PLAY BY PLAY TOYS & NOVELTIES INC, 10-K, 1998-10-29

PLAY BY PLAY TOYS & NOVELTIES INC
10-K, 1998-10-29
DOLLS & STUFFED TOYS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934

For the Fiscal Year Ended Commission file number
July 31, 1998 0-26374

PLAY BY PLAY TOYS & NOVELTIES, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

Texas 74-2623760
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

4400 Tejasco
San Antonio, Texas 78218
(Address of principal executive offices and zip code)

(210) 829-4666
(Registrant's telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
None

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, no par value
(Title of class)

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

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

As of October 20, 1998, the aggregate market value of the voting stock held
by non-affiliates of the registrant (based upon the last reported sale price of
the Common Stock of the registrant as quoted on the National Market System of
the National Association of Securities Dealers Automated Quotation System) was
$41,762,696. (For purposes of calculating the preceding amount only, all
directors, executive officers and shareholders holding 5% or greater of the
registrant's Common Stock are assumed to be affiliates). The number of shares of
Common Stock of the registrant outstanding as of October 20, 1998 was 7,315,000.

DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Company's Proxy Statement for its annual meeting of
shareholders are incorporated by reference into Items 10, 11, 12 and 13 of Part
III. The registrant intends to file such Proxy Statement no later than 120 days
after the end of the fiscal year covered by this Form 10-K.

<PAGE>
TABLE OF CONTENTS

PAGE
------
PART I
ITEM 1. Busines ................................................ 3
General ................................................ 3
Business History ....................................... 3
Company Strengths ...................................... 5
Business Strategy ...................................... 5
Products ............................................... 7
Licensed Products ...................................... 8
Non-Licensed Products .................................. 8
License Agreements ..................................... 9
Sales, Marketing and Distribution ...................... 10
Design and Development ................................. 12
Manufacturers and Suppliers ............................ 13
Advertising ............................................ 13
Vending Operations ..................................... 14
Competition ............................................ 14
Product Liability ...................................... 14
Government Regulation .................................. 14
Tariffs and Duties ..................................... 15
Trademarks ............................................. 15
Employees .............................................. 15
Risk Factors ........................................... 16
ITEM 2. Properties .............................................. 22
ITEM 3. Legal Proceedings ....................................... 23
ITEM 4. Submission of Matters to a Vote of Security Holders ..... 23

PART II
ITEM 5. Market for Registrant's Common Equity and Related
Shareholder Matters ................................... 23
Market Information .................................... 23
Shareholders .......................................... 23
Dividends and Distributions ........................... 24
ITEM 6. Selected Consolidated Financial Data .................... 25
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................... 26
General ............................................... 26
Results of Operations ................................. 28
Liquidity and Capital Resources ....................... 31
Euro .................................................. 33
Dividend Policy ....................................... 33
Year 2000 ............................................. 33
Seasonality ........................................... 34
Inflation ............................................. 35
New Accounting Pronouncement .......................... 35
ITEM 7A. Quantitative and Qualitative Disclosures About
Market Risks ......................................... 35
ITEM 8. Financial Statements and Supplementary Data ............. 36
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure .................. 37

PART III
ITEM 10. Directors and Executive Officers of the Registrant ..... 37
ITEM 11. Executive Compensation ................................. 37
ITEM 12. Security Ownership of Certain Beneficial Owners
and Management ....................................... 37
ITEM 13. Certain Relationships and Related Transactions ......... 37

1
<PAGE>
TABLE OF CONTENTS (CONTINUED)

PAGE
------
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K .................................. 37
SIGNATURES ..................................................... 38
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL
STATEMENT SCHEDULE ......................................... F-1
INDEX TO EXHIBITS .............................................. E-1
Report of Independent Accountants on Financial Schedule ........ S-1
Schedule II - Valuation and Qualifying Accounts ................ S-2

2
<PAGE>
PART I

ITEM 1. BUSINESS

GENERAL

THIS REPORT CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY's
ACTUAL RESULTS COULD DIFFER MATERIALLY. FACTORS THAT COULD CAUSE OR CONTRIBUTE
TO SUCH DIFFERENCES INCLUDE, WITHOUT LIMITATION, COMPETITIVE AND ECONOMIC
FACTORS, PRICE CHANGES BY COMPETITORS, RELATIONSHIPS WITH LICENSORS AND
CUSTOMERS, ABILITY TO MANAGE GROWTH, ABILITY TO SOURCE PRODUCTS, INTERNATIONAL
TRADE RELATIONS, MANAGEMENT OF QUARTER TO QUARTER RESULTS, INCREASES IN COSTS OF
RAW MATERIALS, TIMING OF TECHNOLOGICAL ADVANCES BY THE COMPANY AND ITS
COMPETITORS, LACK OF ACCEPTANCE BY CONSUMERS OF NEW PRODUCTS, AND THE OTHER
FACTORS DISCUSSED BELOW IN "RISK FACTORS", ELSEWHERE HEREIN. UPDATED INFORMATION
WILL BE PERIODICALLY PROVIDED BY THE COMPANY AS REQUIRED BY THE SECURITIES
EXCHANGE ACT OF 1934. AS USED HEREIN, UNLESS THE CONTEXT OTHERWISE REQUIRES, THE
"COMPANY" MEANS PLAYOBYOPLAY TOYS & NOVELTIES, INC., A TEXAS CORPORATION, AND
ITS WHOLLY OWNED SUBSIDIARIES.

The Company designs, develops, markets and distributes stuffed toys,
novelty items and its PLAY-FACES(R) line of sculpted toy pillows based on
licenses for popular children's entertainment characters, professional sports
team logos and corporate trademarks. The Company also designs, develops, markets
and distributes electronic toys and non-licensed stuffed toys and markets and
distributes a broad line of non-licensed novelty items. The Company markets and
distributes its products in both amusement and retail markets and believes that
it is the leading supplier of stuffed toys and novelty items to the domestic
amusement industry. The Company was incorporated in Texas in 1992. Its principal
executive offices are located at 4400 Tejasco, San Antonio, Texas 78218 and its
telephone number is (210) 829-4666.

BUSINESS HISTORY

Over the last five fiscal years, the Company's net sales have grown from
$32.6 million for fiscal 1994 to $178.1 million in fiscal 1998, representing a
54.2% average annual increase, and net income has increased from $1.1 million
for fiscal 1994 to $8.4 million for fiscal 1998, representing an 70.4% average
annual increase. The Company's growth in net sales and net income is primarily
attributable to its introduction of new products and its two strategic
acquisitions.

The Company develops its licensed stuffed toys based principally on
popular, classic characters such as LOONEY TUNES, ANIMANIACS, SUPERMAN, BATMAN,
SCOOBY-DOO(TM), THE FLINTSTONES(TM), POPEYE(TM) and on popular, classic
trademark licenses such as The Coca-Cola Company's COCA-COLA(R) brand stuffed
toys, including the COCA-COLA(R) POLAR BEAR, and Harley-Davidson Motor Company's
HARLEY HOG(TM). THE Company develops a licensed stuffed toy by identifying a
character or trademark license, obtaining the necessary license, designing the
product and developing a prototype, and manufacturing the products through third
party manufacturers. The Company believes that products based on popular,
classic characters and trademarks will have a longer and more stable product
life cycle than products based on newer, less established characters and
trademarks. The Company believes its position as a leading supplier to the
domestic amusement industry allows it to more effectively acquire licenses for
products sold to the amusement market. The Company's non-licensed products
include traditional stuffed toys in various sizes, interactive dolls and novelty
items such as low-priced plastic toys and games used primarily as redemption
prizes by its amusement customers. For fiscal 1998, net sales of licensed
products and non-licensed products accounted for 64.2% and 34.1%, respectively,
of the Company's net sales.

The Company introduced its retail product line in fiscal 1995 with its
originally developed PLAY-FACES(R) line of sculpted toy pillows shaped in the
facial likeness of licensed animated characters. The

<PAGE>
PLAY-FACES(R) line is based upon popular, classic characters, including The Walt
Disney Company's animated characters, LOONEY TUNES, ANIMANIACS, SUPERMAN,
BATMAN, GARFIELD(TM), Rugrats(R), and new characters developed and introduced by
leading entertainment companies, such as the ones presented in The Walt Disney
Company's animated films MULAN, THE LITTLE MERMAID, and 101 DALMATIANS. During
fiscal 1997, the Company extended the line by adding full-bodied pillows, which
are being sold in the domestic section of most mass retail customers. The
Company believes its PLAY-FACES(R) line is a distinct product category that
enhances its ability to acquire additional character and trademark licenses.
PLAY-FACES(R) products accounted for 5.4% of the Company's net saleS for fiscal
1998.

During fiscal 1997, the Company entered the large doll market with a pair
of electronic interactive dolls, the Talkin' Tots(TM) which talk and sing
together utilizing infrared technology. The Company began selling Talkin'
Tots(TM) during the fourth quarter of fiscal 1997 and began television
advertising during the first quarter of fiscal 1998. The Company also developed
a retail line of Looney Tunes products during fiscal 1997, including standing,
sitting and bean bag stuffed toys, and another television promoted electronic
stuffed toy, the Tornado Taz(TM). The Tornado Taz(TM) is A Tasmanian Devil(TM)
that spins, shakes, grunts and laughs. The Looney Tunes products include such
characters as TWEETY(TM), SYLVESTER(TM), TASMANIAN DEVIL(TM), BUGS BUNNY(TM),
SPEEDY GONZALES(TM), YOSEMITE SAM(TM), and DAFFY DUCK(TM).

During fiscal 1998, the Company introduced several new electronic
interactive talking products such as Bugs & Daffy Talkin' Tunes(TM), Sylvester &
Tweety Talkin' Tunes(TM), and Singin' & Swingin' Tweety(TM), which utilize
infrared technology. The Company also introduced full bodied pillows, beanbags
based on the popular Rugrats(TM) characters, and Major League Baseball, National
FootbalL League and National Basketball Association Fanimal beanbags. The
Company also developed a retail line of infant, toddler and preschool products
based on Baby Looney Tunes characters ranging from play toys to pull toys.

During fiscal 1998, the Company enhanced its existing retail and amusement
business by launching a new direct mail division. The new initiative will
provide the Company with an additional channel of distribution for its broad
line of products. The direct mail catalog will include the Company's quality
stuffed toys and novelty items that are based on licenses for popular
entertainment characters, professional sport team logos, and corporate
trademarks. The catalog will also feature the Company's broad line of
non-licensed novelty items, electronic toys and non-licensed stuffed toys.

The Company has a diversified base of customers within the amusement and
retail distribution channels. Amusement customers, which accounted for 69.2% of
net sales for fiscal 1998, include theme parks such as Premier/Six Flags,
Paramount, Universal Studios, Busch Gardens and Sea World, family entertainment
centers such as Tilt, Dave and Buster's, Inc. and Namco, carnivals and state
fairs. In addition to theme parks, family entertainment centers and carnivals,
the Company distributes its amusement merchandise through its Fun Services(R)
(sales through franchisees), fundraising and premium (products designed for
specific companies) customers. Retail customers, which accounted for 29.1% of
net sales for the same period, principally consist of mass merchandisers such as
Wal-Mart, Kmart, and Target, and specialty retailers such as Toys "R" Us and Kay
Bee Toy. No one customer accounted for more than 10% of net sales for fiscal
1998.

The Company completed two strategic acquisitions that have contributed to
its growth. In June 1996, the Company acquired substantially all of the
operating assets, business operations and facilities (the "Ace Acquisition") of
Ace Novelty Co., Inc. ("Ace") for $44.7 million. In November 1996, the Company,
through its wholly-owned subsidiary Play-By-Play Toys & Novelties Europa, S.A.,
("Play-By-Play Europe") acquired The TLC Gift Company, Ltd. ("TLC") based in
Doncaster, England for 40,000 shares of Common Stock. The Ace acquisition
provided the Company with several strategic advantages, including significant
distribution channels in the central and western United States, significant
distribution channels in the outdoor amusement markets, key United States and
international classic character licenses for retail and amusement,

<PAGE>
an in-house design and development team and additional key personnel. The
Company believes that the Ace acquisition contributed to the Company's
profitability in fiscal 1998 and 1997. Similarly, the TLC acquisition resulted
in additional distribution channels in the U.K. where TLC is headquartered and
other areas of Europe. The Company believes that the TLC acquisition has begun
contributing to the Company's net earnings and is partially responsible for its
significant international growth.

COMPANY STRENGTHS

The Company believes its principal strengths include its:

o emphasis on licenses for popular, classic characters and trademarks and new
characters introduced by leading entertainment companies;

o demonstrated ability to develop new and innovative toys such as Talkin'
Tots(TM), Tornado Taz(TM), Bugs & Daffy Talkin' Tunes(TM), Sylvester & Tweety
Talkin' Tunes(TM), and Singin' & Swingin' Tweety(TM), new licensed products
such as the COCA-COLA(R) brand stuff toys, and new product categories such as
the PLAY-FACES(R) line;

o position as the leading domestic supplier of stuffed toys and novelty items
to the amusement industry;

o balance between amusement and retail markets, which reduces seasonality and
increases stability of revenues;

o experienced management team with toy and licensing expertise;

o in-house design and development team which provides the Company the ability
to bring more products to market quicker, thereby taking early advantage of
product trends;

o offices in Hong Kong and China which results in direct sourcing in the Far
East and the ability to better manage product quality, production and timely
availability of products;

o diverse customer base comprised of more than 4,000 customers, with no one
customer accounting for greater than 10% of net sales;

o multiple distribution channels which enhance the Company's ability

o to sell slower moving items while minimizing the impact on gross profit
margins; and

o distribution facilities strategically located throughout North America and
Europe allowing the Company to better serve its customers which typically
have multiple locations and with minimal inventory storage capacity

BUSINESS STRATEGY

The Company's growth strategy includes the following key elements:

LICENSED PRODUCT LINE EXPANSION. The Company believes that by developing
licensed products based principally on popular, classic characters and
trademarks, it has established a core licensed product portfolio that is
characterized by a longer product life cycle than is typical in the toy
industry. The Company intends to continue to develop its licensed product line
by targeting licensing opportunities where it can take advantage of licensor
advertising, publicity and media exposure. The Company believes that its broad
line of licensed products prevents it from becoming overly dependent on a single
product or customer.

<PAGE>
DEVELOPMENT OF INNOVATIVE TOYS AND NEW PRODUCT CATEGORIES. The Company
believes that its development of proprietary toys and other licensed-based
product lines represent distinct unique products, which enhance its market
identification and ability to acquire additional character and trademark
licenses. The Company intends to develop new product categories targeted to both
its amusement and retail customers. The Company strives to develop unique
products with broad end-consumer appeal at competitive prices by identifying
previously undeveloped or under-developed products or product categories and
matching them with popular, classic licensed characters and/or trademarks. The
Company believes it has successfully implemented this approach with its Looney
Tunes product lines, Bugs & Daffy Talkin' Tunes, Sylvester & Tweety Talkin'
Tunes, and Singin' & Swingin' Tweety, PLAY-FACES(R) product lines,
Harley-Davidson Motor Company's HARLEY HOG(TM), and the COCA-COLA(R) POLAR BEAR.

INTERNATIONAL EXPANSION. The Company plans to increase its international
sales, primarily in Europe and Latin America, in both the amusement and retail
markets through the Company's Hong Kong, United States and European distribution
facilities and independent distributors. The Company believes that markets
outside the United States present significant opportunities and are generally
less competitive than the United States market. The Company commenced toy
distribution and sales operations in Europe and Latin America in fiscal 1994.
Since fiscal 1994, international sales have increased at an average annual rate
in excess of 100%, and the Company believes there are additional significant
opportunities for growth in international markets. Additionally, with the newly
obtained worldwide manufacturing and distribution rights for Baby Looney Tunes,
the Company will begin selling in new markets, including the Asia Pacific
countries.

RETAIL MARKET PENETRATION. The Company intends to broaden its retail
distribution both domestically and internationally. Through its licensing and
new product development strategies, the Company plans to further penetrate the
retail market by continuing to develop and introduce new products (such as
Talkin' Tunes(TM) anD Baby Looney Tunes(TM)) and product categories (such as
PLAY-FACES(R)). Since fiscal 1994, retail sales have grown at a weighted average
rate of 103.5% domestically, and at a weighted average rate of 95.9%
internationally. Based on the Company's relatively small share of the retail toy
market and its proven ability to develop product niches and obtain key licenses,
retail products continue to be a growth opportunity for the Company.

AMUSEMENT MARKET PENETRATION. With the Ace Acquisition, the Company
believes that it has become the leading supplier of stuffed toys and novelty
items to the domestic amusement market. The Company believes that this market is
less susceptible to changing consumer preferences than the retail market. The
Company believes that its broad and continually updated line of licensed and
non-licensed stuffed toys and novelty items, its purchasing power, distribution
facilities, and its reputation as a leading amusement supplier provide the
Company with a competitive advantage over many other suppliers to this market.
Since fiscal 1994, amusement sales have grown at a weighted average rate of
48.4% domestically, and at a weighted average rate of 128.4% internationally.
While the Company believes there is greater opportunity to grow its retail and
international businesses than its domestic amusement business, the latter
provides the Company with a stable revenue base and consistent base of cash
flow.

DIRECT MAIL PENETRATION. The Company distributed its first direct mail
catalog in October 1998 to consumers. A staff of veteran direct mail executives,
with proven track records, was assembled to organize the product line and
administer the systems necessary for smooth operations. The services of an
experienced tele-marketing firm were contracted to handle the in-bound consumer
calls, and a fulfillment house was selected to package and ship the consumer
orders. The Company is in the process of purchasing mailing lists that are
focused on our desired customer profile. The Company believes this venture
provides growth opportunities and expands consumer awareness of the Company's
product lines.

<PAGE>
ACQUISITION STRATEGY. The acquisition strategy of the Company is to find
businesses with unique product lines (either licensed or non-licensed) which can
be sold through the Company's existing distribution channels or businesses which
have complimentary distribution channels for the Company's existing product
lines. The Company believes that this strategy will result in greater sales
while reducing the combined companies' general and administrative costs. The Ace
and TLC acquisitions accomplished both of these acquisition objectives.

PRODUCTS

The Company markets a variety of licensed and non-licensed stuffed toys
and novelty items. The following chart shows the breakdown of the Company's net
toy sales (which does not include vending sales) by principal product category:

YEAR ENDED JULY 31,
-----------------------------------
1998 1997 1996
------ ------ ------
(IN MILLIONS)
Licensed products
Stuffed toys ........... $ 94.3 $ 63.4 $ 24.2
Play-Faces(R) .......... 9.5 16.5 19.0
Electronic toys ........ 10.6 2.0 --
------ ------ ------
114.4 81.9 43.2
------ ------ ------
Non-licensed products
Stuffed toys ........... 32.3 38.7 22.1
Novelty items .......... 13.3 8.8 5.4
Electronic toys ........ 15.1 4.8 --
------ ------ ------
60.7 52.3 27.5
------ ------ ------
Total ............... $175.1 $134.2 $ 70.7
====== ====== ======

(PERCENTAGE OF NET TOY SALES)

Licensed products
Stuffed toys ........... 53.9% 47.3% 34.2%
Play-Faces(R) .......... 5.4 12.3 26.9
Electronic toys ........ 6.1 1.5 --
------ ------ ------
65.4 61.1 61.1
------ ------ ------
Non-licensed products
Stuffed toys ........... 18.4 28.8 31.2
Novelty items .......... 7.6 6.5 7.7
Electronic toys ........ 8.6 3.6 --
------ ------ ------
34.6 38.9 38.9
------ ------ ------
Total ............... 100.0% 100.0% 100.0%
====== ====== ======

7
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LICENSED PRODUCTS

In developing its licensed products, the Company seeks to take advantage
of media exposure and goodwill accompanying its licensed characters and
trademarks as well as the advertising and promotional programs provided by its
licensors. Net sales of licensed products were $114.4 million and $81.9 million
(64.2% and 59.7% of net sales) during fiscal 1998 and 1997, respectively.

STUFFED TOYS. The Company designs, develops, markets and distributes over
2,000 different stuffed toys based upon its licenses for children's
entertainment characters and corporate trademarks. Generally, the Company offers
a variety of sizes and styles of its licensed stuffed toys. The Company seeks to
develop its products around both existing and newly-acquired licenses for
commercially established characters and trademarks. The Company's licensed
stuffed toys are generally sold to both amusement customers as redemption prizes
and to retail customers. Licensed stuffed toy products have suggested retail
prices ranging from $5 to $30. To date, the Company's most successful licensed
stuffed toy products have been those based on the Looney Tunes characters, which
include standing, sitting and beanbag stuffed toys.

PLAY-FACES(R). During the first quarter of fiscal 1995, the Company began
selling its PLAY-FACES(R) line of sculpted toy pillows shaped in the facial
likenesses of licensed animated characters. PLAY-FACES(R) are sold primarily to
retail customers and have a suggested retail price of under $20. The Company
believes its PLAY-FACES(R) line is a distinct product category which has
enhanced its ability to acquire additional character and trademark licenses.
PLAY-FACES(R) products accounted for 5.4% of the Company's net sales for fiscal
1998.

ELECTRONIC TOYS. During 1997, the Company introduced a television promoted
electronic stuffed toy, Tornado Taz(TM). Tornado Taz(TM) is a plush depiction of
Tasmanian Devil(TM) that spins, shakes, grunts and laughs. The Company began
selling this product during the fourth quarter of fiscal 1997. Sales of Tornado
Taz(TM) accounted for $10.6 million and $2.0 million of the Company's net toy
sales, or 6.0% and 1.5%, for fiscal 1998 and 1997, respectively. During fiscal
1998, the Company further developed the electronic stuffed toys by adding Bugs &
Daffy Talkin' Tunes(TM), Sylvester & Tweety Talkin' Tunes(TM), and Singin' &
Swingin' Tweety(TM). "Bugs & Daffy Talkin' Tunes(TM) is a plush depiction of
Bugs Bunny(TM) and Daffy Duck(TM), and Sylvester & Tweety Talkin' Tunes(TM) is a
plush depiction of Sylvester(TM) and Tweety(TM) each of which converse utilizing
infrared technology. A squeeze of each stuffed toy's hand initiates the
pre-recorded conversations. Singin' & Swingin' Tweety(TM) is a plush depiction
of Tweety(TM), incorporating motioN sensor technology, that sits in his birdcage
happily singing & swinging on his perch. When motion is detected he exclaims
"Oh, I tawt I taw a putty tat! I did! I did see a putty tat!"

NON-LICENSED PRODUCTS

The Company markets and distributes a broad line of non-licensed products,
including stuffed toys, electronic toys and novelty items. The Company's
non-licensed product line includes stuffed and electronic toys designed and
developed internally, stuffed toy and novelty product lines selected and
modified by the Company from the product lines of third party manufacturers, and
stuffed toys and novelty items purchased directly from third party
manufacturers. Net sales of non-licensed products were $60.7 million and $52.3
million (34.1% and 38.0% of net sales) during fiscal 1998 and 1997,
respectively.

STUFFED TOYS. The Company designs, develops, markets and distributes a
broad line of non-licensed stuffed toys, consisting principally of generic
animal characters and a broad variety of seasonal and holiday characters. The
Company's non-licensed stuffed toys are principally marketed to the amusement
market for use as redemption prizes. The Company frequently redesigns, by color
and otherwise, its product line. Over the three year period ended July 31, 1998,
sales of non-licensed stuffed toys have decreased as a percentage of total net
toy sales, primarily due to changing consumer trends and towards preference
licensed

<PAGE>
merchandise and the Company's decision to focus its working capital on the
growth of its licensed products and novelty item sales. No single non-licensed
stuffed toy accounted for more than 10% of the Company's net sales during fiscal
1998, 1997 or 1996.

NOVELTY ITEMS. The Company markets and distributes a broad line of novelty
items to the amusement market for use as redemption prizes. The Company's
novelty items principally include plastic toys, cosmetic jewelry, novelty school
supplies, inexpensive electronic toys and radios, rubber balls and styrofoam
gliders. The Company frequently changes its mix of novelty items. No single
novelty item accounted for more than 10% of the Company's net sales or 10% of
the Company's net sales of novelty items during fiscal 1998.

ELECTRONIC TOYS. During 1997, the Company entered the large doll market
with the introduction of a set of interactive dolls, the Talkin' Tots(TM) which
talk and sing together utilizing infrareD technology. A squeeze of each doll's
hands initiates the pre-recorded conversations, singing of the alphabet and two
other nursery rhymes. The conversations and nursery rhymes are recorded in
several languages. The Company began selling this product during the fourth
quarter of fiscal 1997. Sales of the Talkin' Tots(TM) accounted for $15.1
million, or 8.6%, and $4.8 million, or 3.6%, of the Company's net toy sales for
fiscal 1998 and 1997, respectively.

LICENSE AGREEMENTS

Approximately 64.2%, 59.7% and 58.2% of the Company's net sales in fiscal
1998, 1997 and 1996, respectively, were derived from product lines based on
entertainment character or corporate trademark licenses. Products based on
Looney Tunes' characters accounted for 50.6% of net sales in fiscal 1998. The
Company's licenses generally have terms of one to three years and limit sales to
certain geographic territories and distribution channels. The Company's license
agreements typically require the payment of non-refundable advances and
guaranteed minimum royalties. Certain of the Company's material licenses are
non-exclusive. The Company emphasizes licenses that permit the Company to market
toys based on characters or trademarks which develop their own popular identity,
often through exposure in television programs, movies, cartoons and comic books
and, in the case of popular, classic characters, often through exposure over
many years. The Company's license agreements also require the Company to obtain
approval of the Company's third party manufacturers and approval of the product
from the licensor. Generally, the Company's license agreements also require the
Company to carry specified types and amounts of insurance. The Company's license
agreements generally require licensor approval prior to merger, reorganization,
certain stock sales, or any assignment of the license, and certain of the
license agreements require prior approval by the licensor of certain "Key" or
"Executive" management changes of the licensee.

In addition to seeking licenses for popular, classic characters and
trademarks, the Company also seeks to acquire licenses for new characters
developed and introduced by leading entertainment companies. The successful
marketing of a product based on a character generally requires the Company to
anticipate and evaluate the popularity of such characters, and to capitalize on
the success of such characters in a timely manner. A determination to acquire a
character license must frequently be made before the commercial introduction of
the property in which the new licensed character appears. Since many toy
products based on licensed characters are successfully marketed for only one or
two years, the success of the Company's character licensing program is dependent
upon the ability of management to acquire licenses and to develop the
corresponding products in a timely manner.

9
<PAGE>
SALES, MARKETING AND DISTRIBUTION

The Company markets and distributes its products domestically and
internationally to a diverse customer base within the amusement and retail toy
markets. The following table sets forth information concerning the Company's
domestic and international net toy sales (which do not include vending sales) by
distribution channel. Sales by the domestic division, including export sales,
such as those to customers in Latin America, are considered domestic sales. The
export sales for fiscal 1998, 1997 and 1996 were $14.4 million, $2.6 million,
and $1.4 million, respectively. Sales by the European subsidiary are considered
international sales.

YEAR ENDED JULY 31,
----------------------------------
1998 1997 1996
------ ------ ------
(IN MILLIONS)
Domestic toy sales:
Retail ....................... $ 41.8 $ 31.7 $ 20.8
Amusement .................... 101.6 81.4 40.8
------ ------ ------
143.4 113.1 61.6
------ ------ ------
International toy sales:
Retail ....................... 10.1 6.6 2.4
Amusement .................... 21.6 14.5 6.7
------ ------ ------
31.7 21.1 9.1
------ ------ ------
Total ..................... $175.1 $134.2 $ 70.7
====== ====== ======

(AS A PERCENTAGE OF NET TOY SALES)

Domestic toy sales:
Retail ....................... 23.9% 23.6% 29.4%
Amusement .................... 58.0 60.7 57.7
------ ------ ------
81.9 84.3 87.1
------ ------ ------
International toy sales:
Retail ....................... 5.8 4.9 3.4
Amusement .................... 12.3 10.8 9.5
------ ------ ------
18.1 15.7 12.9
------ ------ ------
Total ..................... 100.0% 100.0% 100.0%
====== ====== ======

DOMESTIC SALES. The Company's domestic sales are to amusement customers
including theme parks such as Premier/Six Flags, Paramount, Universal Studios,
Busch Gardens and Sea World, family entertainment centers such as Tilt, Dave and
Buster's, Inc. and Namco, carnivals, state fairs and arcade operations, and
retail customers including mass merchandisers such as Wal-Mart, KMart and Target
and specialty retailers such as Toys "R" Us and Kay Bee Toy. During fiscal 1998,
1997, and 1996, no domestic customer accounted for more than 10% of net sales to
domestic customers.

The Company markets its products to amusement and retail customers in the
United States through sixty-six salaried in-house salespersons and through
twenty-five commissioned independent sales representatives. The Company's
in-house and independent sales representatives generally utilize product
samples, catalogs, brochures and other promotional materials to market the
Company's products at trade shows, on-site visits to customers and customer
visits to the Company's showrooms. The Company maintains domestic product
showrooms in San Antonio, Texas; Chicago, Illinois; Los Angeles, California; New
York, New York; and Woodinville, Washington, where it displays its amusement and
retail product lines. The Company's product catalogs and brochures are designed
and developed in-house. Senior

<PAGE>
management coordinates and supervises the Company's sales personnel and
coordinates the Company's independent sales representatives and directly
participates in marketing to its customers. No sales representative generated
more than 10% of net sales to domestic customers during fiscal 1998.

The Company distributes its products from its warehouse/distribution
facilities located in San Antonio, Texas; Los Angeles, California; Chicago,
Illinois; Woodinville, Washington; and Burnaby, British Columbia, and arranges
direct shipments from the Far East to its larger retail customers. During the
third quarter of fiscal 1996, the Company established an office in Hong Kong to
enhance its product development and purchasing capabilities, centralize quality
control and expand its vendor base in the Far East. In fiscal 1998, the Company
further extended its Far East presence by opening an office in China to assist
the Hong Kong office with its responsibilities.

The Company's retail customers are among the largest retailers in the
United States. The retail customers, which accounted for 29.2% of net sales for
fiscal 1998, principally consist of mass merchandisers such as Wal-Mart, KMart
and Target, and specialty retailers such as Toys "R" Us and Kay Bee Toy. Due to
their purchasing volumes and desire to minimize inventory risk, these retailers
are increasingly requiring suppliers, including the Company, to maintain more of
the inventory on hand domestically. Accordingly, the Company is participating in
the electronic data interchange ("EDI") programs with Wal-Mart, Target, Sears,
KMart, Spencer Gifts, Mervyns and Toys "R" Us and is testing the EDI programs
with Linens and Things. The Company plans to participate in EDI programs with
several of its other major retail customers. To participate, the Company
notifies the customer(s) of its desire to participate, and upon the successful
exchange of test data, the Company seeks approval to become an EDI participant
with the customer. No fees or other commitments are required to participate. The
Company believes that this participation will allow the Company to monitor store
inventory levels, schedule production to meet anticipated reorders and maintain
sufficient inventory levels to both serve its customers and better manage its
inventory. The Company does not anticipate that it will be required to make
significant additional capital expenditures or to hire additional employees in
order to participate in such EDI programs. The Company is also testing the
advanced shipping notice ("ASN") program, which is part of the EDI program, with
Mervyns, Sears and Target. The ASN program provides information to the customer
before shipment arrives. The Company believes that this participation will
expedite the customer's receiving process and significantly reduce invoice
quantity discrepancies.

In addition to theme parks, family entertainment centers and carnivals,
the Company distributes its amusement merchandise to Fun Services(R),
fundraising and premium customers. Fun Services(R) consists of sales to
approximately fifty franchisees throughout the United States whereby
Play-By-Play is the franchisor. The Fun Services(R) franchisees sell products at
schools, churches and company fairs. The most notable sales program is the
Santa's Secret Shop(R) which allows school children and their families to
purchase Christmas gifts on the school premises during the holiday season. Fun
Services(R)sales during fiscal 1998 and 1997 were $6.5 million and $7.1 million,
respectively. The fundraising distribution channels consist principally of
various not-for-profit organizations or their independent event contractors. The
premiums distribution channel designs, develops and/or sources stuffed toys and
novelty items specifically customized for customers. These products are
typically distributed by the customer to their clients or employees as
promotional or incentive items. During fiscal 1998, premium and fundraising
sales totaled $14.7 million.

Generally, the Company does not sell any of its products on a consignment
basis and accepts returns only for defective merchandise. In certain instances,
where retailers are unable to resell the quantity of products which they have
ordered from the Company, the Company may, in accordance with industry practice,
assist retailers in selling such excess inventory by offering discounts and
other concessions. Returns, concessions and canceled orders have historically
been immaterial to the Company's net sales.

<PAGE>
INTERNATIONAL SALES. The Company began its international expansion with
the opening of its distribution facility in Valencia, Spain in August 1993. In
November 1996, the Company acquired TLC with distribution facilities in
Doncaster, England. The Company's principal international customers are located
in Spain, the United Kingdom, France, Benelux, Italy, Germany, Portugal, Israel,
Scandinavia, Ireland, Greece, Austria and certain Eastern European countries.
The Company is in the process of further expanding its distribution base in the
Middle East and South Africa.

The Company markets its products to amusement and retail customers in
Spain through fifteen independent commissioned sales representatives located in
Valencia, through eighteen independent commissioned sales representatives
located in the United Kingdom and Ireland and through eighteen independent
distributors located in France, Benelux, Italy, Germany, Austria, Portugal,
Malta, Greece, South Africa, the Middle East, Scandinavia and Eastern Europe,
each of which markets products principally within the country in which it is
located. Foreign independent distributors typically retain their own sales
representatives. The Company maintains product showrooms in Valencia, Spain and
Doncaster, England to display its product lines, and the Company's independent
distributors maintain their own product showrooms to display the Company's
products.

The Company distributes its amusement and retail products to European
customers through its Company-operated European facilities. The Company's
international product line generally includes its products offered in the United
States. The Company also offers products based upon licenses from domestic
licensors, which are exclusive to the European market and licenses from foreign
licensors such as certain major professional soccer teams in Europe.

The Company believes that the retail industry in Europe is as competitive
as that of the United States. The Company's license agreements in Europe are
generally broader than its domestic license agreements. Additionally, the
European licenses generally provide broader availability in terms as to whom the
Company can sell its products. The Company believes that fully utilizing these
licenses is a growth opportunity. Additionally, the Company also plans to
introduce certain new retail products, such as Tornado Taz(TM), Talkin'
Tunes, and Singin' & Swingin' Tweety to the European market.

The Company believes that the amusement industry in Europe is generally
less competitive than that of the United States. The amusement industry in
Europe is fragmented and competitors are generally local. The Company believes
that it was the first to develop and use a product catalogue for European
amusement sales. The amusement industry in Europe has generally had limited
access to licensed products but this trend is slowly changing.

Amusement customers include theme parks such as Port Aventura, Isla Magica
and Monte Tibidabo in Spain and Alton Towers, H. B. Leisure and Chessington Park
in the United Kingdom, Fort Fun Abenteurland and Warner Bros. Movie World in
Germany, Parc Asterix in France, Walibi in Belgium, Efteling in Holland, and
carnivals, fairs and arcade operations. International retail customers include
mass merchandisers such as J-Sainsbury, Tescos, British Homes Stores, Aucham,
Casa, Alcampo, Toys "R" Us, El Corte Ingles, Hipercor, Cana De Azucar and
specialty retailers.

DESIGN AND DEVELOPMENT

The Company relies on its senior management personnel and its marketing
department to target licensing opportunities and its product development
department to design and develop additions to its product line. The Company
typically drafts initial product drawings and produces toy prototypes in-house.
The Company maintains its sample design department in San Antonio, Texas. The
design department enables the Company to expedite the approval of licensed
products from licensors which usually retain the right to approve the licensed
products being marketed by the Company. To date, the Company has

12
<PAGE>
experienced little difficulty in obtaining licensor approval of these products.
The Company's marketing department also designs product packaging and
promotional materials. To minimize the risk associated with introducing new
products, the Company normally solicits the reactions of select customers to
prototypes prior to production.

MANUFACTURERS AND SUPPLIERS

The Company contracts with third party manufacturers in the Far East,
principally within The People's Republic of China ("China"), to manufacture its
stuffed toy products and PLAY-FACES(R) products. The Company's novelty items and
electronic toys are manufactured by third parties located in China, Taiwan and
Hong Kong. The Company's senior management negotiates the majority of its
manufacturing contracts without using agents. During the third quarter of fiscal
1996, the Company established an office in Hong Kong to enhance the Company's
product development and purchasing capabilities, more easily manage quality and
shipping schedules and expand its vendor base in the Far East. The Far East is
the largest and most widely used manufacturing center of toys in the world.
Decisions related to the choice of manufacturer are based on price, quality of
merchandise, consistency and the ability of a manufacturer to meet the Company's
timing requirements for delivery. The Company is not a party to long-term
contractual or other arrangements with any manufacturer and often uses more than
one manufacturer to produce a single product. The majority of the Company's
manufacturing is arranged directly by the Company with the manufacturing
facilities. No manufacturer accounted for more than 10% of the Company's
purchases of toy products during fiscal 1998. While the Company believes that it
is not dependent on any single manufacturer in the Far East, the Company could
be materially, adversely affected by political or economic disruptions affecting
the business or operations of third party manufacturers located in the Far East.

The principal materials used in the production and sale of the Company's
products are taffeta, polyester, polystyrene, acrylic textiles, plastics and
polyvinyl chloride. The manufacturers who deliver completed or partially
completed products to the Company generally purchase these materials. In order
to reduce transportation costs, the Company typically will import certain large
toys as skins and stuff them with either polystyrene or polyester at its
warehouse facilities in the United States or Europe. The Company believes that
an adequate supply of raw materials used in the manufacture of its products is
readily available from existing and alternative sources at reasonable prices.

ADVERTISING

The Company intends to continue to utilize a promotional strategy whereby
the Company will advertise certain of its proprietary products. The Company
believes that television advertising of retail merchandise, properly utilized,
has a positive effect on sales. Although a majority of the Company's retail
advertising budget is allocated to television, the Company continues to expend a
portion if its advertising budget to promote its products through retail
catalogs, advertisements in trade magazines, and cooperative promotional efforts
of retailers. In addition, the Company believes its licensed products benefit
from favorable media exposure such as television programs, movies, commercials,
cartoons and comic books, and by advertising, promotional and other media events
generated by licensors. The Company's advertising expenses were approximately
$7.6 million, $2.7 million and $688,000 during fiscal years 1998, 1997 and 1996,
respectively. The Company's amusement merchandise is typically promoted to the
industry via advertisements in trade publications and catalogs, while retail
merchandise is advertised in television promotions. Advertising expenses consist
primarily of costs incurred in the design, development, printing and shipping of
Company catalogs and a limited number of advertisements in trade publications
such as THE TOY BOOK(TM), AMUSEMENT BUSINESS(TM) and REPLAY MAGAZINE(TM).

13
<PAGE>
VENDING OPERATIONS

The Company owns and operates approximately 1,353 coin-operated amusement
game machines (crane machines, compact disc jukeboxes and video game machines)
located primarily in Texas, of which approximately 786 are placed in Pizza
Hut(R) restaurants. The other approximately 567 coin-operated amusement game
machines are generally operated under month-to-month arrangements with numerous
other small businesses. The Company believes that operating crane machines
improves its ability to serve its amusement customers. The Company shares
machine revenues with the owners of locations where the machines are placed.
Approximately 1.6%, 2.3% and 4.6% of the Company's net sales in fiscal 1998,
1997 and 1996, respectively, were derived from the Company's vending operations.
The Company currently intends to maintain its present level of vending
operations. However, the Company anticipates that its vending revenues will
continue to decrease as a percentage of net sales due to the Company's decision
to focus its working capital on the growth of its licensed product sales.

COMPETITION

The Company faces vigorous competition in the sale of its products.
Competitive factors include new product development, the procurement of
licenses, timely shipment of products, price, product appeal and the
availability of retail shelf space. The toy industry is highly fragmented with
several hundred domestic and international toy companies, importers and
distributors. The Company competes with many larger, better-capitalized
companies, including the Company's licensors, in the design, development,
marketing, and distribution of toys, and the procurement of licenses. The
Company's principal competitors in the retail industry include all major toy
companies. Certain of the Company's licensors, including The Walt Disney
Company, Time Warner Entertainment Company, L.P., Harley-Davidson Motor Company
and The Coca-Cola Company, distribute competing products through proprietary
retail outlets and amusement parks. In addition, the Company faces competition
from a number of smaller toy companies, some of which market single products.

PRODUCT LIABILITY

Products that have been or may be developed or sold by the Company may
expose the Company to potential liability from personal injury or property
damage claims by end-users of such products. The Company currently maintains
product liability insurance coverage in the amount of $1.0 million per
occurrence, with a $20.0 million liability umbrella policy. There can be no
assurance that the Company will be able to maintain such coverage or obtain
additional coverage on acceptable terms, or that such insurance will provide
adequate coverage against any potential claims. Moreover, even if the Company
maintains adequate insurance, any successful claim could materially and
adversely affect the reputation and prospects of the Company.

GOVERNMENT REGULATION

The Company is subject to the provisions of, among other laws, the Federal
Hazardous Substances Act and the Federal Consumer Product Safety Act. Those laws
empower the Consumer Products Safety Commission (the "Consumer Commission") to
protect consumers from hazardous toys and other articles. The Consumer
Commission has the authority to exclude from the market articles which are found
to be hazardous and can require a manufacturer to repurchase such toys under
certain circumstances. Any such determination by the Consumer Commission is
subject to court review. Similar state and local laws exist in the United States
and in many jurisdictions throughout the world. The Company maintains a quality
control program, including the inspection of goods at factories and the
retention of independent testing laboratories

<PAGE>
in Hong Kong, to ensure compliance with applicable laws. The Company believes it
is in material compliance with all applicable consumer safety laws.

The sale of franchises is regulated by the Federal Trade Commission and by
certain state agencies located in jurisdictions where the Company has
franchisees. Principally, these regulations require certain written disclosures
to be made prior to the offer for sale of a franchise. The disclosure documents
are subject to state review and registration requirements and must be
periodically updated, not less frequently than annually. In addition, some
states have relationship laws which prescribe the basis for terminating
franchisees' rights and regulate both the Company's and its franchisee's
post-termination rights and obligations. The Company believes it is in material
compliance with all applicable franchise laws.

TARIFFS AND DUTIES

In December 1994, the United States approved a trade agreement pursuant to
which import duties on toys, games, dolls and other specified items were
eliminated effective January 1, 1995, from products manufactured in all Most
Favored Nation ("MFN") countries (including China). Increases in quotas, duties,
tariffs or other changes or trade restrictions which may be imposed in the
future could have a material adverse effect on the Company's financial
condition, operating results or ability to import products. In particular, the
Company's costs could be increased if China's MFN status is revoked. The loss of
MFN status for China would result in substantial duties on the cost of toy
products manufactured in China and imported into the United States. Currently
there is no duty on the import of these products.

The Company could attempt to mitigate the effects of an increase in duty
by shifting its manufacturing to other countries, but there can be no assurance
that the Company would be successful in this regard. The Company cannot predict
what regulatory changes may occur or the type or amount of any financial impact
on the Company that these changes could have in the future.

Prior to January 1, 1998, Spain imposed an import duty for certain
products imported into the country from China that exceed specified levels. On
January 1, 1998, Spain abolished the quota on toys. Although this import duty
exemption covers all items currently imported by the Company from China to
Spain, future changes in such regulation or in the items imported could result
in the imposition of import duties.

TRADEMARKS

The Company has registered trademarks for Play-By-Play(R) and
PLAY-FACES(R) in the United States and in Spain. The Company has registered
trademarks for Talkin' Tots(R) in the United States. The Company has filed an
application to register Talkin' Tunes and Penny and Patches as trademarks in the
United States.

EMPLOYEES

As of July 31, 1998, the Company employed approximately 736 people in its
toy operations and 21 people in its vending operation. Of the 736 employees in
the toy operations, approximately 450 are engaged in warehousing and
distribution, 97 are engaged in finance and administration, 151 are engaged
primarily in sales and marketing, and 38 are engaged in product development. A
union represents some of the Company's employees in Chicago, Illinois. In Spain,
the Company is subject to various governmental regulations relative to its
employees, and has standard national employment contracts with all of its
Spanish employees. The Company believes its relationship with its employees is
satisfactory.

15
<PAGE>
RISK FACTORS

THIS REPORT CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S
ACTUAL RESULTS COULD DIFFER MATERIALLY. FACTORS THAT COULD CAUSE OR CONTRIBUTE
TO SUCH DIFFERENCES INCLUDE COMPETITIVE AND ECONOMIC FACTORS, CHANGES IN
CONSUMER PREFERENCES, PRICE CHANGES BY COMPETITORS, RELATIONSHIPS WITH LICENSORS
AND CUSTOMERS, ABILITY TO MANAGE GROWTH, ABILITY TO SOURCE PRODUCTS,
INTERNATIONAL TRADE RELATIONS, MANAGEMENT OF QUARTER TO QUARTER RESULTS,
INCREASES IN COSTS OF RAW MATERIALS, TIMING OF TECHNOLOGICAL ADVANCES BY THE
COMPANY AND ITS COMPETITORS, LACK OF ACCEPTANCE BY CONSUMERS OF NEW PRODUCTS,
AND THE OTHER FACTORS DISCUSSED IN THIS SECTION AND ELSEWHERE HEREIN. UPDATED
INFORMATION WILL BE PERIODICALLY PROVIDED BY THE COMPANY AS REQUIRED BY THE
SECURITIES EXCHANGE ACT OF 1934.

RISKS ASSOCIATED WITH LICENSE AGREEMENTS. Sales of licensed products
accounted for approximately 64.2% of the Company's net sales during fiscal 1998.
The Company's license agreements generally require minimum guarantees,
obligating the Company to make specified royalty payments regardless of sales.
The Company's existing license agreements generally have terms ranging from one
to four years. As the Company continues to obtain additional licenses, the
Company expects greater pressure to be placed on the Company's liquidity needs
to fund significant additional royalty advances and guarantees of minimum
royalty payments. In the past, the Company has been successful in renewing its
significant licenses and none of its significant licenses has been terminated;
however, there can be no assurance that the Company will be able to procure new
license agreements or renew existing license agreements, or that existing
licenses will not be terminated. There also can be no assurance that the renewal
of existing licenses or obtaining of additional licenses for characters or
trademarks can be effected on commercially reasonable terms. The Company's
license agreements limit both the products that can be manufactured thereunder
and the territories and markets in which such products may be marketed.
Generally, the Company's license agreements require licensor approval before any
merger or reorganization involving the licensee, certain stock sales, or
assignment of the license. Certain license agreements require licensor approval
of management changes. In addition, the Company's licensors typically have the
right to approve, at their sole discretion, the products developed by the
Company and the third party manufacturer of such products. Obtaining such
approvals may be time consuming and could adversely affect the timing of the
introduction of new products. Certain of the Company's significant licenses are
non-exclusive. Licenses that overlap the Company's licenses with respect to
products, geographic areas and markets have been and may continue to be granted
to competitors of the Company which may adversely affect the Company's product
sales.

Approximately 50.6% of the Company's net sales in fiscal 1998 were derived
from the sale of products based on Warner Brothers' "Looney Tunes". As a result,
a loss of the Time Warner license rights would have a material adverse effect on
the Company. The Company expects that Time Warner may from time to time consider
various opportunities, whether developed internally or proposed by third
parties, involving the commercial exploitation of the "Looney Tunes" characters.
Time Warner would be free to pursue such opportunities directly or with others,
including products and markets licensed to the Company. There can be no
assurance that Time Warner will offer any such business opportunities to the
Company or that such opportunities will be offered on terms acceptable to the
Company.

CONSUMER PREFERENCES; NEW PRODUCT INTRODUCTION. As a result of changing
consumer preferences, many toys are successfully marketed for only one or two
years. There can be no assurance that any of the Company's products or any of
the Company's product lines will continue to be popular for any significant
period of time or that new products and product lines introduced by the Company
will achieve an acceptable degree of market acceptance, or that if such
acceptance is achieved, it will be maintained for any significant period of
time. The Company's success will be dependent upon the Company's ability to
enhance existing product lines and develop new products and product lines. The
failure of the Company's new

<PAGE>
products and product lines to achieve and sustain market acceptance and to
produce acceptable margins could have a material adverse effect on the Company's
financial condition and results of operations.

DEPENDENCE ON KEY PERSONNEL. The Company's future success will be highly
dependent on the continued efforts of Arturo G. Torres, Chairman of the Board
and Chief Executive Officer, Mark A. Gawlik, President and Chief Operating
Officer, Saul Gamoran, Executive Vice President, General Counsel and Secretary,
Raymond G. Braun, Chief Financial Officer and Treasurer, and Francisco Saez
Moya, President, Play By Play Europe, S.A. Although Mr. Torres is actively
involved in the management of the affairs of the Company, he is also involved in
various private business endeavors. Other than employment agreements with Mr.
Gamoran and Mr. Braun and two other employees, the Company has no employment
agreements or noncompete agreements with, or key-man life insurance on the lives
of, any of its senior management or employees. The loss of the services of one
or more of such key personnel could have a material adverse effect upon the
Company. The Company's success is also dependent upon its ability to retain its
key management, sales, marketing, financial and product development personnel
and to attract other personnel to satisfy the Company's needs. There can be no
assurance that the Company will be successful in retaining and attracting such
personnel.

DEPENDENCE ON THIRD PARTY MANUFACTURERS; INTERNATIONAL RELATIONS. To date,
a substantial portion of the Company's products have been manufactured by third
parties in the People's Republic of China. The Company does not have long-term
contracts with any of these manufacturers. Although the Company has begun to
arrange alternate sources of manufacturing outside of China, the Company has
made no definitive plans for securing alternate sources in the event its present
arrangements with Chinese manufacturers prove impossible to maintain.
Accordingly, there can be no assurance that there would be sufficient alternate
manufacturing facilities to meet the increased demand for production which would
likely result from a disruption of manufacturing sources in China. Furthermore,
such a shift to alternate facilities, if available, would likely result in
increased manufacturing costs and could subject the Company's products to
additional and/or higher quotas, duties, tariffs or other restrictions.

China currently enjoys MFN status under United States tariff laws, which
provides the most favorable category of United States import duties. There has
been, and may be in the future, opposition to the extension of MFN status for
China. The loss of MFN status for China would result in a substantial increase
in the import duty of toy products (currently 70% for non-MFN countries)
manufactured in China which would result in increased costs for the Company.
Although the Company would attempt to mitigate this increased cost by shifting
its production to other countries, there can be no assurance that the Company
would be successful in attempting to shift production within a reasonable period
of time. Prior to January 1, 1998, Spain imposed an import duty for certain
products imported into the country from China that exceed specified levels. On
January 1, 1998, Spain abolished the quota on toys. Although this import duty
exemption currently covers all items currently imported by the Company from
China to Spain, future changes in such regulation or in the items imported could
result in the imposition of import duties.

RISK OF FOREIGN OPERATIONS. Foreign operations are generally subject to
risks such as transportation delays and interruptions, political and economic
disruptions, the imposition of tariffs and import and export controls, changes
in governmental policies, delays in and restrictions on the transfer of funds
and currency fluctuations. For example, purchases of inventory by the Company's
European subsidiary from its suppliers in the Far East are subject to currency
risk to the extent that there are fluctuations in the exchange rate between the
United States dollar, the Spanish peseta and the British pound. Certain of this
European subsidiary's license agreements call for payment of royalties in a
currency different from the functional currency, and these arrangements subject
the Company to currency risk to the extent that exchange rates fluctuate from
the date that royalty liabilities are incurred until the date royalties are
actually paid to the licensor. While the Company to date has not experienced any
material adverse effects due to its foreign operations, there can be no
assurance that such events will not occur in the future and any growth of

17
<PAGE>
the Company's international operations will subject it to greater exposure to
risks of foreign operations. Three Latin American customers accounted for $7.7
million of the trade receivables outstanding at July 31, 1998, which
approximates 15.6% of the total outstanding trade receivables. The Company will
from time to time examine the need, if any, to engage in hedging transactions to
reduce the risk of currency fluctuations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

POTENTIAL FOR PRODUCT LIABILITY CLAIMS. Products that have been or may be
developed or sold by the Company may expose the Company to potential liability
from personal injury or property damage claims by end-users of such products.
The Company currently maintains product liability insurance coverage in the
amount of $1.0 million per occurrence, with a $20.0 million umbrella policy. The
Company's license agreements and certain customers require the Company to carry
specified types and amounts of insurance. There can be no assurance that the
Company will be able to maintain such coverage or obtain additional coverage on
acceptable terms, or that such insurance will provide adequate coverage against
any potential claims. Moreover, even if the Company maintains adequate
insurance, any successful claim could materially and adversely affect the
reputation and prospects of the Company. The Company believes that its products
meet all applicable safety standards. See "Business - Licensing," "-Product
Liability" and "-Legal Proceedings."

COMPETITION. The toy industry is highly competitive. Many of the Company's
competitors have longer operating histories, broader product lines and greater
financial resources and advertising budgets than the Company. In addition, the
toy industry has nominal barriers to entry. Competition is based primarily on
the ability to design and develop new toys, procure licenses for popular
characters and trademarks, and successfully market products. Many of the
Company's competitors, including the Company's licensors, offer similar products
or alternatives to the Company's products. Licenses that overlap the Company's
licenses with respect to products, geographic areas and markets have been and
may continue to be granted to competitors of the Company. Certain of the
Company's licensors, including The Walt Disney Company, Warner Brothers',
Harley-Davidson Motor Company and The Coca-Cola Company, distribute competing
products through proprietary retail outlets and amusement parks. The Company's
retail toy products compete with other toy products for retail shelf space.
There can be no assurance that shelf space in retail stores will be available to
support the Company's existing products or the expansion of the Company's
products or product lines. See "Business." There can be no assurance that the
Company will be able to continue to compete effectively in this market place.
See "Business - Competition."

RAW MATERIALS PRICES. The principal raw materials in most of the Company's
products are petrochemical derivatives, taffeta, acrylic textiles, plastics,
polyvinyl chloride, polyethylene and high impact polystyrene. The prices for
such materials are influenced by numerous factors beyond the control of the
Company, including general economic conditions, competition, labor costs, import
duties and other trade restrictions and currency exchange rates. Changing prices
for such raw materials may cause the Company's results of operations to
fluctuate significantly. A large, rapid increase in the price of raw materials
could have a material adverse effect on the Company's operating margins unless
and until the increased cost can be passed along to consumers.

YEAR 2000. Similar to many business entities, the Company will be impacted
by the inability of computer application software programs to distinguish
between the year 1900 and 2000 due to a commonly-used programming convention.
Until such programs are modified or replaced prior to 2000, calculations and
interpretations based on date-based arithmetic or logical operations performed
by such programs may be incorrect.

18
<PAGE>
Management's analysis and review of these areas is comprised primarily of five
phases: developing an inventory of hardware, software and embedded chips;
assessing the degree to which each area is currently in compliance with Year
2000 requirements; performing renovations and repairs as needed to attain
compliance; testing to ensure compliance; and developing a contingency plan if
repair and renovation efforts are either unsuccessful or untimely.

Management has substantially completed the inventory and assessment phases
regarding application systems, process control systems and technology
infrastructure, and is performing upgrades, repairs and testing of the former
two categories. The review of physical infrastructure and business partners and
merchandise suppliers is in the inventory stage. While the Company anticipates
that any additional assessment efforts will be completed by the end of calendar
year 1999. Costs incurred to date have primarily consisted of labor from the
redeployment of existing information technology, legal and operational resources
as well as computer hardware and software costs. The Company has budgeted
approximately $5.0 million for these Year 2000 compliance efforts, however, the
Company's Year 2000 program is an ongoing process and the estimates of costs and
completion dates for various aspects of the program are subject to change.

The Company is currently replacing its financial and core business system
software with new applications that are Year 2000 compliant. The Company has
formed a contingency team to develop a work plan in the event that such programs
are not fully operational by July of calendar year 1999. The Company does not
presently anticipate a material business interruption as a result of the Year
2000.

The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition. The Company's current and planned
activities with respect to the Year 2000 problem are expected to significantly
reduce the Company's level of uncertainty about the problem and, in particular,
about the Year 2000 compliance and readiness of its material customers and
suppliers. The Company believes that, with the implementation of new business
systems and completion of the planned activities as scheduled, the possibility
of significant interruptions of normal operations should be reduced.

Although there is a risk that the Company's plans for achieving Year 2000
compliance may not be completed on time, failure to meet critical milestones
identified in our plans would provide advance notice such that appropriate steps
could be taken to mitigate the risk of failure. Management believes that its
customers and suppliers would also receive advance notice allowing them to
implement alternate plans.

SEASONALITY; WEATHER. Both the retail and amusement toy industries are
inherently seasonal. Generally, in the past, the Company's sales to the
amusement industry have been highest during the third and fourth fiscal
quarters, and collections for those sales have been highest during the
succeeding two fiscal quarters. The Company's sales to the retail toy industry
have been highest during its first and fourth fiscal quarters, and collections
from those sales have been highest during the succeeding two fiscal quarters.
The Company's working capital needs and borrowings to fund those needs have been
highest during the third and fourth fiscal quarters. The Company's international
and domestic operations are also subject to risks due to inclement weather. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

GROWTH STRATEGY. The Company's growth strategy provides for further
development and diversification of the Company's retail and amusement toy
business, expansion into new distribution areas,

<PAGE>
such as catalog, including the attempted acquisition of additional license
agreements and further expansion into international markets. Implementation of
the strategy is subject to risks beyond the Company's control, including
competition, lack of market acceptance of new products, changes in economic
conditions, the inability to obtain or renew licenses on commercially reasonable
terms and the inability to finance the increased levels of accounts receivable
and inventory necessary to support sales growth, if any. There can be no
assurance that the expansion of the Company's business will be successfully
implemented. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."

RAPID GROWTH. The Company experienced significant growth in net sales and
net income in fiscal 1998, 1997 and 1996. As a result of the Company's limited
operating history and sales and income growth, period-to-period comparisons of
operating results may not be meaningful and results of operations from prior
periods may not be indicative of future results. There can be no assurance that
the Company will continue to experience growth in, or maintain its present level
of, net sales or net income. Rapid growth also may render the Company unable to
successfully manage inventory, information systems, and other aspects of its
business. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."

ACQUISITION RISKS. The Company expects to continue to evaluate and pursue
acquisition opportunities available on terms management considers favorable to
the Company. The success of future acquisitions will depend upon the ability of
the Company's management to assess characteristics of the potential target
companies, such as financial condition, attractiveness of products, suitability
of distribution channels, management ability, and the degree to which operations
can be integrated with those of the Company. This assessment is necessarily
inexact and its accuracy is inherently uncertain. This review will not reveal
all existing or potential problems, nor will it permit a buyer to become
sufficiently familiar with the target companies to assess fully their
deficiencies and capabilities. There can be no assurance that the Company's
future acquisitions, if any, will be successful. Any unsuccessful acquisition
could have a material adverse effect on the Company.

SHARES ELIGIBLE FOR FUTURE SALE. The Company has 7,315,000 shares of
Common Stock outstanding as of October 28, 1998. Certain shares of Common Stock
are "restricted securities" under the Securities Act of 1933, as amended (the
"Securities Act"). These "restricted securities," and any shares purchased by
affiliates of the Company, may be sold only if they are registered under the
Securities Act or pursuant to an applicable exemption from the registration
requirements of the Securities Act, including Rule 144 thereunder. There are
1,639,500 shares of common stock owned by existing shareholders and registered
pursuant to a registration statement on Form S-3 as filed by the Company on June
2, 1998 allowing for the resale of such shares free of restriction by applicable
securities laws. There are also (i) 1,834,200 shares of Common Stock reserved
for issuance under outstanding options to purchase shares of Common Stock, (ii)
217,000 shares of Common Stock subject to outstanding warrants and (iii) a
maximum of 937,500 shares of Common Stock issuable upon partial or total
conversion, if any, of the Company's outstanding convertible debentures. In
addition, various persons have "piggy-back" and demand registration rights to
register shares of Common Stock issuable upon the exercise of certain warrants
for public sale under the Securities Act. No prediction can be made as to the
effect, if any, that future sales of shares, or the availability of shares for
future sales, will have on the market price of the Common Stock. The sale of
substantial amounts of Common Stock, or the perception that such sales could
occur, could adversely affect the prevailing market price for the Common Stock.

DIVIDEND POLICY. The Company has never paid any cash dividends. For the
foreseeable future, the Company expects to retain earnings to finance the
expansion and development of its business. Any future payment of cash dividends
will be within the discretion of the Company's Board of Directors, and will
depend on, among other factors, the earnings, capital requirements, operating
and financial condition of the Company and other relevant factors, and
compliance with various financing covenants such as those

<PAGE>
contained in the agreements relative to the credit facilities to which the
Company is or may become a party. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."

ANTI-TAKEOVER PROVISIONS. The Company's Articles of Incorporation and
Bylaws contain, among other things, provisions establishing a classified Board
of Directors, authorizing shares of preferred stock with respect to which the
Board of Directors of the Company has the power to fix the rights, preferences,
privileges and restrictions without any further vote or action by the
shareholders, and requiring a two-thirds vote of shareholders in order to remove
directors, amend the Bylaws and approve certain business combinations with
respect to a "related person." Such provisions could delay, deter or prevent a
merger, consolidation, tender offer, or other business combination or change of
control involving the Company that some or a majority of the Company's
shareholders might consider to be in their best interest, including offers or
attempted takeovers that might otherwise result in such shareholders receiving a
premium over the market price for the Common Stock. The potential issuance of
preferred stock may have the effect of delaying, deferring or preventing a
change in control of the Company, may discourage bids for the Common Stock at a
premium over the market price of the Common Stock and may adversely affect the
market price of, and the voting and other rights of the holders of, Common
Stock. The Company has not issued, and currently has no plans to issue, shares
of preferred stock.

POSSIBLE VOLATILITY OF STOCK PRICE. Market prices for the Common Stock may
be influenced by a number of factors, including the Company's operating results
and other factors affecting the Company specifically, and the toy industry and
the financial markets generally, as well as the depth and liquidity of the
market for the Common Stock. The Company believes that the market price of its
Common Stock will reflect expectations that the Company will be able to continue
to operate and grow its business profitability. If the Company is unable to do
so at a pace that reflects the expectations of the market, investors could sell
shares of the Common Stock at or after the time that it becomes apparent that
such expectations may not be realized, resulting in a decrease in the market
price of the Common Stock. In recent years the stock market has experienced
extreme price and volume fluctuations. This volatility has had a significant
effect on the market prices of securities issued by many companies for reasons
unrelated to their operating performance. In the past, the Company's Common
Stock price has been extremely volatile and has experienced substantial and
sudden fluctuations; accordingly, such volatility may continue in the future.

EXPIRATION OF LINE OF CREDIT. The line of credit matures January 15, 1999.
The Company expects to either extend or refinance the Credit Facility prior to
January 15, 1999. However, there is no assurance that the Company will be able
to refinance or obtain a new line of credit, or that if obtained, it will be on
terms at least as favorable as those on the existing line of credit.

21
<PAGE>
ITEM 2. PROPERTIES

The Company's principal executive offices, warehouse and showroom are
located at 4400 Tejasco, San Antonio, Texas, where the Company occupies 39,450
square feet of office space, 8,600 square feet of showroom space and 192,014
square feet of warehouse space, pursuant to lease agreements that expire during
January and December 2003.

The Company owns the Chicago, Illinois property and building comprising of
9,920 square feet of office space, 6,480 square feet of showroom space, and
363,100 square feet of distribution and warehouse space. The Company has a 51%
ownership interest in the Los Angeles, California property and building
comprised of 6,400 square feet of office space, 6,220 square feet of showroom
space, and 234,740 square feet of distribution and warehouse space. The
remaining 49% interest in the Los Angeles, California facility is owned by and
leased from certain of the Ace Sellers.

The Company also leases the space occupied by its other offices,
warehouses, distribution centers and showrooms as follows:

APPROXIMATE
LOCATION TYPE OF FACILITY SQUARE FOOTAGE
----------- ------------------- ------------------
New York, New York Showroom 4,600

Los Angeles, California Warehouse 119,000

Woodinville, Washington Office/Warehouse 34,100

Kowloon, Hong Kong,
China Office/Showroom/Warehouse 2,300

Burnaby, British Columbia, Office/Warehouse 23,500
Canada and Mississauga,
Ontario

Doncaster, England Office/Showroom/Warehouse 36,000

Valencia, Spain Office/Showroom/Warehouse 108,130

The Company believes that additional office, showroom and warehouse space
is readily available and that such new space, together with the Company's
existing facilities, will be adequate and suitable for the operation of its
business for the foreseeable future.

22
<PAGE>
ITEM 3. LEGAL PROCEEDINGS

The Company is involved in various legal proceedings and claims incident
to the normal conduct of its business. The Company believes that such legal
proceedings and claims, individually and in the aggregate, are not likely to
have a material adverse effect on its financial condition.

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

None.

PART II

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

MARKET INFORMATION

The Company's Common Stock is traded on the Nasdaq National Market System
under the symbol "PBYP." The table sets forth, for the fiscal periods indicated,
the reported high and low close sale prices of the Company's Common Stock, as
reported on the Nasdaq National Market System:

1998 1997
--------------------- ---------------------
HIGH LOW HIGH LOW
-------- ------- -------- -------
First Quarter ........... $23.63 $16.25 $10.00 $ 7.50
Second Quarter .......... 21.38 16.25 12.00 8.13
Third Quarter ........... 21.38 16.19 14.25 9.75
Fourth Quarter .......... 17.75 9.06 16.00 12.38

STOCKHOLDERS

According to the records of the Company's transfer agent, the Company had
98 holders of record of Common Stock as of October 20, 1998. The Company
believes that a substantially larger number of beneficial owners hold such
shares in depository or nominee form.

23
<PAGE>
DIVIDENDS AND DISTRIBUTIONS

The Company has never declared nor paid cash dividends to date on its
Common Stock and does not anticipate paying any cash dividends on its Common
Stock in the near future. It is the current policy of the Board of Directors
(the "Board") to retain earnings to finance the operations and development of
the Company's business. The Company is limited from paying dividends by certain
provisions of the Company's Credit Facility. Any future determination as to the
payment of cash dividends will depend on a number of factors, including future
earnings, capital requirements, the financial condition and prospects of the
Company and any restrictions under credit agreements existing from time to time
as well as such other factors as the Board may deem relevant. There can be no
assurance that the Company will pay dividends in the future. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity & Capital Resources - Dividend Policy."

24
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth selected consolidated financial data for
the Company for the periods and at the dates indicated. The selected
consolidated financial data for the fiscal years ended July 31, 1998, 1997, and
1996 have been derived from the audited Consolidated Financial Statements of the
Company which are included elsewhere in this Form 10-K. The information set
forth below is not necessarily indicative of results of future operations. On
March 31, 1996, the Company sold Restaurants Universal Espana, S.A.
("Restaurants Universal"), its European subsidiary that operated two restaurants
in Spain. The historical financial data for Restaurants Universal has been
reported as discontinued operations and accordingly the historical financial
data for all prior years presented has been restated. This data should be read
in conjunction with, and is qualified in its entirety by, "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
the Consolidated Financial Statements and the Notes thereto, which appear
elsewhere in this Form 10-K.

<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
--------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- --------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
DATA (1):
Net sales (2) .................................... $178,103 $137,386 $ 74,197 $ 47,730 $32,568
Income from continuing operations ................ 8,445 6,216 4,052 1,898 880
Income (loss) from discontinued
operations (2) ................................. -- -- (384) (259) 125
Net income ....................................... $ 8,445 $ 6,216 $ 3,668 $ 1,639 $ 1,074
Basic earnings per common share
from continuing operations ..................... $ 1.30 $ 1.28 $ 0.84 $ 0.74 $ 0.35
Diluted earnings per common share
from continuing operations ..................... $ 1.19 $ 1.25 $ 0.84 $ 0.73 $ 0.35

Average number of shares outstanding
- basic ........................................ 6,474 4,872 4,841 2,580 2,519
Average number of shares outstanding
- diluted ...................................... 7,760 5,036 4,856 2,582 2,519

JULY 31,
--------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- --------- -------- -------
BALANCE SHEET DATA (1):
Working capital .................................. $ 76,454 $ 35,372 $ 19,910 $ 26,159 $ 3,927
Total assets ..................................... 167,884 125,906 104,922 47,300 25,785
Long-term debt, including capital
leases ......................................... 20,962 23,238 11,096 148 332
Total liabilities ................................ 78,895 82,237 62,222 15,273 16,675
Shareholders' equity ............................. 88,989 43,669 38,700 32,027 9,110
</TABLE>

(1) In June 1996, the Company acquired Ace, which was accounted for as a
purchase. Ace's assets and certain liabilities are included in the
Company's Consolidated Balance Sheet at July 31, 1996 and its results of
operations were included in the Consolidated Statement of Operations
beginning June 21, 1996. For these reasons, the Consolidated Statement of
Operations of the Company for the period subsequent to the acquisition is
not comparable to prior periods.
(2) Fiscal years 1995 and 1994 have been restated to reflect the disposition
of 100% of the stock of Restaurants Universal Espana, which was sold
during the third quarter of fiscal 1996. See Note 5 to the Company's
Consolidated Financial Statements.

25
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

GENERAL

THIS REPORT CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S
ACTUAL RESULTS COULD DIFFER MATERIALLY. FACTORS THAT COULD CAUSE OR CONTRIBUTE
TO SUCH DIFFERENCES INCLUDE, COMPETITIVE AND ECONOMIC FACTORS, CHANGES IN
CONSUMER PREFERENCES, PRICE CHANGES BY COMPETITORS, RELATIONSHIPS WITH LICENSORS
AND CUSTOMERS, ABILITY TO MANAGE GROWTH, ABILITY TO SOURCE PRODUCTS,
INTERNATIONAL TRADE RELATIONS, MANAGEMENT OF QUARTER TO QUARTER RESULTS,
INCREASES IN COSTS OF RAW MATERIALS, TIMING OF TECHNOLOGICAL ADVANCES BY THE
COMPANY AND ITS COMPETITORS, LACK OF ACCEPTANCE BY CONSUMERS OF NEW PRODUCTS,
AND THE OTHER FACTORS DISCUSSED IN "RISK FACTORS", AND ELSEWHERE HEREIN. THE
COMPANY AS REQUIRED BY THE SECURITIES EXCHANGE ACT OF 1934 WILL PERIODICALLY
PROVIDE UPDATED INFORMATION.

The following discussion and analysis, together with the accompanying
consolidated financial statements and related notes, will aid in understanding
the Company's results of operations as well as its financial position, cash
flows, indebtedness and other key financial information.

The Company's principal business is to design, develop, market and
distribute stuffed toys, novelty items, and sculpted toy pillows based on
licensed characters and trademarks. The Company also designs, develops, markets
and distributes electronic toys and non-licensed stuffed toys. The Company sells
these products to customers in the amusement and retail markets. The Company's
toy operations accounted for 98.3% of net sales for fiscal 1998. In addition,
the Company owns and operates approximately 1,353 coin-operated amusement game
machines in Texas. Net sales derived from vending operations accounted for 1.6%
of the Company's net sales for fiscal 1998. Net sales from continuing operations
derived from vending operations as a percentage of net sales has declined in
recent periods as the Company has emphasized its toy operations, and the Company
anticipates that such trend will continue.

In March 1996, the Company sold all of the stock of Restaurants Universal,
its European subsidiary that operated two restaurants in Spain, to an unrelated
third party, for approximately $1.6 million. As of July 31, 1998, the carrying
value of the note receivable balance is $742,000 and the Company is not accruing
interest income on this note receivable.

In June 1996, the Company acquired substantially all of the operating
assets, business operations and facilities of Ace. The purchase price of
approximately $44.7 million consists of $39.2 million in cash, $2.9 million in
subordinated debt, $2.4 million in related direct costs, and $200,000 in the
form of warrants issued by the Company to the former owners of Ace ("Ace
Sellers") to purchase up to 35,000 shares of the Company's Common Stock. The
acquisition has been accounted for using the purchase method.

In November 1996, the Company, through Play-By-Play Europe, acquired all
of the outstanding capital stock of TLC based in Doncaster, England for 40,000
shares of restricted common stock. The shares of common stock had a fair market
value of $345,000 at the date of acquisition. The Company incurred $144,000 in
costs directly related to the acquisition. The acquisition has been accounted
for using the purchase method.

Net toy sales to amusement customers accounted for 69.2% of the Company's
net sales for fiscal 1998. The Company sells both licensed and non-licensed
products to its amusement customers for use principally as redemption prizes.
Except for television promoted retail products, sales to amusement

26
<PAGE>
customers generally result in higher gross margins than sales to retail
customers, with gross margins from the sale of licensed products to amusement
customers generally exceeding those of non-licensed products.

Net toy sales to retail customers accounted for 29.1% of the Company's net
sales for fiscal 1998. Since the beginning of fiscal 1994, the Company has
expanded its product offering of licensed stuffed toys through the addition of
several licensed characters and trademarks. Prior to fiscal 1997, substantially
all of the Company's sales to retail customers involved licensed products.
During fiscal 1998, 29.2% of retail sales were from non-licensed goods
consisting principally of the Talkin' Tots(TM). In fiscal 1998, the Company
experienced larger percentage increases in sales to retail customers than to
amusement customers. Based on the current weakness in the domestic retail toy
market, the Company does not expect the growth in the retail division's sales to
continue at rates as rapid as it has experienced in the past years. Due to the
higher volume purchasing power enjoyed by many of the larger retail customers,
sales to retail customers typically involve larger dollar amounts but lower
gross margins than the Company's sales to amusement customers. The television
promoted products have a higher gross profit margin that is offset by the
associated advertising cost, which is reported as a component of selling,
general and administrative costs. The Company incurred approximately $5.7
million of media advertising cost in fiscal 1998 and expects to incur an
additional $1.0 million during the first two fiscal quarters of 1999.

The Company began its international toy operations with the opening of its
distribution facility in Spain in August 1993. Since that time, the Company has
experienced significant sales growth in its international operations,
particularly in Western Europe. European toy operations accounted for 17.8% of
net sales and 27.1% of consolidated operating income for fiscal 1998. The
Company anticipates continued growth in international sales to both the
amusement and retail markets, including continued growth in sales of licensed
products. The Company generally sells the same non-licensed products in Europe
as in the United States. The Company sells certain licensed products exclusively
in certain international countries while others are sold both domestically and
internationally. The Company's European toy sales have generally resulted in
higher gross margins than domestic toy sales, and the Company believes this
trend will continue.

The Company's international toy sales are made primarily to European
countries by Play-By-Play Espana, S.A. located in Valencia, Spain and by
Play-By-Play, U.K. located in Doncaster, England. To date, the cost of most
direct shipment sales from third-party manufacturers to international customers
have been made by Play-By-Play Espana and have been denominated in United States
dollars. Accordingly, the Company is exposed to foreign currency risk from the
shipment date until receipt of payment. Substantially all other sales by such
subsidiary are transacted in Spanish pesetas/British pounds, the functional
currencies, and therefore any gain or loss on currency translation is reported
as a component of Shareholders' Equity on the consolidated financial statements.
When the Company's subsidiaries purchase inventory from suppliers in the Far
East, all such purchases are made in United States dollars and the Company
experiences currency risk to the extent that the exchange rate between the
United States dollar and the Spanish peseta/British pound fluctuate from the
date Play-By-Play Europe is notified that merchandise is shipped until the date
it pays for the goods in United States dollars.

Pursuant to the terms of certain of the Company's license agreements for
the sale of products in Canada, the Company must pay royalties in Canadian
dollars. Play-By-Play Europe also has license agreements for the sale of stuffed
toys in Europe and other continents, which require the subsidiary to pay
royalties in United States dollars. As a result of these license agreements, the
Company experiences currency risk to the extent that exchange rates fluctuate
from the date the royalty liability or minimum guarantee is incurred until the
date the royalty is actually paid to the licensor. Additionally, the Company is
exposed to foreign currency risk for intercompany receivable and payable
transactions through the settlement date.

<PAGE>
Historically, no attempt has been made to minimize, by means of hedging or
derivatives, the risk of potential currency fluctuations, since the currency
risk has not been significant to the Company on a consolidated basis. The total
unhedged exposure related to currency risk at July 31, 1998 was $5.6 million.

The Company experienced significant growth in net sales and net income
during 1997 and 1996 due in part to the Ace and TLC acquisitions which occurred
in June and November 1996, respectively. Accordingly, period-to-period
comparisons of operating results may not be meaningful and results of operations
from prior periods may not be indicative of future results.

RESULTS OF OPERATIONS

The following table sets forth the Company's results of operations as a
percentage of net sales for the periods indicated below:

YEAR ENDED JULY 31,
------------------------------
1998 1997 1996
------ ------ ------
Net sales .................................. 100.0% 100.0% 100.0%
Cost of sales .............................. 65.6 66.3 67.7
------ ------ ------
Gross profit ............................... 34.4 33.7 32.3
Selling, general and administrative
expenses ................................. 24.8 24.2 23.3
------ ------ ------
Operating income ........................... 9.6 9.5 9.0
Interest expense and other income .......... 2.4 3.1 0.1
Income tax provision ....................... 2.6 2.0 3.5
------ ------ ------
Income from continuing operations .......... 4.6 4.4 5.4
Loss from discontinued operations .......... -- -- 0.5
Net income ................................. 4.6% 4.4% 4.9%
====== ====== ======

YEARS ENDED JULY 31, 1998 AND 1997

NET SALES. Net sales for fiscal 1998 increased 29.6%, or $40.7 million, to
$178.1 million from $137.4 million in fiscal 1997. The increase in net sales was
primarily attributable to domestic amusement sales increase of 24.9%, or $20.3
million, to $101.6 million from $81.4 million. Domestic net toy sales for fiscal
1998 compared to fiscal 1997 increased 26.9%, or $30.3 million, to $143.4
million, and international net toy sales increased 50.2%, or $10.6 million, to
$31.7 million.

Net sales of licensed products for fiscal 1998 increased 39.7%, or $32.5
million, to $114.4 million from $81.9 million in fiscal 1997. The increase in
licensed product sales was primarily attributable to growth of net sales of the
Company's licensed products to domestic and international amusement customers of
60.5%, or $29.3 million, to $77.7 million from $48.4 million in fiscal 1997.
Within licensed products, net sales of Looney Tunes' characters increased 75.2%,
or $38.7 million, to $90.2 million for fiscal 1998 from $51.4 million in fiscal
1997. Net sales of the Tornado Taz(TM) accounted for $10.6 million, or 6.0%, of
the Company's net toy sales for fiscal 1998. Net sales of PLAY-FACES(R)
decreased 42.2%, or $7.0 million, to $9.5 million, from $16.5 million in fiscal
1997. Net sales of non-licensed products for fiscal 1998 and 1997 accounted for
34.1%, or $60.7 million, and 38.0%, or $52.2 million, respectively, of the
Company's net sales.

28
<PAGE>
Net toy sales to retail customers for fiscal 1998 and fiscal 1997
accounted for 29.1%, or $51.9 million, and 27.9%, or $38.3 million,
respectively, of the Company's net sales. The 35.5% increase in net sales to
retail customers from fiscal 1997 to fiscal 1998 is primarily attributable to
the introduction of new electronic products added during fiscal 1998, the
Talkin' Tots(TM) sales increase of $10.3 million or 215.6%, the Tornado Taz(TM)
sales increase of $8.6 million or 421.1%, and the increase of licensed stuffed
toys of $1.6 million, or 10.9%. The growth in retail sales was offset with a
decrease in PLAY-FACES(R) sales of $7.0 million or 42.2%.

Net toy sales to amusement customers for fiscal 1998 and fiscal 1997
accounted for 69.2%, or $123.2 million, and 69.8%, or $95.9 million,
respectively, of the Company's net sales. The 28.6%, or $27.4 million, increase
to $77.7 million, is primarily attributable to an increase in sales of licensed
plush toys to amusement customers, a 60.5% increase from fiscal 1997, sales of
novelty items of $4.5 million, a 51.2% increase from fiscal 1997, partially
offset by a decrease in sales of non-licensed plush toys of $6.4 million.

GROSS PROFIT. Gross profit increased 32.3% to $61.3 million in fiscal 1998
from $46.4 million in fiscal 1997, due to the overall increase in the Company's
net sales. Gross profit as a percentage of net sales increased from 33.7% for
fiscal 1997 to 34.4% for fiscal 1998. This increase was principally a result of
increased retail sales of advertised products which carry a higher gross profit
margin which is offset by the advertising costs included in selling, general and
administrative expenses.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. As a percentage of net
sales, selling, general and administrative expenses increased to 24.8% in fiscal
1998 from 24.2% in fiscal 1997. Such expenses increased 32.7% to $44.1 million
for fiscal 1998 from $33.2 million in fiscal 1997. This increase was primarily
attributable to increased television advertisement cost of $5.7 million and
increased payroll and related costs of $3.2 million, product development costs,
and the growth of the Company's infrastructure and increased expenses related to
the expansion of the Company's facilities in the U.S., Hong Kong and Europe. In
addition, during the second half of fiscal 1998, the Company established a
Direct Mail division that incurred expenses for which no revenues were
generated. Management believes that this start-up division will incur losses
approximating $700,000 for fiscal year 1999.

INTEREST EXPENSE AND OTHER INCOME. Interest expense increased 2.2% or
approximately $95,000, to $4.5 million for fiscal 1998 from $4.4 million in
fiscal 1997. An increase in interest expense due to the issuance of the $15.0
million of convertible debt was almost fully offset by the decrease in interest
on the portion of the revolving line of credit that was paid off with funds from
the December 1997 secondary offering. Interest income increased 66.8% or
approximately $144,000, to $360,000 for fiscal 1998 from $216,000 in fiscal 1997
principally due to the interest earned on net proceeds generated from the 1997
follow-on public offering that were temporarily invested.

INCOME TAX EXPENSE. Income tax expense for fiscal 1998 and 1997 reflects
an effective tax rate of 35.0%, compared to the fiscal 1997 rate of 30.5%. The
lower 1997 rate resulted from a low effective tax rate on sales by the Hong Kong
subsidiary, and from an investment tax credit in Spain related to the investment
in the TLC operations in UK.

29
<PAGE>
YEARS ENDED JULY 31, 1997 AND 1996

The comparison between fiscal 1997 and fiscal 1996 was affected by the Ace
acquisition, which occurred on June 20, 1996. Results of operations for fiscal
1996 include approximately 40 days of Ace operations, compared to a full year of
Ace operations in fiscal 1997.

NET SALES. Net sales for the fiscal year ended July 31, 1997 increased
85.2%, or $63.2 million, to $137.4 million from $74.2 million in fiscal 1996.
The increase in net sales was primarily attributable to increased domestic
amusement sales resulting from the Ace acquisition in June 1996, domestic retail
growth of 52.3% and international sales growth of 131.8%. Domestic net toy sales
for fiscal 1997 compared to fiscal 1996 increased 83.7%, or $51.5 million, to
$113.1 million, and international toy sales increased 131.8%, or $12.0 million,
to $21.1 million.

Net sales of licensed products for fiscal 1997 increased 89.7%, or $38.7
million, to $81.9 million from $43.2 million in the fiscal year 1996. The
increase in licensed product sales was primarily attributable to growth of sales
of the Company's licensed products to both retail and amusement customers, and
the Company's European operations, which accounted for $15.0 million of the
Company's net sales of licensed products in fiscal 1997, a 196.9% increase from
fiscal 1996. Within licensed products, sales of Looney Tunes' characters
increased 323.3%, or $39.3 million, to $51.4 million for fiscal 1997 from $12.1
million in fiscal 1996. In addition, the Company began selling Tornado Taz(TM)
during the fourth quarter of fiscal 1997. Sales for the Tornado Taz(TM)
accounted for $2.0 million, or 1.5%, of the Company's net toy sales for fiscal
1997. PLAY-FACES(R) sales decreased 13.3% or $2.5 million, to $16.5 million,
from $19.0 million in fiscal 1996. The Company expects that PLAY-FACES(R) sales
will continue to decrease in fiscal 1998. Net sales of non-licensed products
increased 90.1%, or $24.7 million, to $52.2 million from $27.5 million in fiscal
1996. Net sales of non-licensed stuffed toys increased 75.3%, or $16.6 million,
to $38.7 million from $22.1 million in the comparable period in fiscal 1996.
Within non-licensed products, net sales of novelty items increased 61.8%, or
$3.3 million, to $8.7 million, from $5.4 million in fiscal 1996. The Company
began selling Talkin' Tots(TM) during the fourth quarter of fiscal 1997. Sales
of the Talkin' Tots(TM) accounted for $4.8 million, or 3.6%, of the Company's
net toy sales for fiscal 1997.

Net toy sales to retail customers for fiscal 1997 and fiscal 1996
accounted for 27.9%, or $38.3 million, and 31.3%, or $23.2 million,
respectively, of the Company's net sales. The approximate 65.1% increase in
sales to retail customers from fiscal 1996 to fiscal 1997 is primarily
attributable to the continued growth in domestic and international retail sales
of 52.3%, or $10.9 million, and 176.6%, or $4.2 million, respectively. This
domestic growth was primarily attributable to the introduction of several new
product lines added during fiscal 1997. The decrease in retail sales as a
percentage of total sales from fiscal 1996 to fiscal 1997 was principally due to
the fact that Ace is predominantly a supplier to the amusement industry whereas,
prior to the Ace acquisition, the Company had a more even sales mix of retail
and amusement customers.

Net toy sales to amusement customers for fiscal 1997 and fiscal 1996
accounted for 69.8%, or $95.9 million, and 63.9%, or $47.4 million,
respectively, of the Company's net sales. The 102.0% increase in dollar volume
is primarily attributable to the Ace acquisition and the strong European market,
which accounted for $14.5 million, a 115.8% increase from fiscal 1996.

GROSS PROFIT. Gross profit increased 93.3% to $46.4 million in fiscal 1997
from $24.0 million in fiscal 1996, due to the overall increase in the Company's
net sales. This increase was primarily attributable to the Ace acquisition.
Gross profit as a percentage of net sales increased 1.4% from 32.3% for fiscal
1996 to 33.7% for fiscal 1997. This increase was principally a result of
increased European sales, which carry a higher profit margin and higher domestic
retail margins from the television promoted items.

30
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. As a percentage of net
sales, the selling, general and administrative expenses increased to 24.2% in
fiscal 1997 from 23.3% in fiscal 1996. Such expenses increased 92.0% to $33.2
million for fiscal 1997 from $17.3 million in fiscal 1996. This increase was
primarily attributable to increased sales, television advertising cost of $1.3
million and added distribution facilities from the Ace acquisition.
Additionally, the Company incurred increased occupancy costs relative to the
establishment of a distribution facility in Miami, Florida during late 1996, an
office in Hong Kong, the expansion of the Company's distribution facility in
Europe and one distribution facility associated with the acquisition of TLC.

INTEREST EXPENSE AND OTHER INCOME. Interest expense increased 568% or
approximately $3.7 million, to $4.4 million for fiscal 1997 from $660,000 in
fiscal 1996, principally as a result of the financing of the acquisition of Ace.
Other income decreased 60.6% or approximately $332,000, due to the interest
earned on interest bearing accounts and short-term securities during fiscal 1996
generated from the 1995 initial public offering. Such interest bearing cash and
investments were used to partially fund the acquisition of Ace.

INCOME TAX EXPENSE. Income tax expense for fiscal 1997 reflects an
effective tax rate of 30.5%, compared to the fiscal 1996 rate of 39.3%. The
decrease is attributable primarily to a low statutory tax rate on sales by the
Hong Kong subsidiary in fiscal 1997, and to an investment tax credit in Spain
related to the November 1996 acquisition of TLC. In addition, in fiscal 1996 a
valuation allowance was recorded against the deferred tax asset related to a
capital loss carryover, which increased the effective rate for that year.

LIQUIDITY AND CAPITAL RESOURCES

At July 31, 1998, the Company's working capital was $76.4 million compared
to $35.4 million at July 31, 1997. This increase was primarily attributable to
the completion of the Company's follow-on public offering of its common stock in
December 1997 and the net reduction in amounts borrowed under the Company's line
of credit.

The Company satisfies its capital requirements and seasonal working
capital needs with cash flow primarily from borrowings and secondarily from
operations. The Company's primary capital needs have consisted of funding for
acquisitions, acquisitions of inventory, customer receivables, letters of
credit, licenses and international expansion.

On December 2, 1997, the Company sold 2,300,000 shares of its common stock
in a follow-on public offering at a price of $16.00 per share. The net proceeds
after deducting underwriters' discounts and other expenses were approximately
$34.1 million. In December 1997, a portion of the net proceeds was used to repay
indebtedness of approximately $21.3 million outstanding under the Revolving
Credit Term Loan with Letter of Credit Facility ("Credit Facility") and
approximately $12.8 was used to fund the Company's operations and other working
capital needs (i.e. European expansion).

During July 1997, the Company completed a private placement of 8%
convertible debentures with three investment funds in the aggregate amount of
$15 million. The proceeds were used to retire a $3 million subordinated demand
note due to a shareholder, to provide $3 million of collateral on two lines of
credit with certain banks in Spain, and for general corporate purposes. Interest
accrues at 8% per annum, payable monthly until maturity on June 30, 2004. No
principal is due until June 30, 2000 at which time principal is payable monthly
at a rate of 1% of the outstanding balance with the remaining balance due at
maturity. The debt is convertible into Common Stock at any time during the loan
period at a conversion price of $16 per share. The convertible debt holders may
force redemption upon a change of control of the Common Stock, a change in the
composition of two-thirds of the Company's Board, or if the Common Stock

<PAGE>
received in conversion cannot be publicly traded. The Company incurred costs of
approximately $731,000 in connection with the issuance of the convertible
debentures. Such costs were capitalized and are being amortized to interest
expense over the seven-year term of the convertible debentures on a
straight-line basis, which approximates the interest method.

As of July 31, 1998, the revolving line of credit balance was $14.8
million, the term loan balance was $7.2 million, and the amount of convertible
debt outstanding was $15 million. As of July 31, 1998, the Company had an
aggregate of $13.5 million in outstanding irrevocable letters of credit and
bankers' acceptances. Based on the level of the Company's eligible accounts
receivable and inventory at July 31, 1998, the Company had $4.4 million of
additional borrowing capacity available under the Credit Facility. The Credit
Facility matured on June 20, 1998 and was extended through January 15, 1999. The
Company expects to either extend or refinance the Credit Facility prior to
January 15, 1999. However, there is no assurance that the Company will be able
to refinance or obtain a new line of credit, or that if obtained, it will be on
terms at least as favorable as those on the existing line of credit.

As of July 31, 1998, PlayOByOPlay Europe had an aggregate of approximately
$3.7 million outstanding in irrevocable letters of credit in support of
inventory purchases. The Company's current policy is to permanently reinvest all
earnings from foreign subsidiaries in those operations. This policy restricts
the amount of cash available for distribution by these subsidiaries, however,
the Company may obtain cash from the subsidiaries for repayment of intercompany
obligations incurred in the normal course of business. In the event the Company
changes its policy, a tax liability will be incurred for previous undistributed
earnings, and any distributions would be subject to withholding and current
income taxes.

During fiscal 1997 and 1998, the Company used proceeds from the
aforementioned debt facilities, stock offerings, and operations to fund its
growth. During this period of time a majority of the Company's net sales were
derived from licensed products, a trend which the Company believes will
continue. As the Company continues to expand internationally and obtain
additional licenses, the Company expects greater pressure to be placed on the
Company's liquidity needs to fund significant additional royalty advances and
guarantees of minimum royalty payments. Minimum royalty guarantees have
increased from $6.2 million at July 31, 1997 to $14.6 million at July 31, 1998.
Certain license agreements require the Company to maintain standby letters of
credit or insurance bonds in favor of the licensors securing payment of the
Company's guaranteed minimum royalty payment obligations. The Company believes
that its credit facility after extension or as refinanced, and cash generated
from operations, will be sufficient to fund such growth.

The Company's operating activities used net cash of $23.1 million in
fiscal 1998 and provided net cash of $1.8 million in fiscal 1997. The cash flow
from operations for fiscal 1998 was primarily affected by changes in accounts
receivable as a result of the strong increase in sales experienced by the
Company, as well as inventory which increased in part due to the strong increase
in sales as well as to support the expansion in the European market.

Net cash used in investing activities during fiscal 1998 was $3.3 million
compared to net cash used in investing activities for fiscal 1997 of $1.3
million. For fiscal 1998, net cash used in investing activities consisted
principally of the purchase of property and equipment of approximately $3.3
million. The $3.3 million consisted principally of expenditures of $1.1 million
for the costs incurred related to the new accounting software and operating
system implementation and $874,000 for leasehold improvements for the San
Antonio facility. The Company anticipates to incur capital expenditures of
approximately $5.0 million to improve distribution facilities in the U.S. and
replace its ERP and warehouse distribution software system. For fiscal 1997, net
cash used in investing activities consisted principally of the purchase of
property and equipment of $792,000. Additionally, during fiscal 1997, the
Company issued 40,000 shares of Common Stock to acquire TLC.

Net cash provided by financing activities during fiscal 1998 was $23.6
million and net cash provided by financing activities in fiscal 1997 was $5.7
million. During fiscal 1998, the Company repaid $7.8 million of net borrowings
on the revolving line of credit under the Credit Facility and repaid $2.4
million principal

<PAGE>
on the term loan. During fiscal 1997, cash was used to repay borrowings on the
revolving line of credit of $2.2 million, repay $2.4 million principal on the
term loan, repay the $3.0 million note to the principal shareholder and reduce
the subordinated loan from the Ace Sellers of $1.5 million.

The Company believes that its current available cash, net cash provided by
operating activities and available borrowings under the Company's Credit
Facility will be sufficient to meet the Company's cash requirements through
January 15, 1999. The Company believes that it will be able to extend or
refinance the Credit Facility by January 15, 1999. However, there is no
assurance that the Company will be able to refinance or obtain a new line of
credit, or that if obtained, it will be on terms at least as favorable as those
on the existing line of credit.

EURO. On January 1, 1999, eleven of the fifteen member countries of the
European Union will introduce the euro, which will then become the common
currency among the participating member countries. The participating members'
sovereign currency will be converted to the euro at the exchange rates in effect
on the introduction date. Spain is one of the participating members, which is
the country in which Play By Play Europe is located. Play By Play Europe intends
to keep its books in Spain's sovereign currency, the peseta, through the
substantial portion of the three-year introductory period, at the end of which
all companies in participating member countries must adopt the euro. As Play By
Play Europe's accounting system is currently capable of performing the euro
conversion, the Company does not anticipate that the costs related to the
conversion will be significant. In addition, as Play By Play Europe operates
primarily in Spain and in non-European Union countries, management does not
anticipate that the introduction of the euro will have a material effect on Play
By Play Europe's results of operations, financial position, or cash flows for
the forseeable future.

Management's plan addressing the impact on the Company of the Year 2000
issue focuses on the following areas: application systems, process control
systems (embedded chips), technology infrastructure, and third party business
partners and suppliers with which the Company has significant relationships.
Management's analysis and review of these areas is comprised primarily of five
phases: developing an inventory of hardware, software and embedded chips;
assessing the degree to which each area is currently in compliance with Year
2000 requirements; performing renovations and repairs as needed to attain
compliance; testing to ensure compliance; and developing a contingency plan if
repair and renovation efforts are either unsuccessful or untimely.

33
<PAGE>
merchandise suppliers is in the inventory stage. While the Company anticipates
that any additional assessment efforts will be completed by the end of calendar
year 1999. Costs incurred to date have primarily consisted of labor from the
redeployment of existing information technology, legal and operational resources
as well as computer hardware and software costs. The Company has budgeted
approximately $5.0 million for these Year 2000 compliance efforts, however, the
Company's Year 2000 program is an ongoing process and the estimates of costs and
completion dates for various aspects of the program are subject to change.

SEASONALITY

Both the retail and amusement toy industries are inherently seasonal.
Generally, in the past, the Company's sales to the amusement industry have been
highest during the third and fourth fiscal quarters, and collections for those
sales have been highest during the succeeding two fiscal quarters. The Company's
sales to the retail toy industry have been highest during the first and fourth
fiscal quarters, and collections from those sales have been highest during the
succeeding two fiscal quarters. The Company's working capital needs and
borrowings to fund those needs have been highest during the third and fourth
fiscal quarters. As a result of the Company's increased sales to amusement
customers and to retail customers, the Company anticipates that its borrowings
to fund working capital needs may become more significant in the third and
fourth fiscal quarters.

The Company utilizes borrowings under the Credit Facility to finance
purchases of inventory and accounts receivable, primarily during peak selling
periods. During fiscal 1998, the highest level of aggregate borrowings under the
Credit Facility was $21.9 million in August 1997.

34
<PAGE>
The following sets forth the Company's net sales by fiscal quarter for
fiscal 1998, 1997 and 1996:

FISCAL YEAR
-------------------------------------------
FISCAL QUARTER 1998 1997 1996
----------------- -------- -------- --------
(IN THOUSANDS)
First ................. $58,418 $39,891 $23,439
Second ................ 30,867 22,039 12,023
Third ................. 37,262 28,001 14,302
Fourth ................ 51,556 47,455 24,433

INFLATION

The Company does not believe that inflation in the United States or Europe
in recent years has had a significant effect on its results of operations.

NEW ACCOUNTING PRONOUNCEMENT

In June 1997, the Financial Accounting Standard Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, Disclosures about Segments
of an Enterprise and Related Information ("Statement 131"). Statement 131
establishes standards for the way public business enterprises are to report
information about operating segments in annual financial statements and requires
those enterprises to report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. Statement 131 replaces the "industry segment" concept of Statement 14
with a "management approach" concept as the basis for identifying reportable
segments. The management approach is based on the way management organizes
decisions for assessing performance. Statement 131 is effective for financial
statements for periods beginning after December 15, 1997.

Management has not yet determined the impact, if any, that SFAS 131 will
have on its financial statement disclosures.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk represents the risk of loss that may impact the financial
position, results of operations or cash flows of the Company due to adverse
changes in financial and commodity market prices and rates. The Company is
exposed to market risk in the areas of changes in United States and
international borrowing rates (i.e. prime rate or LIBOR), and changes in foreign
currency exchange rates as measured against the United States ("U.S.") dollar
and functional currencies of its subsidiaries (i.e. British pound/Spanish
peseta). In addition, the Company is exposed to market risk in certain
geographic areas that have experienced or are likely to experience an economic
downturn, such as China and Latin America. The Company purchases substantially
all of its inventory from companies in China, therefore, the Company is subject
to the risk that such suppliers will be unable to provide inventory at
competitive prices. While the Company believes if such as event were to occur,
it would be able to find alternate sources of inventory at competitive prices,
however, there can be no assurance that the Company would be successful. The
Company has $5.2 million of accounts receivable outstanding payable in US
dollars from two companies based in Mexico and Brazil. If the currencies of
these countries were to fall significantly against the US dollar, there can be
no assurance that such companies would be able to repay the receivables in full.
These exposures are directly related to its normal operating and funding
activities.

35
<PAGE>
Historically and as of July 31, 1998, the Company has not used derivative
instruments or engaged in hedging activities to minimize its market risk.

INTEREST RATE RISK

The interest payable on the Company's revolving line-of-credit is variable
based on LIBOR and/or the prime rate, and therefore, affected by changes in
market interest rates. At July 31, 1998, approximately $14.8 million was
outstanding with a weighted average interest rate of 8.5%. The Credit Facility
matures January 15, 1999. The Company expects to either extend or refinance the
Credit Facility prior to January 15, 1999. However, there is no assurance that
the Company will be able to refinance or obtain a new line of credit, or that if
obtained, it will be on terms at least as favorable as those on the existing
line of credit. See "Liquidity and Capital Resources."

FOREIGN CURRENCY RISK

The Company has wholly-owned subsidiaries in Valencia, Spain and
Doncaster, England. Sales from these operations are typically denominated in
Spanish Pesetas or British Pounds, respectively, thereby creating exposures to
changes in exchange rates. Changes in the Pesetas/U.S. Dollars exchange rate and
British Pounds/U.S. Dollars exchange rate may positively or negatively affect
the Company's sales, gross margins and retained earnings. The Company does not
believe that reasonably possible near-term changes in exchange rates will result
in a material effect on future earnings, fair values or cash flows of the
Company, and therefore, has chosen not to enter into foreign currency hedging
transactions. There can be no assurance that such an approach will be
successful, especially in the event of a significant and sudden decline in the
value of the Spanish Peseta or the British Pound. Purchases of inventory by the
Company's European toy subsidiary from its suppliers in the Far East are subject
to currency risk to the extent that there are fluctuations in the exchange rate
between the United States dollar and the Spanish peseta. Certain of this
European subsidiary's license agreements call for payment of royalties in a
currency different from their functional currency, and these arrangements
subject the Company to currency risk to the extent that exchange rates fluctuate
from the date that royalty liabilities are incurred until the date royalties are
actually paid to the licensor.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reference is made to the Financial Statements referred to in the Index on
page F-1 setting forth the consolidated financial statements of Play By Play
Toys & Novelties, Inc. and Subsidiaries, together with the report of
PricewaterhouseCoopers LLP dated October 23, 1998.

36
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

The information required by Part III (Items 10 through 13) is incorporated by
reference to the captions "Principal Shareholders," "Election of Directors,"
"Management" and "Certain Relationships and Related Transactions" in the
Company's definitive Proxy Statement to be filed pursuant to Regulation 14A
within 120 days after the end of the Company's fiscal year covered by this
Report.

PART IV

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

(a)(1) FINANCIAL STATEMENTS. Reference is made to the Index on page F-1 for a
list of all financial statements filed as part of this Report.

(a)(2) FINANCIAL STATEMENT SCHEDULES. Reference is made to the Index on page
F-1 for a list of all financial statement schedules filed as part of
this Report.

(a)(3) EXHIBITS. Reference is made to the Exhibit Index on page E-1 for a
list of all exhibits filed as part of this Report.

(b) REPORTS ON FORM 8-K. None.

37
<PAGE>
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, this 28th day of
October 1998.

PLAY BY PLAY TOYS & NOVELTIES, INC.

By: /s/ RAYMOND G. BRAUN
Raymond G. Braun
CHIEF FINANCIAL OFFICER, TREASURER AND
DIRECTOR

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

SIGNATURE TITLE DATE
------------- ---------- ----------

By: /s/ ARTURO G. TORRES Chairman of the Board and Chief October 28, 1998
Arturo G. Torres Executive Officer (Principal
Executive Officer)

By: /s/ MARK A. GAWLIK President, Chief Operating October 28, 1998
Mark A. Gawlik Officer and Director

By: /s/ RAYMOND G. BRAUN Chief Financial Officer, October 28, 1998
Raymond G. Braun Treasurer and Director
(Principal Financial and
Accounting Officer)

By: /s/ SAUL GAMORAN Executive Vice President, October 28, 1998
Saul Gamoran General Counsel, Corporate
Secretary and Director

By: /s/ FRANCISCO SAEZ MOYA President - Play By Play October 28, 1998
Francisco Saez Moya Europe, S.A. and Director

38
<PAGE>
By: /s/ TOMAS DURAN Director October 28, 1998
Tomas Duran

By: /s/ JAMES F. PLACE Director October 28, 1998
James F. Place

By: /s/ STEVE K. C. LIAO Director October 28, 1998
Steve K. C. Liao

By: /s/ OTTIS W. BYERS Director October 28, 1998
Ottis W. Byers

By: /s/ BERTO GUERRA, JR. Director October 28, 1998
Berto Guerra, Jr.

39
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE

PAGE
------
Consolidated Financial Statements:

Report of Independent Accountants .................................... F-2

Consolidated Balance Sheets as of July 31, 1998 and 1997 ............. F-3
Consolidated Statements of Income for the Fiscal Years Ended
July 31, 1998, 1997 and 1996 ....................................... F-4

Consolidated Statements of Shareholders' Equity for the
Fiscal Years Ended July 31, 1998, 1997 and 1996 .................... F-5

Consolidated Statements of Cash Flows for the Fiscal
Years Ended July 31, 1998, 1997 and 1996 ........................... F-6

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

Financial Statement Schedule:

Report of Independent Accountants on Financial Statement Schedule .... S-1

Schedule II - Valuation and Qualifying Accounts ...................... S-2

All other schedules are omitted as the required information is not applicable or
the information is presented in the consolidated financial statements, related
notes or other schedules.

F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS

To the Shareholders and Board of Directors of
Play By Play Toys & Novelties, Inc. and Subsidiaries:

In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) present fairly, in all material respects, the
financial position of Play By Play Toys & Novelties, Inc. and Subsidiaries at
July 31, 1998 and 1997, and the results of their operations and their cash flows
for each of the three years in the period ended July 31, 1998, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.

PricewaterhouseCoopers LLP

Austin, Texas
October 23, 1998

F-2
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

ASSETS
<TABLE>
<CAPTION>
JULY 31,
------------------------------
1998 1997
------------- -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................. $ 3,024,028 $ 4,960,612
Accounts and notes receivable, less allowance for
doubtful accounts of $5,262,053 and $3,213,653 ....... 48,950,055 37,728,254
Inventories ............................................... 72,613,130 47,239,520
Prepaid royalties ......................................... 2,560,464 1,192,156
Deferred income taxes ..................................... 224,728 --
Other current assets ...................................... 6,135,579 2,589,568
------------- -------------
Total current assets ................................. 133,507,984 93,710,110
Property and equipment, net .................................... 17,914,998 14,985,887
Goodwill, less accumulated amortization of $754,179 and $365,433 14,043,748 14,412,736
Other assets ................................................... 2,417,166 2,796,841
------------- -------------
Total assets ......................................... $ 167,883,896 $ 125,905,574
============= =============

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Bank overdraft ............................................ $ -- $ 461,220
Notes payable to banks and others ......................... 14,760,950 22,607,721
Current maturities of long-term debt ...................... 3,393,149 3,472,017
Current obligations under capital leases .................. 1,142,687 691,333
Accounts payable, trade ................................... 28,070,980 22,340,182
Other accrued liabilities ................................. 5,312,081 5,831,652
Income taxes payable ...................................... 4,374,249 2,437,432
Deferred income taxes ..................................... -- 496,431
------------- -------------
Total current liabilities ............................ 57,054,096 58,337,988
------------- -------------
Long-term liabilities:
Long-term debt, net of current maturities ................. 4,860,247 7,320,233
Convertible subordinated debentures ....................... 15,000,000 15,000,000
Obligations under capital leases .......................... 1,102,135 917,506
Deferred income taxes ..................................... 878,787 660,918
------------- -------------
Total liabilities .................................... 78,895,265 82,236,645
------------- -------------

Commitments and contingencies

Shareholders' equity:
Preferred stock - no par value; 10,000,000 shares
authorized; no shares issued ......................... -- --
Common stock - no par value; 20,000,000 shares
authorized; 7,315,000 and 4,901,300 shares issued .... 1,000 1,000
Additional paid-in capital ................................ 70,986,820 35,006,539
Deferred compensation ..................................... (478,333) (618,333)
Accumulated other comprehensive income .................... (1,548,381) (2,303,027)
Retained earnings ......................................... 20,027,525 11,582,750
------------- -------------
Total shareholders' equity ........................... 88,988,631 43,668,929
------------- -------------
Total liabilities and shareholders' equity ........... $ 167,883,896 $ 125,905,574
============= =============

</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.

F-3
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
FISCAL YEARS ENDED JULY 31,
-----------------------------------------------
1998 1997 1996
--------- -------- ---------
<S> <C> <C> <C>
Net sales ...................................... $ 178,102,835 $ 137,386,257 $ 74,197,301
Cost of sales .................................. 116,755,386 91,024,319 50,218,390
------------- ------------- -------------
GROSS PROFIT .............................. 61,347,449 46,361,938 23,978,911
Selling, general and administrative expenses ... 44,088,681 33,215,225 17,302,800
------------- ------------- -------------
OPERATING INCOME .......................... 17,258,768 13,146,713 6,676,111
Interest expense ............................... (4,509,897) (4,414,701) (660,135)
Interest income ................................ 360,048 215,895 547,807
Other income (loss) ............................ (116,957) (7,785) 107,981
------------- ------------- -------------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAX ...................... 12,991,962 8,940,122 6,671,764
Income tax provision ........................... (4,547,187) (2,724,150) (2,619,649)
------------- ------------- -------------
INCOME FROM CONTINUING OPERATIONS ......... 8,444,775 6,215,972 4,052,115
Discontinued operations:
Loss from discontinued operations ......... -- -- (145,036)
Loss on disposal of discontinued operations -- -- (239,002)
------------- ------------- -------------
NET INCOME ................................ $ 8,444,775 $ 6,215,972 $ 3,668,077
============= ============= =============

Basic earnings (loss) per common share:
From continuing operations ................... $ 1.30 $ 1.28 $ 0.84
From discontinued operations ................. -- -- (0.08)
------------- ------------- -------------
Net income ............................... $ 1.30 $ 1.28 $ 0.76
============= ============= =============

Diluted earnings (loss) per common share:
From continuing operations ................... $ 1.19 $ 1.25 $ 0.84
From discontinued operations ................. -- -- (0.08)
------------- ------------- -------------
Net income ............................... $ 1.19 $ 1.25 $ 0.76
============= ============= =============

Weighted average shares outstanding:
Basic ........................................ 6,473,724 4,871,952 4,841,100
------------- ------------- -------------
Diluted ...................................... 7,759,866 5,035,723 4,855,500
------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.

F-4
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL
-------------------- PAID-IN DEFERRED COMPREHENSIVE RETAINED TREASURY SHAREHOLDERS'
SHARES AMOUNT CAPITAL CONPENSATION INCOME EARNINGS STOCK EQUITY
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, August 1, 1995 ...... 4,541,100 1,000 30,171,150 -- 205,920 1,698,701 (50,000) 32,026,771
Comprehensive income:
Net income ................. 3,668,077 3,668,077
Foreign currency translation
adjustments, net of tax .. (620,226) (620,226)
---------
Comprehensive income .. 3,047,851
---------

Warrants issued .............. 245,350 245,350
Stock issued for exercise of
over-allotment option
of IPO .................... 300,000 3,380,097 3,380,097
Retirement of treasury stock (50,000) 50,000 --
----------------------------------------------------------------------------------------------------
Balance, July 31, 1996 ....... 4,841,100 1,000 33,746,597 -- (414,306) 5,366,778 -- 38,700,069

Comprehensive income:
Net income ................. 6,215,972 6,215,972
Foreign currency translation
adjustments, net of tax .. (1,888,721) (1,888,721)
----------
Comprehensive income .. 4,327,251
----------

Acquisition of TLC ........... 40,000 345,000 345,000
Exercise of stock options .... 20,200 214,942 214,942
Deferred employee
compensation ............... 700,000 (700,000) --
Amortization of deferred
compensation ............... 81,667 81,667
----------------------------------------------------------------------------------------------------
Balance, July 31, 1997 ....... 4,901,300 1,000 35,006,539 (618,333) (2,303,027) 11,582,750 -- 43,668,929

Comprehensive income:
Net income ................. 8,444,775 8,444,775
Foreign currency translation
adjustments, net of tax .. 754,646 754,646
----------
Comprehensive income .. 9,199,421
----------

Warrants issued .............. 522,000 522,000
Stock issued in secondary
public offering ............ 2,300,000 34,147,474 34,147,474
Exercise of stock options .... 113,700 1,310,807 1,310,807
Amortization of deferred
compensation ............... 140,000 140,000
----------------------------------------------------------------------------------------------------
Balance, July 31, 1998 ....... 7,315,000 $1,000 $70,986,820 $ (478,333) $(1,548,381) $20,027,525 $ -- $88,988,631
====================================================================================================
</TABLE>

The accompanying notes are an integral part of the
consolidated financial statements.

F-5
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
FISCAL YEARS ENDED JULY 31,
--------------------------------------------
1998 1997 1996
-------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ......................................................... $ 8,444,775 $ 6,215,972 $ 3,668,077
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Depreciation and amortization ................................... 2,271,943 2,041,950 806,860
Provision for doubtful accounts receivable ...................... 2,173,736 2,024,847 1,163,346
Deferred income tax provision (benefit) ......................... (503,290) 554,229 (74,913)
Amortization of deferred compensation ........................... 140,000 81,667 --
Loss (gain) on sale of property and equipment ................... 89,248 (51,356) (3,718)
Loss from discontinued operations ............................... -- -- 159,359
Change in operating assets and liabilities (net of acquisitions):
Accounts and notes receivable ................................. (13,395,537) (9,822,434) (7,030,009)
Inventories ................................................... (25,373,610) (5,343,092) (13,325,525)
Prepaids and other assets ..................................... (3,987,081) 985,489 (2,488,704)
Accounts payable and accrued liabilities ...................... 5,151,647 4,513,600 2,519,138
Income taxes payable .......................................... 1,936,817 647,106 1,190,791
------------ ------------ ------------
Net cash provided by (used in) operating activities ........ (23,051,352) 1,847,978 (13,415,298)
------------ ------------ ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ................................. (3,269,603) (791,869) (1,770,244)
Proceeds from sale of property and equipment ....................... 35,115 -- 7,794
Proceeds from sale of restaurants .................................. -- -- 79,643
Purchase of TLC, net of cash acquired .............................. -- (488,811) --
Purchase of Ace, net of cash acquired .............................. -- -- (39,168,902)
Maturity of short-term investments ................................. -- -- 973,168
Payments for intangible assets ..................................... (32,246) (29,999) (45,919)
------------ ------------ ------------
Net cash used in investing activities ...................... (3,266,734) (1,310,679) (39,924,460)
------------ ------------ ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from public offering of common stock, net ................. 34,147,474 -- 3,380,097
Net borrowings (repayments) under Revolving Credit Agreement ....... (7,846,771) 831,912 19,342,177
Payment of note payable to shareholder ............................. -- (3,000,000) --
Costs related to issuance of debt .................................. -- (823,862) (755,115)
Proceeds from long-term debt ....................................... -- 15,000,000 14,900,000
Repayment of long-term debt ........................................ (2,570,041) (3,964,594) (99,869)
Repayment of capital lease obligations ............................. (953,393) (628,658) (202,753)
Proceeds from exercise of stock options ............................ 1,310,807 214,942 --
Increase (decrease) in bank overdraft .............................. (461,220) (1,896,216) 2,357,436
------------ ------------ ------------
Net cash provided by financing activities .................. 23,626,856 5,733,524 38,921,973
------------ ------------ ------------
EFFECT OF FOREIGN CURRENCY EXCHANGE RATES ............................ 754,646 (1,841,251) (620,226)
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents ........... (1,936,584) 4,429,572 (15,038,011)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ..................... 4,960,612 531,040 15,569,051
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ........................... $ 3,024,028 $ 4,960,612 $ 531,040
============ ============ ============
</TABLE>

The accompanying notes are an integral part of the
consolidated financial statements.

F-6
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. FORMATION

Play By Play Toys & Novelties, Inc. ("PBP and together with all
majority-owned subsidiaries, the "Company") was formed in January 1992, and
purchased the amusement toy operations on May 18, 1992 from Pizza Management,
Inc., a company previously owned by the Company's Chairman and CEO.

The Company's principal business is to design, develop, market and
distribute stuffed toys, electronic plush toys and sculpted toy pillows and to
market and distribute a broad line of novelty items. The Company sells these
products to customers in the amusement and retail markets. The Company's toy
operations accounted for 98.3% of net sales for fiscal 1998.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of PBP and all
majority-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation. Certain reclassifications have
been made to the prior years' consolidated financial statements to conform with
the current year presentation.

PERVASIVENESS OF ESTIMATES

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

FOREIGN CURRENCY TRANSLATION

All balance sheet accounts of foreign subsidiaries are translated from
foreign currencies into U.S. dollars at the year-end rates of exchange, while
income and expense accounts are translated at average currency exchange rates in
effect during the period. The resulting translation adjustment is recorded as a
separate component of shareholders' equity. Gains and losses from foreign
currency transactions (transactions denominated in a currency other than the
entity's functional currency) are included in other income. The foreign currency
transaction gain (loss) for fiscal 1998 was a loss of $117,000, was not material
for fiscal 1997, and a gain of $108,000 in fiscal 1996. Transaction gains and
losses result primarily from sales in Europe and purchases of products by the
Company's foreign subsidiaries from suppliers in the Far East.

Certain of the Company's license agreements require payment of royalties
in Canadian dollars. The Company's subsidiary in Spain also has license
agreements that requires payment of royalties in United States dollars. As a
result of these license agreements, the Company experiences currency risk to the
extent that exchange rates fluctuate from the date the royalty liability is
incurred until the date the royalty is actually paid to the licensor.
Additionally, the Company is exposed to foreign currency risk for intercompany
receivable and payable transactions through the settlement date.

F-7
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Historically, no attempt has been made to manage, by means of hedging or
derivatives, the risk of potential currency fluctuations. The total unhedged
exposure related to currency risk at July 31, 1998 was $5.6 million.

CASH EQUIVALENTS

For purposes of the statements of cash flows, the Company considers all
time deposits with original maturities of three months or less to be cash
equivalents.

BUSINESS AND CREDIT RISK

Financial instruments that potentially expose the Company to
concentrations of credit risk consist primarily of cash and cash equivalents and
trade receivables. The Company's cash and cash equivalents consist of highly
liquid cash deposits in major financial institutions. From time to time, the
Company may have on deposit in certain bank accounts including foreign banks,
amounts in excess of insured limits. The Company's trade receivables result
primarily from its retail and amusement operations and in general, reflect a
broad customer base. As of July 31, 1998, the outstanding trade receivables were
$49.4 million, of which $27.6 million trade receivables were from customers in
the United States, $10.5 million were trade receivables from customers in Latin
American countries, and $11.3 million trade receivables were from European
customers. In Latin America, three customers accounted for $7.7 million of the
trade receivables outstanding at July 31, 1998, which approximates 15.6% of the
total outstanding trade receivables. Due to the difficult economic environment
in Latin America, the Company provides more aggressive terms to Latin America
customers. The Company generally requires no collateral from its customers;
however, it routinely assesses the financial strength of its customers and in
some instances requires customers to issue a letter of credit for amount of
purchases in favor of the Company. No customer accounted for more than 10% of
the Company's net sales in fiscal 1998, 1997 and 1996.

The majority of the Company's manufacturing is arranged directly by the
Company with third party manufacturers, a substantial portion of which are
located in the People's Republic of China ("China"). The Company does not have
long-term contracts with any of the manufacturers. Although the Company has
begun to arrange alternate sources of manufacturing outside of China, the
Company has made no definitive plans for securing alternate sources in the event
its present arrangements with Chinese manufacturers prove impossible to
maintain, and there can be no assurance that there would be sufficient alternate
manufacturing facilities to meet the increased demand for production which would
likely result from a disruption of manufacturing sources in China. No
manufacturer accounted for more than 10% of the Company's purchases of toy
products during fiscal 1998, 1997 or 1996, with the exception of Tri-State
Manufacturing (China), Ltd. ("Tri-S"), which accounted for 6.6%, 26.3% and 24.5%
of such purchases during fiscal 1998, 1997 and 1996, respectively. During such
period, Tri-S manufactured plush PLAY-FACES(R) and the COCA-COLA(R) brand plush
POLAR BEAR products. Tri-S is currently one of several manufacturers of these
and other products for the Company.

INVENTORIES

Inventories are stated at the lower of cost or market. Cost of PBP's U.S.
inventory is primarily determined using the last-in, first-out (LIFO) method.
Operating supplies and inventory at PBP's subsidiary in Spain and from the
acquisition of Ace Novelty Co., Inc. ("Ace") are determined by the first-in,
first-out (FIFO) method, and inventory-in-transit is determined based on the
specific identification method.

F-8
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost. Maintenance and repairs are
charged to operations, and replacements or betterments are capitalized. Property
or equipment sold, retired, or otherwise disposed of is removed from the
accounts, and any gains or losses thereon are included in operations.
Depreciation and amortization are determined using the straight-line method.

Property and equipment is depreciated and amortized as follows:

TERM
------
Building 20 years
Equipment 10 years
Vehicles 3 years
Computer equipment 3 years
Software 7 years
Leasehold improvements Life of the lease (5-20 years)

INTANGIBLE ASSETS

Goodwill represents the excess purchase price over the fair value of net
assets acquired and is amortized over twenty to forty years (principally forty
years) using the straight-line method.

Other intangible assets consist primarily of debt issuance costs, which
are amortized over the term of the related debt on a straight-line basis, which
approximates the interest method.

IMPAIRMENT OF LONG-LIVED ASSETS

At each balance sheet date, the Company evaluates the propriety of the
carrying amount of its long-lived assets. In the event that facts and
circumstances indicate that the cost of long-lived assets may be impaired, an
evaluation of recoverability would be performed. If an evaluation of impairment
is required, the estimated future undiscounted cash flows associated with the
asset would be compared to the asset's carrying amount to determine if a
write-down to market value or discounted cash flow value is required. The
Company recorded no such write-downs during any of the periods presented.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts reported in the consolidated balance sheet of cash
and cash equivalents, short-term investments, accounts and notes receivable,
accounts payable, and long term debt approximates their fair value. The Company
estimates the fair value of notes receivable by discounting the future cash
flows of the instrument, using the Company's incremental rate of borrowing for a
similar instrument.

REVENUE RECOGNITION

Revenues from sales to customers are recognized when products are shipped.

ADVERTISING

The costs of producing media advertising are capitalized and amortized to
expense over the anticipated sale period, while airtime is expensed over the
sale period. Committed media communication costs are accrued as a cost of sale
of the related product. Costs incurred in the production of catalogs are
deferred and charged to operations in the period in which the related catalogs
are mailed.

F-9
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

INCOME TAXES

Deferred income taxes are recognized for the tax consequences in future
years of differences between tax basis of assets and liabilities and their
financial reporting amounts at each year-end based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.

EARNINGS PER SHARE

The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings Per Share", effective for the year ending July 31,
1998 and has restated its earnings per share ("EPS") disclosure for the years
ended July 31, 1997 and 1996 to comply with SFAS No. 128. SFAS No. 128
simplifies the standards for computing EPS previously found in Accounting
Principles Board Opinion No. 15, "Earnings Per Share", and makes them comparable
to international EPS standards. It replaces the presentation of primary EPS with
a presentation of basic EPS, which excludes dilution. It also requires dual
presentation of basic and diluted EPS on the face of the income statement for
all entities with complex capital structures. Basic earnings per share were
computed by dividing net income by the weighted average number of shares of
common stock outstanding during the period. Diluted earnings per share differs
from basic earnings per share due to the assumed conversions of dilutive
options, warrants and convertible debt outstanding during the period.

The calculations of basic and diluted EPS for the fiscal years ended July 31,
1998, 1997, 1996 are as follows:

<TABLE>
<CAPTION>
FISCAL YEARS ENDED JULY 31,
------------------------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Income from continuing operations available
to common stockholders - basic ................................. $8,444,775 $6,215,972 $4,052,115
Plus: interest on convertible debt ............................... 780,000 61,973 --
---------- ---------- ----------
Income from continuing operations available
to common stockholders plus income from
assumed conversions - diluted .................................. $9,224,775 $6,277,945 $4,052,115
========== ========== ==========
Weighted average shares outstanding - basic ...................... 6,473,724 4,871,952 4,841,100
Plus: assumed exercise of options and warrants .................. 348,642 89,285 14,400
Plus: assumed conversion of convertible debt .................... 937,500 74,486
---------- ---------- ----------
Weighted average shares outstanding - diluted .................... 7,759,866 5,035,723 4,855,500
========== ========== ==========
</TABLE>

During the fiscal years ended July 31, 1998, 1997 and 1996, the Company
had 1,702,558, 980,515, and 719,600, respectively, of common stock options and
warrants outstanding which were not included in the diluted earnings per share
calculation because the options and warrants would have been anti-dilutive.

F-10
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

COMPREHENSIVE INCOME

In fiscal year 1998, the Company adopted SFAS No. 130. "Reporting
Comprehensive Income" which establishes new rules for the reporting and
presentation of comprehensive income and its components in a full set of
financial statements. The Company's comprehensive income is comprised of net
income and foreign currency translation adjustments. The adoption of SFAS No.
130 had no impact on the Company's net income or total shareholders' equity.
Prior to the adoption of SFAS No. 130, foreign currency translation adjustments
were reported separately in the statement of shareholders' equity. The
comprehensive income amounts in the prior fiscal years' financial statements
have been reclassified to conform to SFAS No. 130.

NEW ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standard Board ("FASB") issued SFAS No. 131,
"Disclosure about Segments of an Enterprise and Restated Information," which
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. SFAS No. 131 is effective for financial statements for periods
beginning after December 15, 1997.

Management has not yet determined the impact, if any, that SFAS 131 will
have on its financial statement disclosures.

4. ACQUISITIONS

In June 1996, the Company acquired substantially all of the operating
assets, business operations and facilities (the "Acquisition") of Ace. The
operating results of the Acquisition are included in the Company's consolidated
results of operations from the date of the acquisition. The purchase price of
approximately $44.7 million consisted of $39.2 million in cash, $2.9 million in
subordinated debt, $2.4 million in related direct costs, and $0.2 million in the
form of warrants issued by the Company to the former owners of Ace ("Sellers")
to purchase up to 35,000 shares of the Company's Common Stock, commencing one
year from the date of acquisition. The Acquisition has been accounted for using
the purchase method. The Company recorded approximately $14.1 million of
goodwill, which is the excess of the total purchase price over the fair value of
net assets acquired. Included in net assets is approximately $3.8 million in
certain trade payables and accrued liabilities, which the Company assumed. This
goodwill is being amortized on a straight-line basis over a 40-year period.

The debt incurred by the Company in connection with the Acquisition
consisted of (i) approximately $34.0 million in revolving credit and term loans
under the Revolving Credit Term Loan with Letter of Credit Facility dated June
20, 1996 ("Credit Facility"), which had a maximum aggregate commitment of $65
million among The Chase Manhattan Bank, formerly Chemical Bank, (the "Bank") as
agent, Bank of America, Union Bank of California, and Chase Bank of Texas
(formerly Texas Commerce Bank N.A.) (the "Lenders"), and the Company, Ace
Novelty Acquisition Co., Inc. ("ANAC") and Newco Novelty, Inc., wholly owned
subsidiary of ANAC, as borrowers (see Note 9), (ii) a $3.0 million subordinated
loan from the Company's Chief Executive Officer, and (iii) a $2.9 million
subordinated loan from Sellers. The Credit Facility was amended in fiscal 1998
to have a maximum aggregate commitment of $30 million (see Note 8).

F-11
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. ACQUISITIONS (CONTINUED)

The following is a summary of the Ace assets acquired and liabilities
assumed, at the date of Acquisition:

Current assets ............ $26,779,000
Property and equipment, net 8,737,000
Goodwill .................. 14,054,000
-----------
Total assets .......... $49,570,000
===========
Current liabilities ....... $ 4,826,000
===========

Relative to the Acquisition, the Company adjusted the purchase price
allocation as contingent assets and liabilities were determined or realized in
accordance with Statement of Financial Accounting Standards No. 38, "Accounting
for Preacquisition Contingencies of Purchase Enterprises."

In November 1996, the Company, through its wholly-owned subsidiary Play By
Play Toys & Novelties Europe S.A., acquired all of the outstanding capital stock
of The TLC Gift Company, Ltd. ("TLC") based in Doncaster, England. The Company
effected the purchase of TLC by issuing 40,000 shares of restricted common stock
to the sellers of TLC. The shares had a fair market value of $345,000 at the
date of acquisition. The Company incurred $144,000 in costs directly related to
the acquisition. The acquisition has been accounted for using the purchase
method of accounting, and accordingly, the purchase price has been allocated to
the assets purchased and the liabilities assumed based on the fair values at the
date of acquisition. The Company acquired assets with an approximate value of
$1.9 million and assumed liabilities of $2.6 million, resulting in goodwill of
$1.1 million which is being amortized on a straight-line basis over 20 years.
The operating results have been included in the Company's consolidated financial
statements since the date of acquisition.

5. DISCONTINUED OPERATIONS

In March 1996, the Company sold all of the stock of Restaurants Universal
Espana, S.A. ("Restaurants Universal"), its European subsidiary that operated
two restaurants in Spain, to an unrelated third party, for 205,000,000 Spanish
pesetas, which was approximately $1.6 million at the date of the sale. The sale
resulted in a non-cash, non-recurring charge against earnings of approximately
$239,000 and a loss from discontinued operations of approximately $145,000, for
a total loss from discontinued operations of $384,000 in fiscal year 1996.

F-12
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5. DISCONTINUED OPERATIONS (CONTINUED)

The buyer paid approximately $80,000 in cash, and the Company financed the
balance of the sales price of approximately $1.5 million with the acceptance of
a non-interest bearing note from the purchaser which calls for monthly principal
payments based on the greater of six percent of net annual sales of specific
restaurants, including the restaurants sold by the Company, or a series of
minimum monthly payments over a period of eight years. The note balance, net of
imputed interest of approximately $450,000 calculated at a rate of 10%, is
comprised of the current portion which is included in accounts and notes
receivable and long term portion of the note is included in other assets. The
note is collateralized by all of the stock of Restaurants Universal.

The operating results and the loss on the sale of the restaurants have
been reported separately as a component of discontinued operations in the
Consolidated Statements of Income for the twelve months ended July 31, 1996. The
Company realized no tax benefit from the loss on the sale of Restaurants
Universal. Further, the Company had not previously recorded a tax benefit on the
operating losses of Restaurants Universal. Summarized results of operations for
Restaurants Universal for fiscal year 1996 are as follows:

Net sales ........ $ 1,516,791
Cost of sales .... 1,630,501
Net loss ......... (145,036)

6. INVENTORIES

Inventories consist of the following:

JULY 31,
-------------------------------
1998 1997
----------- -----------
Purchased for resale ............ $72,325,886 $46,898,557
Operating supplies .............. 287,244 340,963
----------- -----------
Total ...................... $72,613,130 $47,239,520
=========== ===========

Replacement cost of inventories approximates LIFO cost at each of the
balance sheet dates. At July 31, 1998 and 1997 inventories in the amount of
$45.3 million and $26.2 million, respectively, were valued using the FIFO and
specific identification methods. The excess current cost over the LIFO value of
inventories was $215,000 at July 31, 1998 and 1997.

F-13
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7. PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

JULY 31,
--------------------------------
1998 1997
------------ ------------
Buildings ............................. $ 3,379,773 $ 3,376,113
Land .................................. 1,207,729 1,207,729
Equipment ............................. 11,656,496 10,226,021
Vehicles .............................. 707,006 565,906
Computer equipment .................... 2,524,361 1,409,556
Software .............................. 1,455,071 284,516
Leasehold improvements ................ 2,213,263 1,347,063
------------ ------------
23,143,699 18,416,904
Accumulated depreciation and
amortization ........................ (5,228,701) (3,431,017)
------------ ------------
$ 17,914,998 $ 14,985,887
============ ============

Included in property and equipment in the accompanying consolidated
balance sheets are the following assets held under capital leases:

JULY 31,
-------------------------------
1998 1997
------------ -----------
Equipment ............................ $ 1,525,726 $ 755,594
Computer equipment ................... 1,073,019 965,369
Accumulated depreciation ............. (766,800) (486,911)
----------- -----------
$ 1,831,945 $ 1,234,052
=========== ===========

F-14

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8. NOTES PAYABLE AND LONG-TERM DEBT

JULY 31,
----------------------------
1998 1997
------------ ------------
Notes Payable:
Revolving line of credit ..................... $ 14,760,950 $ 22,607,721
============ ============
Long-Term Debt:
Term loan .................................... $ 7,200,000 $ 9,600,000
Convertible subordinated debentures .......... 15,000,000 15,000,000
Notes payable to banks, financing companies,
and other due in monthly installments with
interest rates ranging from 7.4% to 12.0%
collaterized by equipment ................. 1,053,396 1,192,250
------------ ------------
23,253,396 25,792,250
------------ ------------
Less current maturities ...................... (3,393,149) (3,472,017)
------------ ------------
$ 19,860,247 $ 22,320,233
============ ============

The aggregate amount of maturities on long-term borrowings as of July 31, 1998
were as follows:

Year ended July 31:
1999 $3,393,149
2000 3,059,709
2001 5,757,421
2002 3,622,355
2003 3,912,974
Beyond 3,507,788
-----------
$23,253,396
===========

CREDIT FACILITY

In June 1996, the Company entered into the Credit Facility (see Note 4)
which replaced the Company's $10 million credit facility. The Credit Facility
included a $53 million revolving line of credit commitment, subject to
availability under a borrowing base calculated by reference to the level of
eligible accounts receivable and inventory, and a $15 million sublimit for the
issuance of letters of credit. The $65 million Credit Facility also included a
$12 million term loan, which requires sixty equal monthly principal payments of
$200,000 plus accrued interest beginning August 1, 1996, with the last payment
due and payable on June 20, 2001.

F-15
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8. NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED)

During fiscal 1998, the Credit Facility was amended to reduce the total
revolving line of credit commitment to an aggregate amount of $30 million, and
reduce the interest rate on borrowings, the commitment fee and the letter of
credit fee. The revolving line of credit of the Credit Facility matured on June
20, 1998 and has been extended through January 15, 1999. The Company expects to
either extend or refinance the Credit Facility prior to January 15, 1999.
However, there is no assurance that the Company will be able to refinance or
obtain a new line of credit, or that if obtained, it will be on terms at least
as favorable as those on the existing line of credit.

Interest on borrowings outstanding under the revolving line of credit is
payable monthly at an annual rate equal to, at the Company's option, (i) the
Bank's Alternate Base Rate or (ii) the LIBOR rate plus 2.00%. The weighted
average interest rate was 8.50% and 8.19% for the years ended July 31, 1998 and
1997, respectively. For amounts outstanding under the term loan, interest is
payable monthly in arrears at an annual rate equal to, at the Company's option,
(i) the Bank's Alternate Base Rate plus 0.25% or (ii) the LIBOR rate plus 2.25%.
The weighted average interest rate was 8.75% and 8.48% for the years ended July
31, 1998 and 1997, respectively.

The Credit Facility is collateralized by a first lien on substantially all
of the Company's domestic assets, and 65% of the issued and outstanding stock of
its foreign subsidiaries.

As of July 31, 1998, the Company had $13.5 million in outstanding
irrevocable letters of credit and bankers' acceptances under the Credit
Facility. Based on the level of the Company's eligible accounts receivable and
inventory at July 31, 1998, the Company had $4.4 million of additional borrowing
capacity available under the Credit Facility, all of which could be used to
support borrowings under the revolving credit line or additional letters of
credit.

The Credit Facility contains certain restrictive covenants and conditions
among which are a prohibition on payment of dividends, limitations on further
indebtedness, restrictions on dispositions and acquisitions of assets,
limitations on advances to third parties and foreign subsidiaries and compliance
with certain financial covenants, including but not limited to a maximum total
debt ratio and minimum interest expense coverage. In addition, the Credit
Facility prohibits the Company's Chief Executive Officer from significantly
reducing his ownership in the Company below specified levels.

NOTE PAYABLE

As part of the consideration for the Acquisition, the Sellers (see Note 4)
received a $2.9 million note (the "Ace Note") from the Company. The first
installment on the Ace Note in the amount of up to $600,000 was due and payable
two business days following the determination of the final balance sheet of Ace
and accrues interest at 8.0% per annum. As of July 31, 1998, the Company
estimated the final balance sheet portion of the note to be approximately
$160,000. The second installment on the Ace Note in the amount of $1.0 million
was paid on December 20, 1996. The third installment on the Ace Note in the
amount of $500,000 was paid June 20, 1997 and is also subject to offset against
any claims by the Company against the Sellers. The fourth installment on the Ace
Note in the amount of $800,000 was due and payable on June 21, 1998 and was also
subject to offset against any claims by the Company against the Sellers.
Interest on the Ace Note, other than with respect to the first installment of
$600,000, is payable monthly in arrears at a rate of 12.0% per annum during the
first six months and 10.0% per annum thereafter, except with respect to the
final payment due June 21, 1998, which bears interest at 12.0% per annum. The
first installment in the

F-16
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PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8. NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED)

amount indicated above and the final installment have not been paid and are
currently subject to offset rights claimed by the Company. The Sellers have
denied such claims and filed a lawsuit to collect such amount in addition to
other claims. The Company is currently in settlement negotiations with the
Sellers, and management believes the net Ace related liability reported by the
Company should approximate the final expected settlement. Payment of all
obligations under the Ace Note is subordinate to payment of the Credit Facility.
Certain assets of the Company collateralize the Ace Note, and are also
subordinate to the Credit Facility.

CONVERTIBLE DEBT

During July 1997, the Company completed a private placement of $15 million
of convertible debentures. The proceeds were used to retire a $3 million
subordinated demand note due to a shareholder, provide $3 million as collateral
on two lines of credit with banks in Spain and for general corporate purposes.
Interest accrues at 8% per annum, payable monthly until maturity on June 30,
2004. Principal is payable commencing June 30, 2000 at a rate of 1% of the
outstanding balance monthly, with the remaining balance due at maturity. The
debt is convertible into Company's common stock at any time during the loan
period at a conversion price of $16.00 per share. Under certain conditions, the
conversion price may be reduced upon the issuance of common stock, including
treasury stock, at a price less than the current conversion price of $16.00 per
share. Such adjustment is based on the Company's cash flows, but cannot be
adjusted to a price less than $14.40 which is 90% of $16.00. Pursuant to the
terms of the Convertible Loan Agreement, the conversion price was adjusted from
the original $17.00 per share to $16.00 per share as a result of the December
1997 offering of the Company's common stock at $16.00 per share. The debenture
holders may force redemption if there is a change of control of the voting
stock, two-thirds of the Board changes without approval of the holders, or the
Company's stock cannot be publicly traded. The Company incurred costs of
approximately $731,000 in connection with the issuance of the convertible
debentures. Such costs were capitalized and are being amortized to interest
expense over the seven-year term of the convertible debentures on a
straight-line basis, which approximates the interest method.

The Convertible Loan Agreement contains certain restrictive covenants and
conditions among which place limitations on further indebtedness, liens,
investments, and dividends and requires compliance with certain financial
covenants and specified ratios. In addition, the Company is required to own all
of the capital stock, or other equity interests in its subsidiaries.

9. COMMITMENTS AND CONTINGENCIES

GUARANTEED PURCHASES

The Company has entered into a guaranteed purchase agreement for $1.7
million to reserve airtime in conjunction with the television promotion of
Talkin' Tunes(TM) and Tornado Taz(TM). The television campaign began national
and spot market television advertising during the first fiscal quarter of 1999.

F-17
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PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. COMMITMENTS AND CONTINGENCIES (CONTINUED)

CAPITAL LEASES

The Company leases equipment under capital lease agreements which expire
at various dates through 2002. The lease agreements generally provide purchase
options and require the Company to pay property taxes, utilities and insurance.

Future minimum lease payments under capital leases at July 31, 1998 are as
follows:

Year ended July 31:
1999 $ 1,284,978
2000 812,996
2001 306,523
2002 34,505
2003 -
-----------
Total minimum lease payments 2,439,002
Less amounts representing interest (194,180)
-----------
2,244,822
Less current portion (1,142,687)
-----------
Long-term obligations under capital leases $ 1,102,135
===========

OPERATING LEASES

The Company leases equipment, vehicles and operating facilities,
consisting primarily of warehouse, distribution and office space, under
operating leases expiring at various dates through 2007. The lease agreements
generally provide renewal options and require the Company to pay property taxes,
utilities and insurance. Rent expense under operating leases was $2.1 million,
$2.5 million and $1.5 million for the years ended July 31, 1998, 1997 and 1996,
respectively.

Minimum rental payments required under operating leases that have initial
or remaining non-cancelable lease terms in excess of one year at July 31, 1998
are as follows:

Year ended July 31:
1999 $ 2,548,921
2000 2,086,460
2001 1,724,808
2002 1,744,890
2003 1,587,768
Thereafter 4,642,369
-----------
Total minimum lease payments $14,335,216
===========

F-18
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PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. COMMITMENTS AND CONTINGENCIES (CONTINUED)

ROYALTIES

The Company markets its products under a variety of licensed trademarks
for which the Company pays associated royalties based on sales of the related
products. Approximately 64.2%, 59.7% and 58.2% of the Company's net sales in
fiscal 1998, 1997 and 1996, respectively, were derived from product lines based
on licensed entertainment character or corporate trademark. The Company's
products based on licensed trademarks for Looney Tunes' characters accounted for
50.6%, 37.5% and 16.4% of net sales in fiscal 1998, 1997 and 1996, respectively.
The Company's products based on trademarks licensed by The Coca-Cola Company
accounted for 2.2%, 4.5% and 13.8% of net sales in fiscal 1998, 1997 and 1996,
respectively. No other license accounted for more than 10% of the Company's net
sales. Some licenses are renewable at the option of the Company upon payment of
certain minimum guaranteed payments or the attainment of certain sales levels
during the initial term of the license. However, there can be no assurance that
the Company will be able to renew its most successful licenses, or obtain new
licenses. Substantially all of the license agreements are for periods of one to
three years and include guaranteed minimum royalty payments and advertising
commitments over the life of the agreements. Royalty expense is recorded based
on sales for the period multiplied by the contractual royalty rate specified in
the related licenses.

Future guaranteed minimum royalty obligations by year-end and in the
aggregate under license agreements consist of the following at July 31, 1998:

Year ended July 31:
1999 $ 8,543,465
2000 5,166,744
2001 874,778
------------
Total minimum royalty payments $ 14,584,987
============

LETTERS OF CREDIT

The Company had commitments in the normal course of business, including
outstanding irrevocable letters of credit and bankers' acceptances to certain
banks approximating $13.5 million at July 31, 1998, relating primarily to the
purchase of merchandise from various third-party overseas manufacturers.
Liabilities under letters of credit are recorded when the Company is notified
that merchandise has been shipped.

As of July 31, 1998, the Company's Spanish subsidiary had $3.7 million
outstanding in irrevocable letters of credit.

LEGAL PROCEEDINGS

The Company is from time to time subject to routine litigation incidental
to its business. The Company's management believes that the results of pending
legal proceedings will not have a material adverse effect on the Company's
consolidated financial position, results of operations or liquidity.

F-19
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In December 1997, a legal action was instituted against the Company by an
individual alleging claims for unfair competition (misappropriation), breach of
contract, breach of implied in fact contract, and quasi contract in connection
with alleged infringement resulting from the sale of Tornado Taz(TM). The
Company has responded by denying the essential allegations of the complaint and
by filing counterclaims for unfair competition (including product disparagement
and trade libel) and tortuous interference with prospective business advantage.
The Company is vigorously prosecuting the counterclaims and has filed a motion
for summary judgement for dismissal of the claims. The plaintiff has filed a
motion for summary judgement for dismissal of the Company's counterclaims. The
plaintiff seeks to recover the Company's profits on the sale of the toy in
question which could be as much as $2 million or more, or alternatively the
plaintiff may seek to recover royalties as a measure of damages, as well as an
injunction that, if granted, would bar future sales by the Company of Tornado
Taz(TM). The Company is vigorously contesting the claims and management believes
that the plaintiff has no basis for its claims.

YEAR 2000 COMPLIANCE

Similar to many business entities, the Company will be impacted by the
inability of computer application software programs to distinguish between the
year 1900 and 2000 due to a commonly-used programming convention. Until such
programs are modified or replaced prior to 2000, calculations and
interpretations based on date-based arithmetic or logical operations performed
by such programs may be incorrect.

F-20
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. COMMITMENTS AND CONTINGENCIES (CONTINUED)

EMPLOYEES

10. ADVERTISING EXPENSES

Advertising expenses consist primarily of costs incurred in the design,
development, printing and shipping of Company catalogs, television advertisement
costs and a limited number of advertisements in trade publications. The Company
implemented a television promotion campaign for the first time in fiscal 1997 in
conjunction with the introduction of the Talkin' Tots(TM) and Tornado Taz(TM).
In fiscal 1998, the television advertising costs were incurred principally in
conjunction with Talkin' Tots(TM), Talkin' Tunes and Tornado Taz(TM). The
Company's total televisiOn advertising expenses were $5.7 million and $1.3
million during fiscal 1998 and 1997, respectively. The Company's total
advertising expenses, including television advertisement costs, were $7.6
million, $2.7 million and $688,000 during fiscal 1998, 1997 and 1996,
respectively.

F-21
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PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11. INCOME TAX

Income tax provision (benefit) is as follows:

YEAR ENDED JULY 31,
-----------------------------------------
1998 1997 1996
------------ ----------- ------------
Federal:
Current provision ............ $ 2,914,676 $ 974,246 $ 1,987,531
Deferred provision (benefit) . (503,290) 554,229 (74,913)
----------- ----------- -----------
Total Federal ............ 2,411,386 1,528,475 1,912,618
----------- ----------- -----------
State - current ........... 441,827 255,102 323,007
----------- ----------- -----------
Foreign - current ........... 1,693,974 940,573 384,024
----------- ----------- -----------
Net provision for income taxes $ 4,547,187 $ 2,724,150 $ 2,619,649
=========== =========== ===========

Reconciliations of the differences between income taxes computed at the
Federal statutory tax rates and income tax provision are as follows:

YEAR ENDED JULY 31,
-----------------------------------------
1998 1997 1996
------------ ------------ -----------
Income taxes computed at Federal
statutory rates ................. $ 4,417,267 $ 3,039,641 $ 2,137,659
Foreign tax differentials ......... (23,834) (531,107) 172,097
Valuation allowance on capital loss
carryover ....................... -- -- 135,693
State tax provision ............... 291,606 168,367 213,185
Other - net ....................... (137,852) 47,249 (38,985)
----------- ----------- -----------
Total provision .............. $ 4,547,187 $ 2,724,150 $ 2,619,649
=========== =========== ===========

The foreign tax differential for the year ended July 31, 1997 results
primarily from a low effective tax rate on sales by the Hong Kong subsidiary,
and from an investment tax credit in Spain related to the investment in the TLC
operations in the U.K.

F-23
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11. INCOME TAX (CONTINUED)

The tax effects of the significant temporary differences that comprise the
deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Assets:
Current:
Accounts receivable ............ $ 1,515,765 $ 707,422 $ 406,011
Capital loss carryover ......... 135,693 135,693 135,693
Other - net .................... 483,848 324,971 86,514
Valuation allowance ............ (135,693) (135,693) (135,693)
----------- ----------- -----------
Gross deferred tax assets .... 1,999,613 1,032,393 492,525
----------- ----------- -----------

Liabilities:
Current - LIFO inventory valuation 1,774,885 1,528,824 715,984
Non-current - basis of property
and equipment ................... 878,787 660,918 379,661
----------- ----------- -----------
Gross deferred tax liabilities 2,653,672 2,189,742 1,095,645
----------- ----------- -----------
Net deferred tax liabilities . $ 654,059 $ 1,157,349 $ 603,120
=========== =========== ===========
</TABLE>

The Company recorded a valuation allowance on the capital loss carryover
as management is uncertain that the Company will be able to realize the benefit
in future periods. Management believes it is more likely than not that the
benefit of the remaining deferred tax assets will be realized, and thus has not
recorded a valuation allowance on these amounts.

Income taxes are not provided on undistributed earnings of foreign
subsidiaries as those earnings are intended to be permanently reinvested in
those operations. These earnings could become subject to additional tax upon
distribution in the form of dividends or otherwise. It is not practicable to
estimate the amount of additional U.S. tax that might be payable on the foreign
earnings; however, any foreign income taxes previously paid would reduce U.S.
income taxes payable.

12. SHAREHOLDERS' EQUITY

SECONDARY OFFERING

On December 2, 1997, the Company sold 2,300,000 shares of its common stock
in a follow-on public offering at a price of $16.00 per share. The total number
of shares sold included 300,000 related to underwriters' over-allotment option,
which was exercised in full. The net proceeds from the issuance and sale of
common stock amounted to $34.1 million after deducting underwriters' discounts
and other expenses. In December 1997, a portion of the net proceeds was used to
repay indebtedness of approximately $21.3 million outstanding under the Credit
Facility and $12.8 million was used to fund the Company's operations.

F-23
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PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12. SHAREHOLDERS' EQUITY (CONTINUED)

STOCK OPTIONS

The Company has a Non-Qualified Stock Option Plan and a 1994 Incentive
Plan (the "Plans"). The Company has reserved 1,300,000 shares of its common
stock for issuance upon exercise of options granted or to be granted under the
Plans. The vesting period for options issued pursuant to the plans generally
range from six months to four or five years from the date of the grant. Under
the Plans and at the discretion of the Board of Directors, awards may be granted
to officers and employees of the Company in the form of incentive stock options
and restricted stock. Stock options may be exercised at a purchase price
determined by the Board of Directors, provided that the exercise price per share
shall be an amount not less than 100% of the fair market value on the date the
option is granted or 110% of fair market value for beneficial owners of 10% or
more of the Company's outstanding shares. The maximum term for all Stock Options
granted under the Plans is ten years (five years in the case of an incentive
stock option granted to a shareholder who owns 10% or more of the Company's
Common Stock).

In January 1997, the Company granted options to purchase 200,000 shares of
the Company's common stock at $8.00 per share, in connection with an officer's
employment agreement. These options vest in equal monthly amounts over a
five-year period commencing February 1, 1997. The Company recognized $140,000
and $81,667 of compensation expense in fiscal 1998 and 1997 and has a balance of
$478,333 and $618,333 in unearned compensation as of July 31, 1998 and 1997,
respectively, related to these options.

In fiscal 1997, the Company's Board of Directors voted that options
granted to officers of the Company prior to December 1996 be re-priced to the
fair market value on the date of re-pricing, which was $11.00, or 110% of fair
market value for beneficial owners of 10% or more of the Company's outstanding
shares of common stock. The resolution was approved at the Annual Meeting of
Shareholders on December 11, 1997. The number of shares re-priced was 159,000.
The original exercise price of the shares ranged from $13.475 to $14.58. Such
options shall vest as originally granted.

The Company has adopted the disclosure-only provisions of
SFAS No. 123, "Accounting for Stock Based Compensation".
Accordingly, no compensation expense has been recognized for the
stock plan.

F-24
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12. SHAREHOLDERS' EQUITY (CONTINUED)

A summary of the status of the Company's stock options as of July 31,
1998, 1997, and 1996 and the changes during the year ended on those dates is
presented below:

<TABLE>
<CAPTION>
FISCAL YEARS ENDED JULY 31,
1998 1997 1996
--------------------------- --------------------------- ---------------------------
WEIGHTED WEIGHTED WEIGHTED
# SHARES OF AVERAGE # SHARES OF AVERAGE # SHARES OF AVERAGE
UNDERLYING EXERICSE UNDERLYING EXERICSE UNDERLYING EXERICSE
OPTIONS PRICES OPTIONS PRICES OPTIONS PRICES
--------------------------- --------------------------- ----------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year ............................. 959,800 $ 10.71 624,000 $ 12.29 151,000 $ 13.48
Granted ............................... 1,034,000 $ 18.99 412,000 $ 9.66 486,000 $ 11.94
Exercised ............................. 111,900 $ 11.82 20,200 $ 12.57 -- --
Forfeited ............................. 24,140 $ 13.47 49,300 $ 11.28 13,000 $ 13.48
Expired ............................... 24,760 $ 11.10 6,700 $ 13.73 -- --
Outstanding at end of year ............ 1,833,000 $ 15.32 959,800 $ 10.71 624,000 $ 12.29
Exercisable at end of year ............ 562,640 $ 12.76 394,700 $ 12.10 114,800 $ 13.79

</TABLE>

1998 1997 1996
-------- ------- -------
Weighted-average fair value of
options granted at premium .......... -- $1.83 $3.66
Weighted-average fair value of
options granted at-the-money ........ 7.26 3.62 $3.46
Weighted-average fair value of
granted at a discount ............... -- 5.81 N/A
Weighted-average fair value of
modifications to options ............ -- 1.09 $0.35

The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for all grants in 1998, 1997 and 1996: dividend yield of 0.00%;
risk-free interest rate of from 5.39% to 6.67%; an expected life of options of 5
years for 10-year options and expected life of 2.5 years for 5-year options; and
a volatility of 30.3% in fiscal 1998 and 23.6% in fiscal 1997 and 1996.

During fiscal 1997, 159,000 previously granted options were modified to
reduce the exercise price. The "Outstanding at the end of year" number of shares
underlying options in the table above and the table below reflects the modified
terms of these options. The fair value of each modification of previously
granted stock options is estimated on the date of the modification using the
Black-Scholes option-pricing model to determine the amount of value added to
each option at the time of modification. The weighted-average assumptions are
the same as for the options granted during fiscal 1998 and 1997.

F-25
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12. SHAREHOLDERS' EQUITY (CONTINUED)

Options outstanding as of July 31, 1998 are summarized below:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- -----------------------------
WEIGHTED AVERAGE
----------------- WEIGHTED AVERAGE WEIGHTED AVERAGE
RANGE OF NUMBER REMAINING ---------------- NUMBER ----------------
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- --------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$ 9.49 to $13.00 ......... 690,600 8.09 $ 10.01 389,140 $ 11.12
$13.01 to $15.95 ......... 113,900 7.12 14.56 82,200 13.65
$15.96 to $19.63 ......... 1,028,500 9.24 18.99 91,300 18.94
--------- -------
$ 9.49 to $19.63 ......... 1,833,000 8.67 15.32 562,640 12.76
========= =======
</TABLE>

NON-EMPLOYEE STOCK OPTIONS

In addition to the options described above, the Company granted 3,000
with an exercise price of $13.48 to a non-employee during fiscal 1995. During
fiscal year 1998, the non-employee exercised 1,800 options. As of July 31, 1998,
600 options were outstanding with a remaining contractual term of 8.85 years.

PRO FORMA NET INCOME AND NET INCOME PER COMMON SHARE

Had the compensation cost for the Company's Plans been
determined consistent with SFAS 123, the Company's net income and net income per
common share for 1998 and 1997 would approximate the pro forma amounts below:

AS REPORTED PRO FORMA AS REPORTED PRO FORMA
7/31/98 7/31/98 7/31/97 7/31/97
----------- ----------- ------------ ----------
SFAS 123 charge ........... -- $1,501,047 -- $ 944,600
APB 25 charge ............. $ 140,000 $ 140,000 $ 81,667 $ 81,667
Net income ................ $8,444,775 $7,083,728 $6,215,972 $5,353,039
Net income per common share $ 1.30 $ 1.09 $ 1.28 $ 1.10

The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts. SFAS 123 does not apply to awards granted prior to
the 1996 fiscal year.

WARRANTS

In connection with the initial public offering in July 1995, the Company
sold warrants to the underwriters for a nominal amount that allows for the
purchase of up to 82,000 shares of the Company's Common Stock. The warrants are
exercisable at $14.70 for a period of four years beginning July 20, 1996.

In addition to the cash paid to the Sellers of Ace (see Note 4), the
Company issued to the Sellers a warrant to purchase up to 35,000 common shares
of the Company's common stock at a price per share of $14.90. The warrant is
exercisable for a period of five years beginning June 20, 1997. The estimated
value of the warrant of $245,350 was recorded as an increase in goodwill, with
an offsetting increase in additional paid-in capital.

F-26
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12. SHAREHOLDERS' EQUITY (CONTINUED)

In connection with the execution of certain license agreements in January
1998, the Company issued to Warner Bros. Consumer Products, a division of Time
Warner Entertainment Company, L. P., a warrant (the "Warner Bros. Warrant") to
purchase up to 100,000 shares of the Company's common stock at a price per share
of $15.4375. The warrant may be exercised in full or in part any time after
January 1, 1998, but no later than December 31, 2000.

PREFERRED STOCK

Pursuant to the Company's Articles of Incorporation, the Board is
authorized to issue from time to time up to 10,000,000 shares of Preferred
Stock, in one or more series, and is authorized to fix the dividend rights,
dividend rates, any conversion rights or right of exchange, any voting right,
any rights and terms of redemption (including sinking fund provisions), the
redemption rights or prices, the liquidation preferences and any other rights,
preferences, privileges and restrictions of any series of Preferred Stock and
the number of shares constituting such series and the designation thereof. There
were no shares of Preferred Stock outstanding as of July 31, 1998 or 1997.

13. TRANSACTIONS WITH RELATED PARTIES

The principal shareholder leases seven land and building packages to a
third party with whom the Company incurred costs of $436,000, $700,000, and
$900,000 million in the years ended July 31, 1998, 1997 and 1996, respectively,
for revenue sharing arrangements in connection with the Company's vending
operations. The Company incurred costs of $76,000, $101,000 and $103,000 for
revenue sharing arrangements in the years ended July 31, 1998, 1997 and 1996,
respectively, in connection with its vending operations with an entity related
to another shareholder that is also a director of the Company.

One of the Company's directors is affiliated with an insurance agency
which provided certain property, casualty and liability insurance to the Company
in fiscal years 1998 and 1997. The Company paid premiums on policies issued by
the affiliated insurance agency totaling $272,600 and $956,000 during fiscal
years 1998 and 1997, respectively.

Interest expense on notes payable to related parties approximated $0,
$257,800, and $30,000 for the years ended July 31, 1998, 1997 and 1996,
respectively.

On February 19, 1997, the Company's European subsidiary, Play By Play
Europe, entered into an agreement with Banco Santander, S.A. Valencia to provide
a U.S. $2.0 million standby letter of credit collaterized by 35,000 shares of
the Company's Chief Executive Officer's personal common stock investment in an
unaffiliated company. No remuneration was paid by the Company to its Chief
Executive Officer as consideration for this guarantee. The standby letter of
credit matured without renewal on October 31, 1997.

F-27
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

14. SUPPLEMENTAL CASH FLOW DISCLOSURES

Supplemental cash flow information with respect to payments of interest
and income taxes is as follows:

YEAR ENDED JULY 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
Interest paid .......... $3,948,834 $3,794,534 $ 422,948
Income taxes paid ...... 2,565,861 942,437 1,594,078

The Company incurred capital lease obligations of $1.6 million, $1.2
million and $967,000 in the years ended July 31, 1998, 1997 and 1996,
respectively.

In November 1996, the Company issued 40,000 shares of restricted common
stock to the sellers of TLC in connection with the acquisition. The shares had a
fair market value of $345,000 at the date of acquisition.

The Company recorded $700,000 as deferred compensation related to the
options to purchase up to 200,000 shares of common stock, granted to an officer
in January 1997. At July 31, 1998, the unamortized balance was $478,333.

During fiscal 1996, the Company retired 24,600 shares of Treasury Stock
outstanding by reducing additional paid-in capital by the $50,000 cost of those
shares. The Company issued a note payable for $2,900,000 and warrants to
purchase up to 35,000 shares of the Company's Common Stock to the Sellers of Ace
to partially finance the Acquisition. The warrants were valued at $245,350 (see
Note 4). The Company recorded a note receivable for 205,000,000 pesetas, or
approximately $1.6 million, from the buyers of the stock of Restaurants
Universal (see Note 5).

In connection with the Warner Bros. Warrant (see Note 12), the Company
recorded $522,000 as a prepaid royalty with an offsetting increase in additional
paid-in capital. The prepaid royalty will be amortized to expense on a
straight-line basis over the life of the related licenses, which terminate
December 2000.

15. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION

The Company operates primarily in one industry segment, the sale of
stuffed toys and novelty items, primarily to customers in the retail and
amusement markets both domestically through its U.S. operations and in Europe
through subsidiaries located in Spain and England.

F-28
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION (CONTINUED)

Information by geographic location is as indicated below. The toys and
novelties industry segment includes sales of toy products and vending operations
for each of the periods presented.

YEAR ENDED JULY 31,
---------------------------------------------
1998 1997 1996
------------- ------------- -------------
Net sales:
United States .... $ 132,002,286 $ 113,725,263 $ 63,643,062
Latin America .... 14,416,516 2,569,451 1,453,459
Europe ........... 31,684,033 21,091,543 9,100,780
------------- ------------- -------------
$ 178,102,835 $ 137,386,257 $ 74,197,301
============= ============= =============

NET OPERATING INCOME:
United States .... $ 9,546,402 $ 9,353,262 $ 5,626,484
Latin America .... 3,156,351 164,768 (167,862)
Europe ........... 4,556,015 3,628,683 1,217,489
------------- ------------- -------------
$ 17,258,768 $ 13,146,713 $ 6,676,111
============= ============= =============

IDENTIFIABLE ASSETS:
United States .... $ 106,488,532 $ 102,567,531 $ 92,069,582
Latin America .... 10,574,279 1,270,720 888,075
Europe ........... 50,821,085 22,067,323 11,964,203
------------- ------------- -------------
$ 167,883,896 $ 125,905,574 $ 104,921,860
============= ============= =============

F-29
<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

16. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

Summarized operating results of the Company by quarter for fiscal years
1998 and 1997 are presented as follows (in thousands, except per share data).
The decrease in basic and diluted earnings per share from fourth quarter fiscal
1997 to fourth quarter fiscal 1998 is primarily due to the issuance of 2.3
million shares during fiscal 1998.

<TABLE>
<CAPTION>
1998
--------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net sales ........................... $58,418 $30,867 $37,262 $51,556
Gross profit ........................ 20,538 10,837 12,746 18,028
Operating income .................... 6,505 912 3,447 6,395
Net income .......................... 3,457 41 1,686 3,261

Net income per share - basic ........ 0.71 0.01 0.23 0.45
Net income per share - diluted ...... 0.58 0.01 0.22 0.41

</TABLE>

<TABLE>
<CAPTION>
1997
-------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
--------- --------- --------- ----------
<S> <C> <C> <C> <C>
Net sales ........................... $ 39,891 $ 22,039 $ 28,001 $ 47,455
Gross profit ........................ 11,052 7,952 10,614 16,744
Operating income .................... 3,479 677 2,592 6,399
Net income (loss) ................... 1,446 (166) 1,025 3,911

Net income (loss) per share - basic . 0.30 (0.03) 0.21 0.80
Net income (loss) per share - diluted 0.30 (0.03) 0.20 0.73

</TABLE>

F-30
<PAGE>
INDEX TO EXHIBITS

EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -------------------------
2.1 Asset Purchase Agreement dated May 1, 1996, by and among Ace Novelty
Acquisition Co., Inc. a Texas corporation ("Buyer"), Play By Play Toys
& Novelties, Inc., a Texas corporation and the parent corporation of
Buyer ("PBYP"), Ace Novelty Co., Inc., a Washington corporation
("ACE"), Specialty Manufacturing Ltd., a British Columbia, Canada
corporation ("Specialty"), ACME Acquisition Corp., a Washington
corporation ("ACME"), and Benjamin H. Mayers and Lois E. Mayers,
husband and wife, Ronald S. Mayers, a married individual, Karen
Gamoran, a married individual, and Beth Weisfield, a married individual
(collectively, "Stockholders") (filed as Exhibit 2.1 to Form 8-K, Date
of Event: May 1, 1996), incorporated herein by reference.

2.2 Amendment No. 1 to Asset Purchase Agreement dated June 20, 1996 by, and
among Buyer, PBYP, ACE, Specialty, ACME and Stockholders. (filed as
Exhibit 2.2 to Form 8-K, Date of Event: May 1, 1996), incorporated
herein by reference.

3.1 Amended Articles of Incorporation of the Company (filed as Exhibit 3.1
to the Registration Statement on Form S-1, File No. 33-92204),
incorporated herein by reference.

3.2 Amended and Restated Bylaws of the Company (filed as Exhibit 3.2 to the
Registration Statement on Form S-1, File No. 33-92204), incorporated
herein by reference.

4.1 Specimen of Common Stock Certificate (filed as Exhibit 4.1 to the
Registration Statement on Form S-1, File No. 33-92204), incorporated
herein by reference.

4.2 Form of Warrant Agreement and Form of Warrant (filed as Exhibit 4.2 to
the Registration Statement on Form S-1, File No. 33-92204),
incorporated herein by reference.

4.3 Form of Play By Play Toys & Novelties, Inc. Grant of Incentive Stock
Option (filed as Exhibit 4.3 to the Registration Statement on Form S-1,
File No. 33-92204), incorporated herein by reference.

4.4 Form of Play By Play Toys & Novelties, Inc. Non-qualified Stock Option
Agreement (filed as Exhibit 4.4 to the Registration Statement on Form
S-1, File No. 33-92204), incorporated herein by reference.

4.5 Play By Play Toys & Novelties, Inc. Warrant to Purchase Common Stock
(filed as Exhibit 4 to Form 8-K, Date of Event: May 1, 1996),
incorporated herein by reference.

10.1 Play By Play Toys & Novelties, Inc. 1994 Incentive Plan
(filed as Exhibit 10.1 to the Registration Statement on
Form S-1, File No. 33-92204), incorporated herein by
reference.

10.2 Credit Agreement dated June 20, 1996, by and among Play By Play Toys &
Novelties, Inc., Ace Novelty Acquisition Co., Inc., Newco Novelty, Inc.
and Chemical Bank, a New York banking corporation as agent for the
lenders (filed as Exhibit 10.1 to Form 8-K, Date of Event: May 1,
1996), incorporated herein by reference.

E-1
<PAGE>
INDEX TO EXHIBITS (CONTINUED)

EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- --------------------------------

10.3 Promissory Note dated June 20, 1996, of Ace Novelty Acquisition Co.,
Inc. payable to the order of Ace Novelty Co., Inc. in the principal sum
of $2,900,000 (filed as Exhibit 10.5 to Form 8-K, Date of Event: May 1,
1996), incorporated herein by reference.

10.4 Employment agreement dated November 4, 1996, between the Company and
Raymond G. Braun, as amended by Amendment No.1 to Employment agreement
dated August 29, 1997 (filed as Exhibit 10.4 to Form 10-K for the
fiscal year ended July 31, 1997), incorporated herein by reference.

10.5 Non-Qualified Stock Option agreement dated November 4, 1996, between
the Company and Raymond G. Braun, as amended by Amendment No. 1 to
Non-Qualified Stock Option agreement dated August 29, 1997 (filed as
Exhibit 10.5 to Form 10-K for the fiscal year ended July 31, 1997),
incorporated herein by reference.

10.6 Employment agreement dated May 2, 1996, between the Company and Saul
Gamoran, as amended by Amendment No. 1 dated May 16, 1996 (filed as
Exhibit 10.6 to Form 10-K for the fiscal year ended July 31, 1997),
incorporated herein by reference.

10.7 Employment agreement dated June 20, 1997, between the Company and James
A. Weisfield (filed as Exhibit 10.7 to Form 10-K for the fiscal year
ended July 31, 1997), incorporated herein by reference.

10.8 Subordinated Convertible Debenture Agreements dated July 3, 1997,
between the Company and each of Renaissance Capital Growth and Income
Fund III, Inc., Renaissance U.S. Growth and Income Trust PLC and Banc
One Capital Partners II, Ltd. (the "Convertible Lenders") (filed as
Exhibit 10.8 to Form 10-K for the fiscal year ended July 31, 1997),
incorporated herein by reference.

10.9 Convertible Loan Agreement dated July 3, 1997, among the Company, the
Convertible Lenders and Renaissance Capital Group, Inc. (filed as
Exhibit 10.9 to Form 10-K for the fiscal year ended July 31, 1997),
incorporated herein by reference

10.10 License Agreement dated March 22, 1994 by and between Warner Bros., a
division of Time Warner Entertainment, L.P., and the Company (as
successor by assignment to Ace Novelty, Inc.) (filed as Exhibit 10.10
to Form 10-K for the fiscal year ended July 31, 1997), incorporated
herein by reference.

10.11 License Agreement dated March 22, 1996 by and between Warner Bros., a
division of Time Warner Entertainment, L.P., and the Company (as
successor by assignment to Ace Novelty, Inc.) (filed as Exhibit 10.11
to Form 10-K for the fiscal year ended July 31, 1997), incorporated
herein by reference.

E-2
<PAGE>
INDEX TO EXHIBITS (CONTINUED)

EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- ---------------------------
10.12 License Agreement dated September 10, 1997 by and between Warner Bros.,
a division of Time Warner Entertainment, L.P., and the Company (as
successor by assignment to Ace Novelty, Inc.) (filed as Exhibit 10.12
to Form 10-K for the fiscal year ended July 31, 1997), incorporated
herein by reference.

10.13 License Agreement dated January 1, 1998 by and between Warner Bros., a
division of Time Warner Entertainment, L.P. and the Registrant (filed
as Exhibit 10.13 to Form 10-Q for the quarter ended January 31, 1998,
and incorporated herein by reference).

10.14 License Agreement dated January 1, 1998 by and between Warner Bros., a
division of Time Warner Entertainment, L.P. and the Registrant (filed
as Exhibit 10.14 to Form 10-Q for the quarter ended January 31, 1998,
and incorporated herein by reference).

10.15 Amendment dated January 14, 1998 to License Agreement dated September
10, 1997 by and between Warner Bros., a division of Time Warner
Entertainment, L.P. and the Registrant (filed as Exhibit 10.15 to Form
10-Q for the quarter ended January 31, 1998, and incorporated herein by
reference).

21 Subsidiaries of the Company.

23.1 Consent of PricewaterhouseCoopers LLP

27 Financial Data Schedule

E-3
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE

To the Board of Directors
of Play By Play Toys & Novelties, Inc. and Subsidiaries

Our audits of the consolidated financial statements referred to in our report
dated October 23, 1998 appearing on page F-2 of this 1998 Annual Report on Form
10-K also included an audit of the financial statement schedule listed in Item
14(a)(2) of this Form 10-K. In our opinion, this financial statement schedule
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.

PricewaterhouseCoopers LLP

Austin, Texas
October 23, 1998

S-1

<PAGE>
PLAY BY PLAY TOYS & NOVELTIES, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
BALANCE ADDITIONS BALANCE
AT BEGINNING CHARGED TO COSTS AT END
OF PERIOD AND EXPENSES DEDUCTIONS* OF PERIOD
--------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts:
Year ended July 31, 1996 $946,466 $1,163,346 $488,209 $1,621,603
Year ended July 31, 1997 1,621,603 2,024,847 432,797 3,213,653
Year ended July 31, 1998 3,213,653 2,173,736 125,336 5,262,053

- --------------------------------------------------------------------------
*Net of recoveries of $56,987, $24,406,and $28,704 in 1998, 1997, and 1996, respectively.

</TABLE>

S-2

EXHIBIT 21

SUBSIDIARIES OF THE COMPANY

Play by Play (Far East) Limited

Play By Play Toys & Novelties Europa, A.A.

Restaurants International, Inc.

Newco Novelty, Inc.

Ace Novelty Co., Inc.

Play By Play Toys & Novelties U.K., Ltd

EXHIBIT 23.1

CONSENT OF INDEPENDENT ACCOUNTANTS

We consent to the incorporation by reference in the registration statements on
Form S-8 (File No. 333-07031) and Form S-3 (File No. 333-55849) of our report
dated October 23, 1998, on our audits of the consolidated financial statements
and financial statement schedule of Play By Play Toys & Novelties, Inc. and
Subsidiaries as of July 31, 1998 and 1997, and for each of the three years in
the period ended July 31, 1998, which report is included in this Annual Report
on Form 10-K.

PricewaterhouseCoopers LLP

Austin, Texas
October 29, 1998

<ARTICLE> 5
<LEGEND>
THE FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE CONDENSED CONSOLIDATED BALANCE SHEETS AND THE CONDENSED STATEMENTS OF
OPERATIONS FOUND ON PAGES F-3 AND F-4 OF THE COMPANY'S FORM 10-K FOR THE TWELVE
MONTHS ENDED JULY 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1998
<PERIOD-END> JUL-31-1998
<CASH> 3,024,028
<SECURITIES> 0
<RECEIVABLES> 54,212,108
<ALLOWANCES> 5,262,053
<INVENTORY> 72,613,130
<CURRENT-ASSETS> 133,507,984
<PP&E> 23,143,699
<DEPRECIATION> 5,288,701
<TOTAL-ASSETS> 167,883,896
<CURRENT-LIABILITIES> 57,054,096
<BONDS> 0
0
0
<COMMON> 1,000
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 167,883,896
<SALES> 178,102,835
<TOTAL-REVENUES> 178,102,835
<CGS> 116,755,386
<TOTAL-COSTS> 116,755,386
<OTHER-EXPENSES> 44,088,681
<LOSS-PROVISION> 2,173,736
<INTEREST-EXPENSE> 4,509,897
<INCOME-PRETAX> 12,991,962
<INCOME-TAX> 4,547,187
<INCOME-CONTINUING> 8,444,775
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,444,775
<EPS-PRIMARY> 1.30
<EPS-DILUTED> 1.19

</TABLE>