenter, Inc.
("BabyCenter") pursuant to a reorganization agreement executed in April 1999. As
consideration for the purchase, the Company issued to the stockholders of
BabyCenter approximately 16.0 million shares of the Company's common stock
valued at $190.0 million based upon the stock price on the date that the
transaction was announced. The Unaudited Pro Forma Condensed Combined Statement
of Operations for the year ended March 31, 2000 gives effect to transaction as
if it had taken place on April 1, 1999. The Unaudited Pro Forma Condensed
Combined Statement of Operations for the year ended March 31, 1999 gives effect
to the BabyCenter acquisition as if it had taken place on April 1, 1998. The
Unaudited Pro Forma Condensed Combined Balance Sheet as of March 31, 1999 gives
effect to transaction as if it had taken place on March 31, 1999.

The acquisition has been accounted for as a purchase and the acquisition
costs of $190.0 million have been allocated to the assets acquired and the
liabilities assumed based upon estimates of their respective fair values. A
total of $189.0 million, representing the excess of the purchase price over the
fair value of the net tangible assets acquired, has been allocated to intangible
assets and is being amortized over five years. Had the acquisition been
completed on March 31, 1999, a total of $183.9 million, representing the excess
of the purchase price over the fair value of the net tangible assets acquired as
of March 31, 1999, would have been allocated to intangible assets and amortized
over five years.

The Company's historical consolidated results of operations as of March 31,
2000 incorporate BabyCenter's results of operations commencing upon the July 1,
1999 acquisition date. Accordingly, the Unaudited Pro Forma Condensed Combined
Statement of Operations for the year ended March 31, 2000 combines the Company's
historical consolidated results of operations for the year ended March 31, 2000
and BabyCenter's historical results of operations for the quarter ended June 30,
1999. Additionally, the Unaudited Pro Forma Condensed Combined Statement of
Operations for the year ended March 31, 2000 is based upon an acquisition cost
of $190.0 million and assumes that an estimated $189.0 million excess of
acquisition cost over the book value of BabyCenter's net tangible assets is
allocated to intangible assets with a useful life of five years.

The Unaudited Pro Forma Condensed Combined Statement of Operations for the
year ended March 31, 1999 combines the Company's historical results for the year
ended March 31, 1999 with BabyCenter's historical results for the year ended
March 31, 1999. In addition, the Unaudited Pro Forma Condensed Combined
Statement of Operations for the year ended March 31, 1999 is based upon an
acquisition cost of $190.0 million and assumes that an estimated $183.9 million
excess of acquisition cost over the book value of BabyCenter's net tangible
assets as of March 31, 1999 is allocated to intangible assets with a useful life
of five years.

The pro forma financial information has been prepared on the basis of the
assumptions described in the notes. The pro forma financial information is not
necessarily indicative of the results of operations of the combined company had
the acquisition occurred on April 1, 1999, March 31, 1999 or April 1, 1998, nor
is it necessarily indicative of future results.

67
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 2000
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
PRO FORMA
ETOYS BABYCENTER ADJUSTMENTS TOTAL
--------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales.................................... $ 151,036 $ 2,052 $ -- $ 153,088
Cost of sales................................ 121,973 971 -- 122,944
--------- ------- -------- ---------
Gross profit................................. 29,063 1,081 -- 30,144
Operating expenses:
Marketing and sales........................ 120,460 1,839 -- 122,299
Web site and technology.................... 43,429 926 -- 44,355
General and administrative................. 16,665 4,401 -- 21,066
Goodwill amortization...................... 27,835 -- 9,452 (5) 37,287
Deferred compensation amortization......... 13,701 1,149 -- 14,850
--------- ------- -------- ---------
Total operating expenses................. 222,090 8,315 9,452 239,857
--------- ------- -------- ---------
Operating loss............................... (193,027) (7,234) (9,452) (209,713)
Other income (expense):
Interest income............................ 7,409 114 -- 7,523
Interest expense........................... (4,008) (45) -- (4,053)
--------- ------- -------- ---------
Loss before provision for taxes.............. (189,626) (7,165) (9,452) (206,243)
Provision for taxes.......................... (1) (1) -- (2)
--------- ------- -------- ---------
Net loss..................................... $(189,627) $(7,166) $ (9,452) $(206,245)
========= ======= ======== =========
Basic and diluted net loss per share......... $ (1.78) $ (1.87)
========= =========
Shares used to compute basic and diluted net
loss per share............................. 106,597 3,990 (6) 110,587
========= ======== =========
</TABLE>

See notes to unaudited pro forma condensed combined financial information.

68
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
PRO FORMA
ETOYS BABYCENTER ADJUSTMENTS TOTAL
----- ---------- ----------- --------
<S> <C> <C> <C> <C>
Net sales...................................... $ 29,959 $ 4,768 $ -- $ 34,727
Cost of sales.................................. 24,246 981 -- 25,227
-------- ------- -------- --------
Gross profit................................... 5,713 3,787 -- 9,500
Operating expenses:
Marketing and sales.......................... 20,719 2,461 -- 23,180
Web site and technology...................... 3,608 3,752 -- 7,360
General and administrative................... 4,352 1,802 -- 6,154
Goodwill amortization........................ 319 -- 36,788 (5) 37,107
Deferred compensation amortization........... 5,814 573 -- 6,387
-------- ------- -------- --------
Total operating expenses................... 34,812 8,588 36,788 80,188
-------- ------- -------- --------
Operating loss................................. (29,099) (4,801) (36,788) (70,688)
Other income (expense):
Interest income.............................. 589 280 -- 869
Interest expense............................. (47) (24) -- (71)
-------- ------- -------- --------
Loss before provision for taxes................ (28,557) (4,545) (36,788) (69,890)
Provision for taxes............................ (1) -- -- (1)
-------- ------- -------- --------
Net loss....................................... $(28,558) $(4,545) $(36,788) $(69,891)
======== ======= ======== ========
Basic and diluted net loss per share........... $ (0.85) $ (1.41)
======== ========
Shares used to compute basic and diluted net
loss per share............................... 33,428 16,003 49,431
======== ======== ========
</TABLE>

See notes to unaudited pro forma condensed combined financial information.

69
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
AS OF MARCH 31, 1999

(IN THOUSANDS)

<TABLE>
<CAPTION>
PRO FORMA
ETOYS BABYCENTER ADJUSTMENTS TOTAL
-------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................... $ 20,173 $ 9,000 $ -- $ 29,173
Inventories................................. 5,067 201 -- 5,268
Prepaids and other current assets........... 1,577 750 -- 2,327
-------- ------- -------- --------
Total current assets.......................... 26,817 9,951 -- 36,768
Property and equipment........................ 2,505 1,582 (530)(3) 3,557
Accumulated depreciation and amortization..... (369) (278) -- (647)
-------- ------- -------- --------
2,136 1,304 (530) 2,910
Goodwill (net of accumulated amortization).... 637 -- 183,942 (2) 184,579
Other assets.................................. 1,076 40 -- 1,116
-------- ------- -------- --------
Total assets.................................. $ 30,666 $11,295 $183,412 $225,373
======== ======= ======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................ $ 4,236 $ 693 $ 780 (3) $ 5,709
Deferred revenues........................... -- 713 -- 713
Accrued expenses............................ 530 605 1,879 (3) 3,014
Current portion of long-term notes payable
and capital lease obligations............. 230 118 -- 348
-------- ------- -------- --------
Total current liabilities..................... 4,996 2,129 2,659 9,784
Long-term notes payable and capital lease
obligations................................. 477 564 -- 1,041
Redeemable Convertible Preferred Stock........ 49,291 -- -- 49,291
Stockholders' equity (deficit)................ (24,098) 8,602 (632)(3) 165,257
(8,602)(4)
189,987 (4)
-------- ------- -------- --------
Total liabilities and stockholders' equity
(deficit)................................... $ 30,666 $11,295 $183,412 $225,373
======== ======= ======== ========
</TABLE>

See notes to unaudited pro forma condensed combined financial information.

70
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED

FINANCIAL INFORMATION

The pro forma information gives effect to the Company's acquisition of
BabyCenter through a merger and exchange of shares. The Unaudited Pro Forma
Condensed Combined Statement of Operations for the year ended March 31, 2000
reflects this transaction as if it had taken place on April 1, 1999. The
Unaudited Pro Forma Condensed Combined Statement of Operations for the year
ended March 31, 1999 reflects this transaction as if it had taken place on
April 1, 1998. The Unaudited Pro Forma Condensed Combined Balance Sheet as of
March 31, 1999 reflects this transaction as if it had taken place on March 31,
1999.

The BabyCenter acquisition has been accounted for using the purchase method
of accounting. The pro forma financial information has been prepared on the
basis of assumptions described in the following notes and include assumptions
relating to the allocation of the consideration paid for the assets and
liabilities of BabyCenter based upon estimates of their fair value. In opinion
of the Company's management, all adjustments necessary to present fairly such
pro forma financial information have been based on the terms and structure of
the BabyCenter merger.

The pro forma financial information is not necessarily indicative of what
the actual financial results would have been had this transaction taken place on
April 1, 1999, March 31, 1999 or April 1, 1998 and does not purport to indicate
the results of future operations.

The pro forma financial information gives effect to the following pro forma
adjustments:

1. In accordance with the reorganization agreement for the BabyCenter
merger:

The BabyCenter merger has been accounted for using the purchase method of
accounting. The purchase price was based on $11.00 per share, which was the
mid-point of the Company's filing range at the announcement of the BabyCenter
merger.

The purchase price was determined as follows:

<TABLE>
<CAPTION>
BABYCENTER FAIR VALUE
SHARES ETOYS SHARES (IN THOUSANDS)
---------- ------------ --------------
<S> <C> <C> <C>
Shares............................... 7,651,521 16,003,095 $176,034
Stock options........................ 1,299,027 2,716,905 13,953
---------- ----------- --------
Totals............................. 8,950,548 18,720,000 $189,987
========== =========== ========
</TABLE>

The BabyCenter shares were first converted to the Company's equivalent
shares by taking the number of BabyCenter shares multiplied by the exchange
ratio of approximately 2.09 shares of the Company for each BabyCenter share.

The fair value of "shares" was calculated by taking the fair value of the
stock ($11.00 per share) times the number of the Company's shares to be
exchanged.

With respect to stock options exchanged as part of the BabyCenter merger,
all vested and unvested BabyCenter options exchanged for the Company's options
are included as part of the purchase price based on their fair value.

The fair value of the stock was calculated by taking the vested and unvested
options to purchase the Company's shares (2,716,905 options) times the fair
value of the stock ($11.00 per share) less the proceeds which will be received
from the optionholders upon exercise.

71
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED

FINANCIAL INFORMATION (CONTINUED)

The pro forma financial information has been prepared on the basis of
assumptions described in these notes and include assumptions relating to the
allocation of the consideration paid for the assets and liabilities of
BabyCenter based upon estimates of their fair value.

The Unaudited Pro Forma Condensed Combined Statement of Operations for the
year ended March 31, 2000 is based upon an acquisition price of $190.0 million
and assumes that an estimated $189.0 million excess of acquisition costs over
the book value of BabyCenter's net tangible assets is allocated to intangible
assets with a useful life of five years. The table below reflects the
acquisition cost, purchase price allocation and annual amortization of
intangible assets acquired as of July 1, 1999 based upon the historical amounts
recorded (in thousands):

<TABLE>
<CAPTION>
ANNUAL
AMORTIZATION AMORTIZATION OF
LIFE (IN YEARS) INTANGIBLES
--------------- ---------------
<S> <C> <C> <C>
ESTIMATED ACQUISITION COST:
Estimated purchase price............ $189,987
========
PURCHASE PRICE ALLOCATION:
Estimated fair value of net tangible
assets of BabyCenter at July 1,
1999.............................. $ 2,745
Purchase price adjustments to
acquired assets and liabilities... (1,797)
Intangible assets acquired:
Goodwill.......................... 189,039 5 $37,808
--------
$189,987
========
</TABLE>

The Unaudited Pro Forma Condensed Combined Balance Sheet as of March 31,
1999 is based upon an acquisition price of $190.0 million and assumes that an
estimated $183.9 million excess of acquisition costs over the book value of
BabyCenter's net tangible assets as of March 31, 1999 is allocated to intangible
assets. The table below reflects the acquisition cost, purchase price allocation
and amortization of intangible assets acquired had the acquisition of BabyCenter
been completed on March 31, 1999 (in thousands):

<TABLE>
<CAPTION>
ANNUAL
AMORTIZATION AMORTIZATION OF
LIFE (IN YEARS) INTANGIBLES
--------------- ---------------
<S> <C> <C> <C>
ESTIMATED ACQUISITION COST:
Estimated purchase price............ $189,987
========
PURCHASE PRICE ALLOCATION:
Estimated fair value of net tangible
assets of BabyCenter at March 31,
1999.............................. $ 8,602
Purchase price adjustments to
acquired assets and liabilities... (2,557)
Intangible assets acquired:
Goodwill.......................... 183,942 5 $36,788
--------
$189,987
========
</TABLE>

72
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED

FINANCIAL INFORMATION (CONTINUED)

The Unaudited Pro Forma Condensed Combined Statement of Operations for the
year ended March 31, 1999 is based upon an acquisition price of $190.0 million
and assumes that an estimated $183.9 million excess of acquisition costs over
the book value of BabyCenter's net tangible assets as of March 31, 1999 is
allocated to intangible assets with a useful life of five years.

Tangible assets of BabyCenter acquired in the BabyCenter merger principally
include cash and fixed assets. Liabilities of BabyCenter assumed in the
BabyCenter merger principally include accounts payable, accrued payroll and
other current liabilities.

2. The pro forma adjustment is for goodwill allocation of $183.9 million.

3. The pro forma adjustments are for purchase price adjustments applied to
certain assets acquired and liabilities assumed in connection with the
BabyCenter merger aggregating to $2.6 million.

4. The pro forma adjustment to stockholders' equity reflects the
elimination of BabyCenter's stockholders' equity ($8.6 million) and the impact
of the issuance of the Company's common stock ($190.0 million) in connection
with the BabyCenter merger.

5. The pro forma adjustment is for goodwill amortization of $9.5 million
and $36.8 million for the years ended March 31, 2000 and 1999, respectively.
Goodwill amortization for the year ended March 31, 2000 reflects the reduction
of goodwill associated with the sale of CHI which occurred in January 2000.

6. The pro forma adjustment is to adjust weighted average shares
outstanding for the year ended March 31, 2000. As the acquisition of BabyCenter
was completed on July 1, 1999, the historical weighted average shares
outstanding only reflect the issuance of shares for the purchase of BabyCenter
from the original date of issuance on July 1, 1999, or nine months. Accordingly,
the weighted average shares for basic and diluted net loss per share has been
adjusted to give effect to the shares being issued and outstanding for the year
ended March 31, 2000.

73
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
BabyCenter, Inc.

We have audited the accompanying balance sheets of BabyCenter, Inc. as of
September 30, 1997 and 1998 and March 31, 1999, and the related statements of
operations, stockholders' equity, and cash flows for the period from inception
(February 11, 1997) to September 30, 1997, for the year ended September 30,
1998, and for the six months ended March 31, 1999. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of BabyCenter, Inc. at
September 30, 1997 and 1998 and March 31, 1999, and the results of its
operations and its cash flows for the period from inception (February 11, 1997)
to September 30, 1997, for the year ended September 30, 1998 and for the six
months ended March 31, 1999, in conformity with generally accepted accounting
principles.

Ernst & Young LLP

Palo Alto, California
April 30, 1999

74
<PAGE>
BABYCENTER, INC.

BALANCE SHEETS

<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------ MARCH 31,
1997 1998 1999
---------- ----------- -----------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $1,795,941 $ 1,201,786 $ 8,999,635
Short-term investments............................. 972,713 -- --
Accounts receivable, net of allowance of $30,000 at
March 31, 1999................................... 11,500 706,136 669,388
Inventories........................................ -- -- 201,286
Other current assets............................... 18,913 69,367 80,149
---------- ----------- -----------
Total current assets................................. 2,799,067 1,977,289 9,950,458

Property and equipment, net.......................... 91,538 601,867 1,304,404

Other assets......................................... 29,906 36,892 40,025
---------- ----------- -----------
$2,920,511 $ 2,616,048 $11,294,887
========== =========== ===========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................... $ 34,004 $ 292,439 $ 693,418
Accrued liabilities................................ 6,206 25,202 604,930
Deferred revenue................................... 53,876 464,920 713,161
Current portion of capital lease obligations....... 33,421 124,135 117,659
---------- ----------- -----------
Total current liabilities............................ 127,507 906,696 2,129,168

Capital lease obligations, net of current portion.... 51,079 38,661 564,089

Commitments

Stockholders' equity:
Preferred stock, $0.001 par value, 5,700,000 shares
authorized, issuable in series: 2,862,717,
2,895,930, and 4,895,930 convertible shares
issued and outstanding at September 30, 1997 and
1998 and March 31, 1999, respectively (aggregate
liquidation preference of $13,331,330 at
March 31, 1999).................................. 3,260,981 3,310,981 13,245,642
Common stock, $0.001 par value, 11,000,000 shares
authorized, 1,759,138 and 2,297,096 shares issued
and outstanding at September 30, 1997 and 1998
and March 31, 1999, respectively................. 1,759 1,759 1,104,606
Additional paid-in capital......................... -- -- 9,874,296
Notes receivable from officers..................... -- -- (1,102,000)
Deferred compensation.............................. -- -- (8,896,144)
Accumulated deficit................................ (520,815) (1,642,049) (5,624,770)
---------- ----------- -----------
Total stockholders' equity........................... 2,741,925 1,670,691 8,601,630
---------- ----------- -----------
$2,920,511 $ 2,616,048 $11,294,887
========== =========== ===========
</TABLE>

See accompanying notes.

75
<PAGE>
BABYCENTER, INC.

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(FEBRUARY 11, SIX MONTHS ENDED
1997) TO YEAR ENDED MARCH 31,
SEPTEMBER 30, SEPTEMBER 30, -------------------------
1997 1998 1998 1999
-------------- -------------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues................................ $ 7,624 $ 1,935,668 $ 250,869 $ 3,083,355

Costs and expenses:
Cost of revenues...................... -- 178,924 10,021 812,569
Technology and development............ 200,057 1,374,012 364,605 2,742,789
Marketing and sales................... 56,918 853,015 210,184 1,817,701
General and administrative............ 280,621 744,761 282,691 1,912,386
---------- ----------- --------- -----------
Total costs and expenses................ 537,596 3,150,712 867,501 7,285,445
---------- ----------- --------- -----------

Loss from operations.................... (529,972) (1,215,044) (616,632) (4,202,090)

Interest and other income, net.......... 9,157 93,810 57,201 219,369
---------- ----------- --------- -----------
Net loss................................ $ (520,815) $(1,121,234) $(559,431) $(3,982,721)
========== =========== ========= ===========

Basic and diluted net loss per share.... $ (1.17) $ (1.41) $ (0.82) $ (3.78)
========== =========== ========= ===========

Weighted-average shares used in per
share calculation..................... 446,340 792,778 683,374 1,053,685
========== =========== ========= ===========
</TABLE>

See accompanying notes.

76
<PAGE>
BABYCENTER, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED NOTES
STOCK COMMON STOCK ADDITIONAL RECEIVABLE DEFERRED
----------------------- ---------------------- PAID-IN FROM STOCK
SHARES AMOUNT SHARES AMOUNT CAPITAL OFFICERS COMPENSATION
--------- ----------- --------- ---------- ---------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
Issuance of common stock
for cash and conversion
of debt................ -- $ -- 1,759,138 $ 1,759 $ -- $ -- $ --
Issuance of Series A
convertible preferred
stock for cash, net of
issuance costs of
$10,000................ 1,202,046 771,333 -- -- -- -- --
Issuance of Series B
convertible preferred
stock for cash, net of
issuance costs of
$10,350................ 1,660,671 2,489,648 -- -- -- -- --
Net loss................. -- -- -- -- -- -- --
--------- ----------- --------- ---------- ---------- ----------- -----------
Balance at September 30,
1997................... 2,862,717 3,260,981 1,759,138 1,759 -- -- --
Issuance of Series B
convertible preferred
stock for cash......... 33,213 50,000 -- -- -- -- --
Net loss................. -- -- -- -- -- -- --
--------- ----------- --------- ---------- ---------- ----------- -----------
Balance at September 30,
1998................... 2,895,930 3,310,981 1,759,138 1,759 -- -- --
Issuance of Series C
convertible preferred
stock for cash, net of
Issuance costs of
$65,339................ 2,000,000 9,934,661 -- -- -- -- --
Issuance of common stock
upon exercises of stock
options................ -- -- 537,958 1,102,847 -- (1,102,000) --
Issuance of warrant for
services............... -- -- -- -- 405,523 -- --
Deferred compensation.... -- -- -- -- 9,468,773 -- (9,468,773)
Amortization of deferred
compensation........... -- -- -- -- -- -- 572,629
Net loss................. -- -- -- -- -- -- --
--------- ----------- --------- ---------- ---------- ----------- -----------
Balance at March 31,
1999................... 4,895,930 $13,245,642 2,297,096 $1,104,606 $9,874,296 $(1,102,000) $(8,896,144)
========= =========== ========= ========== ========== =========== ===========

TOTAL
ACCUMULATED STOCKHOLDERS'
DEFICIT EQUITY
------------- --------------
<S> <C> <C>
Issuance of common stock
for cash and conversion
of debt................ $ -- $ 1,759
Issuance of Series A
convertible preferred
stock for cash, net of
issuance costs of
$10,000................ -- 771,333
Issuance of Series B
convertible preferred
stock for cash, net of
issuance costs of
$10,350................ -- 2,489,648
Net loss................. (520,815) (520,815)
----------- -----------
Balance at September 30,
1997................... (520,815) 2,741,925
Issuance of Series B
convertible preferred
stock for cash......... -- 50,000
Net loss................. (1,121,234) (1,121,234)
----------- -----------
Balance at September 30,
1998................... (1,642,049) 1,670,691
Issuance of Series C
convertible preferred
stock for cash, net of
Issuance costs of
$65,339................ -- 9,934,661
Issuance of common stock
upon exercises of stock
options................ -- 847
Issuance of warrant for
services............... -- 405,523
Deferred compensation.... -- --
Amortization of deferred
compensation........... -- 572,629
Net loss................. (3,982,721) (3,982,721)
----------- -----------
Balance at March 31,
1999................... $(5,624,770) $ 8,601,630
=========== ===========
</TABLE>

See accompanying notes.

77
<PAGE>
BABYCENTER, INC.

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(FEBRUARY 11, SIX MONTHS ENDED
1997) TO YEAR ENDED MARCH 31,
SEPTEMBER 30, SEPTEMBER 30, --------------------------
1997 1998 1998 1999
-------------- -------------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $ (520,815) $(1,121,234) $ (559,431) $ (3,982,721)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation.............................. 9,443 80,101 26,225 188,211
Issuance of warrant for services.......... -- -- -- 405,523
Amortization of deferred compensation..... -- -- -- 572,629
Changes in operating assets and
liabilities:
Accounts receivable..................... (11,500) (694,636) 3,000 36,748
Inventories............................. -- -- -- (201,286)
Other current assets.................... (18,913) (50,454) (162,041) (10,782)
Other assets............................ (29,906) (6,986) (8,329) (3,133)
Accounts payable........................ 34,004 258,435 29,526 400,979
Accrued liabilities..................... 6,206 18,996 5,051 579,728
Deferred revenue........................ 53,876 411,044 87,257 248,241
---------- ----------- ---------- ------------
Net cash used in operating activities....... (477,605) (1,104,734) (578,742) (1,765,863)
---------- ----------- ---------- ------------
INVESTING ACTIVITIES
Purchases of property and equipment......... -- (400,112) (2,900) (659,682)
Purchase of short-term investments.......... (972,713) -- -- --
Proceeds from maturity of short-term
investments............................... -- 972,713 972,713 --
---------- ----------- ---------- ------------
Net cash provided by (used in) investing
activities................................ (972,713) 572,601 969,813 (659,682)
---------- ----------- ---------- ------------
FINANCING ACTIVITIES
Proceeds from issuance of preferred stock... 3,260,981 50,000 -- 9,934,661
Proceeds from issuance of common stock...... 1,759 -- -- 847
Proceeds from lease financing of
equipment................................. -- -- -- 400,112
Repayments of principal on capital leases... (16,481) (112,022) (40,407) (112,226)
---------- ----------- ---------- ------------
Net cash provided by (used in) financing
activities................................ 3,246,259 (62,022) (40,407) 10,223,394
---------- ----------- ---------- ------------
Net increase (decrease) in cash and cash
equivalents............................... 1,795,941 (594,155) 350,664 7,797,849
Cash and cash equivalents at beginning of
period.................................... -- 1,795,941 1,795,941 1,201,786
---------- ----------- ---------- ------------
Cash and cash equivalents at end of
period.................................... $1,795,941 $ 1,201,786 $2,146,605 $ 8,999,635
========== =========== ========== ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
Interest paid............................... $ -- $ 17,008 $ 5,234 $ 11,513
========== =========== ========== ============
Property and equipment acquired under lease
financing................................. $ 100,981 $ 190,318 $ 102,623 $ 231,066
========== =========== ========== ============
</TABLE>

See accompanying notes.

78
<PAGE>
BABYCENTER, INC.

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND NATURE OF BUSINESS

BabyCenter, Inc. (the "Company") is an Internet information and commerce
company serving new and expectant parents. BabyCenter, Inc. produces
BabyCenter.com, the Web's information source on preconception, pregnancy and
baby, and operates the BabyCenter Store, an online store with related products
and supplies. BabyCenter, Inc. also develops Internet information and marketing
products for healthcare companies. BabyCenter, Inc. was incorporated in Delaware
on February 11, 1997. BabyCenter, Inc. conducts its business within one industry
segment and all operations through September 30, 1998 were based in the United
States.

Since its incorporation, BabyCenter, Inc. has incurred cumulative losses
totaling approximately $5,625,000 and expects to incur additional losses for the
next several years. BabyCenter, Inc.'s current operating plan shows that
BabyCenter, Inc. will continue to require additional capital to fund its
operations and market its products. To date, BabyCenter, Inc. has financed its
operations with the net proceeds from private placements of its equity
securities, and capital equipment lease financing. BabyCenter, Inc. plans to
seek additional funding through public or private financing or other
arrangements with third parties. If the financing arrangements contemplated by
management are not consummated, BabyCenter, Inc. may have to seek other sources
of capital or reevaluate its operating plans.

INTERIM FINANCIAL STATEMENTS

The accompanying statements of operations and cash flows for the six months
ended March 31, 1998 are unaudited. In the opinion of management, the unaudited
financial statements have been prepared on the same basis as the audited
financial statements and include all adjustments, consisting of normal recurring
adjustments, necessary for fair presentation of the results of operations and
cash flows for the interim period.

USE OF ESTIMATES

The preparation of 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 the
accompanying notes. Actual results could differ materially from these estimates.

CASH, CASH EQUIVALENTS, AND SHORT-TERM INVESTMENTS

BabyCenter, Inc. considers all highly liquid investments with a maturity
from date of purchase of three months or less to be cash equivalents. Management
has designated these investments as available for sale. BabyCenter, Inc. invests
its excess cash in money market funds and corporate debt obligations of
financial institutions in the United States. The short-term investments at
September 30, 1997 were comprised of corporate debt obligations with maturities
of less than one year. These investments are reported at amortized cost which
approximates fair value. BabyCenter, Inc. had no short-term investments at
September 30, 1998 and March 31, 1999. The carrying amount reported on the
balance sheet for cash and cash equivalents approximates their fair value. Fair
values are estimated based on quoted market prices or pricing models using
current

79
<PAGE>
BABYCENTER, INC.

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
market rates. Realized gains or losses for the period from inception
(February 11, 1997) to September 30, 1997 ("period ended September 30, 1997"),
the year ended September 30, 1998, and the six months ended March 31, 1998 and
1999 were not material.

CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS

Financial instruments that subject BabyCenter, Inc. to concentrations of
credit risk consist principally of cash investments and accounts receivable.
BabyCenter, Inc. invests cash which is not required for immediate operating
needs principally in deposits and money market funds, which bear minimal risk.
BabyCenter, Inc. has not experienced any significant losses on these
investments.

For the period ended September 30, 1997, 3 customers (Health Trac, Inc.,
Charles Schwab, Inc. and Palo Alto Medical Foundation) accounted for 41%, 41%,
and 18%, respectively, of total revenue. At September 30, 1997, 1 customer
represented 100% of the total balance of accounts receivable. For the year ended
September 30, 1998, 3 customers (The Procter and Gamble Distributing Company,
SmithKline Beecham, Inc. and Blue Shield of California) accounted for 31%, 18%,
and 16%, respectively, of total revenue. At September 30, 1998, 2 customers
represented 66% and 11% of the total balance of accounts receivable. For the six
months ended March 31, 1999, 3 customers (Blue Shield of California, The Procter
and Gamble Distributing Company and Johnson & Johnson Consumer Company, Inc.)
represented 36%, 13%, and 10%, respectively, of total revenue. At March 31,
1999, 2 customers represented 60% and 10% of the total balance of accounts
receivable. BabyCenter, Inc. performs ongoing credit evaluations of its
customers but does not require collateral. There have been no material losses on
individual customer receivables.

INVENTORIES

Inventories are stated at the lower of cost (using the first-in, first-out
method) or market and consist primarily of finished goods.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost, net of accumulated amortization
and depreciation. Property and equipment are depreciated on a straight-line
basis over the estimated useful lives of the assets, typically three to five
years. Assets acquired under lease and leasehold improvements are amortized
using the straight-line method over the shorter of the estimated life of the
asset or the remaining term of the lease.

REVENUE RECOGNITION

Revenues primarily consist of online and publishing services revenues.
Online revenues are derived principally from the sale of banner advertisements
and sponsorship advertising. In general, the sponsorship advertising contracts
have longer terms than standard banner advertising contracts and also involve
more integration, such as the placement of buttons which provide users with
direct links to the advertiser's website. Advertising revenues on each banner
and sponsorship contract are recognized ratably in the period in which the
advertisement is displayed, provided that no significant Company obligations
remain and collection of the resulting receivable is probable.

80
<PAGE>
BABYCENTER, INC.

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Company obligations typically include guarantees of a minimum number of
"impressions," or times that an advertisement appears in pages viewed by users
of BabyCenter, Inc.'s online properties. To the extent minimum guaranteed
impressions are not met, BabyCenter, Inc. defers recognition of the
corresponding revenues until the remaining guaranteed impression levels are
achieved.

BabyCenter, Inc. also earns revenue on sponsorship and Internet marketing
contracts which generally involve fees relating to the design, coordination,
editorial content, website hosting, and integration of the customer's content
and links into BabyCenter, Inc.'s online properties. These fees are generally
recognized as revenue as earned over the period in which related impressions or
services are delivered.

Publishing services revenue consists of developing customized print
products. Such revenue is recorded when earned, generally upon delivery of the
product. Payments received which are related to future performance are deferred
and recognized as revenue when earned.

Revenues from electronic commerce transactions, which consist primarily of
merchandise sold via the Internet, include outbound shipping and handling
charges and are recognized when the products are shipped. Revenues from
electronic commerce transactions from inception through September 30, 1998 were
not significant. Such revenues and cost of revenues were approximately $610,000
and $560,000 for the six months ended March 31, 1999.

COST OF REVENUES

Cost of online revenues consist of merchandise sold, inbound, and outbound
shipping costs and direct cost of order fulfillment. Cost of publishing services
revenue comprises direct printing and publishing cost. Such costs are expensed
as incurred.

TECHNOLOGY AND DEVELOPMENT

Technology and development expenses consist principally of payroll and
related expense for development, editorial, systems and telecommunications
operations personnel and consultants, systems and telecommunications
infrastructure, store management, and costs of acquired content. To date, all
such development costs have been expensed as incurred.

ADVERTISING COSTS

Advertising costs are accounted for as expenses in the period in which they
are incurred. Advertising expense for the period ended September 30, 1997 and
the year ended September 30, 1998 was approximately $14,500 and $260,000.
Advertising expense for the six months ended March 31, 1998 and 1999 was
approximately $60,450 and $609,000.

STOCK-BASED COMPENSATION

BabyCenter, Inc. grants stock options for a fixed number of shares to
employees with an exercise price equal to the fair value of the shares at the
grant date. BabyCenter, Inc. accounts for stock option grants in accordance with
the provisions of the Accounting Principles Board's Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25") and, accordingly, recognizes no

81
<PAGE>
BABYCENTER, INC.

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
compensation expense for stock options granted with exercise prices that are not
less than the fair value of BabyCenter, Inc.'s common stock on the date of
grant.

NET LOSS PER SHARE

Basic and diluted net loss per share has been computed using the
weighted-average number of shares of common stock outstanding during the period
less shares subject to repurchase. Had BabyCenter, Inc. been in a net income
position, diluted earnings per share would have included the shares used in the
computation of basic net income per share as well as the impact of outstanding
options and warrants to purchase common stock, using the treasury stock method,
to purchase an additional 281,895 shares for the period ended September 30,
1997, 677,320 shares for the year ended September 30, 1998 and 537,507 and
1,024,858 shares for the six months ended March 31, 1998 and 1999. Such shares
have been excluded because they are antidilutive for all periods presented.
Shares of convertible preferred stock have been excluded from the computation.

A reconciliation of shares used in the calculation of basic and diluted net
loss per share follows:

<TABLE>
<CAPTION>
SIX MONTHS ENDED
PERIOD ENDED YEAR ENDED MARCH 31,
SEPTEMBER 30, SEPTEMBER 30, -------------------------
1997 1998 1998 1999
-------------- -------------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net loss............... $ (520,815) $(1,121,234) $ (559,431) $(3,982,721)
=========== =========== =========== ===========
Basic and diluted:
Weighted-average
shares of common
stock
outstanding........ 1,759,138 1,759,138 1,759,138 1,827,702
Less weighted-
average shares
subject to
repurchase......... (1,312,798) (966,360) (1,075,764) (774,017)
----------- ----------- ----------- -----------
Shares used in
computing basic and
diluted net loss
per share.......... 446,340 792,778 683,374 1,053,685
=========== =========== =========== ===========
Basic and diluted net
loss per share....... $ (1.17) $ (1.41) $ (0.82) $ (3.78)
=========== =========== =========== ===========
</TABLE>

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"), and No. 131, "Disclosures About Segments of an Enterprise
and Related Information" ("SFAS 131") (collectively, the "Statements").
BabyCenter, Inc. adopted these Statements as of October 1, 1998.

82
<PAGE>
BABYCENTER, INC.

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SFAS 130 establishes new standards for reporting and displaying comprehensive
income and its components. The adoption of SFAS 130 had no impact on the
BabyCenter, Inc.'s results of operations or financial condition. SFAS 131
requires disclosure of certain information regarding operating segments,
products and services, geographic areas of operation, and major customers.
BabyCenter, Inc. operates as one reportable segment and has determined that the
specific additional information and disclosure requirements under SFAS 131 are
not material to BabyCenter, Inc. for the period ended March 31, 1999.

In June 1998, the FASB issued Statement of Financial Accounting Standard
No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging
Activities," which will be effective for the year ending September 30, 2000.
This statement establishes accounting and reporting standards requiring that
every derivative instrument, including certain derivative instruments embedded
in other contracts, be recorded in the balance sheet as either an asset or
liability measured at its fair value. The statement also requires that changes
in the derivative's fair value be recognized in earnings unless specific hedge
accounting criteria are met. BabyCenter, Inc. believes the adoption of SFAS 133
will not have a material effect on the financial statements, since it currently
does not invest in derivative instruments and engage in hedging activities.

In March 1998, the American Institute of Certified Public Accountants issued
SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use" ("SOP 98-1"). SOP 98-1 requires that entities capitalize
certain costs related to internal use software once certain criteria have been
met. BabyCenter, Inc. is required to implement SOP 98-1 for the year ending
September 30, 2000. Adoption of SOP 98-1 is expected to have no material impact
on BabyCenter, Inc.'s financial condition or results of operations.

2. PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------- MARCH 31,
1997 1998 1999
--------- --------- ----------
<S> <C> <C> <C>
Furniture and equipment................... $ 98,593 $685,858 $1,458,850
Software.................................. 2,388 2,653 120,409
Leasehold improvements.................... -- 2,900 2,900
-------- -------- ----------
100,981 691,411 1,582,159
Less accumulated depreciation............. (9,443) (89,544) (277,755)
-------- -------- ----------
Property and equipment, net............... $ 91,538 $601,867 $1,304,404
======== ======== ==========
</TABLE>

Property and equipment includes certain furniture, computers, and equipment
financed under capital leases. The cost of such assets under capital leases was
$100,981 and $285,745 at September 30, 1997 and 1998, and $916,924 at March 31,
1999. Accumulated amortization for these assets was $9,443 and $88,748 at
September 30, 1997 and 1998 and $169,616 at March 31, 1999.

83
<PAGE>
BABYCENTER, INC.

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)

3. COMMITMENTS

OPERATING LEASE COMMITMENTS

BabyCenter, Inc. leases its facilities under noncancelable operating leases
expiring in May and July 1999. Rent expense for facilities under operating
leases was approximately $25,300 and $107,000 for the period ended September
1997 and for the year ended September 30, 1998. Rent expense was approximately
$65,600 and $141,600 for the six months ended March 31, 1998 and 1999. Future
minimum rental commitments under operating leases at March 31, 1999 are as
follows:

CAPITAL LEASE OBLIGATIONS

BabyCenter, Inc. leases certain furniture, computers and equipment under
noncancelable capital leases. Obligations under capital leases represent the
present value of future noncancelable rental payments under various lease
agreements.

Future minimum lease payments under capital leases are as follows at
March 31, 1999:

<TABLE>
<S> <C>
Fiscal year ended
1999...................................................... $ 144,166
2000...................................................... 259,018
2001...................................................... 170,032
2002...................................................... 160,166
2003...................................................... 39,272
2004 and thereafter....................................... 2,355
---------
Total minimum lease payments................................ 775,009
Less amount representing interest........................... (93,261)
---------
Present value of net minimum lease payments................. 681,748
Less current portion........................................ (117,659)
---------
Long-term portion........................................... $ 564,089
=========
</TABLE>

4. STOCKHOLDERS' EQUITY

CONVERTIBLE PREFERRED STOCK

BabyCenter, Inc.'s Certificate of Incorporation provide for the issuance of
up to 5,700,000 shares of convertible preferred stock, 1,307,693 of which have
been designated as Series A, 1,860,672 as Series B, and 2,500,000 as Series C.
Shares outstanding at March 31, 1999 are 1,202,046 Series A, 1,693,884 Series B
and 2,000,000 Series C.

84
<PAGE>
BABYCENTER, INC.

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)

4. STOCKHOLDERS' EQUITY (CONTINUED)
Each share of Series A, B and C preferred stock is convertible, at the
option of the holder, into a share of common stock, on a one-for-one basis,
subject to certain adjustments for dilution, if any, resulting from future stock
issuances. Additionally, the preferred shares automatically convert into common
stock concurrent with the closing of an underwritten public offering of common
stock under the Securities Act of 1933 in which BabyCenter, Inc. receives at
least $15,000,000 in gross proceeds and the price per share is at least $10.00
(subject to adjustment for a recapitalization or certain other stock
adjustments).

Series A, B and C preferred stockholders are entitled to annual
noncumulative dividends, before and in preference to any dividends paid on
common stock, when and as declared by the board of directors. No dividends have
been declared through March 31, 1999.

The Series A, B and C preferred stockholders are entitled to receive, upon
liquidation or merger, a distribution of $0.65, $1.51 and $5.00 per share
(subject to adjustment for a recapitalization) plus all declared but unpaid
dividends. Thereafter, the remaining assets and funds, if any, shall be
distributed ratably on a per-share basis among the common stockholders and the
Series A, B and C preferred stockholders.

The Series A, B and C preferred stockholders have voting rights equal to the
common shares they would own upon conversion.

As of March 31, 1999, BabyCenter, Inc. has reserved 4,895,930 shares of
common stock for issuance upon conversion of its Series A, B and C preferred
stock.

COMMON STOCK

Since inception (February 11, 1997), BabyCenter, Inc. issued 2,277,397
shares of common stock to founders and officers for cash and notes receivable.
The common stock is subject to repurchase, at the Company's option, until
vested. Shares generally vest over a period of three to four years. At
March 31, 1999, approximately 928,113 shares were subject to repurchase. The
weighted-average fair value of unvested stock issued during the period since
inception (February 11, 1997) is $3.11 per share.

WARRANTS

In October 1998, BabyCenter, Inc. entered into an agreement with a vendor
for the supply goods and certain fulfillment services to support electronic
commerce transactions of BabyCenter, Inc. In connection with this agreement,
BabyCenter, Inc. granted the vendor a warrant to purchase up to 120,000 shares
of common stock of BabyCenter, Inc. at a price of $0.25 per share. The warrant
becomes exercisable ratably over the term of the agreement. At March 31, 1999,
warrants for 60,000 shares were not exercisable. The warrant expires in November
2003. The warrant has been accounted for as a variable award and as such during
the six months ended March 31, 1999, the Company recorded a charge of $405,523
related to the value of the warrants which became exercisable during the period.
This amount is included in marketing and sales expense in the accompanying
Statement of Operations.

85
<PAGE>
BABYCENTER, INC.

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)

4. STOCKHOLDERS' EQUITY (CONTINUED)
In October 1998, BabyCenter, Inc. issued warrants to purchase up to 22,000
shares of Series C convertible preferred stock at $5.00 per share in connection
with an equipment lease financing arrangement. These warrants are immediately
exercisable and expire in October 2003 or earlier upon completion of the merger.
No amount was allocated to the value these warrants as such amounts were not
significant.

NOTES RECEIVABLE FROM OFFICERS

Notes receivable from officers, totaling $1,102,000 at March 31, 1999
represent interest bearing full recourse notes from certain officers issued to
finance the purchase of 527,000 shares of common stock of BabyCenter, Inc. The
notes bear interest at a rate of 4.77% per annum, with principal and interest
due and payable on various dates in March 2003.

1997 STOCK PLAN

In February 1997, the board of directors adopted the 1997 Stock Plan (the
"Plan") for issuance of options of common stock to eligible participants.
Options granted may be either incentive stock options or nonstatutory stock
options. Incentive stock options may be granted to employees with exercise
prices of no less than the fair value and nonstatutory options may be granted to
eligible participants at exercise prices of no less than 85% of the fair value
of the common stock on the grant date as determined by the board of directors.
Options generally vest at the rate of 25% after one year from the date of grant,
with the remaining balance vesting monthly over the next three years with a term
of 10 years. BabyCenter, Inc. has reserved 2,261,500 shares of common stock for
the grant of options under the Plan.

Pro forma information regarding net loss is required by Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), and has been determined as if BabyCenter, Inc. had
accounted for its employee stock options under the fair value method as
specified by SFAS 123. The fair value of these options was estimated at the date
of grant using the minimum value method with the following weighted-average
assumptions: no dividends; an expected life of five years; and a risk-free
interest rate of approximately 6% for the period ended September 30, 1997, for
the year ended September 30, 1998 and for the six months ended March 31, 1998
and 1999.

The effect of applying the FASB statement's minimum value method to
BabyCenter, Inc.'s stock options granted did not result in pro forma net loss
amounts that are materially different from the reported historical amounts.
Therefore, such pro forma information is not separately presented herein. Future
pro forma net income (loss) results may be materially different from actual
amounts reported.

86
<PAGE>
BABYCENTER, INC.

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)

4. STOCKHOLDERS' EQUITY (CONTINUED)
A summary of activity under BabyCenter, Inc.'s stock option plan was as
follows:

<TABLE>
<CAPTION>
SHARES UNDER WEIGHTED-
SHARES AVAILABLE OPTIONS AVERAGE
FOR GRANT OUTSTANDING EXERCISE PRICE
---------------- ------------ --------------
<S> <C> <C> <C>
Shares authorized for issuance.... 559,440 -- --
Options granted................... (281,895) 281,895 $0.07
---------- --------
Balance at September 30, 1997..... 277,545 281,895 $0.07
Additional authorization.......... 602,060 -- --
Options granted................... (521,612) 521,612 $0.17
Options exercised................. -- -- --
Options forfeited................. 126,187 (126,187) $0.08
---------- --------
Balance at September 30, 1998..... 484,180 677,320 $0.14
Additional authorization.......... 1,100,000 -- --
Options granted................... (792,038) 792,038 $2.38
Options exercised................. -- (537,958) $2.05
Options forfeited................. 48,542 (48,542) $0.40
---------- --------
Balance at March 31, 1999......... 840,684 882,858 $1.34
========== ========
</TABLE>

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- --------------------------
WEIGHTED- OPTIONS
OPTIONS AVERAGE WEIGHTED- EXERCISABLE AT WEIGHTED-
OUTSTANDING AT REMAINING AVERAGE SEPTEMBER AVERAGE
EXERCISE PRICE SEPTEMBER 30, CONTRACTUAL EXERCISE 30, EXERCISE
RANGE 1998 LIFE PRICE 1998 PRICE
-------------- -------------- ----------- --------- -------------- ---------
(IN YEARS)
<S> <C> <C> <C> <C> <C>
$0.07-$0.95 688,570 8.92 $0.31 215,208 $0.13
$2.00-$4.00 194,288 9.93 $3.50 7,750 $3.20
------- -------
$0.07-$4.00 882,858 9.25 $1.34 222,958 $0.47
======= =======
</TABLE>

The weighted-average fair value of options granted during the period ended
September 30, 1997, the year ended September 30, 1998 and the six months ended
March 31, 1999 was $0.04, $0.04 and $0.56.

DEFERRED COMPENSATION

BabyCenter, Inc. recorded deferred compensation of $9,469,000 for the six
months ended March 31, 1999. The amount recorded represents the difference
between the grant price and the deemed fair value of BabyCenter, Inc.'s common
stock subject to options granted. The amortization of deferred compensation is
being amortized to operations over the vesting period of the options, which is
typically four years. Total amortization recognized was $573,000 for the six
months ended March 31, 1999.

87
<PAGE>
BABYCENTER, INC.

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)

5. INCOME TAXES

As of March 31, 1999, BabyCenter, Inc. had federal net operating loss
carryforwards of approximately $4,800,000. The net operating loss and credit
carryforwards will expire at various dates beginning in 2012 through 2019, if
not utilized.

Utilization of the net operating losses may be subject to a substantial
annual limitation due to the "change in ownership" provisions of the Internal
Revenue Code of 1986 and similar state provisions. The annual limitation may
result in the expiration of net operating losses and credits before utilization.

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. As of September 30, 1997
and 1998, and March 31, 1999, BabyCenter, Inc. had deferred tax assets of
approximately $200,000, $600,000 and $2,000,000. The net deferred tax assets
relate primarily to net operating loss carryforwards and have been fully offset
by a valuation allowance.

6. YEAR 2000 ISSUE (UNAUDITED)

Many currently installed computer systems and software products are coded to
accept only two-digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four-digit entries in order to
distinguish 21st century dates from 20th century dates. As a result, computer
systems and/or software used by many companies will need to be upgraded to
comply with Year 2000 requirements. Significant uncertainty exists concerning
the potential effects associated with this issue. Although BabyCenter, Inc.
believes that its products and services are Year 2000 compliant, there can be no
assurance that Year 2000 errors or defects will not be discovered in
BabyCenter, Inc.'s current and future products or services. Any failure by
BabyCenter, Inc. to make its products Year 2000 compliant could result in a
decrease in revenue and an increase in the allocation of resources to address
Year 2000 problems without additional revenue commensurate with such dedication
of resources, or an increase in litigation costs relating to losses suffered by
BabyCenter, Inc.'s customers due to such Year 2000 problems.

BabyCenter is in the process of reviewing the year 2000 compliance of its
internally developed proprietary software. This review has included testing to
determine how its systems will function at and beyond the year 2000. BabyCenter
expects to complete these tests during the summer of 1999. Since inception,
BabyCenter has internally developed substantially all of the systems for the
operation of its Web site. These systems include the software used to provide
its Web site's search, customer interaction, and transaction-processing and
distribution functions, as well as monitoring and back-up capabilities. Based
upon its assessment to date, BabyCenter believes that its internally developed
proprietary software is year 2000 compliant.

BabyCenter is currently assessing the year 2000 readiness of its third-party
supplied software, computer technology and other services, which include
software for use in its accounting, database and security systems. The failure
of such software or systems to be year 2000 compliant could have a material
negative impact on BabyCenter's corporate accounting functions and the operation
of its Web site. As part of the assessment of the year 2000 compliance of these
systems, BabyCenter has sought assurances from these vendors that their
software, computer technology

88
<PAGE>
BABYCENTER, INC.

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)

6. YEAR 2000 ISSUE (UNAUDITED) (CONTINUED)
and other services are year 2000 compliant. BabyCenter has expensed amounts
incurred in connection with year 2000 assessment since its formation through
March 31, 1999. Such amounts have not been material. BabyCenter expects this
assessment process to be completed during the summer of 1999. Based upon the
results of this assessment, BabyCenter will develop and implement, if necessary,
a remediation plan with respect to third-party software, third-party vendors and
computer technology and services that may fail to be year 2000 compliant.
BabyCenter expects to complete any required remediation during the summer of
1999. At this time, the expenses associated with this assessment and potential
remediation plan that may be incurred in the future cannot be determined;
therefore, BabyCenter has not developed a budget for these expenses. The failure
of BabyCenter's software and computer systems and of its third-party suppliers
to be year 2000 compliant would have a material adverse effect on it.

The year 2000 readiness of the general infrastructure necessary to support
its operations is difficult to assess. For instance, BabyCenter depends on the
integrity and stability of the Internet to provide its services. BabyCenter also
depends on the year 2000 compliance of the computer systems and financial
services used by consumers. Thus, the infrastructure necessary to support its
operations consists of a network of computers and telecommunications systems
located throughout the world and operated by numerous unrelated entities and
individuals, none of which has the ability to control or manage the potential
year 2000 issues that may impact the entire infrastructure. BabyCenter's ability
to assess the reliability of this infrastructure is limited and relies solely on
generally available news reports, surveys and comparable industry data. Based on
these sources, BabyCenter believes most entities and individuals that rely
significantly on the Internet are carefully reviewing and attempting to
remediate issues relating to year 2000 compliance, but it is not possible to
predict whether these efforts will be successful in reducing or eliminating the
potential negative impact of year 2000 issues. A significant disruption in the
ability of consumers to reliably access the Internet or portions of it or to use
their credit cards would have an adverse effect on demand for BabyCenter's
services and would have a material adverse effect on BabyCenter.

At this time, BabyCenter has not yet developed a contingency plan to address
situations that may result if BabyCenter or its vendors are unable to achieve
year 2000 compliance because BabyCenter currently does not believe that such a
plan is necessary. The cost of developing and implementing such a plan, if
necessary, could be material. Any failure of its material systems, BabyCenter's
vendors' material systems or the Internet to be year 2000 compliant could have
material adverse consequences for BabyCenter. Such consequences could include
difficulties in operating BabyCenter's Web site effectively, taking product
orders, making product deliveries or conducting other fundamental parts of
BabyCenter's business.

7. SUBSEQUENT EVENT

On April 18, 1999, BabyCenter, Inc. and eToys Inc. signed a definitive
agreement to merge BabyCenter, Inc. with eToys Inc. Consummation of the merger
is expected by the end of the quarter ended June 30, 1999 and is subject to
certain closing conditions, including governmental approvals and approval by the
stockholders of BabyCenter, Inc. Under the terms of agreement, eToys Inc. would
issue its shares to the stockholders of BabyCenter, Inc. The merger is to be
treated as a purchase by eToys Inc. for accounting purposes.

89
<PAGE>
PART III

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

None.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding our executive officers required by Part III, Item 10,
is set forth in Item 1 of Part I herein under the caption "Executive Officers
and Directors." Information required by Part III, Item 10, regarding our
directors is included in our Proxy Statement relating to our annual meeting of
stockholders to be held in September, 2000, and is incorporated herein by
reference. Information relating to compliance with Section 16(a) of the
Securities Exchange Act of 1934, as amended, is set forth in the Proxy Statement
and incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

Information required by Part III, Item 11, is included in our Proxy
Statement relating to our annual meeting of stockholders to be held in
September, 2000, and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information required by Part III, Item 12, is included in our Proxy
Statement relating to our annual meeting of stockholders to be held in
September, 2000, and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information regarding certain relationships and related transactions is
included in our Proxy Statement relating to our annual meeting of stockholders
to be held in September, 2000, and is incorporated herein by reference.

PART IV

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

(A) LIST OF DOCUMENTS FILED AS A PART OF THIS REPORT:

(1) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<S> <C>
eTOYS INC.
Report of Ernst & Young LLP, Independent Auditors
Consolidated Balance Sheets as of March 31, 2000 and 1999
Consolidated Statements of Operations for the Years Ended
March 31, 2000, 1999 and 1998
Consolidated Statements of Stockholders' Equity (Deficit)
for the Years Ended March 31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the Years Ended
March 31, 2000, 1999 and 1998
Notes to Consolidated Financial Statements
</TABLE>

90
<PAGE>

<S> <C>
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
Unaudited Pro Forma Condensed Combined Statements of
Operations for the Years Ended March 31, 2000 and 1999
Unaudited Pro Forma Condensed Combined Balance Sheet as of
March 31, 1999
Notes to Unaudited Pro Forma Condensed Combined Financial
Information

BABYCENTER, INC.
Report of Independent Auditors
Balance Sheets as of September 30, 1997 and 1998 and
March 31, 1999
Statements of Operations for Inception to September 30,
1997; the Year Ended September 30, 1998; and the Six
Months Ended March 31, 1998 and 1999
Statements of Stockholders' Equity (Deficit) for the Periods
Ended September 30, 1997 and 1998 and March 31, 1999
Statements of Cash Flows for Inception to September 30,
1997; the Year Ended September 30, 1998; and the Six
Months Ended March 31, 1998 and 1999
Notes to Financial Statements
</TABLE>

(2) INDEX TO FINANCIAL STATEMENT SCHEDULES

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

(3) INDEX TO EXHIBITS

<TABLE>
<CAPTION>
NUMBER DESCRIPTION
------ -----------
<C> <S>
2.1* Agreement and Plan of Reorganization by and among eToys,
BabyCenter, Inc. and, with respect to Article VII only,
Pat Kenealy as Shareholder Representative, dated as of
April 18, 1999.
3.1* Amended and Restated Certificate of Incorporation of eToys.
3.4* Amended and Restated Bylaws of eToys.
4.1* Specimen Stock Certificate.
4.2 Indenture for the 6.25% Convertible Subordinated Notes due
2004, dated as of December 6, 1999, by and between eToys
and U.S. Bank Trust National Association, as debt trustee
including the form of 6.25% Convertible Subordinated Note
due 2004 in Section 2.1 of the Indenture.
4.3 Registration Rights Agreement, dated as of December 1, 1999,
by and among eToys and the Initial Purchasers of the Notes
10.1*+ Stock Purchase Agreement dated June 27, 1997 between eToys
and Edward C. Lenk.
10.2*+ Restricted Stock Purchase Agreement dated June 27, 1997
between eToys and Edward C. Lenk.
10.3*+ Stock Purchase Agreement dated June 27, 1997 between eToys
and Frank C. Han.
10.4*+ Restricted Stock Purchase Agreement dated June 27, 1997
between eToys and Frank C. Han.
10.5* Note and Stock Purchase Agreement dated June 27, 1997
between eToys and idealab!.
10.6* Series A Preferred Stock Purchase Agreement dated December
23, 1997 among eToys and certain investors.
10.7* Series B Preferred Stock Purchase Agreement dated June 4,
1998 among eToys and certain investors.
10.8* Lease dated January 22, 1999 between eToys and Spieker
Properties, L.P.
10.9* Standard Industrial Lease Agreement dated June 26, 1998
between eToys and Newcrow (amended October 15, 1998).
10.10* Form of Indemnification Agreement between eToys and each of
its officers and directors.
</TABLE>

91
<PAGE>

<TABLE>
<CAPTION>
NUMBER DESCRIPTION
------ -----------
<C> <S>
10.11* 1999 Directors' Stock Option Plan.
10.12*+ Offer Letter dated December 5, 1998 between eToys and John
R. Hnanicek.
10.13*+ Offer Letter dated December 28, 1998 between eToys and Louis
V. Zambello III.
10.14*+ Offer Letter dated January 12, 1999 between eToys and
Steven J. Schoch.
10.15* Equipment Lease Line dated December 24, 1998 between eToys
and Comdisco, Inc.
10.16* Series C Preferred Stock Purchase Agreement dated March 24,
1999 among eToys and certain investors.
10.17* Amended and Restated Investors' Rights Agreement dated
March 24, 1999 among eToys and certain investors.
10.18* Amended and Restated Voting Agreement dated March 24, 1999
among eToys and certain investors.
10.19* Amended and Restated Right of First Refusal and Co-Sale
Agreement dated March 24, 1999 among eToys and certain
investors.
10.20*+ 1997 Stock Plan (as amended).
10.21*+ 1999 Stock Plan (as amended).
10.22*+ 1999 Employee Stock Purchase Plan (as amended).
10.23*+ Offer Letter dated May 13, 1999 between eToys and
Janine Bousquette.
10.24* Deed of Lease, dated as of May 10, 1999, between eToys and
East Bowles, L.L.C.
10.25 Intentionally omitted
10.26 Sub-Sublease Agreement dated as of February 2000 between
USWeb Corporation and the Company
10.27 Sublease dated as of November 8, 1999 between
Kennedy-Wilson, Inc. and the Company
10.28 Lease Agreement dated as of February 28, 2000 between
ProLogis Development Services Incorporated and eToys
Distribution LLC
10.29 Lease dated as of March 9, 2000 between Land Securities PLC
and eToys UK Limited
10.30 Lease dated as of March 15, 2000 between Coal Pension
Properties Limited and eToys UK Limited
10.31 Leases dated as of March 16, 2000 between Highwoods Realty
Limited Partnership and eToys Distribution LLC
10.32** Lease dated December 14, 1999 between the Company and Kilroy
Realty L.P.
10.33 Business Premises Lease Agreement between Despa Deutsche
Sparkassen-Immobilien-Anlage-Gesellschaft mbH and eToys
Germany GmbH
10.34 Belgium Distribution Center Lease dated as of March 31, 2000
between La SA TTS Belgium and La SPRL eToys Belgium
12.1 Statement re: Computation of Ratio of Earnings to Fixed
Charges
21 Subsidiaries of the Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors
23.2 Consent of Ernst & Young LLP, Independent Auditors
27.1 Financial Data Schedule
99.1 Undertakings incorporated by reference into Form S-8
Registration Statement No. 333-78853
99.2 Undertakings incorporated by reference into Form S-8
Registration Statement No. 333-82147
99.3 Undertakings incorporated by reference into Form S-8
Registration Statement No. 333-36362
</TABLE>

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

* Incorporated by reference to the Company's Registration Statement of Form S-1
(Registration No. 333-72469)

** Incorporated by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended December 31, 1999

+ Executive Compensation Plan or Agreement

(B) REPORTS ON FORM 8-K

None.

92
<PAGE>
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, as of June 1, 2000.

<TABLE>
<S> <C> <C>
eTOYS INC.

By: /s/ EDWARD C. LENK
-----------------------------------------
Edward C. Lenk
PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated as of June 1, 2000.

<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S> <C>
President, Chief Executive
/s/ EDWARD C. LENK Officer and Chairman of the
------------------------------------------- Board (Principal Executive
Edward C. Lenk Officer)

/s/ STEVEN J. SCHOCH Chief Financial Officer
------------------------------------------- (Principal Financial and
Steven J. Schoch Accounting Officer)

/s/ PETER C.M. HART
------------------------------------------- Director
Peter C.M. Hart

/s/ TONY HUNG
------------------------------------------- Director
Tony Hung

/s/ MICHAEL MORITZ
------------------------------------------- Director
Michael Moritz

/s/ DANIEL NOVA
------------------------------------------- Director
Daniel Nova
</TABLE>