<PAGE>

   AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 27, 1996

                                                     REGISTRATION NO. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
 
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                            ------------------------
 
                                    FORM S-1
                             REGISTRATION STATEMENT
                                     UNDER
                           THE SECURITIES ACT OF 1933

                            ------------------------
 
                            LEWIS GALOOB TOYS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                            ------------------------
 
<TABLE>
<S>                           <C>                           <C>
       DELAWARE                        5040                     94-1716574
(STATE OR OTHER JURISDICTION  (PRIMARY STANDARD INDUSTRIAL   (I.R.S. EMPLOYER
    OF INCORPORATION OR        CLASSIFICATION CODE NUMBER)  IDENTIFICATION NO.)
       ORGANIZATION)
</TABLE>
 
                            ------------------------
 
                              500 FORBES BOULEVARD
                     SOUTH SAN FRANCISCO, CALIFORNIA 94080
                                 (415) 952-1678
              (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
       INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

                            ------------------------
 
                            WILLIAM G. CATRON, ESQ.
                  EXECUTIVE VICE PRESIDENT AND GENERAL COUNSEL
                            LEWIS GALOOB TOYS, INC.
                              500 FORBES BOULEVARD
                     SOUTH SAN FRANCISCO, CALIFORNIA 94080
                                 (415) 952-1678
           (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
                   INCLUDING AREA CODE, OF AGENT FOR SERVICE)

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

                                   Copies to:
 
<TABLE>
<S>                                     <C>
        STEPHEN M. BESEN, ESQ.                 JEFFREY S. MARCUS, ESQ.
      WEIL, GOTSHAL & MANGES LLP               MORRISON & FOERSTER LLP
           767 FIFTH AVENUE                  1290 AVENUE OF THE AMERICAS
       NEW YORK, NEW YORK 10153                NEW YORK, NEW YORK 10104
            (212) 310-8000                          (212) 468-8000
</TABLE>
 
                            ------------------------
 
    APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
 
    If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: / /
 
    If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
 
    If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier registration statement for the same
offering. / /
 
    If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /

                            ------------------------
 
                        CALCULATION OF REGISTRATION FEE
 
<TABLE>
<CAPTION>
                                                                 PROPOSED
                                                             MAXIMUM OFFERING    PROPOSED MAXIMUM
          TITLE OF EACH CLASS                 AMOUNT TO         PRICE PER           AGGREGATE           AMOUNT OF
     OF SECURITIES TO BE REGISTERED         BE REGISTERED        SHARE(1)         OFFERING PRICE     REGISTRATION FEE
<S>                                        <C>               <C>                 <C>                 <C>
Common Stock, $.01 par value............    2,751,796(2)         $28.563           $78,599,550           $27,104
</TABLE>
 
(1) Estimated solely for purposes of calculating the registration fee. Pursuant
    to Rule 457(c), equals the average of the high and low sales prices of the
    Common Stock on the New York Stock Exchange on September 20, 1996.

(2) Includes 358,930 shares of Common Stock which the Underwriters have an
    option to purchase from the Company to cover over-allotments, if any.


                            ------------------------
 
    THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
================================================================================

<PAGE>

                            LEWIS GALOOB TOYS, INC.

                             CROSS-REFERENCE SHEET
                   PURSUANT TO ITEM 501(b) OF REGULATION S-K
 
<TABLE>
<CAPTION>
      FORM S-1 ITEM NUMBER AND HEADING     CAPTION OR LOCATION IN PROSPECTUS
     -----------------------------------  -----------------------------------
 
<S>  <C>                                  <C>
 1.  Forepart of the Registration
       Statement and Outside Front Cover
       Page of Prospectus...............  Facing Page of Registration
                                            Statement; Cross-Reference Sheet;
                                            Outside Front Cover Page of
                                            Prospectus
 
 2.  Inside Front and Outside Back Cover
       Pages of Prospectus..............  Inside Front Cover Page and Outside
                                            Back Cover Page of Prospectus
 
 3.  Summary Information, Risk Factors
       and Ratio of Earnings to Fixed
       Charges..........................  Prospectus Summary; Risk Factors;
                                            Not Applicable
 
 4.  Use of Proceeds....................  Prospectus Summary; Use of Proceeds
 
 5.  Determination of Offering Price....  Not Applicable
 
 6.  Dilution...........................  Not Applicable
 
 7.  Selling Security Holders...........  Outside Front Cover Page; Principal
                                            and Selling Stockholders
 
 8.  Plan of Distribution...............  Outside Front Cover Page;
                                            Underwriting
 
 9.  Description of Securities to be
       Registered.......................  Outside Front Cover Page;
                                            Prospectus Summary; Dividends;
                                            Price Range of Common Stock;
                                            Description of Capital Stock
 
10.  Interests of Named Experts and
       Counsel..........................  Legal Matters; Experts
 
11.  Information with Respect to the
       Registrant.......................  Outside Front Cover Page;
                                            Prospectus Summary; Risk Factors;
                                            Dividend Policy; Price Range of

                                            Common Stock; Capitalization;
                                            Selected Consolidated Financial
                                            Data; Management's Discussion and
                                            Analysis of Financial Condition
                                            and Results of Operations;
                                            Business; Management; Principal
                                            and Selling Stockholders; Certain
                                            Transactions; Description of
                                            Capital Stock; Index to Financial
                                            Statements
 
12.  Disclosure of Commission Position
       on Indemnification for Securities
       Act Liabilities..................  Not Applicable
</TABLE>


<PAGE>
 
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT.
A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION.  THESE SECURITIES MAY
NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME
THE REGISTRATION STATEMENT BECOMES EFFECTIVE.  THIS PROSPECTUS SHALL
NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY
NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH
SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION
OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.


               SUBJECT TO COMPLETION, DATED SEPTEMBER 27, 1996

PROSPECTUS
 
                                2,392,866 SHARES
 
                                    [LOGO]
 
                                  COMMON STOCK

                            ------------------------
 
     Of the 2,392,866 shares of Common Stock offered hereby, 2,000,000 shares
are being issued and sold by Lewis Galoob Toys, Inc. (the 'Company') and 392,866
shares are being sold by the Selling Stockholder. See 'Principal and Selling
Stockholders.' The Company will not receive any proceeds from the sale of shares
by the Selling Stockholder.
 
     The Common Stock is traded on the New York Stock Exchange, Inc. (the
'NYSE') under the symbol 'GAL.' On September 26, 1996, the closing price per
share of Common Stock, as reported by the NYSE, was $29 3/4.

                            ------------------------
 
    THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. SEE 'RISK
                         FACTORS' BEGINNING ON PAGE 7.

                            ------------------------
 
         THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
          SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
           COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION
              OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
                 ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
                      REPRESENTATION TO THE CONTRARY IS A
                               CRIMINAL OFFENSE.


<TABLE>
<CAPTION>
                                                                                              PROCEEDS TO

                                    PRICE TO          UNDERWRITING        PROCEEDS TO           SELLING
                                     PUBLIC           DISCOUNTS(1)         COMPANY(2)        STOCKHOLDER(2)
<S>                               <C>                 <C>                 <C>                 <C>
Per Share....................     $                   $                   $                   $
Total(3).....................     $                   $                   $                   $
</TABLE>
 
(1) In connection with this offering, the Company and the Selling Stockholder
    have agreed to indemnify the Underwriters against certain liabilities,
    including liabilities under the Securities Act of 1933, as amended. See
    'Underwriting.'
 
(2) Before deducting expenses of this offering payable by the Company estimated
    at $         . Does not include payment to the Company of an aggregate of
    $1,700,000 upon the exercise by the Selling Stockholder of warrants
    concurrently with this offering.
 
(3) The Company has granted to the Underwriters a 45-day option to purchase up
    to 358,930 additional shares of Common Stock solely to cover
    over-allotments, if any, on the same terms and conditions as set forth
    above. If such option is exercised in full, the total Price to Public,
    Underwriting Discounts, Proceeds to Company and Proceeds to Selling
    Stockholder will be $         , $         , $         and $         ,
    respectively. See 'Underwriting.'

                            ------------------------
 
     The shares of Common Stock are offered by the Underwriters, subject to
prior sale, when, as and if delivered to and accepted by the Underwriters, and
subject to the right of the Underwriters to reject any order in whole or in part
and certain other conditions. It is expected that delivery of certificates for
the shares of Common Stock will be made at the offices of Bear, Stearns
Securities Corp., 1 Metrotech Center No., Brooklyn, New York 11201, as agent for
the Representatives, on or about             , 1996.
 
GERARD KLAUER MATTISON & CO., LLC
 
                            WILLIAM BLAIR & COMPANY
 
                                                       JEFFERIES & COMPANY, INC.

                            ------------------------
 
               THE DATE OF THIS PROSPECTUS IS             , 1996


<PAGE>

                               [PICTURES OF TOYS]
 
     The Galoob logo and name are trademarks of the Company. Micro
Machines(Registered), Action Fleet(Trademark), Double Takes(Trademark) and
DOUBLE Double Takes(Trademark) are trademarks of the Company. Dragon
Flyz(Registered) and Sky Dancers(Registered) are trademarks licensed to the
Company by Abrams Gentile Entertainment Inc. Star Wars(Trademark) is a trademark
licensed to the Company by Lucasfilm Ltd. ('Lucasfilm'). Jonny Quest(Trademark)
is a trademark licensed to the Company by Turner Home Entertainment, Inc.
('Turner'). Pound Puppies(Registered) and Pound Pur-r-ries(Registered) are
trademarks licensed to the Company by Pound Puppies, Inc. Anastasia(Registered)
is a trademark licensed to the Company by Twentieth Century Fox Licensing and
Merchandising ('Fox'). Men in Black(Registered) and Starship
Troopers(Registered) are trademarks licensed to the Company by Sony Signatures
Licensing ('Sony'). All other trademarks appearing in this Prospectus are the
property of their respective holders.
 
     IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE NYSE OR OTHERWISE. SUCH STABILIZING, IF
COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
 
                                       2


<PAGE>

                               PROSPECTUS SUMMARY
 
     The following summary is qualified in its entirety by reference to, and
should be read in conjunction with, the more detailed information (including the
consolidated financial statements and the notes thereto) appearing elsewhere in
this Prospectus. Each prospective investor is urged to read this Prospectus in
its entirety and should carefully consider the matters set forth in 'Risk
Factors.' Except for the historical information contained herein, the discussion
in this Prospectus contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in the section entitled 'Risk
Factors' and elsewhere in this Prospectus. Unless otherwise indicated, all
information in this Prospectus assumes no exercise of the Underwriters'
over-allotment option. See 'Underwriting.'
 
                                  THE COMPANY
 
     Founded in 1957, the Company is a leading international toy company that
designs, develops, markets and sells a variety of high-quality toy products in
an expanding number of product categories. The Company believes it is a leading
innovator in the toy industry as evidenced by: its award-winning Sky Dancers,
the world's first flying doll, introduced in late 1994; its Double Takes line of
Micro Machines transforming playsets, introduced in 1995; its line of Star Wars
Action Fleet toys representing a new scale in the male action category; and
Dragon Flyz, the world's first fully articulated flying male action figure. The
Company's Micro Machines line, introduced in 1987, is the most comprehensive
line of miniature scale play for boys in the United States, embracing
traditional vehicle, military and male action play patterns. The Company's Sky
Dancers line has been the number-one selling mini-doll in the United States in
1995 and 1996, and Dragon Flyz became the second best selling male action line
in the United States within weeks of its national introduction in June.
 
     The Company's 1996 product offerings consist of six product lines: Micro
Machines, Star Wars Action Fleet, Dragon Flyz, Jonny Quest, Sky Dancers, and
Pound Puppies. In addition to extensions of these product lines, the Company's
1997 product offerings are expected to include new product lines based on three
entertainment properties: Men In Black, a new science fiction adventure comedy
film scheduled to be released by Sony in the summer of 1997; Starship Troopers,
a new science fiction adventure film scheduled to be released by Sony in the
summer of 1997; and Anastasia, a new animated film scheduled to be released by
Fox in the fall of 1997. In connection with the scheduled re-release of the Star
Wars movie trilogy in early 1997, the Company plans to introduce new Star Wars
Micro Machines and Action Fleet toys. In addition, the Company intends to
aggressively pursue licensing rights in connection with the release of the new
Star Wars movie trilogy scheduled to start in 1999.
 
     The Company's products are sold in more than 50 countries worldwide. These
products are principally sold direct to retailers in the United States and to
toy distributors outside of the United States. Since 1993, the Company's
revenues have grown approximately 64% from approximately $134 million in 1993 to
approximately $220 million in 1995. In 1995, approximately one-third of the

Company's revenues were derived from international sales which have increased by
approximately 77% since 1993.
 
     Although the Company's sales have increased significantly since 1993, its
market share in 1995 was only approximately one percent of the total $13.4
billion U.S. wholesale toy shipments and, therefore, management believes there
is substantial opportunity for continued growth. The recent consolidations among
both toy companies and toy retailers have also provided increased growth
opportunities for the Company. The Company believes that the consolidation of
the industry into fewer larger toy companies combined with the Company's proven
success in developing and marketing licensed products make the Company a
relatively more attractive licensee to toy inventors and other licensors. In
addition, as a result of industry concentration, the Company has become a
relatively more attractive supplier to retailers that do not wish to be
dependent on a few dominant toy companies. Toy retailer concentration has also
been advantageous to the Company as it has reduced the need to support a large,
expensive sales and distribution organization to service numerous small
customers. This also enables the Company to ship product, manage account
relationships and track retail sales as effectively as much larger competitors.
 
                                       3

<PAGE>

     These industry trends and developments, combined with the successful
implementation of the Company's growth strategy, lead the Company to believe
that it is well positioned for future growth. The key elements of the Company's
growth strategy are as follows:
 
o Build The Company's Core Brand--Micro Machines.  The Company seeks to continue
  expanding its Micro Machines brand as the most comprehensive universe of
  miniature scale play for boys. The Company intends to accomplish this by
  extending Micro Machines into additional play patterns, such as the Micro
  Machines Exploration line for 1997, and to continue acquiring and exploiting
  new entertainment licenses to keep Micro Machines at the leading edge of boys'
  play.
 
o Enter New Product Categories.  The Company has entered and intends to continue
  to enter into new toy categories. Entering 1993, the Company competed
  primarily in only one category of the toy industry (excluding video
  games)--miniature vehicles, which generated approximately $240 million of
  total U.S. wholesale toy shipments in that year. Currently, the Company
  competes in four categories that generated approximately $2.1 billion of the
  total U.S. wholesale toy shipments in 1995. The Company considers entering new
  categories which have the following characteristics: (i) low barriers to entry
  such that there is no dominant competitor; and (ii) potential to create
  product lines that can become multi-year brands based upon collectibility and
  thematic extendability.
 
o Expand Profit Margins On Rising Sales.  A key goal of the Company is to expand
  profit margins while continuing to increase sales, thereby increasing the rate
  of profit growth faster than the rate of sales growth. The Company seeks to
  increase profit margins by: (i) increasing gross margins; (ii) achieving
  economies of scale on increasing sales volume, thereby reducing operating

  expenses as a percentage of sales; and (iii) leveraging its investments in
  product development, tooling and marketing over the longer life spans of its
  multi-year brands.
 
o Develop Strategic Alliances With Major Content Providers.  Over the past three
  years, the Company has developed important relationships with four major
  entertainment companies, Lucasfilm, Fox, Sony and Turner, which have licensed
  to the Company the rights to make toys based on certain of their properties.
  The Company intends to continue to aggressively pursue opportunities to expand
  its relationships with these entertainment companies and to form additional
  alliances with other entertainment companies in order to assure access to a
  continuous flow of quality entertainment properties that have potential to
  generate successful toy product lines.
 
o Leverage International Distribution Networks.  The Company believes it has
  developed a strong network of distributors in its key markets outside the
  United States and through such network has the ability to increase its
  international sales. While Europe has traditionally accounted for the highest
  percentage of the Company's international sales, the Company continues to
  build its worldwide distribution network and sees the potential for growth in
  new markets such as Mexico and Latin America, the Pacific Rim and the Middle
  East.
 
     The Company, which commenced operations in 1957, was incorporated under the
laws of the State of California in 1968. The Company was reincorporated in the
State of Delaware in 1987. The Company's Board of Directors has approved a
resolution to change the Company's name to Galoob Toys, Inc. and intends to seek
stockholder approval of such change at the Company's 1996 annual stockholders'
meeting currently scheduled to be held on October 30, 1996. The Company's
principal executive offices are located at 500 Forbes Boulevard, South San
Francisco, California 94080 and its telephone number is (415) 952-1678.
 
                                       4

<PAGE>

                                  THE OFFERING
 
<TABLE>
<S>                                  <C>
Common Stock Offered by the
  Company..........................  2,000,000
 
Common Stock Offered by the Selling
  Stockholder......................  392,866 shares
 
Common Stock to be Outstanding
  after the Offering(1)............  17,540,017 shares
 
NYSE Symbol for the Common Stock...  GAL
 
Use of Proceeds to the Company.....  To prepay indebtedness under its
                                     short-term credit facilities, to
                                     repay the mortgage on the Company's

                                     headquarters and for working
                                     capital and general corporate
                                     purposes, which could include
                                     payments to acquire entertainment
                                     license rights or other license
                                     rights for future toy products and
                                     properties.
</TABLE>
 
- ------------------
(1) Excludes (i) 1,495,210 shares of Common Stock reserved for issuance upon
    exercise of stock options outstanding at August 30, 1996 and (ii) 75,000
    shares of Common Stock reserved for issuance upon exercise of warrants
    outstanding at August 30, 1996. See 'Capitalization,' 'Management' and
    'Description of Capital Stock.'
 
                                       5

<PAGE>

                        SUMMARY CONSOLIDATED FINANCIAL DATA
                       (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
     The information set forth below should be read in conjunction with
'Selected Consolidated Financial Data,' 'Management's Discussion and Analysis of
Financial Condition and Results of Operations' and the Company's consolidated
financial statements and related notes thereto included elsewhere in this
Prospectus.
 
<TABLE>
<CAPTION>
                                                                                 SIX MONTHS ENDED
                                               YEAR ENDED DECEMBER 31,               JUNE 30,
                                           --------------------------------    --------------------
                                             1993        1994        1995        1995        1996
                                           --------    --------    --------    --------    --------
<S>                                        <C>         <C>         <C>         <C>         <C>
STATEMENTS OF OPERATIONS DATA:
Net revenues............................   $134,334    $178,792    $220,044    $ 71,560    $ 86,723
Gross margin............................     59,187      83,636      99,210      25,107      38,943
Earnings (loss) from operations.........     (9,215)      9,322      12,989      (6,980)     (2,223)
Net proceeds from Nintendo award........         --      12,124          --          --          --
Interest expense........................     (1,836)     (2,609)     (3,429)     (1,387)     (1,596)
Earnings (loss) before income taxes.....    (10,915)     19,202       9,999      (8,258)     (3,728)
Net earnings (loss).....................    (10,924)     18,424       9,399      (8,258)     (3,728)
Preferred stock dividends...............      3,127       3,127       3,127       1,564          21
Charge related to exchange of preferred
  stock for common......................         --          --          --          --      24,279
Net earnings (loss) applicable to common
  shares................................   $(14,051)   $ 15,297    $  6,272    $ (9,822)   $(28,028)
                                           ========    ========    ========    ========    ========
Common shares and common shares
  equivalents outstanding-- average.....      9,548      10,111      10,451      10,064      12,774
Net earnings (loss) per common share(1):

  Primary...............................   $  (1.47)   $   1.51    $   0.60    $  (0.98)   $  (2.19)
                                           ========    ========    ========    ========    ========

  Fully diluted.........................   $  (1.47)   $   1.41    $   0.60    $  (0.98)   $  (2.19)
                                           ========    ========    ========    ========    ========

</TABLE>
 
<TABLE>
<CAPTION>
                             DECEMBER 31,               JUNE 30, 1996
                            ---------------     -----------------------------
                                 1995             ACTUAL       AS ADJUSTED(2)
                            ---------------     -----------    --------------
<S>                         <C>                 <C>            <C>
BALANCE SHEET DATA:
Working capital..........      $  54,670         $  47,611        $105,083
Total assets.............        120,084           124,694         143,204
Short-term debt..........         19,493            38,962              --
Long-term debt...........         14,000                --              --
Shareholders' equity.....         54,172            63,082         120,554
</TABLE>
 
- ------------------
(1) For a discussion of the impact on net earnings of certain unusual,
    non-recurring items, see 'Management's Discussion and Analysis of Financial
    Condition and Results of Operations.'
 
(2) Adjusted to reflect the sale of 2,000,000 shares of Common Stock offered by
    the Company in this offering based on an assumed offering price of $29 3/4
    per share, the last reported sale price of the Common Stock on September 26,
    1996 (after deducting the underwriting discounts and estimated offering
    expenses payable by the Company), the proceeds from the exercise of warrants
    by the Selling Stockholder and the anticipated application of the estimated
    net proceeds therefrom. See 'Use of Proceeds' and 'Capitalization.'
 
                                       6

<PAGE>

                                  RISK FACTORS
 
     Prospective investors should carefully consider the following risk factors,
in addition to the other information in this Prospectus, prior to making an
investment decision. Certain statements in this Prospectus that are not
historical are forward-looking, including known and unknown risks and
uncertainties. Many factors, including the risk factors identified below, could
cause the actual results, performance or achievements of the Company to be
materially different from any future results, performance or achievements that
may be expressed or implied by such forward-looking statements.
 
DEPENDENCE ON LIMITED NUMBER OF PRODUCT LINES
 
     The Company derives a substantial portion of its revenue from a limited

number of product lines. Although, in recent years, its product portfolio has
been significantly broadened and diversified, a decrease in popularity of a
particular product line or key products within a given product line during any
year could have a material adverse effect on the Company's business, financial
condition and results of operations. Sales of Micro Machines and all girls'
product lines (primarily consisting of sales of Sky Dancers), represented 63%
and 8% of the Company's revenue in 1994, and 44% and 40% of the Company's
revenue in 1995, respectively. Micro Machines is an established brand that has
been marketed continuously since 1987. The Company's success in girls' toys is
relatively recent dating back to the introduction of Sky Dancers in 1994.
Although at the present time demand remains strong for Micro Machines, Sky
Dancers and the Company's new product lines (Dragon Flyz and Pound Puppies),
there can be no assurance that any of these products will retain their current
popularity. See 'Business--Products' and 'Management's Discussion and Analysis
of Financial Condition and Results of Operations.'
 
CONSUMER PREFERENCES AND NEW PRODUCT INTRODUCTIONS
 
     Consumer preferences in the toy industry are continuously changing and are
difficult to predict. Relatively few products achieve market acceptance, and
even when they do achieve commercial success, products often have short life
cycles. There can be no assurance that (i) new products or product lines will be
introduced by the Company or, if introduced by the Company, will achieve any
significant degree of market acceptance, (ii) acceptance, if achieved, will be
sustained for any significant amount of time or (iii) such products' life cycles
will be sufficient to permit the Company to recover research, development,
licensing, manufacturing, marketing and other costs associated therewith.
Failure of new product lines or product innovations to achieve or sustain market
acceptance could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the success of many
of the Company's entertainment-related products is dependent on the popularity
generated by movies, television programs and other media events. There can be no
assurance that these movies, television programs or other media events will be
produced as scheduled, that they will be popular and successful or that such
entertainment media will result in substantial promotional value to the
Company's products. See 'Business--Advertising and Promotion.'
 
LICENSING AND RELATED RIGHTS
 
     The Company produces substantially all of its products under licenses from
other parties. Some of these licenses confer rights to exploit original concepts
developed by toy inventors and designers. Other licenses, referred to as
entertainment licenses, permit the Company to manufacture and market toys based
on characters or properties which develop their own popular identity through
exposure in various media such as movies, television programs, cartoons and
books. Most entertainment licenses extend for one to three years and are often
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. There can be no assurance that the Company's revenue from a
licensed product will exceed the minimum guaranteed payments required to be made
by the Company to licensors. The Company pays royalties to its licensors which
typically range from 2% to 16% of net sales. As of June 30, 1996, minimum future
guaranteed payments aggregated approximately $3,653,000. Royalties expense
totaled approximately $10,439,000, $16,326,000 and $13,498,000 for the
six months ended June 30, 1996 and in 1995 and 1994,

respectively. As a result of increased competition among toy companies for
licenses, in certain instances the Company has paid, and may in the future be
required to pay, higher royalties and higher advances and/or minimum guaranteed
payments in order to obtain attractive properties for the development of product
lines. Because the Company produces substantially all of its products under
licenses, the failure to enter into such licensing arrangements or to retain
 
                                       7

<PAGE>

license rights could have a material adverse effect on the Company's business,
financial condition and results of operations.
 
     The Company is an active participant in the market for entertainment
licenses. A determination to acquire an entertainment license must usually be
made before the commercial introduction of the property in which a licensed
character or property appears, and these license arrangements usually require
the payment of non-refundable advances or guaranteed minimum royalties.
Accordingly, the success of an entertainment licensing program is dependent upon
the ability of management to assess accurately the future success and popularity
of the properties that it is evaluating, to bid for products on a selective
basis in accordance with such evaluation, and to capitalize on the properties
for which it has obtained licenses in an expeditious manner. There can be no
assurance that the Company will be able to continue to enter into entertainment
licensing arrangements in the future for successful and popular properties on
terms that are acceptable to the Company.
 
     Since October 1992, the Company has had a license from Lucasfilm Ltd. to
produce Micro Machines products based on the popular Star Wars movie trilogy.
This license expires on December 31, 1997. Although the Company believes its
relationship with Lucasfilm is excellent, there can be no assurance that
Lucasfilm will choose to renew or extend the Company's Star Wars license for
1998 and beyond. If the Company is unable to renew or extend the Star Wars
license or if it is unable to renew or extend it for all of the current products
lines, the loss of all or part of such license could have a material adverse
effect on the Company's business, financial condition and results of operations.
See 'Business--Licensing Strategy.'
 
DEPENDENCE ON MAJOR CUSTOMERS
 
     Like other major toy companies, the Company is dependent upon toy retailers
and mass merchandisers to sell its products. The United States market accounted
for over 60% of the Company's revenues in each of the last three years. The
retail toy industry in the United States is highly concentrated, with the top
five retailers accounting for more than 50% of United States retail toy sales in
1995. For the year ended December 31, 1995, approximately 49% of the Company's
worldwide net revenues were from these five retailers, two of which were the
Company's largest customers accounting for approximately 31% of worldwide net
revenues. The Company does not have long-term written contracts with its retail
customers. An adverse change in, or termination of, the Company's relationship
with or the financial viability of one or more of its major customers could have
a material adverse effect on the Company's business, financial condition and
results of operations. Increased concentration could enhance the remaining toy

retailers' ability to negotiate more favorable terms and prices from the
Company. See 'Business--Sales, Marketing and Distribution.'
 
DEPENDENCE ON KEY PERSONNEL
 
     The Company's operations and prospects are dependent in large part on its
executive management group. Although the core of the current executive
management group has been very stable and in place since 1991, there can be no
assurance that the Company will be able to retain all of the members of its
executive management group. There is strong competition for skilled, competent
personnel in the toy industry. Although the Company has been successful in
retaining and hiring management personnel, no assurance can be made that the
Company can continue to do so in the future.
 
DEPENDENCE ON KEY MANUFACTURERS
 
     During the last four years, the Company has concentrated its sourcing of
products from a limited number of high-quality manufacturers in China. In 1995,
four companies manufactured approximately 88% of the Company's products and a
single manufacturer, Harbour Ring International Ltd. and its affiliates
('Harbour Ring'), produced approximately 60% of the Company's products. The
Company believes that its relationships with Harbour Ring and its other key
manufacturers are excellent. However, because the Company does not have control
over these unaffiliated manufacturers, there can be no assurance that Harbour
Ring and the Company's other key manufacturers will continue to dedicate
sufficient production capacity to satisfy the Company's production requirements
and specifications. Any interruption of the Company's manufacturing arrangements
with Harbour Ring or the Company's other key manufacturers could cause a delay
in production of the Company's products for delivery to its customers and could
have a material adverse effect on the Company's business, financial condition
and results of operations. While the Company believes that alternative
 
                                       8

<PAGE>

manufacturers exist in the event of a substantial interruption in manufacturing
arrangements with the existing key manufacturers, there can be no assurance that
alternative arrangements could be timely provided on terms acceptable to the
Company.
 
SEASONALITY; PAYMENT TERMS
 
     Toy industry sales are highly seasonal and driven by disproportionate
customer demand for toys to be sold during the Christmas holiday season.
Approximately two-thirds of the Company's shipments typically occur in the
second half of the year. As a result, the Company's operating results vary
significantly from quarter to quarter within any given year. Orders placed with
the Company for shipment are cancelable until the time of shipment. The
combination of seasonal demand and the potential for order cancellation makes
accurate forecasting of future sales difficult and causes the Company to believe
backlog may not be an accurate indicator of the Company's future sales.
Similarly, comparison between fiscal periods of successive years may not be
indicative of results of operations for any given full year. The seasonality

creates significant peaks in working capital requirements.
 
     Further, similar to other toy companies, many of the Company's sales occur
on terms that permit payment considerably more than 90 days after shipment of
merchandise, increasing the Company's need for working capital beyond that which
would be required if terms of payment were shorter. See 'Management's Discussion
and Analysis of Financial Condition and Results of Operations--Liquidity,
Financial Resources and Capital Expenditures.'
 
FOREIGN OPERATIONS
 
     All of the Company's products are manufactured to its specifications by
nonaffiliated parties located in China and, to a lesser extent, other foreign
locations. Therefore, the Company could be adversely affected by political or
economic unrest or disruptions affecting business in such countries. The Company
does not carry insurance for political or economic unrest or disruptions for
several reasons, including, but not limited to, costs of such insurance and the
limited insurance coverage available. The political unrest in 1989 in China had
an insignificant impact on the manufacturing and shipping of the Company's
products. There can be no assurance that in the future the Company will not be
adversely affected by political or economic disruptions in China or other
foreign locations.
 
     Further, changes in tariffs could have an adverse effect on the cost of
goods imported from China. While China is currently accorded Most Favored Nation
('MFN') status by the United States, this status is subject to annual review
(which was last renewed in June 1996) and could be revoked prospectively for any
given year. Current MFN tariffs on toys imported into the United States are
zero, and the loss of MFN status for China would result in a substantial
increase in tariffs applicable to toys imported from China. This increase in
duty would be large enough that it could have a material adverse effect on the
Company's business, financial condition and results of operations. Products
shipped from China to other countries would not be affected by China's loss of
MFN status with the United States without similar actions being taken by the
other importing countries. Moreover, many other toy companies also source
products from China and could be affected to similar degrees.
 
     The Company can also be subject to the imposition of retaliatory tariffs or
other import restrictions as a result of a trade dispute between China and the
United States. Generally, trade negotiations over matters in dispute between the
two countries have been difficult but have been resolved without the imposition
of trade retaliation. In the past, proposed retaliation by the United States has
not included increased tariffs or other trade restrictions applicable to toys
imported from China. It is possible, however, that some future trade dispute
could result in substantial increases in tariffs or other restrictions on
imports, such as quotas, of toys from China. These increased tariffs or other
restrictions could be imposed under Section 301 of the Trade Act of 1974, as
amended, whether or not the trade dispute itself involved toys. Such increased
tariffs or other trade restrictions could have a material adverse effect on the
Company's business, financial condition and results of operations.
 
     The impact on the Company of any political or economic unrest or
disruptions in China, the loss of China's MFN status or the imposition of
retaliatory trade restrictions on products manufactured in China would depend on

several factors, including, but not limited to, the Company's ability to (i)
procure alternative manufacturing sources satisfactory to the Company, (ii)
retrieve its tooling located in China, (iii) relocate its production in
sufficient time to meet demand, and (iv) pass cost increases likely to be
incurred as a result of such factors to the Company's customers through product
price increases. As a result, any political or economic unrest or
 
                                       9

<PAGE>

disruptions in China, the loss of China's MFN status or the imposition of
retaliatory trade restrictions on products manufactured in China could have a
material adverse effect on the Company's business, financial condition and
results of operations. See 'Business--Manufacturing.'
 
     In 1994, certain quotas on toy products made in China were introduced in
the European Economic Community. The quotas did not have a material impact on
the Company's business in 1995 and, although no assurance can be given, are not
expected to have a material impact on the Company's business in the foreseeable
future.
 
     In addition, the Company's subsidiary, Galco International Toys, N.V.
('Galco') is located in Hong Kong. On July 1, 1997, ownership of Hong Kong,
currently a dependency of the United Kingdom, will revert back to China. At the
present time, the Company is unable to predict the effect, if any, that such
change will have on the Company's or Galco's business, financial condition or
results of operations. In addition, changes in the relationship between the
United States dollar and the Hong Kong dollar may have an impact on the cost of
goods purchased from manufacturers.
 
COMPETITION
 
     The toy industry is highly competitive. The Company competes with several
larger domestic and foreign toy companies, such as Hasbro, Inc. ('Hasbro') and
Mattel, Inc. ('Mattel'), and many smaller companies in all aspects of its
business, including the design and development of new toys, the procurement of
licenses, the improvement and expansion of previously introduced products and
product lines and the marketing and distribution of its products, including
obtaining adequate shelf space. Some of these companies have longer operating
histories, broader product lines and greater financial resources and advertising
budgets than the Company. In addition, it is common in the toy industry for
companies to market products which are similar to products being successfully
marketed by competitors. See 'Business--Competition.'
 
INVENTORY MANAGEMENT; DISTRIBUTION
 
     Many of the Company's significant customers use, to some extent, inventory
management systems to track sales of particular products and rely on reorders
being rapidly filled by suppliers, rather than maintaining large on-hand
inventories to meet consumer demand. While these systems reduce a retailer's
investment in inventory, they increase pressure on suppliers like the Company to
fill orders promptly and shift a portion of the retailer's inventory risk onto
the supplier. Production of excess products by the Company to meet anticipated

demand could result in increased inventory carrying costs for the Company. In
addition, if the Company fails to anticipate the demand for products, it may be
unable to provide adequate supplies of popular toys to retailers in a timely
fashion, particularly during the Christmas season, and may consequently lose
potential sales.
 
     The Company utilizes warehouse facilities primarily in Union City,
California for storage of its products. Disruptions in shipments from Asia or
from the Union City facility could have a material adverse effect on the
business, financial condition and results of operations of the Company.
 
RAW MATERIALS PRICES
 
     The principal raw materials in most of the Company's products are
petrochemical resin derivatives, such as polyethylene and high impact
polystyrene, and paper. The prices for such raw 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 customers.
 
POTENTIAL PRODUCT LIABILITY
 
     The Company is engaged in a business which could result in possible claims
for injury or damage resulting from its products. However, the Company is not a
defendant in any product liability lawsuit. While the Company currently
maintains product liability insurance, there can be no assurance that it will be
able to maintain such insurance on acceptable terms or that any such insurance
will provide adequate protection against potential liabilities. A successful
claim brought against the Company resulting in a final judgment in excess of its
 
                                       10

<PAGE>

insurance coverage could have a material adverse effect on the Company's
business, financial condition and results of operations. See
'Business--Government Regulations.'
 
GOVERNMENT REGULATIONS
 
     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 Product Safety Commission (the 'CPSC') to protect consumers
from hazardous toys and other articles. The CPSC has the authority to exclude
from the market articles which are found to be unsafe or hazardous and can
require a manufacturer to recall such products under certain circumstances.
Similar laws exist in some states and cities in the United States and in Canada
and Europe. The Company's products are designed and tested to meet or exceed all
applicable regulatory and voluntary toy industry safety standards. The Company
emphasizes the safety and reliability of its products and has established a

strong quality assurance and control program to meet the Company's objective of
delivering high quality, safe products. While the Company believes that it is,
and will continue to be, in compliance in all material respects with applicable
laws, rules and regulations, there can be no assurance that the Company's
products will not be found to violate such laws, rules and regulations, or that
more restrictive laws, rules or regulations will not be adopted in the future
which could make compliance more difficult or expensive or otherwise adversely
affect the Company's business or prospects. Moreover, sales of the Company's
products have significantly increased over the past year and several of the
Company's products are new. The claims experience with respect to product
safety, therefore, is difficult to predict. For the foregoing reasons, there can
be no assurance that the Company will not be subject to material liabilities on
account of product liability claims in the future. See 'Business--Government
Regulations.'
 
INTELLECTUAL PROPERTY RIGHTS
 
     Most of the Company's products are copyrighted and sold under trademarks.
In addition, certain products incorporate patented devices or designs. The
Company or its licensors customarily seek protection of major patents,
trademarks and copyrights in the United States and certain other countries.
These intellectual property rights can be significant assets of the Company.
Although the Company believes its rights to these properties are adequately
protected, the loss of certain of its rights for particular product lines may
have a material adverse effect on the Company's business, financial condition
and results of operations. See 'Business--Intellectual Property Rights.'
 
ANTI-TAKEOVER PROVISIONS
 
     The Company's Certificate of Incorporation ('Certificate') and By-Laws
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
stockholders, and requiring the vote of holders of 80% of the voting power of
the Company in order to remove directors, amend the By-Laws and approve certain
business combinations with 'Related Persons.' In addition, the Company has a
shareholder rights plan which under certain circumstances, including the
acquisition of 20% or more of the Common Stock by a person, gives the holders of
rights the right to acquire shares of Common Stock with a value equal to two
times the exercise price of the rights. Such provisions may 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
stockholders might consider to be in their best interests, including offers or
attempted takeovers that might otherwise result in such stockholders receiving a
premium over the market price for the Common Stock. In addition, such provisions
are expected to discourage certain types of coercive takeover practices and
inadequate takeover bids and to encourage persons seeking to acquire control of
the Company first to negotiate with the Company before making a bid for the
Common Stock at a premium over the market price of the Common Stock. Such
provisions may also adversely affect the market price of, and the voting and
other rights of the holders of, Common Stock. See 'Description of Capital
Stock--Certain Provisions of the Company's Certificate of Incorporation and
By-Laws.' In addition, the Company intends to enter into agreements with certain

of its executive officers providing for, among other things, severance payments
if the officer's employment is terminated following a change of control. See
'Management--Severance Agreements with Management.' Each of the items described
above could have the effect of deterring transactions that would result in a
change of control.
 
                                       11

<PAGE>

                                USE OF PROCEEDS
 
     The Company intends to use the net proceeds of this offering (including the
proceeds from the exercise of the Warrants (as defined herein) to acquire
392,866 shares of Common Stock), estimated to be approximately $57 million
(based on an assumed offering price of $29 3/4 per share), for the reduction of
indebtedness aggregating approximately $43 million under its short-term credit
facility (as of August 30, 1996), to repay a mortgage on the Company's
headquarters aggregating approximately $4 million, and for working capital and
general corporate purposes, which could include payments to acquire
entertainment license rights or other license rights for future toy products and
properties.The Company may also use a portion of the net proceeds to acquire
other businesses or product lines which the Company believes will complement its
existing business, although the Company has no present intention, understanding
or agreement with respect to any such acquisitions. The credit facility matures
on March 31, 1997, and bears interest at an annual rate of 1% over the prime
rate as announced from time to time by CoreStates Bank N.A., which is currently
9.25%. The mortgage on the Company's headquarters matures on November 30, 1996,
and bears interest at an annual fixed rate of 10.3%. The Company will not
receive any proceeds from the sale of Common Stock by the Selling Stockholder
but will receive an aggregate of $1.7 million from the exercise of warrants to
purchase Common Stock (the 'Warrants') held by the Selling Stockholder.
 
                                DIVIDEND POLICY
 
     The Company has not declared or paid any cash dividends on the Common Stock
since its initial public offering in 1984. The Board of Directors of the Company
has no current plans to pay cash dividends on the Common Stock. The Company's
existing credit facility prevents the Company from paying cash dividends on the
Common Stock without consent of its lender. See 'Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity, Financial
Resources and Capital Expenditures.' In addition, future dividend policy will
depend on the Company's earnings, capital requirements, financial condition and
other factors considered relevant by the Board of Directors.
 
                                       12


<PAGE>

                          PRICE RANGE OF COMMON STOCK
 
     The Common Stock of the Company is listed on the NYSE under the symbol GAL.
The following table sets forth the high and low closing sale prices for the

Common Stock, as reported on the NYSE, Composite Tape. The reported last sale of
Common Stock on the NYSE on September 26, 1996, was $29 3/4.
 
<TABLE>
<CAPTION>
FISCAL
 YEAR                                                        HIGH    LOW
- ------                                                       ----    ---
<S>     <C>                                                  <C>     <C>
1994    First Quarter.....................................   $10 1/2 $ 6 1/8
        Second Quarter....................................     6 7/8   5 1/2
        Third Quarter.....................................     8 1/2   6 1/8
        Fourth Quarter....................................     7 3/8   4 3/4
 
1995    First Quarter.....................................   $ 7 3/4 $ 5 1/4
        Second Quarter....................................     8 3/8   6
        Third Quarter.....................................     9 1/2   6 1/2
        Fourth Quarter....................................    13 3/4   9 1/4
 
1996    First Quarter.....................................   $20 1/4 $10 1/2
        Second Quarter....................................    28 1/4  18 7/8
        Third Quarter (through September 26, 1996)........    30 1/2  22 3/8
</TABLE>
 
As of August 30, 1996, there were approximately 1,300 holders of record of the
Common Stock, excluding beneficial owners of shares registered in nominee or
street name.
 
                                       13

<PAGE>

                                 CAPITALIZATION
 
     The following table sets forth the actual capitalization of the Company at
June 30, 1996, and as adjusted to reflect (i) the sale by the Company of
2,000,000 shares of Common Stock offered hereby (at an assumed public offering
price of $29 3/4 per share) and the application of the estimated net proceeds
therefrom to repay certain indebtedness as described in 'Use of Proceeds' and
(ii) the exercise by the Selling Stockholder of Warrants to purchase an
aggregate of 392,866 shares of Common Stock concurrently with this offering.
 
<TABLE>
<CAPTION>
                                                          JUNE 30, 1996
                                                     -----------------------
                                                      ACTUAL     AS ADJUSTED
                                                     --------    -----------
                                                         (IN THOUSANDS)
<S>                                                  <C>         <C>
Short-term debt(1) (including current portion of
  long-term debt).................................   $ 38,962     $      --
                                                     --------    -----------
                                                     --------    -----------
Long-term debt....................................         --            --
Shareholders' equity:
  Common Stock, $.01 par value; 50,000,000 shares
     authorized; 15,119,651 and 17,512,517 shares
     issued and outstanding, actual and as
     adjusted(2)..................................        151           175
  Additional paid-in capital......................    105,774       163,222
  Retained earnings (deficit).....................    (42,396)      (42,396)
  Cumulative translation adjustment...............       (447)         (447)
                                                     --------    -----------
     Total shareholders' equity...................     63,082       120,554
                                                     --------    -----------
     Total capitalization.........................   $ 63,082     $ 120,554
                                                     --------    -----------
                                                     --------    -----------
</TABLE>
 
- ------------------
(1) The Company is party to a credit agreement which makes available to the
    Company a maximum credit line of $60,000,000 through March 31, 1997. For
    additional information on short-term debt, see 'Management's Discussion and
    Analysis of Financial Condition and Results of Operations--Liquidity,
    Financial Resources and Capital Expenditures.'
 
(2) Actual and as adjusted outstanding shares do not include (i) 1,360,250
    shares of Common Stock reserved for issuance upon exercise of outstanding
    stock options or (ii) 100,000 shares of Common Stock reserved for issuance
    upon exercise of outstanding warrants not being exercised in connection with
    this offering.
 

                                       14


<PAGE>

                      SELECTED CONSOLIDATED FINANCIAL DATA
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
     The selected consolidated financial data for each of the five years ended
December 31, 1995 are derived from the audited consolidated financial statements
of the Company. The selected consolidated financial data for the six months
ended June 30, 1995 and June 30, 1996 are derived from the unaudited financial
statements of the Company for such periods and, in the opinion of management,
includes all adjustments, consisting only of normal recurring adjustments,
necessary for a fair statement of the results for the unaudited interim periods.
Results for the six months ended June 30, 1996 are not necessarily indicative of
results for any other period or the entire year. The selected consolidated
financial data set forth below should be read in conjunction with the Company's
consolidated financial statements and related notes thereto included elsewhere
in the Prospectus and 'Management's Discussion and Analysis of Financial
Condition and Results of Operations.'
 
<TABLE>
<CAPTION>
                                                                                                              SIX MONTHS ENDED
                                                                 YEAR ENDED DECEMBER 31,                          JUNE 30,
                                                 --------------------------------------------------------    -------------------
                                                   1991        1992        1993        1994        1995       1995        1996
                                                 --------    --------    --------    --------    --------    -------    --------
<S>                                              <C>         <C>         <C>         <C>         <C>         <C>        <C>
STATEMENT OF OPERATIONS DATA:
Net revenues..................................   $150,636    $166,280    $134,334    $178,792    $220,044    $71,560    $ 86,723
Costs of products sold........................     86,455      90,823      75,147      95,156     120,834     46,453      47,780
                                                 --------    --------    --------    --------    --------    -------    --------
Gross margin..................................     64,181      75,457      59,187      83,636      99,210     25,107      38,943
                                                 --------    --------    --------    --------    --------    -------    --------
Operating expenses:
  Advertising and promotion...................     22,848      22,826      23,537      30,616      31,240      9,662      12,411
  Other selling and administrative............     24,663      25,224      22,031      22,913      30,768     12,332      13,253
  Royalties, research and development.........     19,648      26,124      18,788      20,785      24,213     10,093      15,502
  Variable stock option plan expense..........         --          --       4,046          --          --         --          --
                                                 --------    --------    --------    --------    --------    -------    --------
Total operating expenses......................     67,159      74,174      68,402      74,314      86,221     32,087      41,166
                                                 --------    --------    --------    --------    --------    -------    --------
Earnings (loss) from operations...............     (2,978)      1,283      (9,215)      9,322      12,989     (6,980)     (2,223)
Expenses related to resignation of former
  officer.....................................     (3,807)     (2,152)         --          --          --         --          --
Net proceeds from Nintendo award..............         --          --          --      12,124          --         --          --
Interest expense..............................     (1,775)     (1,550)     (1,836)     (2,609)     (3,429)    (1,387)     (1,596)
Other income, net.............................      1,020         210         136         365         439        109          91
                                                 --------    --------    --------    --------    --------    -------    --------
Earnings (loss) before income taxes...........     (7,540)     (2,209)    (10,915)     19,202       9,999     (8,258)     (3,728)
Provision for income taxes....................         --         238           9         778         600         --          --
                                                 --------    --------    --------    --------    --------    -------    --------

Net earnings (loss)...........................     (7,540)     (2,447)    (10,924)     18,424       9,399     (8,258)     (3,728)
Preferred stock dividends paid................      3,127         782          --          --          --         --           6
Preferred stock dividends in arrears..........         --       2,345       3,127       3,127       3,127      1,564          15
Charge related to the exchange of preferred
  stock for common............................         --          --          --          --          --         --      24,279
                                                 --------    --------    --------    --------    --------    -------    --------
Net earnings (loss) applicable to common
  shares......................................   $(10,667)   $ (5,574)   $(14,051)   $ 15,297    $  6,272    $(9,822)   $(28,028)
                                                 ========    ========    ========    ========    ========    =======    ========
Net earnings (loss) per common share:
  Primary.....................................   $  (1.14)   $  (0.59)   $  (1.47)   $   1.51    $   0.60    $ (0.98)   $  (2.19)
                                                 ========    ========    ========    ========    ========    =======    ========
  Fully diluted...............................   $  (1.14)   $  (0.59)   $  (1.47)   $   1.41    $   0.60    $ (0.98)   $  (2.19)
                                                 ========    ========    ========    ========    ========    =======    ========
Common shares and common share equivalents
  outstanding--average........................      9,325       9,400       9,548      10,111      10,451     10,064      12,774
</TABLE>
 
<TABLE>
<CAPTION>
                                                                       DECEMBER 31,                               JUNE 30,
                                                 --------------------------------------------------------    -------------------
                                                   1991        1992        1993        1994        1995       1995        1996
                                                 --------    --------    --------    --------    --------    -------    --------
<S>                                              <C>         <C>         <C>         <C>         <C>         <C>        <C>
BALANCE SHEET DATA:
Working capital...............................   $ 29,127    $ 27,070    $ 30,813    $ 53,219    $ 54,670    $43,137    $ 47,611
Total assets..................................     64,016      71,604      71,005     100,766     120,084     94,748     124,694
Long-term debt................................      5,244       4,944      18,608      18,414      14,000     18,309          --
Shareholders' equity..........................     35,092      32,246      22,162      44,768      54,172     36,572      63,082
</TABLE>
 
                                       15


<PAGE>

                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
     The following 'Management's Discussion and Analysis of Financial Condition
and Results of Operations' contains forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those discussed herein. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in the section
entitled 'Risk Factors' and elsewhere in this Prospectus.
 
OVERVIEW
 
     Founded in 1957, the Company is a leading international toy company that
designs, develops, markets and sells a variety of high-quality, innovative toy
products in an expanding number of product categories. The Company's toy
products currently fall into four categories: miniature vehicles and male action
figures for boys, and miniature dolls and plush toys for girls.

 
     From 1990 through 1993, the Company had a period of declining revenues and
suffered net losses. Commencing in 1991, the Company installed a new management
team, led by Mark Goldman, and began implementing a recovery plan designed to
reposition the Company, return the Company to profitability and enable it to
capitalize on its growth strategy. The recovery plan focused on three key goals:
(i) to restore and expand the Company's core business of the Micro Machines
product line, (ii) to focus on growth opportunities in new product areas such as
the male action figure category and girls' product lines and (iii) to reduce the
Company's cost structure and lower its break-even point. Due to the relatively
long lead time for new products and product lines in the toy industry, the
recovery plan was designed to turn the Company around over a three-year period
and return the Company to profitability in 1994.
 
     Since 1993, the Company's revenues have grown approximately 64% from
approximately $134 million in 1993 to approximately $220 million in 1995. This
trend has continued with revenues for the first six months of 1996, increasing
21% over the comparable period in 1995. In addition, in each of 1994 and 1995,
the Company had record sales and earnings during the important fourth quarter.
The Company believes that its operating performance over the past two years
demonstrates that its recovery plan has succeeded and that the Company is now
well positioned for future growth.
 
     The successful implementation of its recovery plan has enabled the Company
to restructure its balance sheet to improve its liquidity and cash flow. In
March 1995, the Company renegotiated its existing credit facility to extend the
maturity by two years, increase availability from $40 million to $60 million and
decrease the annual interest rate by one percent. In February 1996, the Company
gave notice of its intention to redeem its 8% Convertible Subordinated
Debentures due 2000 (the 'Debentures'). As a result, the $14 million aggregate
principal amount of outstanding Debentures was converted into an aggregate of
approximately 1.5 million shares of Common Stock. In addition, in March 1996, an
offer by the Company to exchange shares of its Common Stock for its outstanding
shares of Depositary Convertible Exchangeable Preferred Stock (the 'Depositary
Shares') resulted in 98% of the holders of Depositary Shares converting such
shares into an aggregate of approximately 3.3 million shares of Common Stock.
The remainder of such Depositary Shares were either redeemed or converted into
Common Stock in June 1996. As a result of the foregoing, the Company reduced its
outstanding indebtedness and the aggregate liquidation preference of preferred
stock outstanding by approximately $51 million, increased shareholders' equity
by approximately $12 million, reduced annual interest payments by $1.1 million
and eliminated annual preferred stock dividend obligations of $3.1 million.
 
     The Company's products are sold in over 50 countries worldwide. In general,
the Company sells its products directly to retailers in the United States and to
toy distributors outside the United States. Approximately one-third of the
Company's revenues are generated from sales of its products outside of the
United States. Although the Company sells approximately one-half of its unit
volume outside the United States, its sales revenue and gross margins are lower
on its international sales because international prices are lower as the
distributor is responsible for the cost of importing, promoting and reselling
the product and takes ownership and risk of loss on the product at the time of
delivery in Hong Kong or other Far East locations. Accordingly, because of the
different pricing between the products sold in the U.S. and internationally, the

mix of sales between U.S. and international customers will affect the revenues
and gross margins of the Company. While the Company has historically realized
lower gross margins on international sales of its toys, the operating expenses
associated with those international sales are typically less than the operating
expenses associated with domestic sales.
 
                                       16

<PAGE>

     Revenues are recognized as product is shipped. The Company provides
reserves for defective returns and other allowances at the time of shipment as a
percentage of sales, based upon historical experience. Many of the Company's
shipments of products to U.S. customers are made on terms that permit payment
considerably more than 90 days after shipment of merchandise. Products sold to
markets outside of the United States, however, are generally manufactured and
sold based upon orders accompanied by letters of credit that entitle the Company
to draw payment thereunder within 30 days of shipment.
 
     Transactions involving Galco, which were in Hong Kong dollars, have been
translated into U.S. dollars in accordance with Statement of Financial
Accounting Standards ('SFAS') No. 52, Foreign Currency Translation. All asset
and liability accounts of Galco have been translated using rates of exchange in
effect at the balance sheet date. Revenues and expenses are translated at the
weighted average of exchange rates in effect during the year. Gains or losses
from foreign currency translation adjustments are charged or credited directly
to a separate component of shareholders' equity.
 
     Costs incurred for tooling and package design are deferred and amortized
over the expected life of the products, which typically ranges from one to two
years.
 
  Results of Operations
 
     The following table sets forth certain operating data (as a percentage of
the Company's net revenues) for the years ended December 31, 1993, 1994 and 1995
and the six months ended June 30, 1995 and 1996:
 
<TABLE>
<CAPTION>
                                       YEAR ENDED             SIX MONTHS
                                      DECEMBER 31,          ENDED JUNE 30,
                                 -----------------------    --------------
                                 1993     1994     1995     1995     1996
                                 -----    -----    -----    -----    -----
<S>                              <C>      <C>      <C>      <C>      <C>
Net revenues..................   100.0%   100.0%   100.0%   100.0%   100.0%
Cost of products sold.........    56.0     53.2     54.9     64.9     55.1
                                 -----    -----    -----    -----    -----
Gross margin..................    44.0     46.8     45.1     35.1     44.9
Advertising and promotion
  expenses....................    17.5     17.1     14.2     13.6     14.3
Other selling and
  administrative expenses.....    16.4     12.8     14.0     17.2     15.3

Royalties, research and
  development expenses........    14.0     11.7     11.0     14.1     17.9
Variable stock option plan
  expenses....................     3.0       --       --       --       --
                                 -----    -----    -----    -----    -----
Earnings (loss) from
  operations..................    (6.9)     5.2      5.9     (9.8)    (2.6)
Net proceeds from Nintendo
  award.......................      --      6.8       --       --       --
Interest expense..............    (1.3)    (1.5)    (1.5)    (1.9)    (1.8)
Other income, net.............     0.1      0.2      0.2      0.2      0.1
Provision for income taxes....      --     (0.4)    (0.3)      --       --
                                 -----    -----    -----    -----    -----
Net earnings (loss)...........    (8.1)%   10.3%     4.3%   (11.5)%   (4.3)%
 =====  =====   =====    =====    =====
</TABLE>
 
     Net earnings (loss) have been affected by certain unusual, non-recurring
items. A comparison of the net earnings (loss) per common share and the net
earnings (loss) per common share adjusted to exclude unusual items is set forth
below.
 
<TABLE>
<CAPTION>
                                                                                   SIX MONTHS ENDED
                                            YEAR ENDED DECEMBER 31,                    JUNE 30,
                                           --------------------------    ------------------------------------
                                            1993      1994      1995           1995                1996
                                           ------    ------    ------    ----------------    ----------------
<S>                                        <C>       <C>       <C>       <C>                 <C>
Net earnings (loss) per common share on
  a primary basis, as reported..........   $(1.47)   $ 1.51    $ 0.60         $(0.98)             $(2.19)
Net earnings (loss) per common share on
  a primary basis, adjusted to exclude
  unusual items.........................   $(1.05)   $ 0.34    $ 0.60         $(0.98)             $(0.29)
</TABLE>
 
     The unusual items excluded are as follows: (i) variable stock option plan
expense of $4,046 in 1993, (ii) net proceeds from Nintendo award of $11,810
(after taxes) in 1994, and (iii) a one-time charge related to the exchange of
preferred stock for Common Stock of $24,279 in 1996.
 
                                       17

<PAGE>

  Six Months Ended June 30, 1996 and 1995
 
     Net revenues increased 21% to $86.7 million in the six months ended June
30, 1996 as compared to $71.6 million in the six months ended June 30, 1995. The
growth in net sales in the first six months of 1996 was attributable to domestic
sales which increased 54%, rising to $56.3 million. International sales
decreased 13% to $30.4 million, reflecting slower first quarter sales prior to
the second quarter recovery that led to record international second quarter

sales of $19.5 million.
 
     The Company's worldwide sales of boys' toys increased 38% in the first six
months of 1996 as compared to the first six months of 1995. The growth in net
sales of the boys' toys line of business for the six months ended June 30, 1996
was primarily attributable to the following: (i) worldwide sales of Micro
Machines, led by the recently introduced Star Wars Action Fleet, an extensive
line of Star Wars vehicles, playsets and miniature action figures, increased by
38% versus the comparable period from the previous year, and (ii) in March 1996,
the Company initiated sales of Dragon Flyz, a line of flying articulated action
figures plus vehicles and accessories. This increase was offset by the
anticipated decrease in sales of boys' toys based on Biker Mice from Mars.
 
     The Company's worldwide sales of girls' toys increased 17% for the six
months ended June 30, 1996 as compared to the six months ended June 30, 1995.
The increase was led principally by the Pound Puppies line.
 
     Gross margins were $38.9 million in the first six months of 1996, an
increase of $13.8 million from the first six months of 1995. This increase was
due to higher sales volume and an increase in the gross margin rate to 44.9% in
the first six months of 1996 from 35.1% in the first six months of 1995. The
increase in the gross margin rate was attributable to the following: (i)
economies of scale associated with the efficient utilization of tooling, (ii)
reduced product costs, (iii) a change in product mix, and (iv) a different mix
of sales between domestic and international markets. The Company's gross margin
rate on domestic sales is significantly greater than foreign sales because the
Company's prices on foreign sales are lower than on domestic sales as the
foreign customer is responsible for the cost of importing and promoting the
products. To improve the matching of costs and revenues, in January 1996, the
Company revised the timing of its amortization of tooling and packaging design
costs. These costs are now being amortized on a percentage of annual sales basis
rather than the previous straight-line basis. This change also contributed
approximately $1.5 million to gross margin for the six month ended June 30,
1996. This amount will reverse for the second half of the year.
 
     Advertising and promotion expenses were $12.4 million, or 14.3% of net
revenues, for the six months ended June 30, 1996, as compared to $9.7 million,
or 13.6% of net revenues, in the same period of 1995. The higher expenses were
primarily a result of a planned increase in domestic television advertising
expenses and the higher percentage relates to the different mix of domestic and
international sales.
 
     Other selling and administrative expenses were $13.3 million for the six
months ended June 30, 1996, as compared to $12.3 million in the six months ended
June 30, 1995. These expenses for the six months ended June 30, 1996 were
reduced by $2.3 million received in settlement of a claim for damages. This
benefit was partially offset by $2.0 million of unusual legal expenses incurred
during the six months ended June 30, 1996, related to this claim and a lawsuit
where the Company is the plaintiff. Additionally, the Company incurred higher
planned personnel costs during the six months ended June 30, 1996.
 
     Royalties, research and development expenses were $15.5 million for the six
months ended June 30, 1996, as compared to $10.1 million in the six months ended
June 30, 1995. The increase was due to higher royalty expenses associated with

increased sales volume and the write-off of royalty advances associated with
discontinued products as well as increased research and development expenses
associated with the expansion of the Company's lines of toys.
 
     Interest expense was $1.6 million for the six months ended June 30, 1996,
as compared to $1.4 million in the six months ended June 30, 1995. The increase
was due primarily to higher average borrowings outstanding during the six month
period partially offset by a lower average interest rate and the retirement of
the Debentures.
 
     No tax recovery was reported because of the cumulative net operating loss
brought forward into the year. At December 31, 1995, the Company had net
operating loss carryforwards of approximately $7.3 million and unused federal
tax credits of approximately $1.8 million available to reduce taxes in future
periods. At December 31, 1995 and June 30, 1996, the Company maintained a
valuation reserve on its net deferred tax asset. There is no assurance that the
deferred tax valuation allowance established in accordance with Statement of
Financial Accounting Standards Number 109, 'Accounting for Income Taxes', of
$5.2 million at December 31, 1995 will not continue to be required. The Company
will continue to periodically evaluate this reserve on a quarterly basis. For a
discussion of various factors which could impact the Company's future
profitability and its ability to recognize and utilize its net operating loss
carryforwards and federal tax credits, see 'Risk Factors.'
 
                                       18

<PAGE>

  Years Ended December 31, 1995 and 1994
 
     Net revenues in 1995 were $220.0 million which represented a 23% increase
from 1994 net revenues of $178.8 million. The strong sales growth for 1995 was
attributable to two principal factors: (i) record international sales of $80.7
million, an increase of 35% from 1994, and (ii) an increase in worldwide sales
of girls' toys by more than 500% to $88.0 million, which represented 40% of net
revenues as compared to only 8% of net revenues in 1994. The girls' toys line
increase was due to the introduction of the popular Sky Dancers flying dolls and
the My Pretty DollHouse line of miniature houses and accessories.
 
     The Company's boys' toys business declined 22% in 1995 as compared to 1994
as a result of the discontinuance of the Biker Mice from Mars line to domestic
retailers and a decline in consumer demand for the Z-Bots and Power Rangers
segments of Micro Machines. The Company had anticipated such discontinuance and
sales declines in these products. However, the Company's worldwide Micro
Machines sales in 1995, excluding Z-Bots and Power Rangers, grew by 15% over
1994. Micro Machines, through the fourth quarter of 1995, had twelve consecutive
quarters of U.S retail sales growth.
 
     Gross margin was $99.2 million in 1995, an increase of 18.6% or $15.6
million from 1994. The increase was due to higher sales volume offset slightly
by a lower gross margin rate. The gross margin rate decreased to 45.1% in 1995
from 46.8% in 1994 due mainly to three factors. First, tooling and packaging
design costs were a higher percent of revenues in 1995 as compared to 1994 in
support of the Company's expanded product line. Second, international sales as a

percentage of worldwide revenues were higher in 1995 compared to 1994. Third,
sharp price increases on plastics and packaging materials in the third and
fourth quarters of 1995 occurred too late in the year for the Company to pass
such increases on to its customers. The reduced gross margin rate was partially
offset by the elimination of duty on toys imported into the United States from
China.
 
     Advertising and promotion expenses were $31.2 million or 14.2% of net
revenues in 1995 as compared to $30.6 million or 17.1% of net revenues in 1994.
The decrease in advertising and promotion expenses as a percent of net revenues
was a result of higher marketing efficiencies domestically, coupled with the
effects of the higher sales growth rate internationally where the Company's
distributors absorb their own advertising costs. Other selling and
administrative expenses were $30.8 million in 1995 as compared to $23.0 million
in 1994. The increase in expenses was due mainly to higher planned personnel
costs as a result of the Company's growth and product line expansion, higher
freight costs, and higher legal expenses. Royalties, research and development
expenses increased to $24.2 million in 1995 as compared to $20.8 million in
1994. The increase in 1995 was due to higher royalty expenses associated with
increased sales volume as well as increased research and development expenses
due to expansion of the number of product lines. Although total operating
expenses increased by $11.9 million in 1995 as compared to 1994, operating
expenses as a percent of net revenues declined to 39.2% in 1995 from 41.6% in
1994.
 
     Earnings from operations were $13.0 million, an increase of 39% from 1994
earnings from operations of $9.3 million, reflecting the growth of net revenues
of 23% and lower operating expenses as a percent of net revenue.
 
     In 1994, the net proceeds of $12.1 million from the Nintendo award
represents the receipt of the Company's share of proceeds from its litigation
with Nintendo of America, Inc. The amount was reflected in 1994 results and had
no impact on 1995 results.
 
     Interest expense was $3.4 million in 1995 as compared to $2.6 million in
1994. The increase was due primarily to higher average borrowings needed to fund
working capital to support higher sales, offset by a slightly lower interest
rate in 1995 as compared to 1994 on the Company's revolving credit facility.
 
     Income tax expense for 1995 and 1994 includes provisions for federal, state
and foreign income taxes, after taking into account the available net operating
loss carryforwards from prior years. At December 31, 1995, the Company has
federal net operating loss carryforwards of approximately $7.3 million and
unused federal tax credits of approximately $1.8 million available to reduce
taxes in future periods.
 
                                       19

<PAGE>

  Years Ended December 31, 1994 and 1993
 
     Net revenues, including both toy sales and sales of the Game Genie video
game enhancer, were $178.8 million in 1994, which represented a 33% increase

from net revenues of $134.3 million in 1993. Worldwide toy sales increased 72%
in 1994 as compared to 1993 with domestic toy sales increasing 103% and
international toy sales increasing 33% during such period.
 
     In 1994, sales of Micro Machines products grew significantly for the second
consecutive year. Net sales in 1994 climbed to $113.0 million, a 59% increase
over 1993 levels. Much of the growth in the Micro Machines line was attributable
to licensed products such as Star Wars, Star Trek and Power Rangers. The
Company's Biker Mice From Mars action figures, introduced in late 1993,
generated 1994 sales of $41.4 million as compared to $4.3 million in 1993. In
addition, shipments of two new product lines late in 1994, Sky Dancers, a flying
doll, and My Pretty DollHouse, generated sales of $3.3 million and $3.0 million,
respectively. Game Genie sales were $4.2 million in 1994 as compared to $32.8
million in 1993. This decrease in Game Genie sales reflected the normal maturity
cycle for such products and such decline was expected.
 
     Gross margin totaled $83.6 million in 1994, an increase of $24.4 million or
41.3% from 1993. This increase was due to higher sales volume and a higher gross
margin rate. The gross margin rate improved to 46.8% in 1994 from 44.0% in 1993
due to three factors. First, the international gross margin rate was higher due
to a change in product mix. Second, the percent of U.S. sales to worldwide sales
was greater. Third, while tooling, packaging design and other costs in the
aggregate were higher in 1994 compared to 1993, they were lower as a percent of
sales in 1994 compared to 1993.
 
     Advertising and promotion expenses were $30.6 million or 17.1% of net
revenues in 1994 compared to $23.5 million or 17.5% of net revenues in 1993. The
higher expenses were primarily a result of an increase in planned domestic
television advertising expense in connection with the Company's expanded product
lines. Other selling and administrative expenses were $23.0 million in 1994
compared to $22.0 million in 1993. This increase was due mainly to incentive
compensation which was reinstated based on the Company's 1994 performance.
Royalties, research and development expenses were $20.8 million in 1994 as
compared to $18.8 million in 1993. This increase was due to higher royalty
expenses associated with increased sales volume.
 
     The $4.0 million expense in 1993 related to the variable stock option plan
was a one-time charge.
 
     Although total operating expenses (excluding the expenses related to the
variable stock option plan) increased by $10.0 million in 1994 as compared to
1993, operating expenses as a percent of net revenues declined from 47.9% in
1993 to 41.6% in 1994.
 
     Earnings from operations were $9.3 million in 1994 as compared to a loss of
$9.2 million in 1993, reflecting the growth of net revenues of 33%, the
increased gross profit rate and lower operating expenses as a percent of
revenues.
 
     In 1994, the net proceeds of $12.1 million from the Nintendo award
represents the receipt of the Company's share of proceeds from its litigation
with Nintendo. This amount was reflected in 1994 results and had no impact on
1993 results.
 

     Interest expense in 1994 was $2.6 million compared to $1.8 million in 1993.
$1.0 million of such increase was due to the Company's Debentures being
outstanding for the full year compared to being outstanding for less than two
months in 1993. Interest was reduced by lower average borrowings under the
Company's line of credit in 1994, although interest rates were higher.
 
     The income tax expense for 1994 includes provisions for federal, state and
foreign income taxes, after taking into account the available net operating loss
carryforwards from prior years. In 1993, the tax provision represented only
foreign income taxes as there was no taxable U.S. income. At December 31, 1994,
the Company had federal net operating loss carryforwards of approximately $11.5
million and unused federal tax credits of approximately $1.7 million available
to reduce taxes in future periods.
 
  Liquidity, Financial Resources and Capital Expenditures
 
     Demand for the Company's products is greatest in the third and fourth
quarters of the year. As a result collections of accounts typically peak in the
fourth quarter and early first quarter of the following year. Due to the
seasonality of its revenues and collections, the Company's working capital
requirements fluctuate significantly during the year. The Company's seasonal
financing requirements are usually highest during the fourth quarter of each
calendar year.
 
                                       20

<PAGE>

     On March 31, 1995, the Company entered into an amended and restated loan
and security agreement (the 'Credit Agreement') with Congress Financial
Corporation (Central) (the 'Lender'). The Credit Agreement extends through March
31, 1997 and provides a revolving line of credit of $40 million secured by
substantially all the assets of the Company, with provision to increase the line
to $60 million at the option of the Company. Borrowing availability is
determined by a formula based on qualified assets. The annual interest rate is
equal to the prime rate of CoreStates Bank N.A. as announced from time to time
plus 1%. At June 30, 1996, approximately $34.6 million was outstanding and $5.1
million was available to borrow under the Credit Agreement. The Company intends
to use the proceeds of this offering to repay amounts outstanding under the
Credit Agreement. However, the Company does not intend to reduce the
availability under the Credit Agreement and may, from time to time, reborrow
amounts available under the Credit Agreement for working capital and general
corporate purposes. See 'Use of Proceeds.' Upon the expiration of the Credit
Agreement, the Company intends to replace the Credit Agreement with a new credit
facility.
 
     During 1995, the Company used $7.1 million of cash in its operating
activities. This resulted primarily from a $10.5 million increase in accounts
receivable due to increased sales and to a $4.9 million increase in prepaid
expenses reflecting advances made to licensors of future products.
 
     During the six months ended June 30, 1996, the Company used $16.2 million
of cash in its operating activities. This usage resulted from the net loss,
increases in inventories, tooling and related costs and prepaid expenses and

other assets, and from decreases in accounts payable and accrued expenses. These
changes reflect the Company's normal seasonal pattern and the increase in sales
volume.
 
     Working capital was $47.6 million at June 30, 1996 compared to $43.1
million at June 30, 1995 and $54.7 million at December 31, 1995 compared to
$53.2 million at December 31, 1994. The ratio of current assets to current
liabilities was 1.8 to 1.0 at June 30, 1996 compared to 2.1 to 1.0 at June 30,
1995 and 2.1 to 1.0 at December 31, 1995 compared to 2.4 to 1.0 at December 31,
1994.
 
     Capital expenditures for 1995 were approximately $1.0 million. The Company
had no material commitments for capital expenditures at June 30, 1996. However,
the Company expects that total capital expenditures for 1996 will be
approximately twice the 1995 amount.
 
     The Company believes that its cash flow from operations, cash on hand and
borrowings under the Credit Agreement, together with the net proceeds to the
Company from this offering, will be sufficient to meet its working capital and
capital expenditure requirements and provide the Company with adequate liquidity
to meet its anticipated operating needs for the foreseeable future. However, the
financing of any significant future product or property acquisitions (including
up-front licensing payments), may require additional debt or equity financing.
 
  Recent Accounting Pronouncement
 
     The FASB issued a new standard, SFAS No. 123, 'Accounting for Stock-Based
Compensation,' which contains a fair value-based method for valuing stock-based
compensation that entities may use, which measures compensation cost at the
grant date based on the fair value of the award. Compensation is then recognized
over the service period, which is usually the vesting period. Alternatively, the
standard permits entities to continue accounting for employee stock options and
similar equity instruments under APB Opinion 25, 'Accounting for Stock Issued to
Employees.' Entities that continue to account for stock options using APB
Opinion 25 are required to make pro forma disclosures of net income and earnings
per share, as if the fair value-based method of accounting defined in SFAS No.
123 had been applied. The Company has determined to continue to account for
stock options using APB Opinion 25 and will make required pro forma disclosures
in the notes to its consolidated financial statements. The Company will be
required to adopt the new standard for the year ending December 31, 1996.
 
  Impact of Inflation
 
     The cost of the Company's operations is influenced to the extent of any
price increases in the cost of raw materials. In management's opinion, other
than the sharp increases in prices of plastics and packaging materials
experienced in the third and fourth quarters of 1995, general inflation did not
have a material impact on the Company's business in 1995. The Company did not
implement any substantial price increases in 1995 or 1994 on continuing product
lines.
 
                                       21

<PAGE>


                                    BUSINESS
 
     The following 'Business' section contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in the
section entitled 'Risk Factors' and elsewhere in this Prospectus.
 
GENERAL
 
     Founded in 1957, the Company is a leading international toy company that
designs, develops, markets and sells a variety of high-quality toy products in
an expanding number of product categories. The Company believes it is a leading
innovator in the toy industry as evidenced by: its award-winning Sky Dancers,
the world's first flying doll, introduced in late 1994; its Double Takes line of
Micro Machines transforming playsets, introduced in 1995; its line of Star Wars
Action Fleet toys representing a new scale in the male action category; and
Dragon Flyz, the world's first fully articulated flying male action figure. The
Company's Micro Machines line, introduced in 1987, is the most comprehensive
line of miniature scale play for boys in the United States, embracing
traditional vehicle, military and male action play patterns. The Company's Sky
Dancers line has been the number-one selling mini-doll in the United States in
1995 and 1996, and Dragon Flyz became the fourth best selling male action line
in the United States within weeks of its national introduction in June.
 
     The Company's 1996 product offerings consist of six product lines: Micro
Machines, Star Wars Action Fleet, Dragon Flyz, Jonny Quest, Sky Dancers, and
Pound Puppies. In addition to extensions of these product lines, the Company's
1997 product offerings are expected to include new product lines based on three
entertainment properties: Men In Black, a new science fiction adventure comedy
film scheduled to be released by Sony in the summer of 1997; Starship Troopers,
a new science fiction adventure film scheduled to be released by Sony in the
summer of 1997; and Anastasia, a new animated film scheduled to be released by
Fox in the fall of 1997. In connection with the scheduled re-release of the Star
Wars movie trilogy in early 1997, the Company plans to introduce new Star Wars
Micro Machines and Action Fleet toys. In addition, the Company intends to
aggressively pursue licensing rights in connection with the release of the new
Star Wars movie trilogy scheduled to start in 1999.
 
     The Company's products are sold in more than 50 countries worldwide. These
products are principally sold direct to retailers in the United States and to
toy distributors outside of the United States. Since 1993, the Company's
revenues have grown approximately 64% from approximately $134 million in 1993 to
approximately $220 million in 1995. In 1995, approximately one-third of the
Company's revenues were derived from international sales which have increased by
approximately 77% since 1993.
 
     Although the Company's sales have increased significantly since 1993, its
market share in 1995 was only approximately one percent of the total $13.4
billion U.S. wholesale toy shipments and, therefore, management believes there
is substantial opportunity for continued growth. The recent consolidations among
both toy companies and toy retailers have also provided increased growth
opportunities for the Company. The Company believes that the consolidation of

the industry into fewer larger toy companies combined with the Company's proven
success in developing and marketing licensed products make the Company a
relatively more attractive licensee to toy inventors and other licensors. In
addition, as a result of industry concentration, the Company has become a
relatively more attractive supplier to retailers that do not wish to be
dependent on a few dominant toy companies. Toy retailer concentration has also
been advantageous to the Company as it has reduced the need to support a large,
expensive sales and distribution organization to service numerous small
customers. This also enables the Company to ship product, manage account
relationships and track retail sales as effectively as much larger competitors.
 
INDUSTRY OVERVIEW
 
     According to the Toy Manufacturers of America, Inc. ('TMA'), an industry
trade group, total domestic shipments of toys, excluding video games and
accessories, were approximately $13.4 billion in 1995. According to the TMA, the
United States is the world's largest toy market, followed by Japan and Western
Europe. The Company estimates that the two largest U.S. toy companies, Mattel
and Hasbro, collectively hold a dominant share of the domestic non-video toy
market. In addition, hundreds of smaller companies compete in the design
 
                                       22

<PAGE>

and development of new toys, the procurement of licenses, the improvement and
expansion of previously introduced products and product lines and the marketing
and distribution of toy products.
 
     A substantial majority of the toys sold in the U.S. are manufactured,
either in whole or in part, overseas where labor rates are comparatively low.
The largest foreign producer markets are China and, to a lesser extent, other
countries in the Far East.
 
     Toy manufacturers sell their products either directly to retailers, or to
wholesalers who carry the product lines of many manufacturers. Retail toy sales
have become increasingly concentrated through a small number of large chains,
such as Toys 'R' Us, Inc. ('Toys 'R' Us'), Wal-Mart Stores, Inc. ('Wal-Mart'),
Kmart Corporation, Target Stores, Inc., a division of Dayton-Hudson Corp., and
Kaybee Toys, Inc., a division of Consolidated Stores Inc., which generally
feature a large selection of toys, some at discount prices, and seek to maintain
lean inventories to reduce their own inventory risk. According to the TMA, the
top five U.S. toy retailers collectively hold more than half of the retail
domestic market for toy sales, and their collective market share has grown in
recent years.
 
GROWTH STRATEGY
 
     The Company believes its recent success has left it well positioned for
future growth. The key elements of the Company's growth strategy are as follows:
 
o Build The Company's Core Brand--Micro Machines.  The Company seeks to continue
  expanding its Micro Machines brand as the most comprehensive universe of
  miniature scale play for boys. The Company intends to accomplish this by

  extending Micro Machines into additional play patterns, such as the Micro
  Machines Exploration line (Micro Machines that float in water) for 1997, and
  to continue acquiring and exploiting new entertainment licenses to keep Micro
  Machines at the leading edge of boys' play.
 
o Enter New Product Categories.  The Company has entered and intends to continue
  to enter into new toy categories. Entering 1993, the Company competed
  primarily in only one category of the toy industry (excluding video
  games)--miniature vehicles, which generated approximately $240 million of
  total U.S. wholesale toy shipments in that year. In 1995, the Company competed
  in four categories that generated approximately $2.1 billion of the total U.S.
  wholesale toy shipments. The Company considers entering new categories which
  have the following characteristics: (i) low barriers to entry such that there
  is no dominant competitor; and (ii) potential to create product lines that can
  become multi-year brands based upon collectibility and thematic extendability.
  The Company believes that developing product lines with multi-year lives helps
  sustain growth rates because each year's new product introductions add to a
  continuing base of multi-year products instead of merely replacing the sales
  volume lost as each of the previous year's product life cycles come to an end.
  In addition, management believes that there is significant potential for
  future product innovation, and intends to aggressively develop new products
  and product line extensions. As a result, the Company intends to continue to
  make significant investments in new products and product development.
 
o Expand Profit Margins On Rising Sales.  A key goal of the Company is to expand
  profit margins while continuing to increase sales, thereby increasing the rate
  of profit growth faster than the rate of sales growth. The Company seeks to
  increase profit margins by: (i) increasing gross margins; (ii) achieving
  economies of scale on increasing sales volume thereby reducing operating
  expenses as a percent of sales; and (iii) leveraging its investments in
  product development, tooling and marketing over the longer life spans of its
  multi-year brands. In addition, the Company plans to leverage its
  relationships with key manufacturers to increase efficiency and reduce costs.
  For example, the Company increasingly allows its key manufacturers to
  participate in the design and engineering process for its products allowing
  the Company to reduce the lead time to develop and deliver new products and
  enabling the Company's development personnel to concentrate more on developing
  new product concepts rather than design and engineering.
 
o Develop Strategic Alliances With Major Content Providers.  Over the past three
  years, the Company has developed important relationships with four major
  entertainment companies, Lucasfilm, Fox, Sony and Turner, which have licensed
  to the Company rights to make toys based on certain of their properties. The
  Company intends to continue to aggressively pursue opportunities to expand its
  relationships with these entertainment companies and to form additional
  alliances with other entertainment companies in order to assure access to a
  continuous flow 
 
                                       23

<PAGE>

  of quality entertainment properties that have potential to generate successful
  toy product lines. The Company's first major entertainment alliance was

  initiated in 1992 with Lucasfilm to give the Company the right to use the
  popular Star Wars trilogy in certain of its product lines. Subsequently, the
  Company has entered into important alliances with Fox, to obtain exclusive
  worldwide first rights to licensed toys based on all Fox theatrical and
  television properties (excluding the Fox Children's Network) to 2004
  (inclusive of renewal rights) and Turner with respect to the worldwide master
  toy license for The Real Adventures of Jonny Quest. In 1996, the Company
  entered into agreements with Sony with respect to licenses for two Sony
  properties, Starship Troopers, produced by TriStar Pictures and Walt Disney
  Motion Picture Group, and Men in Black, produced by Columbia Pictures and
  Amblin Entertainment. The Company's 1997 product offerings are expected to
  include products based on each of the entertainment properties referred to
  above. See '--Licensing Strategy.'
 
o Leverage International Distribution Networks.  Management believes that
  markets outside the United States, including Western Europe and Japan in
  particular, present significant continuing growth opportunities for the
  Company. The Company's products are sold in over 50 countries worldwide and
  the Company believes that it has one of the leading international presences
  among U.S. toy companies. Unlike many of its major U.S. competitors, the
  Company sells its products internationally through a network of leading
  distributors in their respective markets. The Company believes it has
  developed strong relationships with its key distributors outside of the United
  States and such distributors have a good reputation in, and knowledge of, the
  markets they serve. The Company believes that the success of its products in
  foreign markets continues to bolster distributor confidence in the
  marketability of the Company's products, resulting in a greater commitment by
  the distributors to the Company's products, and, in turn, greater sales for
  the Company. In addition, the Company believes that it has significantly
  reduced many of the risks associated with international sales by dealing with
  a variety of leading toy distributors in certain of its markets, requiring the
  Company's distributors to promote the Company's products in their markets and
  bear the costs of such promotion, requiring the Company's distributors to pay
  for the Company's products through letters of credit and requiring the
  distributors to bear the cost of transportation as well as the risk of damage
  or loss upon delivery to the distributors from the Far East. While Europe has
  traditionally accounted for the highest percentage of the Company's
  international sales, the Company continues to build its worldwide network and
  has seen growth in new markets such as Mexico and Latin America, the Pacific
  Rim and the Middle East. In addition, management believes that the
  international expansion of certain major U.S. toy retailers offers
  opportunities for the Company to leverage its existing relationships with such
  retailers.
 
     There can be no assurance that the Company will be able to implement all or
any part of its growth strategy or, if the Company is able to implement such
strategy, that it will be successful. For a discussion of important factors that
could affect the Company's ability to successfully implement its strategy in the
future, see 'Risk Factors.'
 
PRODUCTS
 
     The Company's 1996 product offerings consist of six product lines: Micro
Machines, Star Wars Action Fleet, Dragon Flyz, Jonny Quest, Sky Dancers, and

Pound Puppies. In addition to extensions of its current product lines, the
Company's 1997 product offerings are expected to include new product lines based
on three entertainment properties: Men In Black, a new science fiction adventure
comedy film scheduled to be released by Sony in the summer of 1997; Starship
Troopers, a new science fiction adventure film scheduled to be released by Sony
in the summer of 1997; and Anastasia, a new animated film that is scheduled to
be released by Fox in the fall of 1997. In connection with the re-release of the
Star Wars movie trilogy scheduled for February 1997, the Company is also
planning to introduce new Micro Machines and Action Fleet vehicles based on its
Star Wars license.
 
                                       24

<PAGE>

     The following chart sets forth the Company's product lines for 1996 and
proposed product lines for 1997:
 
<TABLE>
<CAPTION>
CATEGORIES                                                            PRODUCTS
                                           1996                                            1997
                      ----------------------------------------------  ----------------------------------------------
<S>                   <C>                                             <C>
BOYS
Micro Machines Scale  Basic (Collections, Playsets, Double Takes      Basic (Collections, 10th Year Collections,
                      Playsets)                                       Playsets, Double Takes Playsets, DOUBLE Double
                                                                      Takes)

                      Exploration (Sea Collection)                    Exploration (Sea Collection, Low Priced
                                                                      Playsets, DOUBLE Double Takes Playsets)

                      Military (Collections, Playsets, Double Takes   Military (Collections, Playsets, Double Takes
                      Playset)                                        Playsets, DOUBLE Double Takes Playsets)

                      Jonny Quest (Collections, Playsets)             Jonny Quest (Collections, Playsets)
                      Action (Collections, James Bond 007, Indiana    Action (Predator, Terminator 2, Star Trek)
                      Jones, Aliens and Predators)

                      Space (Star Trek, Babylon 5, Aliens and         Space (Vehicle Collections, Playset)
                      Predator)
                                                                      Racing Licenses (Indianapolis 500, U.S.A.
                                                                      500).

                      Star Wars (Collections, Droids, X-Ray Fleet,    Star Wars (Collections, Figure Collections,
                      Shadows of the Empire, Playsets, Transforming   Figure Heads with Figure, Epic Collections
                      Action Sets)                                    with Vehicles and Figures, X-Ray Fleet, 20th
                                                                      Anniversary Die Cast Vehicles, Adventure Gear;
                                                                      Transforming Action Sets, Double Takes
                                                                      Playset)

                                                                      Men in Black

                                                                      Starship Troopers

Action Fleet          Star Wars (Battle Packs Vehicle with Figures,   Star Wars (Battle Packs, Vehicle Collections,
                      Ice Planet Hoth Playset, The Death Star         Imperial/Rebel Flight Controller, Series X
                      Playset)                                        Prototype Vehicles, Hoth/Death Star/Yavin
                                                                      Playsets)

                                                                      Starship Troopers (Battle Packs, Vehicle/Bug
                                                                      Collections, Tethered RC Bug/Drop Ship)
                                                                      Aliens and Predators

Male Action Figures   Dragon Flyz (Assortment, Figure, Gremwing,      Dragon Flyz (F.I.S.T. Force Figures,
                      Dragon Launcher)                                Assortment, Sky Dragons Assortments, Gremwing,
                                                                      Battle Blazers, Deluxe Raptor, Doomfrye

                                                                      Deluxe)

                      Jonny Quest (Assortment, Figure with Vehicle,   Jonny Quest (Real World, Deluxe QuestWorld,
                      Rover and Porpoise Sub, Cybercopter)            Aerohawk, Wave Ranger, Ice Runner, Quest
                                                                      Rover/Quest Porpoise; Quest Cyber Gyrobug,
                                                                      Quest Race Car; QuestWorld Cybercopter, Shadow
                                                                      Slayer)

                                                                      Men in Black (Figures, Alien Figures, Edgar
                                                                      with Kay, Van Figure, LTD Electric Vehicle,
                                                                      Tethered RC, Playset)
                                                                      Starship Troopers

GIRLS
Mini Dolls            Sky Dancers                                     Sky Dancers
                      Fairy Flyers (Doll, Doll and Animal, Carousel)  Pretty Scent
                      Basic Sky Dancers (Doll, Bent Leg, Magic        Sky Dancers Animated Adventures
                      Swan/Pegasus Flying Princess, Assortment)       Flying Fairy Tales
                      Pretty Lights (Doll, Multiple Doll)             Sparkle Dome
                                                                      Anastasia

Plush Toys            Pound Puppies                                   Pound Puppies
                      Puppies or Pur-r-ries                           Pure Breds--Puppies or Kittens
                      Wrinkle Pup                                     Pound Bunnies
                      Mommy and Pups/Kitties                          Mom & Babies
                      Brush'n Style Puppy                             Feature Puppies (Wiggle'n Walk, Fashion,
                                                                      Brush'n Style, Feed'n Cuddle)
 
Fashion Dolls                                                         Anastasia
</TABLE>
 
                                       25

<PAGE>

BOYS' PRODUCTS
 
o  MICRO MACHINES
 
   Now in its ninth year, the Micro Machines line is the most comprehensive line
   of minature scale play for boys in the United States, embracing traditional
   vehicle, military and male action play patterns. The Company continues to
   grow and expand its segments of Micro Machines miniature vehicles (1/100
   scale), figures, playsets and accessories. Additions to the basic, space,
   military and licensed segments have created more than 40 playsets, 500
   vehicles and 130 collections for 1996. Enhanced by the introduction of
   innovative new segments, such as Double Takes, a transforming playset
   featuring two action play environments in one toy, and Exploration, Micro
   Machines that float in water, the 1996 line presents the most comprehensive
   universe of miniature play for children in the brand's history. Micro
   Machines also features products based on the popular Star Wars trilogy. Other
   Micro Machines licensed properties include Star Trek, Aliens, Indiana Jones
   and Predator.
 

o  ACTION FLEET
 
   In 1996, the Company introduced Action Fleet, an innovative scale segment of
   vehicles, figures and playsets that are larger than Micro Machines but less
   than one-half the size of traditional male action figures. Action Fleet
   features five-to-seven inch long vehicles and fully poseable one to one and
   one-half inch tall figures, which are compatible with separate Action Fleet
   playsets. Based on the successful expansion of the Micro Machines Star Wars
   brand, the initial introduction of the Action Fleet line consists of
   vehicles, figures and playsets from the Star Wars movie trilogy.
 
o  DRAGON FLYZ
 
   In 1996, the Company also introduced Dragon Flyz, the first poseable flying
   action figures for boys. Inspired by the Company's successful Sky Dancers
   flying dolls for girls, this line consists of articulated action figures that
   fly with the help of special dragon shaped launchers. Dragon Flyz will be
   supported domestically and internationally by an independently produced
   animated syndicated television show, which began airing in the U.S. in
   September 1996. Dragon Flyz became the second best selling male action line
   in the United States within weeks of its national introduction in June.
 
o  JONNY QUEST
 
   The Company's Jonny Quest product line, also introduced in 1996, results from
   the Company's worldwide master toy license with Turner for The Real
   Adventures of Jonny Quest property. The Real Adventures of Jonny Quest is
   based on the updated reintroduction of the classic 1960's animated television
   property from Hanna-Barbera cartoons and Turner. The Company's Jonny Quest
   product line features both real-world and futuristic, virtual-reality
   QuestWorld figures and vehicles in both the traditional male action scale and
   Micro Machines scale. The Real Adventures of Jonny Quest is being supported
   across all Turner Broadcasting divisions and airing a total of 21 times
   weekly in September 1996 on Turner Network Television, Turner Broadcasting
   System and The Cartoon Network.
 
o  MEN IN BLACK
 
   In the spring of 1997, the Company plans to introduce new product lines based
   on the characters in Columbia Pictures' and Amblin Entertainment's science
   fiction adventure comedy scheduled to be released in the summer of 1997 in
   both the traditional male action scale and Micro Machines scale.
 
o  STARSHIP TROOPERS
 
   In the spring of 1997, the Company plans to introduce new product lines based
   on the science fiction adventure Starship Troopers in the Micro Machines
   scale, Action Fleet scale and male action scale. Starship Troopers, which is
   being produced under an arrangement between TriStar Pictures and Walt Disney
   Motion Pictures Group, is expected to be released in the summer of 1997.
 
                                       26

<PAGE>


GIRLS' PRODUCTS
 
o  SKY DANCERS
 
   First introduced in late 1994, the award-winning Sky Dancers line is one of
   the most successful new girls' toy concepts in recent years and has been the
   number one selling mini-doll in the United States in 1995 and 1996. Featured
   on the cover of The New York Times Magazine, the innovative Sky Dancers line
   of dolls and playsets features the first known girls' doll that flies. These
   collectible ballerina dolls fly utilizing a special launcher with pull-cord
   action created in various themes. The playsets included Magic Rolling
   Launchers in the shape of a swan and pegasus. The Sky Dancers flying doll and
   accessory line has been extended to include new segments, including Pretty
   Lights with light-up flying dolls and launchers; smaller-size Fairy Flyers
   flying dolls, pets and Magical Flying Carousel playset; Fairy Tale Couples;
   and the Flying Princess doll with graceful fluttering wings. Sky Dancers are
   also featured in a new independently produced animated syndicated television
   show, which began airing in the U.S. in September 1996.
 
o  POUND PUPPIES
 
   In 1996, the Company also reintroduced a small-scale version of Pound Puppies
   and Pound Pur-r-ries, one of the most successful plush toy lines of the
   1980's. The Company has created a new miniature scale and added new themes to
   expand the line. The Company will also introduce Brush 'n Style, a puppy that
   has long furry ears that allow little girls to create a variety of
   'hair-styles' using the fancy hair accessories that are included with the
   puppy.
 
o  ANASTASIA
 
   In the fall of 1997, the Company plans to introduce a new line of miniature
   and fashion dolls based on the characters in Anastasia. Anastasia, which will
   be the first animated film from Fox's The Animation Studio, re-explores the
   classic legend of the lost princess Anastasia, the surviving daughter of
   Russia's last Czar and is scheduled for a fall 1997 release.
 
LICENSING STRATEGY
 
     The Company produces substantially all of its products under licenses from
other parties. Some of these licenses confer rights to exploit original concepts
or products developed by toy inventors and designers. Other licenses, referred
to as entertainment licenses, permit the Company to design, develop, manufacture
and market toys based on characters or properties which have their own popular
identity, often through exposure in various media such as television programs,
movies, cartoons and books. Normally most entertainment licenses extend for one
to three years and are typically 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. Licenses for original ideas
from toy inventors or designers typically extend for either a set number of
years or the commercial life of the product. The Company typically obtains the
domestic and international rights for the licensed products.
 

     The Company is an active participant in the market for entertainment
licenses. A determination to acquire an entertainment license must usually be
made before the commercial introduction of the property in which a licensed
character or property appears, and these license arrangements usually require
the payment of non-refundable advances or guaranteed minimum royalties.
Accordingly, the success of an entertainment licensing program is dependent upon
the ability of management to assess accurately the future success and popularity
of the properties that it is evaluating, to bid for products on a selective
basis in accordance with such evaluation, and to capitalize on the properties
for which it has obtained licenses in an expeditious manner.
 
     In October 1992, the Company first obtained a license from Lucasfilm to
produce three collections of vehicles based on the Star Wars trilogy. As a
result of the Company's continued success with the Star Wars products, Lucasfilm
has extended and expanded the Company's right to produce Star Wars toys
including the innovative Action Fleet line of vehicles, figures and playsets
introduced in 1996. In February 1997, Lucasfilm is scheduled to re-release its
classic Star Wars trilogy in theaters across the United States with enhanced
digital sound and previously unreleased footage. The Company expects that such
re-release may have a positive impact on the sales of its Star Wars products
although no assurance can be made that the re-release will occur as scheduled or
that it will impact the Company's sales of Star Wars products. The Company's
Star Wars license from Lucasfilm expires on December 31, 1997. Although the
Company believes its relationship with Lucasfilm is
 
                                       27

<PAGE>

excellent, there can be no assurance that Lucasfilm will choose to renew or
extend the Company's Star Wars license. In addition, Lucasfilm currently intends
to begin releasing a new Star Wars movie trilogy commencing in 1999. The Company
intends to aggressively pursue renewal of its current Star Wars license for 1998
as well as licenses in connection with the release of the new trilogy in 1999.
However, if the Company is unable to renew or extend the Star Wars license or if
it is unable to renew or extend it for all of the current products lines, the
loss of all or part of such license could have a material adverse effect on the
business, financial condition and results of operations of the Company. See
'Risk Factors--Licensing and Related Rights.'
 
     As part of its strategic licensing program, the Company has signed an
agreement with Fox that gives the Company the exclusive worldwide first rights
to license toys based on all new Fox theatrical and television properties
(excluding the Fox Children's Network) to the year 2004 (including renewal
rights granted to the Company). The agreement fulfills a key growth objective by
forming an alliance with a powerful content provider and assures access to a
continuous flow of quality entertainment properties from Twentieth-Century Fox
Film Corporation, Fox Animation Studios, Twentieth-Century Fox Television, Fox
Broadcasting Company, Fox Family Films, Fox 2000 Pictures, and Fox Searchlight
Pictures. Pursuant to this agreement, the Company has determined to produce toys
based on the full-length animated feature film Anastasia due to be released in
the fall of 1997.
 
     In addition to the Fox agreement, the Company has signed a worldwide master

toy license agreement with Turner for The Real Adventures of Jonny Quest and has
already begun to ship its Jonny Quest line of action figures and vehicles. The
Company has also been awarded the worldwide master toy license by Sony for
TriStar Pictures' science fiction adventure Starship Troopers(Trademark), which
is being produced under an arrangement between TriStar Pictures and the Walt
Disney Motion Pictures Group and is expected to be released in the summer of
1997. In addition, Sony has issued the Company the worldwide master toy license
for Columbia Pictures' and Amblin Entertainment's science fiction adventure
comedy Men in Black, which is also expected to be released in the summer of
1997. The Company's 1997 product lines are expected to feature products based on
the Starship Troopers and Men in Black motion pictures.
 
     The Company pays royalties to its licensors which typically range from 2%
to 16% of net sales. The Company also frequently guarantees payment of a minimum
royalty. As of June 30, 1996 minimum future guaranteed payments aggregated
approximately $3,653,000. Royalties expense totaled approximately $10,439,000,
$16,326,000 and $13,498,000 for the six months ended June 30, 1996 and in 1995
and 1994, respectively. As a result of increased competition among toy companies
for licenses, in certain instances the Company has paid, and may in the future
be required to pay, higher royalties and higher minimum guaranteed payments in
order to obtain attractive properties for the development of product lines. See
'Risk Factors-- Licensing and Related Rights.'
 
SALES, MARKETING AND DISTRIBUTION
 
  Domestic
 
     The Company markets and sells its products throughout the world, with sales
to customers in the United States aggregating 63%, 66% and 66% of consolidated
net sales in 1995, 1994 and 1993, respectively.
 
     The Company sells its products in the United States directly to specialty
toy retailers, discount and chain stores, catalog and mail order companies,
department stores, variety stores and independent distributors which purchase
the products directly from the Company and ship them to retail outlets. In 1995
and 1994, Toys 'R' Us accounted for approximately 20% and 21% of the Company's
consolidated net sales, respectively. Wal-Mart accounted for approximately 11%
of net sales in 1995.
 
     The Company has a sales staff of six people, supplemented by several
manufacturers' representative organizations in the United States that act as
independent contractors. The Company's sales staff and the manufacturers'
representatives offer the Company's products through the use of samples and
promotional materials at toy shows and by making regular customer sales calls.
The Company presents its products directly to key retail accounts. The Company
also directly introduces and markets to customers new products and extensions to
previously marketed product lines by participating in the major trade shows in
New York, Hong Kong and Europe and through the maintenance of a showroom in New
York City. Manufacturers' representatives utilized
 
                                       28

<PAGE>


by the Company receive commissions, which were approximately 0.8%, 1.0% and 1.3%
of net sales in 1995, 1994 and 1993, respectively.
 
     The Company utilizes warehouse facilities primarily in Union City,
California for storage of its products. Disruptions in shipments from Asia or
from the Union City facility could have a material adverse effect on the
business, financial condition and results of operations of the Company.
 
     The Company does not sell its products on consignment and ordinarily
accepts returns only for defective merchandise. Returns have historically not
been significant. In certain instances, where retailers are unable to resell the
quantity of products which they have purchased from the Company, the Company
may, in accordance with industry practice, assist retailers in selling such
excess inventory by offering credits and other price concessions.
 
     The Company plans to establish a new subsidiary to design, develop and sell
lines of toys that will not be advertised on television by the Company. These
products which are known as 'F.O.B.' within the industry will be sold on an
international and domestic basis, and will be primarily based on the Company's
advertised product lines, including its entertainment licensed products.
 
  International
 
     The Company has an extensive international sales program. The Company, in
conjunction with its wholly-owned subsidiary Galco International Toys, N.V.
('Galco'), located in Hong Kong, actively sells its products in over 50
countries and sells directly to approximately 60 separate, independent toy
distributors, each of which is domiciled in the respective country to which
sales are made. While the dollar volume of international sales accounted for
approximately one-third of total Company sales in 1995, approximately one-half
of all of the Company's toys sold were shipped to countries outside the United
States. This is due to the fact that international sale prices to distributors
are significantly lower than U.S. domestic sale prices to retail accounts since
international distributors are responsible for all importation, warehousing,
marketing, promotional and selling related costs.
 
     The Company believes that it has significantly reduced many of the risks
associated with international sales by dealing with leading toy distributors in
certain of its markets, requiring the Company's distributors to promote the
Company's products in their markets and bear the costs of such promotion,
requiring the Company's distributors to pay for the Company's products through
letters of credit and requiring the distributors to bear the cost of
transportation as well as the risk of damage or loss upon delivery to the
distributors in the Far East. The Company's risks are further reduced because
its distributors bear the cost and risk of carrying inventory in the Company's
products and the credit risk of collecting receivables from their retail
customers.
 
     Sales by the Company to foreign customers are ordinarily denominated in
U.S. dollars and, accordingly, the Company's revenues are not affected by
fluctuations in monetary exchange rates. However, the value of the U.S. dollar
in relation to the value of other currencies of the countries into which the
Company's products are sold may have a positive or negative impact on the
Company's sales volume over time, depending on the change in relationship of the

respective currencies because the Company's products compete with products for
which wholesale prices are denominated in the local currency.
 
ADVERTISING AND PROMOTION
 
     The Company's advertising and promotion expenses are significant. Although
a portion of the Company's advertising budget is expended for newspaper
advertising, magazine advertising, catalogs and other promotional materials, the
Company allocates the bulk of its advertising budget to television. As is common
practice in the toy industry, the Company advertises on national network,
syndicated, cable and local spot television. The Company often pre-tests
advertisements to evaluate their effectiveness on the target market. The bulk of
the Company's advertising and promotions occur in the early spring leading up to
Easter and the fall season leading up to Christmas. The Company's retail
customers also provide advertising for the Company's products and may, from time
to time, receive a credit allowance in connection with such advertising. With
respect to entertainment licenses, the Company believes it benefits from
advertising and promotion from the major studios with respect to their
entertainment properties and their promotion tie-ins.
 
                                       29

<PAGE>

RESEARCH AND DEVELOPMENT
 
     The Company employs its own designers and engineers and also utilizes the
services of independent designers and engineers on an ongoing basis. The Company
presents its designers with toy concepts licensed or, to a lesser extent,
originated by it, and the designers create renderings of the proposed product.
Designs are then presented to the Company's engineers, who, using the
renderings, perform mechanical drawings and engineering services and create
prototypes for new products. Prototypes for proposed products are continuously
reviewed by the Company's management, including representatives of marketing,
sales and manufacturing, prior to final acceptance. Character licensors usually
retain the right to approve the products being marketed by the Company.
 
     The Company spent approximately $7,886,000, $7,288,000 and $7,451,000 on
research and development activities in 1995, 1994 and 1993, respectively, and
$5,063,000 in the first six months of 1996, in each case exclusive of amounts
paid to certain inventors and designers who receive royalties as licensors. Such
amounts do not include approximately $12,388,000, $7,149,000 and $4,502,000
incurred in 1995, 1994, 1993, respectively, and $3,350,000 incurred in the first
six months of 1996 for tooling and package design.
 
MANUFACTURING
 
     The Company's products are manufactured to its specifications by
nonaffiliated third party manufacturers, usually located in the Far East. Over
80% of the Company's products were produced in China in 1995. See 'Risk
Factors--Foreign Operations.' These manufacturers are responsible for all
aspects of the production of the Company's products in accordance with Company
product specifications.
 

     The Company's manufacturing is currently performed by 21 manufacturers,
some of whom derive a substantial percentage of their business from the Company.
During the last four years, the Company has reduced the number of its
manufacturers and concentrated its sourcing of products from a limited number of
high quality manufacturers. In 1995, four companies manufactured approximately
88% of the Company's products and a single group, Harbour Ring, produced
approximately 60% of the Company's products. The Company believes that its
relationships with Harbour Ring and its other key manufacturers are excellent.
It is anticipated in 1996 that manufacturers' production will be similarly
concentrated as in 1995. See 'Risk Factors--Dependence on Key Manufacturers.'
 
     The Company, through its wholly-owned subsidiary Galco, maintains close
contact with the Company's manufacturers and subcontractors and monitors the
quality of the products produced. Galco's employees arrange with manufacturers
for the production, shipment and delivery of products, monitor the quality of
the products produced, and undertake certain elements of the design and
development of new products. Decisions related to the choice of manufacturer are
based on price, quality of merchandise, reliability and the ability of a
manufacturer to meet the Company's timing requirements for delivery. Generally,
tooling is owned by the Company but may be utilized by different manufacturers
if the need arises for alternate sources of production.
 
     The Company does not carry insurance for political or economic unrest or
disruption for several reasons, including, but not limited to, costs of such
insurance and the limited insurance coverage available. The impact on the
Company from such unrest or disruption would depend on several factors,
including, but not limited to, the nature, extent and location of such unrest or
disruption and the Company's ability to: (i) procure alternative manufacturing
sources outside of the country involved; (ii) retrieve its tooling; (iii)
relocate its production in sufficient time to meet demand; and (iv) pass cost
increases likely to be incurred as a result of such factors to the Company's
customers through product price increases. See 'Risk Factors--Foreign
Operations.'
 
     Transactions in which the Company purchases goods from manufacturers are
mostly denominated in Hong Kong dollars and, accordingly, fluctuations in Hong
Kong monetary exchange rates may have an impact on cost of goods. However, in
recent years, the value of the Hong Kong dollar has had a continuing stable
relationship to the value of the U.S. dollar and the Company has not experienced
any significant foreign currency fluctuations. Inflationary pressure in China
could have an effect on the cost of product sourced from China.
 
     The principal raw materials used in the production and sale of the
Company's products are plastics and paper products. The Company believes that an
adequate supply of raw materials used in the manufacture of its products are
readily available from existing and alternate sources. See 'Risk Factors--Raw
Material Prices.'
 
                                       30

<PAGE>

INTELLECTUAL PROPERTY RIGHTS
 

     Most of the Company's products are copyrighted and sold under trademarks
owned by or licensed to the Company. In addition, certain products incorporate
patented devices or designs. The Company or its licensors customarily seek
protection of major product patents, trademarks and copyrights in the United
States and certain other countries. These intellectual property rights can be
significant assets of the Company. Although the Company believes it is
adequately protected, the loss of certain of its rights for particular product
lines may have a material adverse effect on its business, financial condition
and results of operations.
 
COMPETITION
 
     The toy industry is highly competitive. The Company competes with several
larger domestic and foreign toy companies, such as Hasbro and Mattel, and many
smaller companies in all aspects of its business, including the design and
development of new toys, the procurement of licenses, the improvement and
expansion of previously introduced products and product lines, and the marketing
and distribution of its products including obtaining adequate shelf space. Some
of these companies have longer operating histories, broader product lines and
greater financial resources and advertising budgets than the Company. In
addition, it is common in the toy industry for companies to market products
which are similar to products being successfully marketed by competitors. The
Company believes that the strength of its management team, the quality of its
products, its relationships with inventors, designers and licensors, its
distribution channels and its overhead and operational controls allow the
Company to compete effectively in the marketplace. See 'Business Research and
Development' and 'Business--Sales, Marketing and Distribution.'
 
SEASONALITY AND BACKLOG
 
     Toy industry sales are highly seasonal and driven by disproportionate
customer demand for toys to be sold during the Christmas holiday season.
Approximately two-thirds of the Company's shipments typically occur in the
second half of the year. As a result, the Company's operating results vary
significantly from quarter to quarter within any given year. Orders placed with
the Company for shipment are cancelable until the time of shipment. The
combination of seasonal demand and the potential for order cancellation makes
accurate forecasting of future sales difficult and causes the Company to believe
backlog may not be an accurate indicator of the Company's future sales.
Similarly, comparison between fiscal periods of successive years may not be
indicative of results of operations for any given full year. The seasonality
creates significant peaks in working capital requirements. See 'Risk
Factors--Seasonality; Payment Terms.'
 
GOVERNMENT REGULATIONS
 
     The Company is subject to the provisions of, among other laws, the Federal
Hazardous Substances Act and the Federal Consumer Product Safety Act. These laws
empower the CPSC to protect consumers from hazardous toys and other articles.
The CPSC has the authority to exclude from the market articles which are found
to be unsafe or hazardous and can require a manufacturer to recall such products
under certain circumstances. Similar laws exist in some states and cities in the
United States and in Canada and Europe. The Company's products are designed and
tested to meet or exceed all applicable regulatory and voluntary toy industry

safety standards. The Company emphasizes the safety and reliability of its
products and has established a strong quality assurance and control program to
meet the Company's objective of delivering high-quality, safe products. The
Company believes that all of its products meet or exceed applicable safety
standards in the United States and other jurisdictions. See 'Risk
Factors--Government Regulations; --Potential Product Liability.'
 
PROPERTIES
 
     The Company's principal executive offices are located at 500 Forbes
Boulevard, South San Francisco, California, where the Company owns a building
with approximately 136,000 square feet. The Company occupies approximately
67,000 square feet of office space and leases the remaining approximately 69,000
square feet of warehouse space to third parties. The Company also has 125,000
square feet of warehouse space at Union City, California, under a lease which
expires in 1997, with rights to renew for an additional five-year term. The
Company is considering various alternatives to renewing the Union City,
California lease and believes that adequate facilities will be available to the
Company. The Company has a showroom, consisting of approximately 17,200 square
feet, which is located at 1107 Broadway, New York, New York, under a lease that
expires in 2006,
 
                                       31

<PAGE>

and office and warehouse space in Hong Kong consisting of approximately 30,000
square feet under leases which expire at varying dates through 1998. The
Company's properties will be expanded as necessary to support future growth
levels in the Company's business.
 
EMPLOYEES
 
     As of August 30, 1996, the Company had 236 employees; 137 in the United
States and 99 in the Far East. Nine of the Company's warehouse employees, some
of whom are employed only on a seasonal basis, are subject to a collective
bargaining agreement which expires May 31, 1998. The Company believes that its
labor relations are satisfactory.
 
LEGAL PROCEEDINGS
 
  Licensing Litigation
 
     In June 1995, the Company filed a declaratory judgment action in United
States District Court for the Northern District of California. The suit names
Clemens V. Hedeen, Jr., Patti Jo Hedeen, and various affiliated entities, as
defendants, and seeks a determination that the Company is not obligated to pay
royalties to the defendants under their license agreement on certain specific
products sold under the Company's 'Micro Machines' name and trademark.
Defendants filed a cross-complaint for breach of this license agreement claiming
damages for past royalties allegedly due but not paid under the license
agreement, and claiming entitlement to additional royalties on future sales of
such products. Defendants also are asking the court to order that the Company
cease the manufacture and sale of certain portions of the Micro Machines product

line, and convey to the defendants certain rights to the Micro Machines product
line, including patent and trademark rights. Defendants also claim the license
agreement to be terminated for the non-payment of the royalties at issue. The
defendants filed a motion for summary judgment, which was denied by the court in
late 1995. The Company's complaint is presently being amended to address
additional issues between the parties. Although there can be no assurance of the
outcome of this matter, the Company believes that it has meritorious factual and
legal claims in connection with this matter.
 
     In October 1995, the Company filed a breach of contract action in the
United States District Court for the Northern District of California. The suit
names Abrams Gentile Entertainment Inc. and Up, Up and Away as defendants, and
alleges damages for the licensing, marketing and sale of products that are in
violation of the Company's rights as licensee under its Sky Dancers and Dragon
Flyz license agreements with Abrams Gentile Entertainment, Inc. The defendants
have filed a number of counterclaims, including breach of contract, interference
with contractual relationships, misappropriation of copyright, unfair
competition and trade libel. The Company's attempt to obtain a partial temporary
restraining order was denied by the court in December 1995 on the basis that
equitable relief was not appropriate and that the Company could be adequately
compensated through legal damages. The Company is pursuing its damage claim, and
a trial date is yet to be established. Although there can be no assurance of the
outcome of this matter, the Company believes that it has meritorious factual and
legal claims in connection with this matter.
 
  Manufacturer Litigation
 
     In January 1991, the Company, through its wholly owned subsidiary, Galco,
filed a lawsuit in Hong Kong against Kader Industrial Co., Ltd. ('Kader'),
alleging damages suffered by both Galco and the Company as a result of Kader's
defective manufacturing of two lead doll items for the Company's Bouncin' Babies
toy line in 1990. Kader filed counterclaims alleging breach of 17 individual
contracts. In August 1996, the trial court rendered a decision in favor of Kader
on the general issue of liability in this matter, including an award based on
Kader's counterclaims which is estimated to be approximately $250,000, plus
prejudgment interest. In addition, the court awarded certain litigation costs to
Kader, the amount of which will be determined in future proceedings and could
substantially exceed the amount of the damages awarded. The Company is presently
considering whether it will seek an appeal in this matter.
 
     Although there can be no assurance of the outcome of these matters, in the
opinion of management of the Company, none of the three above matters of
litigation is likely to have a material adverse effect on the business,
financial condition and results of operations of the Company.
 
                                       32

<PAGE>

                                   MANAGEMENT
 
EXECUTIVE OFFICERS AND DIRECTORS
 
     The executive officers and members of the Board of Directors of the Company

(the 'Board') and their respective positions are as follows:
 
<TABLE>
<CAPTION>
NAME                             AGE   POSITION
- ------------------------------   ---   -----------------------------------
<S>                              <C>   <C>
Mark D. Goldman...............   45    President, Chief Executive Officer
                                       and Director
William G. Catron.............   50    Executive Vice President, General
                                       Counsel, Chief Administrative
                                       Officer and Secretary
Loren Hildebrand..............   57    Executive Vice President, Sales
Ronald Hirschfeld.............   46    Executive Vice President,
                                       International Sales and Marketing
Roger Kowalsky................   62    Executive Vice President, Chief
                                       Financial Officer and Director
Gary J. Niles.................   56    Executive Vice President, Marketing
                                       and Product Acquisition
Louis R. Novak................   48    Executive Vice President and Chief
                                       Operating Officer
John C. Beuttell..............   49    Senior Vice President,
                                       Marketing--Male Action
Jay B. Foreman................   34    Senior Vice President, F.O.B.
                                       Business
H. Alan Gaudie................   55    Senior Vice President, Finance and
                                       Assistant Secretary
Ronnie Soong..................   50    Managing Director of Galco
Terrell (Mark) Taylor.........   55    Senior Vice President, Product
                                       Design
Andrew J. Cavanaugh...........   49    Director
Paul A. Gliebe, Jr............   62    Director
Scott R. Heldfond.............   50    Director
S. Lee Kling..................   67    Director
</TABLE>
 
     Mark D. Goldman, a Director of the Company, has served as President and
Chief Executive Officer of the Company since June 1991. From 1987 to 1991, Mr.
Goldman served as Executive Vice President and Chief Operating Officer. Prior to
1987, Mr. Goldman served in various executive capacities at Ages Entertainment
Software, Inc. (formerly Sega Enterprises, Inc.) and Mattel, Inc.
 
     William G. Catron has served as Executive Vice President, General Counsel
and Chief Administrative Officer since May 1992 and as Corporate Secretary of
the Company since June 1995. From 1985 to 1992, Mr. Catron was Senior Vice
President, Assistant General Counsel for Paramount Pictures Corporation. Prior
to 1985, Mr. Catron served in various executive capacities at Ages Entertainment
Software, Inc. (formerly Sega Enterprises, Inc.) and Mattel, Inc.
 
     Loren Hildebrand has served as Executive Vice President, Sales of the
Company since April 1994. From 1992 to 1994, Mr. Hildebrand was President of
Creative Consultants and from 1991 to 1992 he was Executive Vice President of
Bandai U.S. Inc., a toy manufacturer. From 1989 to 1992, Mr. Hildebrand was
Executive Vice President and a partner in Toy Soldiers, Inc., a start-up

company. Prior to 1989, Mr. Hildebrand was a consultant for Worlds of Wonder and
Executive Vice President, Sales, Merchandising and Distribution for Mattel, Inc.
 
     Ronald Hirschfeld has served as Executive Vice President, International
Sales and Marketing of the Company since February 1994. From 1989 to 1994, Mr.
Hirschfeld served as Senior Vice President, International Sales and Marketing.
Prior to 1989, Mr. Hirschfeld served as Senior Vice President, International
Operations from 1987 to 1989 and has held various positions with the Company
since 1978.
 
                                       33

<PAGE>

     Roger Kowalsky has served as Executive Vice President and Chief Financial
Officer of the Company since June 1996 and a Director of the Company since June
1994. From 1989 to 1996, Mr. Kowalsky served as Director of the Vermont Studio
Center, an organization dedicated to visual artists and writers. From 1983 to
1986, Mr. Kowalsky served as Senior Vice President, Finance & Administration for
Yale Materials Handling Corporation. Prior to such time, from 1969 to 1982, Mr.
Kowalsky worked at Pullman Inc., rising to Executive Vice President, Finance &
Administration and President of Pullman Trailmobile, a subsidiary of Pullman
Inc.
 
     Gary J. Niles has served as Executive Vice President, Marketing and Product
Acquisition of the Company since February 1992. From 1989 to 1992, Mr. Niles
served as Senior Vice President, Toys-Boys Division. Before joining the Company,
Mr. Niles was an executive with U.A.C., Ltd., a division of Universal Matchbox,
Revell Incorporated and Ages Entertainment Software, Inc. (formerly Sega
Enterprises, Inc.).
 
     Louis R. Novak has served as Executive Vice President and Chief Operating
Officer of the Company since February 1992. From 1989 to 1992, Mr. Novak served
as Senior Vice President, Operations. From 1986 to 1989 he was Senior Vice
President, Worldwide Product Operations for Coleco Industries, Inc. Prior to
1986, Mr. Novak was an executive with All American Gourmet Company, Inc., a
manufacturer of frozen food products, and for Mattel, Inc.
 
     John C. Beuttell has served as Senior Vice President, Marketing-Male Action
of the Company since February 1996. From 1993 to 1996, Mr. Beuttell served as
the Executive Vice President, International Marketing at YES! Entertainment.
From 1991 to 1993, Mr. Beuttell was a principal at JB Marketing Consulting. From
1988 to 1991, Mr. Beuttell served as Vice President of Sales and Marketing for a
toy company called TSR, Inc.
 
     Jay B. Foreman has been Senior Vice President, F.O.B. Business of the
Company since May 1996. From 1992 to 1996, Mr. Foreman served as Executive Vice
President-U.S. Operations of Play By Play Toys & Novelties, Inc. From 1990 until
1992, Mr. Foreman served as Co-General Manager of the Toys and Novelties
Division of Pizza Management, Inc.
 
     H. Alan Gaudie has served as Senior Vice President, Finance of the Company
since April 1992 and Assistant Secretary since June 1995. From 1985 to 1992, Mr.
Gaudie served as Corporate Controller, Vice President, Senior Vice President and

acting Chief Financial Officer.
 
     Ronnie Soong has served as Managing Director of Galco since May 1995. From
1993 to 1995, Mr. Soong served as General Manager of Galco. From 1989 to 1993,
Mr. Soong was General Manager of Zindart Industrial Co., Ltd. Prior to 1989, Mr.
Soong was the General Manager of Buddy L (HK) Ltd. from 1989 to 1993 and an
executive with the Ertl Company in Taiwan from 1987 to 1989.
 
     Terrell (Mark) Taylor has served as Senior Vice President, Product Design
of the Company since November 1995. From 1988 to 1995, Mr. Taylor served as
Senior Vice President, Product Design for Mattel, Inc. From 1987 to 1988, Mr.
Taylor served as Vice President with Entertech/LJN Toys. Prior to 1987, Mr.
Taylor served in various executive capacities at Playmates Toys, Tomy Toys, and
Mattel, Inc. In addition, Mr. Taylor was a principal partner with Taylor/Salari
Design.
 
     Andrew J. Cavanaugh, a Director of the Company, since 1993, serves as a
Senior Vice President Corporate Human Resources of Estee Lauder Inc. Mr.
Cavanaugh has been affiliated with Estee Lauder in an executive capacity since
1988. Prior to undertaking his current position, Mr. Cavanaugh served as a
Senior Consultant with Coopers & Lybrand, New York City, from 1986 through 1988,
and Senior Vice President Administration of Paramount Pictures Corporation from
1984 through 1986.
 
     Paul A. Gliebe, Jr., a Director of the Company since 1986, has been a Vice
President of Smith Barney Inc. since 1974. Smith Barney Inc. has provided
investment-related services to the Company in the past and during the current
fiscal year.
 
     Scott R. Heldfond, a Director of the Corporation since 1986, has served as
Managing Director of Hales Capital Advisors, LLC, an insurance industry merchant
bank firm, since January 1995. Mr. Heldfond also serves as a consultant to Aon
Risk Services (successor entity to Rollins Hudig Hall and DSI Insurance
Services), an insurance broker. From 1992 to 1994 he was president and CEO of
Rollins Real Estate/Investment and prior thereto was president and CEO of DSI
Insurance Services. The Company has retained Aon in the past and during the
current fiscal year.
 
                                       34

<PAGE>

     S. Lee Kling, a Director of the Company since 1991, has served since 1991
as Chairman of the Board of Kling Rechter & Company, a merchant banking company
which operates in partnership with Barclays Bank PLC. Mr. Kling served as
Chairman of the Board of Landmark Bancshares Corporation, a bank holding company
in St. Louis, Missouri ('Landmark'), until December 1991 when Landmark merged
with Magna Group, Inc. Mr. Kling had served in such capacity with Landmark since
1974 and had also served as Chief Executive Officer of Landmark from 1974
through October 1990 except for the period from May 1978 to January 1979 when he
served as Assistant Special Counselor on Inflation for the White House and
Deputy for Ambassador Robert S. Strauss. Mr. Kling serves on the Boards of
Directors of Magna Group, Inc., Falcon Products, Co., Bernard Chaus Inc.,
E-Systems, Inc., Top Air Manufacturing, Inc., National Beverage Corp. and

Hanover Direct, Inc.
 
COMMITTEES OF THE BOARD OF DIRECTORS
 
     The Board has an Executive Committee, an Audit Committee and a Compensation
Committee.
 
     The Executive Committee is comprised of Andrew J. Cavanaugh, Mark Goldman
and S. Lee Kling. The Executive Committee has the authority to act in place of
the Board on all matters which would otherwise come before the Board except for
such matters which are required by law or by the Company's Certificate of
Incorporation or By-Laws to be acted upon exclusively by the Board. In addition,
the Executive Committee has the responsibility to nominate persons for election
as directors of the Corporation.
 
     The Audit Committee is comprised of S. Lee Kling, Scott R. Heldfond, and
Paul A. Gliebe, Jr. The Audit Committee is responsible for reviewing the
Company's financial statements, recommending the appointment of the Company's
independent auditors and reviewing the overall scope of the audit.
 
     The Compensation Committee is comprised of Andrew J. Cavanaugh, Scott R.
Heldfond and S. Lee Kling. The Compensation Committee is responsible for
reviewing the compensation arrangements relating to senior officers of the
Company and administering and making recommendations to the Board regarding the
bonus and incentive compensation plans for the senior officers of the Company.
The Compensation Committee also administers the Company's Amended and Restated
1984 Employee Stock Option Plan, the 1994 Senior Management Stock Option Plan
and the 1995 Non-Employee Directors' Stock Option Plan.
 
                                       35

<PAGE>

EXECUTIVE COMPENSATION
 
     The following table summarizes the compensation paid by the Company and its
subsidiaries, as well as certain other compensation paid or accrued, to the
Chief Executive Officer of the Company and the other five most highly
compensated executive officers of the Company who earned in excess of $100,000
for the Company's fiscal years ended December 31, 1993, 1994 and 1995 (each
person appearing in the table is referred to as a 'Named Executive'):
 
                           SUMMARY COMPENSATION TABLE
 
<TABLE>
<CAPTION>
                                                  ANNUAL COMPENSATION                             LONG-TERM
                                     ---------------------------------------------              COMPENSATION
                                                                        OTHER           -----------------------------
                                             SALARY      BONUS         ANNUAL                            ALL OTHER
NAME AND PRINCIPAL POSITION          YEAR      ($)        ($)      COMPENSATION($)      OPTIONS(#)    COMPENSATION($)
- ----------------------------------   ----    -------    -------    ---------------      ----------    ---------------
<S>                                  <C>     <C>        <C>        <C>                  <C>           <C>
Mark D. Goldman                      1995    400,000    750,000         0                 200,000          3,980(2)

  President and Chief                1994    400,000    600,000         0                 229,630(1)       3,760(2)
  Executive Officer                  1993    319,500          0         0                  29,630          3,540(2)

Gary J. Niles                        1995    300,000    360,000         0                       0          1,440(4)
  Executive Vice President,          1994    261,055    316,800         0                 157,870(3)       1,440(4)
  Marketing and Product              1993    212,623          0         0                  20,370          1,440(4)
  Acquisition

Louis R. Novak                       1995    272,803    334,567         0                       0            870(6)
  Executive Vice President and       1994    261,055    316,800         0                 157,870(5)         870(6)
  Chief Operating Officer            1993    256,797          0         0                  20,370            510(6)

Loren Hildebrand                     1995    230,063    282,150         0                       0          2,250(8)
  Executive Vice President,          1994    159,375    275,000(7)      0                 100,000            840(8)
  Sales

William G. Catron                    1995    236,729    217,745         0                       0            870(12)
  Executive Vice President,          1994    226,535    206,640         0                  86,111(11)        870(12)
  General Counsel, Chief             1993    214,813     25,000(9)      27,429(10)         11,111            870(12)
  Administrative Officer and
  Secretary

Ronald Hirschfeld                    1995    235,073    216,222         0                       0          1,440(13)
  Executive Vice President,          1994    223,634    203,425         0                  86,111(11)        510(13)
  International Sales and            1993    198,021          0         0                  11,111            510(13)
  Marketing
</TABLE>
 
- ------------------
 (1) Represents 229,630 options granted pursuant to the 1994 Senior Management
     Stock Option Plan (the '1994 Plan'). Does not include 129,311 shares of
     Common Stock granted in connection with the termination of the 1992 Senior
     Management Stock Option Plan (the '1992 Plan').
 
 (2) This amount represents $3,980 in premiums paid by the Company with respect
     to term life insurance in 1995, $3,760 in premiums paid by the Company with
     respect to term life insurance in 1994 and $3,540 in premiums paid by the
     Company with respect to term life insurance in 1993.
 
 (3) Represents 157,870 options granted pursuant to the 1994 Plan. Does not
     include 88,900 shares of Common Stock granted in connection with the
     termination of the 1992 Plan.
 
 (4) This amount represents $1,440 in premiums paid by the Company with respect
     to term life insurance in each of 1993, 1994 and 1995.
 
 (5) Represents 157,870 options granted pursuant to the 1994 Plan. Does not
     include 88,900 shares of Common Stock granted in connection with the
     termination of the 1992 Plan.
 
                                              (Footnotes continued on next page)
 
                                       36


<PAGE>

(Footnotes continued from previous page)

 (6) This amount represents $870 in premiums paid by the Company with respect to
     term life insurance in each of 1994 and 1995 and $510 in premiums paid by
     the Company with respect to term life insurance in 1993.
 
 (7) This amount includes a $50,000 bonus paid to the Named Executive in
     connection with the Named Executive's hiring.
 
 (8) This amount represents $2,250 in premiums paid by the Company with respect
     to term life insurance in 1995 and $840 in premiums paid by the Company
     with respect to term life insurance in 1994.
 
 (9) This amount represents a bonus paid to the Named Executive in connection
     with the Named Executive's hiring.
 
(10) This amount includes an automobile allowance (which is provided to all
     senior officers of the Company) paid by the Company in 1993 in the amount
     of $14,400 and fees paid by the Company to the Company's accountants in the
     amount of $7,700 in 1993 in connection with the Named Executive's hiring.
 
(11) Represents 86,111 options granted pursuant to the 1994 Senior Management
     Stock Option Plan. Does not include 48,491 shares of Common Stock granted
     in connection with the termination of the 1992 Plan.
 
(12) This amount represents $870 in premiums paid by the Company with respect to
     term life insurance in each of 1993, 1994 and 1995.
 
(13) This amount represents $1,440 in premiums paid by the Company with respect
     to term life insurance in 1995 and $510 paid by the Company with respect to
     term life insurance premiums paid in 1994 and 1993.
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
     The members of the Compensation Committee are set forth under
'Management--Committees of the Board of Directors' and their relationship with
the Company is set forth under 'Management--Executive Officers and Directors.'
None of the members of the Compensation Committee has served as a member of the
compensation committee of another entity so as to create any compensation
committee interlock. No members of the Compensation Committee are employed by
the Company.
 
OPTION GRANTS IN LAST FISCAL YEAR
 
     The following table sets forth certain information regarding options
granted to the Named Executives during the Company's 1995 fiscal year:
 
<TABLE>
<CAPTION>
                                                   INDIVIDUAL GRANTS                   
                                -------------------------------------------------------    POTENTIAL REALIZABLE VALUE
                                SHARES OF                                                               AT

                                  COMMON        % OF TOTAL                                   ASSUMED ANNUAL RATES OF
                                  STOCK       OPTIONS GRANTED                              STOCK PRICE APPRECIATION FOR
                                UNDERLYING    TO EMPLOYEES IN    EXERCISE                         OPTION TERM(1)
                                 OPTIONS        FISCAL YEAR       PRICE      EXPIRATION    ----------------------------
NAME                            GRANTED(#)     (OF 320,000)       ($/SH)        DATE       5%($)(3)           10%($)(4)
- -----------------------------   ----------    ---------------    --------    ----------    --------           ---------
<S>                             <C>           <C>                <C>         <C>           <C>                <C>
Mark D. Goldman..............     200,000(2)        62.5%          6.125       4/18/05      770,396           1,952,335
Gary J. Niles................           0            N/A             N/A        N/A          N/A                 N/A
Louis R. Novak...............           0            N/A             N/A        N/A          N/A                 N/A
Loren Hildebrand.............           0            N/A             N/A        N/A          N/A                 N/A
William G. Catron............           0            N/A             N/A        N/A          N/A                 N/A
Ronald Hirschfeld............           0            N/A             N/A        N/A          N/A                 N/A
</TABLE>
 
- ------------------
(1) Potential realizable value is based on the assumed annual growth rates for
    each of the grants shown over their option term. The dollar amounts in these
    columns are for illustrative purposes only as required by the rules of the
    Securities and Exchange Commission and, therefore, are not intended to
    forecast future financial performance or possible future appreciation, if
    any, in the price of the shares of Common Stock. Prospective investors are
    cautioned against drawing any conclusions from the appreciation data shown,
    aside from the
 
                                              (Footnotes continued on next page)
 
                                       37

<PAGE>

(Footnotes continued from previous page)

    fact that optionees will realize value from their option grants only if the
    price of the shares of Common Stock appreciates, which would benefit all
    stockholders commensurately.
 
(2) Options granted under the Amended and Restated 1984 Employee Stock Option
    Plan.
 
(3) The projected stock price would be $9.98 per share.
 
(4) The projected stock price would be $15.89 per share.
 
     Without the prior consent of the Company, the Named Executives may not sell
or otherwise transfer the shares of Common Stock acquired upon the exercise of
any option listed in the above table for seven months following the date that a
participant exercises such option. If at any time during the first six months of
such seven-month period, the optionee ceases to be an employee of the Company,
the Company will have the right to repurchase, at the exercise price therefor,
the shares of Common Stock which the optionee had acquired upon such option
exercise. Unexercised options will automatically terminate on the date that an
optionee ceases to serve as an employee of the Company unless such termination
of the optionee's employment with the Company results from his or her

retirement, death or disability.
 
     The Company does not currently grant stock appreciation rights.
 
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
 
     The following table sets forth information with respect to the options
exercised by the Named Executives during the 1995 fiscal year and the
unexercised options held by the Named Executives as of the end of the Company's
1995 fiscal year.
 
<TABLE>
<CAPTION>
                                                                     NUMBER OF SECURITIES
                                                                    UNDERLYING UNEXERCISED           VALUE OF UNEXERCISED
                                     SHARES                       OPTIONS AT FISCAL YEAR END         IN-THE-MONEY OPTIONS
                                   ACQUIRED ON                               (#)                   AT FISCAL YEAR-END($)(1)
                                    EXERCISE         VALUE       ----------------------------    ----------------------------
NAME                                   (#)        REALIZED($)    EXERCISABLE    UNEXERCISABLE    EXERCISABLE    UNEXERCISABLE
- --------------------------------   -----------    -----------    -----------    -------------    -----------    -------------
<S>                                <C>            <C>            <C>            <C>              <C>            <C>
Mark D. Goldman.................           0              0        244,754         209,876         823,074        1,152,159
Gary J. Niles...................       2,500          7,500        156,080           6,790         442,320           18,673
Louis R. Novak..................           0              0        151,080           6,790         415,470           18,673
Loren Hildebrand................           0              0         50,000          50,000         300,000          300,000
William G. Catron...............           0              0         82,408           3,703         226,622           10,183
Ronald Hirschfeld...............      13,125         44,844         82,408           3,703         226,622           10,183
</TABLE>
 
- ------------------
(1) The closing sales price of the Common Stock on the New York Stock Exchange
    on December 31, 1995 was $11.75 per share.
 
CERTAIN EMPLOYEE PLANS
 
     On July 29, 1996, subject to stockholder approval, the Compensation
Committee adopted and the Board ratified the 1996 Share Incentive Plan (the
'Incentive Plan'). The Incentive Plan is intended to provide incentives which
will attract, motivate and retain highly competent persons as key employees of
the Company and its subsidiaries, by providing them opportunities to acquire
shares of stock or to receive monetary payments based on the value of such
shares as described below. The Incentive Plan is intended to assist in aligning
the interests of the Company's key employees to those of its stockholders.
 
     The Incentive Plan provides for the grant of any or all of the following
types of benefits: (1) stock options including incentive stock options and
non-qualified stock options; (2) stock appreciation rights; (3) stock awards,
including restricted stock; (4) performance awards; and (5) stock units
(collectively, 'Benefits'). Benefits may be granted singly, in combination, or
in tandem as determined by the Compensation Committee. Stock awards, stock
options, performance awards and stock units may, as determined by the
Compensation Committee in its discretion, constitute performance-based awards.
 

     The Incentive Plan makes available for Benefits an aggregate amount of
1,850,000 shares of Common Stock, of which (i) 1,000,000 shares of Common Stock
have been designated for executive management and (ii) 850,000 shares of Common
Stock have been designated for all key employees. The maximum number of shares
 
                                       38

<PAGE>

of Common Stock with respect to which Benefits may be granted (or measured) to
any individual participant may not exceed 500,000.
 
     On July 29, 1996, subject to stockholder approval, the Compensation
Committee adopted and the Board ratified the 1996 Long Term Compensation Plan.
The 1996 Long Term Compensation Plan is intended to enhance stockholder value
over the longer term by providing executive management with meaningful financial
rewards for exceptional corporate performance that results in increases in the
Company's earnings. The payment of compensation pursuant to the 1996 Long Term
Compensation Plan is dependent on the Company achieving a cumulative earnings
per share goal (as set forth in the 1996 Long Term Compensation Plan) for the
period of July 1, 1996 through December 31, 1998 (the 'Performance Period')
based upon a specific annual growth rate from the Company's 1995 earnings.
Achieving the specified goal will enable members of executive management to earn
an award of three (3) times their annual salary as of July, 1996 (the 'Targeted
Award'). In addition, exceeding such goal by at least 50% will enable members of
executive management to earn an award equal to 125% of their Targeted Award. The
maximum amount of compensation that any member of executive management may
receive pursuant to the 1996 Long Term Compensation Plan with respect to the
Performance Period is $1.875 million. The number of employees currently eligible
to participate in the 1996 Long Term Compensation Plan is seven.
 
     The Company will seek stockholder approval of both the Incentive Plan and
the 1996 Long Term Compensation Plan at its annual stockholders' meeting, which
is currently scheduled to be held on October 30, 1996.
 
SEVERANCE AGREEMENTS WITH MANAGEMENT
 
     On October 27, 1994, the Company entered into a severance agreement (the
'Severance Agreement') with Mark Goldman, effective as of July 13, 1994. The
Severance Agreement sets forth severance benefits which are payable if Mr.
Goldman's employment is terminated for various reasons, including termination by
him of his employment following a change in control of the Company, as follows
(the 'Severance Payment'):
 
          (i) If Mr. Goldman is terminated without cause (as defined in the
     Severance Agreement) prior to a Change in Control (as defined in the
     Severance Agreement), or if Mr. Goldman terminates his employment for good
     reason (as defined in the Severance Agreement) prior to a Change in
     Control, the Severance Agreement provides that the Company shall pay to Mr.
     Goldman a lump sum payment equal to (a) two times Mr. Goldman's annualized
     current base compensation and (b) the greater of (1) two times the greater
     of (x) the incentive compensation bonus (excluding stock options or shares
     issued pursuant to a stock option, restricted stock or similar plan or
     long-term incentive bonuses) paid to Mr. Goldman for the previous year's

     performance or (y) the incentive compensation bonus (excluding stock
     options or shares issued pursuant to a stock option, restricted stock or
     similar plan or long-term incentive bonuses) that would be payable to Mr.
     Goldman if performance relative to plan for the current year was the same
     as performance relative to plan year-to-date (such performance is to be
     measured by the ratio of year-to-date actual performance divided by
     year-to-date plan performance; the index(es) of performance shall be the
     same as the most recent annual cash incentive compensation plan approved by
     the Board of Directors) (the amount equal to the greater of the amounts
     described in clauses (x) and (y) shall be hereinafter referred to as the
     'Annual Bonus'); or (2) five hundred thousand dollars ($500,000).
 
          (ii) If Mr. Goldman is terminated by the Company within twenty-four
     (24) months following a Change in Control (as defined in the Severance
     Agreement), or if Mr. Goldman terminates his employment for good reason (as
     defined in the Severance Agreement) within twenty-four (24) months
     following a Change in Control, the Severance Agreement provides that the
     Company shall pay to Mr. Goldman a lump sum payment equal to (a) three
     times Mr. Goldman's annualized current base compensation, (b) the greater
     of (1) three times the Annual Bonus or (2) five hundred thousand dollars
     ($500,000) and (c) three times the car allowance in effect for Mr. Goldman
     at the time of termination and a lump sum amount equal to three times the
     insurance and maintenance cost incurred for said vehicle during Mr.
     Goldman's last full year of employment with the Corporation. Furthermore,
     the Severance Agreement provides that the Company shall continue to provide
     Mr. Goldman with certain fringe benefits for a period of three years
     following the date of Mr. Goldman's termination, subject to mitigation by
     Mr. Goldman.
 
                                       39

<PAGE>

          (iii) If Mr. Goldman is terminated for cause, or if Mr. Goldman
     terminates his employment other than for good reason (as defined in the
     Severance Agreement), the Severance Agreement provides that the Company
     must pay to Mr. Goldman his unpaid compensation for services prior to
     termination and the value of any accrued unused vacation pay to the date of
     termination.
 
     The maximum Severance Payment that the Company would have been required to
make under the Severance Agreement if such amount became payable in fiscal 1995
was approximately $3,515,824. The Severance Agreement contains a 'gross-up'
provision pursuant to which any Severance Payment, which would be subject to
certain excise taxes occuring as a result of a Change in Control, would include
an additional gross-up payment resulting in Mr. Goldman's retaining an amount
equal to the Severance Payment minus all ordinary taxes on such payment.
 
     Mr. Goldman is employed by the Company as its President and Chief Executive
Officer without an employment agreement. The Company has purchased a life
insurance policy in a $2,000,000 face amount for Mr. Goldman who designated the
beneficiary of such insurance.
 
     It is currently anticipated that each of the six Executive Vice Presidents

of the Company will enter into a Severance and Change in Control Agreement (the
'Severance and Change in Control Agreement') with the Company, which provides,
among other things, that if the executive is terminated other than for Cause (as
such term will be defined in the Severance and Change in Control Agreement) the
executive is entitled to continue to receive his salary and certain benefits
(excluding continuation of any bonus) for a period of up to twelve (12) months.
These severance payments may be reduced in the event that the executive com-
mences regular full-time employment during such period. If there is a Change
in Control (as such term will be defined in the Severance and Change in Control
Agreement) and the executive's employment is terminated within twelve (12)
months of such Change in Control, voluntarily or involuntarily (other than for
Cause), the above-described severance package is replaced with a lump sum
payment equal to three (3) times such executive's annual salary, bonus and
certain benefits, plus the continuation of certain benefits for a thirty-six
(36) month period of time. In addition, if the executive's employment is
terminated involuntarily, other than for Cause, during the next twelve (12)
months following the first anniversary of the Change in Control, the executive
is entitled to continue to receive his salary and certain benefits (excluding
continuation of any bonus) for a period of up to twenty-four (24) months. Any
payment or benefit received pursuant to the Severance and Change in Control
Agreement would be reduced to the extent that such payment or benefit will be
subject to certain excise taxes occuring as a result of a Change in Control.
 
DIRECTOR COMPENSATION
 
     Directors who are not full-time employees of the Company receive an annual
fee of $15,000 plus $500 for each meeting of the Board or any committee thereof
attended by such director. In addition, non-employee directors are automatically
granted an option to purchase 2,000 shares of Common Stock on January 1 of each
year under the 1995 Non-Employee Directors' Stock Option Plan adopted June 20,
1995. Non-employee directors received options immediately exercisable into 2,000
shares of Common Stock on July 1, 1995 and January 1, 1996. All directors are
reimbursed by the Company for out-of-pocket expenses incurred by them as
directors of the Company.
 
                                       40

<PAGE>

                       PRINCIPAL AND SELLING STOCKHOLDERS
 
     The following table sets forth certain information as of August 30, 1996,
with respect to the Common Stock of the Company beneficially owned by (a) each
director of the Company, (b) all persons known by the Company to be the
beneficial owner of more than 5% of the Common Stock of the Company, (c) the
Named Executives, (d) all executive officers and directors of the Company as a
group and (e) the Selling Stockholder.

<TABLE>
<CAPTION>
                                                        SHARES                                          SHARES
                                                     BENEFICIALLY               SHARES               BENEFICIALLY
                                                    OWNED PRIOR TO              BEING                   OWNED
                                                     OFFERING(2)               OFFERED              AFTER OFFERING

                                           --------------------------------    --------    --------------------------------
NAME OF BENEFICIAL OWNER(1)                    NUMBER           PERCENT                        NUMBER           PERCENT
- ----------------------------------------   --------------    --------------                --------------    --------------
<S>                                        <C>               <C>               <C>         <C>               <C>
American Express Financial
  Corporation(3)........................        1,235,100          8.2%              --         1,235,100          7.0%
Wells Fargo Foundation(4)...............          392,866          2.5%         392,866                 0            0
William G. Catron(5)....................          127,017            *               --           127,017            *
Andrew J. Cavanaugh(6)..................            5,700            *               --             5,700            *
Paul A. Gliebe, Jr.(6)..................            6,350            *               --             6,350            *
Mark D. Goldman(7)......................          609,041          3.9%              --           609,041          3.4%
Scott R. Heldfond(6)....................            7,450            *               --             7,450            *
Loren Hildebrand(8).....................          110,080            *               --           110,080            *
Ronald Hirschfeld(9)....................           99,044            *               --            99,044            *
S. Lee Kling(6).........................            9,000            *               --             9,000            *
Roger Kowalsky(6).......................            6,550            *               --             6,550            *
Gary J. Niles(10).......................          193,311          1.3%              --           193,311          1.1%
Louis R. Novak(10)......................          178,447          1.2%              --           178,447          1.0%
All executive officers and directors as
  a group
  (consisting of 16 persons)(11)........        1,413,641          8.7%               0         1,413,641          7.6%
</TABLE>
 
- ------------------
  *  Less than 1%.
 
 (1) Unless otherwise indicated, address is Company's address at 500 Forbes
     Boulevard, South San Francisco, California 94080.
 
 (2) This table identifies persons having sole voting and/or investment power
     with respect to the shares of Common Stock set forth opposite their names
     as of August 30, 1996, according to the information furnished to the
     Company by each of them. A person is deemed to be the beneficial owner of
     shares of Common Stock that can be acquired by such person within 60 days
     from the date of this Prospectus upon the conversion of convertible
     securities or the exercise of warrants or options. Percentage of Beneficial
     Ownership is based on a total of 15,147,151 shares of Common Stock
     outstanding and assumes in each case that the person only, or group only,
     exercised his or its rights to purchase all shares of Common Stock
     underlying convertible securities, options or warrants.
 
 (3) Address is IDS Tower 10, Minneapolis, MN 55440.
 
 (4) Address is 420 Montgomery Street, 12th Floor, San Francisco, CA 94104.
     Includes warrants to purchase 392,866 shares of Common Stock, all of which
     will be exercised and sold pursuant to the offering.
 
 (5) Includes options to purchase 96,191 shares of Common Stock.
 
 (6) Includes options to purchase 4,000 shares of Common Stock.
 
 (7) Includes options to purchase 454,630 shares of Common Stock.
 
 (8) Includes options to purchase 110,080 shares of Common Stock.

 
                                              (Footnotes continued on next page)
 
                                       41

<PAGE>

(Footnotes continued from previous page)

 (9) Includes options to purchase 22,008 shares of Common Stock.
 
(10) Includes options to purchase 167,950 shares of Common Stock.
 
(11) Includes an aggregate of options to purchase 1,105,000 shares of Common
     Stock.
 
                 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     Louis R. Novak, Executive Vice President and Chief Operating Officer of the
Company, borrowed money from the Company on July 31, 1995 and April 15, 1996 and
on each occasion executed a note payable to the Company. The first note, dated
July 31, 1995, is in the principal amount of $57,042 and bears interest at the
rate of 8.75%. The second note, dated April 15, 1996, is in the principal amount
of $60,647 and bears interest at the rate of 8.5%. Both notes are due on demand
and are secured by Common Stock owned by Mr. Novak. Mr. Novak repaid this
indebtedness on September 4, 1996.
 
     On August 29, 1996, Mark D. Goldman, President, Chief Executive Officer and
Director of the Company, borrowed $950,000 in connection with the purchase of a
personal residence and executed a note payable to the Company, which is secured
by a second mortgage on such residence. The note will bear no interest unless
Mr. Goldman's employment with the Company is terminated and, at such time, the
note will bear interest at one percent per annum in excess of the Prime Rate
charged by Citibank F.S.B. During the term of Mr. Goldman's employment with the
Company, in accordance with the Internal Revenue Code of 1986, as amended (the
'Code'), interest will be imputed at the applicable federal rate as determined
under the Code. Commencing on the first day of September 1996, principal in the
amount of $100 shall be paid on the first of each month. The balance of the
principal shall be paid on the earlier to occur of (i) August 29, 2006 or (ii)
one year from the date Mr. Goldman's employment with the Company is terminated.
 
                          DESCRIPTION OF CAPITAL STOCK
 
     The Company has an authorized capital of 50,000,000 shares of Common Stock
$.01 par value, and 1,000,000 shares of preferred stock, par value $1.00 per
share. As of August 30, 1996, 15,147,151 shares of Common Stock were
outstanding, held of record by approximately 1,300 persons.
 
COMMON STOCK
 

     The holders of Common Stock are entitled to one vote per share on all
matters voted on by stockholders, including the election of directors. Except as
otherwise required by law or provided in any resolution adopted by the Board
with respect to any series of preferred stock of the Company, the holders of
Common Stock exclusively possess all voting power. Subject to any preferential
rights of any outstanding series of preferred stock of the Company, the holders
of Common Stock are entitled to such dividends as may be declared from time to
time by the Board from funds available for distribution to such holders. No
holder of Common Stock has any preemptive right to subscribe to any securities
of the Company of any kind or class or any cumulative voting rights.
 
CERTAIN PROVISIONS OF THE COMPANY'S CERTIFICATE OF INCORPORATION AND BY-LAWS
 
  General
 
     The Company's Certificate and the By-Laws of the Company contain several
provisions that will make difficult the acquisition of control of the Company by
means of a tender offer, open market purchases, proxy fight or otherwise. These
provisions are expected to discourage certain types of coercive takeover
practices and inadequate takeover bids and to encourage persons seeking to
acquire control of the Company first to negotiate with the Company. The Company
believes that the benefits of increased protection of the Company's potential
ability to negotiate with the proponent of an unfriendly or unsolicited proposal
to take over or restructure the
 
                                       42

<PAGE>

Company outweigh the disadvantages of discouraging such proposals because, among
other things, negotiation of such proposals could result in an improvement of
their terms.
 
     Set forth below is a summary of certain provisions in the Certificate and
the By-Laws. The description is intended as a summary only and is qualified in
its entirety by reference to the Certificate and the By-Laws.
 
  Preferred Stock
 
     The Certificate authorizes the issuance of 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 stockholders.
 
  Shareholder Rights Plan
 
     The Company has a shareholder rights plan which, under certain
circumstances, including the acquisition of 20% or more of the Common Stock by a
person, gives the holders of rights the right to acquire shares of Common Stock
having a value of twice the exercise price of the rights.
 
  Board of Directors
 
     The Certificate and the By-Laws provide for a Board divided into three

classes of directors serving staggered three-year terms. With respect to the
present Board, the term of the first class of directors will expire at the 1997
annual meeting of stockholders, the term of the second class of directors will
expire at the 1998 annual meeting of stockholders and the term of the third
class of directors will expire at the 1996 annual meeting of stockholders. The
Certificate and the By-Laws provide that the number of directors will be fixed
from time to time exclusively by the Board, and a majority of the Board then in
office may fill any vacancies on the Board. These rights would be subject to the
voting rights of holders of any issue of preferred stock of the Company. The
Certificate also provides that, subject to the rights of the holders of
preferred stock of the Company, directors may be removed only for cause and only
by the affirmative vote of holders of at least 80% of the voting power of the
Company ('Voting Stock'), voting together as a single class.
 
  Stockholder Actions and Special Meetings
 
     The Certificate provides that stockholder action can be taken only at an
annual or special meeting of stockholders and prohibits stockholder action by
written consent in lieu of a meeting. The Certificate and the By-Laws provide
that, subject to the rights of holders of any series of preferred stock, special
meetings of stockholders can be called only by the Board, the Chairman of the
Board, the President of the Company or a committee of the Board whose power and
authority include the power to call such a meeting or at the request of a
majority of the Board. Subject to the rights of holders of any series of
preferred stock, stockholders are not permitted to call a special meeting or to
require that the Board call a special meeting of stockholders.
 
     The By-Laws establish an advance notice procedure with regard to business
introduced by a stockholder to be brought before an annual meeting of
stockholders of the Company which is not specified in the notice of annual
meeting. In addition, pursuant to the Certificate, the By-Laws establish an
advance notice procedure with regard to nominations for the election of
directors by a stockholder.
 
     The Certificate requires the vote of not less than 80% of the Voting Stock
to approve certain business combinations with any person which beneficially owns
at least 25% or more of the outstanding Voting Stock of the Company (a 'Related
Person') unless (1) the directors of the Company by a two-thirds vote of all
directors in office have approved in advance the acquisition of Voting Stock
that caused the Related Person to become a Related Person or have approved the
business combination or (2) such Related Person has been a Related Person for at
least three years prior to the business combination.
 
  Amendment of Certain Provisions of the Certificate and By-Laws
 
     Subject to the voting rights of holders of any issue of preferred stock of
the Company, the Certificate and the By-Laws contain provisions requiring the
affirmative vote of the holders of at least 80% of the Voting Stock to amend
certain provisions of the Certificate and certain provisions of the By-Laws
relating to the classified board,
 
                                       43

<PAGE>


fixing the number of directors, removal of directors, filling vacancies on the
Board, requiring that any stockholder action be taken only at an annual or
special meeting of stockholders and prohibiting the calling of special meetings
by stockholders.
 
  Section 203 of the Delaware General Corporation Law
 
     The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law ('DGCL'). Section 203 provides, with certain exceptions,
that a Delaware corporation may not engage in any of a broad range of business
combinations with a person or affiliate or associate of such person who is an
'interested stockholder' for a period of three years from the date such person
became an interested stockholder unless: (i) the transaction resulting in a
person's becoming an interested stockholder, or the business combination, is
approved by the board of directors of the corporation before the person becomes
an interested stockholder; (ii) the interested stockholder acquires 85% or more
of the outstanding voting stock of the corporation in the same transaction which
makes it an interested stockholder (excluding certain employee stock option
plans); or (iii) on or after the date the person becomes an interested
stockholder, the business combination is approved by the corporation's board of
directors and by the holders of at least 66 2/3% of the corporation's
outstanding voting stock at an annual or special meeting, excluding shares owned
by the interested stockholder. An 'interested stockholder' is defined as any
person that is (x) the owner of 15% or more of the outstanding voting stock of
the corporation or (y) an affiliate or associate of the corporation and was the
owner of 15% or more of the outstanding voting stock of the corporation at any
time within the three year period immediately prior to the date on which it is
sought to be determined whether such person is an interested stockholder.
 
  Directors' Liability
 
     The Certificate contains provisions to (i) eliminate the personal liability
of its directors for monetary damages resulting from breaches of their fiduciary
duty (other than breaches of the duty of loyalty, acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of law,
violations under Section 174 of the DGCL or for any transaction from which the
director derived an improper personal benefit) and (ii) indemnify its directors
and officers to the fullest extent permitted by Section 145 of the DGCL,
including circumstances in which indemnification is otherwise discretionary.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to directors, officers and controlling persons of the Company, the
Company has been advised that, in the opinion of the Commission, such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. The Company believes that these provisions are
necessary to attract and retain qualified persons as directors and officers.
 
AMENDMENT TO THE COMPANY'S CERTIFICATE OF INCORPORATION
 
     On July 29, 1996, the Board approved a resolution authorizing an amendment
to the Certificate of Incorporation of the Company to change the Company's name
to Galoob Toys, Inc. The Company will seek stockholder approval of this
amendment to its Certificate of Incorporation at its annual stockholders'
meeting, which is currently scheduled to be held on October 30, 1996.

 
TRANSFER AGENT AND REGISTRAR
 
     Continental Stock Transfer & Trust Company, 2 Broadway, New York, New York
is the transfer agent and registrar for the Common Stock.
 
                                       44

<PAGE>

                                  UNDERWRITING
 
     The several underwriters named below (the 'Underwriters'), for whom Gerard
Klauer Mattison & Co., LLC ('GKM'), William Blair & Company, L.L.C. and
Jefferies & Company, Inc. are acting as representatives (the 'Representatives'),
have severally agreed, subject to the terms and conditions set forth in the
underwriting agreement by and among the Company, the Selling Stockholder and the
Representatives (the 'Underwriting Agreement'), to purchase from the Company and
the Selling Stockholder, and the Company and the Selling Stockholder have agreed
to sell to the Underwriters, the respective number of shares of Common Stock set
forth opposite each Underwriter's name below.
 

<TABLE>
<CAPTION>
                                                                   NUMBER
                        UNDERWRITERS                             OF SHARES
- ------------------------------------------------------------   --------------
<S>                                                            <C>
Gerard Klauer Mattison & Co., LLC...........................
William Blair & Company, L.L.C..............................
Jefferies & Company, Inc....................................
 
                                                               --------------
     Total..................................................        2,392,866
</TABLE>
 
     The nature of the Underwriters' obligations under the Underwriting
Agreement is such that all shares of Common Stock being offered, excluding
shares covered by the over-allotment option granted to the Underwriters, must be
purchased if any are purchased. In the event of a default by any Underwriter,
the Underwriting Agreement provides that, in certain circumstances, purchase
commitments of the nondefaulting Underwriters may be increased or such
Underwriting Agreement may be terminated.
 
     The Representatives have advised the Company and the Selling Stockholder
that the Underwriters propose to offer the shares of Common Stock directly to
the public initially at the public offering price set forth on the cover page of
this Prospectus and to selected dealers at such price less a concession of not
more than $       per share. Additionally, the Underwriters may allow, and such
dealers may reallow, a concession not in excess of $       per share to certain
other dealers. After the public offering of the Common Stock, the public
offering price and other selling terms may be changed by the Representatives.
 

     The Company has granted the Underwriters an option, exercisable within 45
days after the date of this Prospectus, to purchase up to an additional 358,930
shares of Common Stock, at the same price per share to be paid by the
Underwriters for the other shares offered hereby. If the Underwriters purchase
any of such additional shares pursuant to this option, each Underwriter will be
committed to purchase such additional shares in approximately the same
proportion as set forth in the table above. The Underwriters may exercise the
option only for the purpose of covering over-allotments, if any, made in
connection with the distribution of the shares of Common Stock offered hereby.
 
     The Company, the Company's directors and executive officers and the Selling
Stockholder have agreed, subject to certain exceptions, not to offer, sell,
contract to sell or otherwise dispose of any shares of Common Stock or any right
to acquire Common Stock for a period of 90 days after the date of this
Prospectus without the written consent of GKM.
 
     The Company and the Selling Stockholder have agreed to indemnify the
Underwriters and their controlling persons against certain liabilities,
including liabilities under the Securities Act of 1933, as amended (the
'Securities Act'), or to contribute to payments the Underwriters may be required
to make in respect thereof.
 
     The Company has retained the financial advisory services of GKM in recent
years. In connection with the sale of the Debentures in 1993, GKM received a fee
for its services, which included warrants to purchase 150,000 shares of Common
Stock, at an exercise price of $9.50. GKM has been listed as a selling
stockholder under an effective registration statement to sell shares of Common
Stock, which are issuable upon conversion of the warrants it received as part of
its compensation in connection with the sale of the Debentures. GKM currently
holds warrants to purchase 75,000 shares of Common Stock and has agreed not to
sell such shares for a period of 90 days after the date of this Prospectus. In
connection with the Company's offer to exchange shares of Common Stock for
outstanding shares of Depositary Shares in March 1996, GKM provided financial
advisory services to
 
                                       45

<PAGE>

the Company and delivered a fairness opinion, for which the Company paid GKM
fees and expense reimbursement totaling $728,901.
 
                                 LEGAL MATTERS
 
     The validity, authorization and issuance of the Common Stock offered hereby
will be passed upon for the Company by Weil, Gotshal & Manges LLP, New York, New
York. Certain legal matters with respect to the offering will be passed upon for
the Underwriters by Morrison & Foerster LLP, New York, New York.
 
                                    EXPERTS
 
     The consolidated financial statements as of December 31, 1995 and 1994 and
for each of the three years in the period ended December 31, 1995 included in
this Prospectus have been so included in reliance on the report of Price

Waterhouse LLP, independent accountants, given on the authority of said firm as
experts in auditing and accounting.
 
                             AVAILABLE INFORMATION
 
     The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the 'Exchange Act'), and in accordance
therewith, files reports, proxy statements and other information with the
Securities and Exchange Commission (the 'Commission'). These reports, proxy
statements and other information filed by the Company can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024 of the Commission's office at 450 Fifth Street N.W., Washington, D.C.
20549, and at its regional offices located at Suite 1400, Citibank Center, 500
West Madison Street, Chicago, Illinois 60661 and at Suite 1300, Seven World
Trade Center, New York, New York 10048. Copies of such material can be obtained
from the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. In addition, the Commission
maintains a web site at http://www.sec.gov that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the Commission. The Company's Common Stock is listed on the
New York Stock Exchange and copies of reports, proxy statements and other
information concerning the Company can be inspected at the offices of the New
York Stock Exchange at 20 Broad Street, New York, New York 10005.
 
     The Company has filed with the Commission a Registration Statement on Form
S-1 and schedules and exhibits thereto under the Securities Act with respect to
the Common Stock offered hereby. This Prospectus, which constitutes a part of
the Registration Statement, does not contain all the information set forth in
the Registration Statement and the exhibits and schedules thereto, certain
portions of which are omitted in accordance with the rules and regulations of
the Commission. Statements made in this Prospectus as to the contents of any
contract, agreement, or other document referred to are not necessarily complete.
With respect to each such contract, agreement or other document filed with the
Commission as an exhibit to the Registration Statement, reference is made to the
copy of such contract, agreement or document filed as an exhibit to the
Registration Statement for a more complete description of the matter involved,
and each such statement shall be deemed qualified in its entirety by such
reference. For further information with respect to the Company and the Common
Stock offered hereby, reference is made to such Registration Statement and the
exhibits and schedules thereto.
 
CAUTIONARY STATEMENT FOR PURPOSES OF THE 'SAFE HARBOR' PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
 
     This Prospectus includes 'forward-looking statements' within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. All
statements other than statements of historical fact, including without
limitation those with respect to the Company's objectives, plans and strategy
set forth under Business-- Growth Strategy and those preceded by or that include
the words 'believes,' 'expects,' 'anticipates,' 'intends,' 'is scheduled to' or
similar expressions, are forward-looking statements. Although the Company
believes that the expectations reflected in such forward-looking statement are
reasonable, it can give no assurance that those expectations will prove to have
been correct. Important factors that could cause actual results to differ

materially from the Company's expectations ('Cautionary Statements') are
disclosed in this Prospectus in conjunction with the forward-looking statements
and under 'Risk Factors,' and all written and oral forward-looking statements
attributable to the Company or persons acting on its behalf are expressly
qualified in their entirety by those Cautionary Statements.
 
                                       46

<PAGE>

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                PAGE
                                                               -------
<S>                                                            <C>
Financial Statements:

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

Consolidated Financial Statements:

Consolidated Balance Sheets--December 31, 1994 and December
  31, 1995..................................................       F-3

Consolidated Statements of Operations for the years ended
  December 31, 1993, 1994 and 1995..........................       F-4

Consolidated Statements of Changes in Shareholders' Equity
  for the years ended December 31, 1993, 1994 and 1995......       F-5

Consolidated Statements of Cash Flows for the years ended
  December 31, 1993, 1994 and 1995..........................       F-6

Notes to Consolidated Financial Statements for the years
  ended December 31, 1993, 1994 and 1995.... ...............   F-7  to
                                                                  F-19

Consolidated Balance Sheets--June 30, 1995, December 31,
  1995 and June 30, 1996 (unaudited)........................      F-20

Consolidated Statements of Operations for the six months
  ended June 30, 1995 and 1996 (unaudited)..................      F-21

Consolidated Statements of Cash Flows for the six months
  ended June 30, 1995 and 1996 (unaudited)..................      F-22

Notes to Consolidated Financial Statements for the six
  months ended June 30, 1995 and 1996 (unaudited)...........   F-23 to
                                                                  F-24
</TABLE>
 
                                      F-1

<PAGE>

                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and Shareholders of Lewis Galoob Toys, Inc.
 
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of Lewis
Galoob Toys, Inc. and its subsidiaries at December 31, 1994 and 1995, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1995, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
 
                                          PRICE WATERHOUSE LLP
 
San Francisco, California
February 8, 1996
(except as to Note R,
which is as of February 12, 1996)
 
                                      F-2

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                         (IN THOUSANDS, EXCEPT SHARES)
 
<TABLE>
<CAPTION>
                                                         DECEMBER 31,
                                                     --------------------
                                                       1994        1995
                                                     --------    --------
<S>                                                  <C>         <C>
                      ASSETS
Current Assets:
  Cash and cash equivalents.......................   $  2,225    $  2,030
  Accounts receivable, net........................     57,883      68,402
  Inventories.....................................     16,824      17,491
  Tooling and related costs.......................      8,379       8,311
  Prepaid expenses and other assets...............      5,492      10,348
                                                     --------    --------
     Total current assets.........................     90,803     106,582
Land, building and equipment, net.................      8,400       8,913
Other assets......................................      1,563       4,589
                                                     --------    --------
                                                     $100,766    $120,084
                                                     --------    --------
                                                     --------    --------
 
       LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
  Notes payable...................................   $  6,971    $ 15,071
  Accounts payable................................     14,973      17,141
  Accrued expenses................................     14,939      14,547
  Income taxes payable............................        499         731
  Current portion of long-term debt...............        202       4,422
                                                     --------    --------
     Total current liabilities....................     37,584      51,912
Long-term debt....................................     18,414      14,000
Shareholders' equity:
  Preferred stock.................................
     Authorized 1,000,000 shares..................
     Issued and outstanding 183,950 shares of $17
      convertible exchangeable preferred stock at 
      $200 liquidation value per share............     36,790      36,790
  Common Stock, par value $.01 per share..........
     Authorized 50,000,000 shares.................
     Issued and outstanding 10,055,089 shares in
      1994 and 10,089,961 shares in 1995..........        101         101
  Additional paid-in capital......................     31,506      31,579
  Retained earnings (deficit).....................    (23,182)    (13,851)
  Cumulative translation adjustment...............       (447)       (447)
                                                     --------    --------

     Total shareholders' equity...................     44,768      54,172
                                                     --------    --------
                                                     $100,766    $120,084
                                                     --------    --------
                                                     --------    --------
</TABLE>
 
             The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
 
                                      F-3

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                               YEARS ENDED DECEMBER 31,
                                           --------------------------------
                                             1993        1994        1995
                                           --------    --------    --------
<S>                                        <C>         <C>         <C>
Net revenues............................   $134,334    $178,792    $220,044
Costs of products sold..................     75,147      95,156     120,834
                                           --------    --------    --------
Gross margin............................     59,187      83,636      99,210
                                           --------    --------    --------
Operating expenses:
  Advertising and promotion.............     23,537      30,616      31,240
  Other selling and administrative......     22,031      22,913      30,768
  Royalties, research and development...     18,788      20,785      24,213
  Variable stock option plan expense....      4,046          --          --
                                           --------    --------    --------
Total operating expenses................     68,402      74,314      86,221
                                           --------    --------    --------
Earnings (loss) from operations.........     (9,215)      9,322      12,989
Net proceeds from Nintendo award........         --      12,124          --
Interest expense........................     (1,836)     (2,609)     (3,429)
Other income, net.......................        136         365         439
                                           --------    --------    --------
Earnings (loss) before income taxes.....    (10,915)     19,202       9,999
Provision for income taxes..............          9         778         600
                                           --------    --------    --------
Net earnings (loss).....................    (10,924)     18,424       9,399
Preferred stock dividends in arrears....      3,127       3,127       3,127
                                           --------    --------    --------
Net earnings (loss) applicable to common
  shares................................   $(14,051)   $ 15,297    $  6,272
                                           --------    --------    --------
                                           --------    --------    --------
Common shares and common share
  equivalents outstanding--average......      9,548      10,111      10,451
Net earnings (loss) per common share:
  Primary...............................   $  (1.47)   $   1.51    $   0.60
  Fully Diluted.........................      (1.47)       1.41        0.60
</TABLE>
 
             The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                      F-4

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
                         (IN THOUSANDS, EXCEPT SHARES)
 
<TABLE>
<CAPTION>
                                         PREFERRED STOCK      COMMON STOCK      ADDITIONAL   RETAINED   CUMULATIVE
                                        -----------------   -----------------    PAID-IN     EARNINGS   TRANSLATION
                                        SHARES     AMTS       SHARES     AMTS    CAPITAL     (DEFICIT)  ADJUSTMENT    TOTAL
                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
<S>                                     <C>       <C>       <C>          <C>    <C>          <C>        <C>          <C>
Balance at 12/31/92.................... 183,950   $36,790    9,472,057   $95     $ 26,425    $(30,652)    $ (412)    $32,246
 
Net loss...............................      --        --           --    --           --     (10,924)        --     (10,924)
 
Common stock issued....................      --        --       89,800     1          343          --         --         344
 
Warrants issued........................      --        --           --    --          525          --         --         525
 
Common stock received in exchange for
  shares issued and cancelled..........      --        --       (2,500)   --           --         (20)        --         (20)
 
Cumulative translation adj. and
  other................................      --        --           --    --           --          --         (9)         (9)
                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
 
Balance at 12/31/93.................... 183,950    36,790    9,559,357    96       27,293     (41,596)      (421)     22,162
 
Net earnings...........................      --        --           --    --           --      18,424         --      18,424
 
Common stock issued, net...............      --        --       47,000     1          161          --         --         162
 
Termination of 1992 Plan...............      --        --      449,732     4        4,042          --         --       4,046
 
Common stock received in exchange for
  shares issued and cancelled..........      --        --       (1,000)   --           10         (10)        --          --
 
Cumulative translation adj. and
  other................................      --        --           --    --           --          --        (26)        (26)
                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
 
Balance at 12/31/94.................... 183,950    36,790   10,055,089   101       31,506     (23,182)      (447)     44,768
 
Net earnings...........................      --        --           --    --           --       9,399         --       9,399
 
Common stock issued, net...............      --        --       58,751    --          228          --         --         228
 
Common stock received in exchange for
  shares issued and cancelled..........      --        --      (11,202)   --         (155)        (68)        --        (223)
 
Reclamation of shares..................      --        --      (12,677)   --           --          --         --          --

                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
 
Balance at 12/31/95.................... 183,950   $36,790   10,089,961   $101    $ 31,579    $(13,851)    $ (447)    $54,172
                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
</TABLE>
 
             The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                     F-5

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                         (IN THOUSANDS, EXCEPT SHARES)
 
<TABLE>
<CAPTION>
                                               YEARS ENDED DECEMBER 31,
                                           --------------------------------
                                             1993        1994        1995
                                           --------    --------    --------
<S>                                        <C>         <C>         <C>
Cash flow from operating activities:
  Net earnings (loss)...................   $(10,924)   $ 18,424    $  9,399
  Adjustments to reconcile net earnings
     (loss) to net cash used in
     operating activities:
     Depreciation.......................        682         628         528
     Variable stock option plan
       accrual..........................      4,046          --          --
     Changes in assets and liabilities:
       Accounts receivable..............      2,523     (24,500)    (10,519)
       Inventories......................        691      (3,845)       (667)
       Tooling and related costs........     (2,212)     (3,359)         68
       Prepaid expenses and other
          current assets................        285       1,849      (4,856)
       Accounts payable.................      1,449       4,140       2,168
       Accrued expenses.................     (3,002)         67        (392)
       Income taxes payable.............       (549)        217         232
       Other assets.....................       (437)       (168)     (3,026)
                                           --------    --------    --------
     Net cash (used in) provided by
       operating activities.............     (7,448)     (6,547)     (7,065)
                                           --------    --------    --------
Cash flow from investing activities:
  Investment in land, building and
     equipment, net.....................        (82)       (466)     (1,041)
                                           --------    --------    --------
     Net cash (used in) provided by
       investing activities.............        (82)       (466)     (1,041)
                                           --------    --------    --------
Cash flow from financing activities:
  Net borrowings (repayments) under
     notes payable......................     (5,698)      6,971       8,100
  Borrowings under long-term debt
     agreement..........................     14,000          --          --
  Repayments under long-term debt
     agreements.........................       (191)       (194)       (194)
  Proceeds from issuance of common
     stock, net.........................        324         162           5
  Other, net............................         (9)        (26)         --
                                           --------    --------    --------

     Net cash provided by (used in)
       financing activities.............      8,426       6,913       7,911
                                           --------    --------    --------
Increase (decrease) in cash and cash
  equivalents...........................        896        (100)       (195)
Cash and cash equivalents at beginning
  of year...............................      1,429       2,325       2,225
                                           --------    --------    --------
Cash and cash equivalents at end of
  year..................................   $  2,325    $  2,225    $  2,030
                                           --------    --------    --------
                                           --------    --------    --------
</TABLE>

Supplemental disclosure of non-cash activity:
    In 1994, the Company issued 449,732 shares of common stock in
     connection with the termination of the 1992 Senior Management Stock
     Option Plan. (See Note O).
Supplemental disclosure of cash flow
  information:
  Cash paid for interest................   $  1,604    $  2,656    $  3,050
  Cash paid for income taxes............   $    574    $    822    $    390

 
             The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                     F-6

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
 
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Organization and Business
 
     The Company has been engaged in business since 1957 and was originally
incorporated in California on November 6, 1968 and reincorporated in Delaware on
August 28, 1987. The Company is engaged in the design, development, marketing
and distribution of high quality toys worldwide. The Company's products are
primarily manufactured in the People's Republic of China.
 
  Consolidation
 
     The consolidated financial statements include the accounts of the Company
and its subsidiaries, principally Galco International Toys, N.V. ('Galco'). All
significant intercompany accounts have been eliminated in consolidation. Certain
amounts in the financial statements of prior years have been reclassified to
conform with the current year's presentation.
 
  Revenue Recognition
 
     The Company records a transaction as a sale when inventory is shipped to
the customer and title passes. The Company provides for returns using a
percentage of gross sales, based on historical experience.
 
  Foreign Currency Translation
 
     The financial statements of Galco have been translated into U.S. dollars in
accordance with Statement of Financial Accounting Standards ('SFAS') No. 52,
Foreign Currency Translation. All asset and liability accounts have been
translated using rates of exchange in effect at the balance sheet date. Revenues
and expenses are translated at the weighted average of exchange rates in effect
during the year. Gains or losses from foreign currency translation adjustments
are charged or credited directly to a separate component of shareholders'
equity.
 
  Use of Estimates
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
  Cash and Cash Equivalents
 
     Cash equivalents consist primarily of marketable securities with original

maturities of less than ninety days.
 
  Concentration of Credit Risk
 
     Accounts receivable primarily represent balances due from customers. The
Company performs credit evaluations of each of its customers and maintains
allowances for potential credit losses. Such losses have generally been within
management's expectations.
 
  Inventories
 
     Inventories are stated at lower of cost (first-in, first-out) or market.
 
  Tooling and Related Costs
 
     Costs incurred for tooling and package design are deferred and amortized
over the life of the products, which range from one to two years.
 
                                      F-7

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

  Prepaid Expenses
 
     Prepaid expenses include costs such as those incurred in the creation of
television commercials which are deferred and amortized over their lives which
is estimated to be one year or the period the commercial is used, if shorter. On
January 1, 1995, the Company implemented SOP 93-7 'Reporting on Advertising
Costs.' Implementation of the new standard had no material impact on the
financial statements. Prepaid expenses also include prepaid insurance, prepaid
samples, prepaid advertising media, and royalty advances.
 
  Land, Building and Equipment
 
     Land, building and equipment are stated at cost. Depreciation is provided
using the straight-line method over the estimated useful lives of the respective
assets. Amortization of leasehold improvements is provided using the
straight-line method over the estimated useful lives of the assets, or the term
of the applicable lease, whichever is less. Estimated useful lives are 35 years
for building and building improvements, 1 to 12 years for leasehold
improvements, 5 years for office furniture, fixtures and equipment (including
computer equipment), and 3 to 6 years for vehicles.
 
     For the year ended December 31, 1995, the Company implemented SFAS No. 121
'Accounting for the Impairment of Long-Lived Assets'. Implementation of SFAS No.
121 has been determined to have no material impact on the financial statements.
 

  Research and Development
 
     Research and development is expensed as it is incurred. Total expenses for
the year 1993, 1994 and 1995 were $7,451,000, $7,288,000 and $7,886,000,
respectively.
 
  Income Taxes
 
     In 1993, the Company retroactively adopted SFAS 109, 'Accounting for Income
Taxes'. SFAS 109 prescribes an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in the Company's financial
statements or tax returns. In estimating future tax consequences, SFAS 109
generally considers all expected future events other than enactments of changes
in the tax law or rates. Previously, the Company used the SFAS 96 asset and
liability approach that gave no recognition to future events other than the
recovery of assets and settlement of liabilities at their carrying amounts.
Adoption of SFAS 109 did not have a material effect on the financial statements.
 
  Earnings Per Share
 
     Primary earnings per share is based on the net earnings (loss) applicable
to common shares, after providing for the dividends in arrears on the preferred
stock, for the year divided by the weighted average number of common and common
equivalent shares outstanding. Primary earnings per share for the years ended
December 31, 1994 and 1995 have been adjusted by common equivalent shares
resulting from the assumed exercise of common stock options and stock warrants.
Primary earnings per share for the year ended 1993 has not been adjusted by
common equivalent shares since the effect would be anti-dilutive. Fully diluted
earnings per share for the year ended 1994 includes the effect of the assumed
conversion of the $17 Convertible Exchangeable Preferred Stock and the 8%
Convertible Subordinated Debentures into common stock. Fully diluted earnings
per share for the years ended December 31, 1995 and 1993 were the same as
primary earnings per share since the effect of the assumed conversion is
anti-dilutive.
 
                                      F-8

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

  Recent Accounting Pronouncement
 
     In 1995, the FASB issued a new standard, SFAS No. 123, 'Accounting for
Stock-Based Compensation', which contains a fair value-based method for valuing
stock-based compensation that entities may use, which measures compensation cost
at the grant date based on the fair value of the award. Compensation is then
recognized over the service period, which is usually the vesting period.

Alternatively, the standard permits entities to continue accounting for employee
stock options and similar equity instruments under APB Opinion 25, 'Accounting
for Stock Issued to Employees'. Entities that continue to account for stock
options using APB Opinion 25 are required to make pro forma disclosures of net
income and earnings per share, as if the fair value-based method of accounting
defined in SFAS No. 123 had been applied. The Company has not determined which
method it will follow in the future. The Company will be required to adopt the
new standard for the year ending December 31, 1996.
 
NOTE B--ACCOUNTS RECEIVABLE, NET
 
<TABLE>
<CAPTION>
                                                        DECEMBER 31,
                                                     ------------------
                                                      1994       1995
                                                     -------    -------
                                                       (IN THOUSANDS)
<S>                                                  <C>        <C>
Trade receivables.................................   $65,757    $76,834
Provisions for:
  Advertising allowances..........................    (2,900)    (5,800)
  Return of defective goods.......................      (900)      (700)
  Markdowns and discounts.........................    (3,400)    (2,975)
  Doubtful accounts...............................      (897)      (507)
                                                     -------    -------
     Net trade receivables........................    57,660     66,852
Other receivables.................................       223      1,550
                                                     -------    -------
                                                     $57,883    $68,402
                                                     -------    -------
                                                     -------    -------
</TABLE>
 
NOTE C--INVENTORIES
 
<TABLE>
<CAPTION>
                                                        DECEMBER 31,
                                                     ------------------
                                                      1994       1995
                                                     -------    -------
                                                       (IN THOUSANDS)
<S>                                                  <C>        <C>
Finished goods....................................   $15,596    $17,023
Raw materials and parts...........................     1,228        468
                                                     -------    -------
                                                     $16,824    $17,491
                                                     -------    -------
                                                     -------    -------
</TABLE>
 
                                      F-9


<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE D--LAND, BUILDING AND EQUIPMENT, NET
 
<TABLE>
<CAPTION>
                                                       DECEMBER 31,
                                                     ----------------
                                                      1994      1995
                                                     ------    ------
                                                      (IN THOUSANDS)
<S>                                                  <C>       <C>
Land and building.................................   $9,564    $9,567
Office furniture, fixtures and equipment..........    4,360     4,646
Leasehold improvements............................      787     1,267
Vehicles..........................................      104       104
                                                     ------    ------
                                                     14,815    15,584
Less accumulated depreciation.....................    6,415     6,671
                                                     ------    ------
                                                     $8,400    $8,913
                                                     ------    ------
                                                     ------    ------
</TABLE>
 
NOTE E--NOTES PAYABLE
 
     On March 31, 1995, the Company entered into an amended and restated loan
and security agreement (the 'New Agreement') with Congress Financial Corporation
(Central) (the 'Lender'). The New Agreement extends through March 31, 1997 and
provides a line of credit of $40 million, with provision to increase the line to
$60 million at the option of the Company. Borrowing availability is determined
by a formula based on qualified assets. The interest is at prime rate plus 1%.
In consideration for entering into the New Agreement, the Company paid a
$100,000 fee; additional fees will be paid if the Company exercises its option
to increase the line. The Company has also agreed to pay an unused line fee of
0.25% and certain management fees. The New Agreement provides that the preferred
dividend payment may not be made without the prior consent of the Lender. The
deferred loan fee is included in other assets and is being amortized using a
straight-line method over the term of the loan.
 
     The maximum outstanding borrowings, average outstanding balances and
weighted average rates of interest for notes payable were as follows:
 
<TABLE>
<CAPTION>
                                                        DECEMBER 31,
                                                     ------------------
                                                      1994       1995

                                                     -------    -------
                                                       (IN THOUSANDS)
<S>                                                  <C>        <C>
Maximum outstanding at month end..................   $18,209    $30,235
Average outstanding amount during the year........     4,184     14,211
Weighted average interest rate for the year.......      11.2%      10.4%
</TABLE>
 
                                      F-10

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE F--INCOME TAXES
 
     Earnings (loss) before income taxes and the provision for income taxes are
as follows:
 
<TABLE>
<CAPTION>
                                                   DECEMBER 31,
                                           -----------------------------
                                             1993       1994       1995
                                           --------    -------    ------
                                                  (IN THOUSANDS)
<S>                                        <C>         <C>        <C>
Earnings (loss) before income taxes:
  Domestic..............................   $(10,806)   $18,861    $9,288
  Foreign...............................       (109)       341       711
                                           --------    -------    ------
                                           $(10,915)   $19,202    $9,999
                                           --------    -------    ------
                                           --------    -------    ------
Provision for income taxes:
Current:
  Federal...............................   $     --    $   490    $  187
  State.................................         --        201       278
  Foreign...............................          9         87       135
                                           --------    -------    ------
                                                  9        778       600
Deferred:
  Federal...............................         --         --        --
  State.................................         --         --        --
  Foreign...............................         --         --        --
                                           --------    -------    ------
                                           $      9    $   778    $  600
                                           --------    -------    ------
                                           --------    -------    ------
</TABLE>
 

     Deferred tax liabilities (assets) consist of the following:
 
<TABLE>
<CAPTION>
                                                   DECEMBER 31,
                                           ----------------------------
                                            1993       1994       1995
                                           -------    -------    ------
                                                  (IN THOUSANDS)
<S>                                        <C>        <C>        <C>
Prepaid expenses........................   $ 2,065    $ 1,586    $2,475
Other temporary differences.............       647        705       766
                                           -------    -------    ------
Gross deferred tax liabilities..........     2,712      2,291     3,241
                                           -------    -------    ------
Accrued expenses........................    (1,377)      (939)     (613)
Defectives provision....................      (560)      (315)     (245)
Other temporary differences.............    (1,936)    (2,970)   (3,244)
Net operating loss carryforwards........   (11,128)    (4,037)   (2,567)
Research and development tax credit
  carryforward..........................      (765)      (765)     (765)
Other...................................      (765)      (944)   (1,027)
                                           -------    -------    ------
Gross deferred tax assets...............   (16,531)    (9,970)   (8,461)
                                           -------    -------    ------
Deferred tax assets valuation
  allowance.............................    13,819      7,679     5,220
                                           -------    -------    ------
                                           $    --    $    --    $   --
                                           -------    -------    ------
                                           -------    -------    ------
</TABLE>
 
     A deferred tax valuation allowance has been recorded for the net operating
loss carryforwards and other credits which may not be utilized. The net change
in the valuation allowance for deferred tax assets was an increase (decrease) of
$1,648,000, ($6,140,000) and ($2,459,000) in 1993, 1994 and 1995, respectively.
 
     At December 31, 1995, the Company had federal net operating loss
carryforwards for income tax purposes of approximately $7,300,000. The
carryforwards expire in different years through the year 2008. The Company also
has federal minimum tax credit carryforwards of $1,028,000 that are allowed to
be carried forward indefinitely and federal research and development credits of
$765,000, which will expire in different years
 
                                      F-11

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 

NOTE F--INCOME TAXES--(CONTINUED)

through the year 2003. If certain substantial changes in the Company's ownership
should occur, there would be an annual limitation on the amount of operating
loss carryforwards which can be utilized.
 
     The provision for income taxes differs from the provisions determined by
applying the applicable U.S. statutory federal income tax rates to pretax income
as a result of the following differences:
 
<TABLE>
<CAPTION>
                                            YEARS ENDED DECEMBER 31,
                                           ---------------------------
                                           1993       1994       1995
                                           -----      -----      -----
<S>                                        <C>        <C>        <C>
Federal income taxes (benefit) at the
  U.S. statutory rate...................   (34.0%)     35.0%      35.0%
Increase (decrease) in income taxes
  resulting from:
  Effects of U.S. and foreign income
     taxes on foreign operations........     0.1       (0.2)      (1.1)
  State income taxes, net of loss
     carryforwards, less federal tax
     benefits...........................      --        0.9        2.8
  Benefit of reversing temporary
     differences for which benefits were
     not previously recorded............      --         --      (20.9)
  Loss carryback/carryforward...........    34.0      (31.6)     (13.8)
Other...................................      --         --        4.0
                                           -----      -----      -----
                                             0.1%       4.1%       6.0%
                                           -----      -----      -----
                                           -----      -----      -----
</TABLE>
 
     During 1993, the Company settled with the Internal Revenue Service ('IRS')
and the California Franchise Tax Board ('CFTB') regarding audits of the years
1982 through 1990 for federal purposes and 1983 through 1989 for California
purposes. The Company adequately provided for the amounts settled with the IRS
and the CFTB.
 
     No domestic deferred taxes have been provided on unremitted earnings of the
foreign subsidiary. All such earnings are expected to be reinvested in the
subsidiary. Undistributed earnings for which the Company has not provided taxes,
which may be payable on distribution, were approximately $5,200,000 as of
December 31, 1995. No foreign taxes will be withheld on the distribution of the
untaxed earnings.
 
NOTE G--LEASES
 
     The Company leases its domestic warehouse and showroom facilities, and its
facilities in Hong Kong. The leases have been classified as operating leases and

are for terms expiring at various dates through 2000. Under the terms of the
facility leases, rents are adjusted annually for changes in the consumer price
index and increases in property taxes. The Company has a lease option on the
domestic warehouse to renew for one five-year term.
 
     Future minimum lease payments for all noncancellable operating leases as of
December 31, 1995 (in thousands) are as follows:
 
<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31,
- -------------------------
<S>                         <C>
1996.....................   $  972
1997.....................      869
1998.....................      772
1999.....................      636
2000.....................      323
                            ------
                            $3,572
                            ------
                            ------
</TABLE>
 
     Net rental expense for the years ended December 31, 1993, 1994 and 1995 was
$1,449,000, $1,515,000 and $1,988,164, respectively.
 
                                      F-12

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE H--ROYALTY CONTRACTS
 
     The Company has future minimum royalty guarantee payments as of December
31, 1995 (in thousands) as follows:
 
<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31,
- -------------------------
<S>                         <C>
1996.....................   $3,067
1997.....................    1,915
1998.....................      340
1999.....................      500
                            ------
                            $5,822

                            ------
                            ------
</TABLE>
 
NOTE I--ACCRUED EXPENSES
 
<TABLE>
<CAPTION>
                                                        DECEMBER 31,
                                                     ------------------
                                                      1994       1995
                                                     -------    -------
                                                       (IN THOUSANDS)
<S>                                                  <C>        <C>
Accrued advertising...............................   $   272    $    --
Accrued royalties.................................     6,039      6,003
Accrued compensation and commissions..............     3,875      4,814
Accrued freight and duty..........................     1,483        495
Accrued interest..................................     1,108      1,139
Accrued inventory purchase commitments............     1,320      1,450
Other accrued expenses............................       842        646
                                                     -------    -------
                                                     $14,939    $14,547
                                                     -------    -------
                                                     -------    -------
</TABLE>
 
     During 1995, the Company settled with the United States Customs Service
('Customs') regarding the audit of duty due on importations of goods into the
United States of the years 1988 through 1991. The Company adequately provided
for the amount settled with Customs.
 
NOTE J--LONG-TERM DEBT
 
<TABLE>
<CAPTION>
                                                        DECEMBER 31,
                                                     ------------------
                                                      1994       1995
                                                     -------    -------
                                                       (IN THOUSANDS)
<S>                                                  <C>        <C>
8% Convertible Subordinated Debentures due and
  payable on November 30, 2000, interest paid
  semi-annually...................................   $14,000    $14,000
Mortgage secured by headquarters land and
  building, payable in monthly installments of
  $55,314 (principal and interest) through
  November 30, 1996 when the remaining outstanding
  balance is due, interest rate 10.3%.............     4,616      4,422
                                                     -------    -------
                                                      18,616     18,422
Current portion...................................       202      4,422
                                                     -------    -------

                                                     $18,414    $14,000
                                                     -------    -------
                                                     -------    -------
</TABLE>
 
     On November 17, 1993, the Company issued in a private placement $14 million
in principal amount of 8% Convertible Subordinated Debentures (the '8%
Debentures'), at par. The interest is to be paid semi-annually. The 8%
Debentures mature on November 30, 2000 and are convertible into shares of the
Company's common
 
                                      F-13

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE J--LONG-TERM DEBT--(CONTINUED)

stock at $9.26 calculated based upon 115% of the average of the Company's
closing common stock price for the ten business days ending November 12, 1993.
In connection with the 8% Debentures, the Company paid a commission to its
investment bankers of $560,000 and issued warrants for 150,000 shares, which
were valued at $525,000 and recorded as additional paid-in capital. These
deferred loan costs are included in other assets and are amortized using a
straight-line method over the term of the loan. (See Note R.)
 
NOTE K--MAJOR CUSTOMERS
 
     The Company had transactions with one customer, Toys 'R' Us, Inc. that
accounted for approximately 21% of net revenues in 1993 and 1994, and 20% of net
revenues in 1995. Wal-Mart accounted for approximately 11% of net revenues in
1995.
 
NOTE L--PROFIT SHARING PLAN
 
     The Company has a 401(k) profit sharing plan covering all non-union
full-time employees. The plan is qualified under Section 401(a) of the Internal
Revenue Code so that contributions to the plan by the Company are not taxable
until distributed to employees. Contributions under the plan are at the
discretion of the Board of Directors and are subject to the amounts allowable
under applicable provisions of the Internal Revenue Code. No Company
contributions have been made in 1993, 1994 or 1995.
 
NOTE M--LITIGATION
 
     On May 17, 1990, the Company filed a complaint against Nintendo of America,
Inc. ('Nintendo') seeking a declaratory judgment and injunctive relief in the
United States District Court, Northern District of California (the 'District
Court'). This complaint sought confirmation of the Company's right to market,
distribute and sell its Game Genie product. On June 1, 1990, Nintendo filed a

complaint in the same District Court alleging copyright and trademark
infringement and seeking a preliminary and permanent injunction and unspecified
damages.
 
     On April 11, 1994, Nintendo paid the Company $16.1 million representing the
full damage award plus interest and related costs. The Company retained
approximately $12.1 million of this amount, and the Company's Game Genie
licensors were paid the remaining $4.0 million. Notwithstanding such payment, on
June 20, 1994, Nintendo filed a petition for a Writ of Certiorari with the
United States Supreme Court, which asked the Supreme Court to review the damage
award on a discretionary basis. On October 3, 1994, the Supreme Court rejected
Nintendo's petition and affirmed Galoob's right to the full damage award. There
is no further basis for appeal by Nintendo.
 
     Nintendo's original trademark claim and the Company's original anti-trust
cross-claim against Nintendo were severed from the copyright claims that were
adjudicated on July 3, 1991. On January 18, 1995 these claims were dismissed
with prejudice by Nintendo and Galoob, respectively. The Nintendo Game Genie
infringement lawsuit is now complete.
 
     The Company is involved in various other litigation and legal matters which
are being defended and handled in the ordinary course of business. None of these
matters is expected to result in outcomes having a material adverse effect on
the Company's consolidated financial position or results of operation.
 
NOTE N--SHAREHOLDERS' EQUITY
 
     In 1989, the Company issued 183,950 authorized shares of $17 Convertible
Exchangeable Preferred Stock with a $200 liquidation value (the 'Preferred
Stock') and deposited them with a U.S. Bank (the 'Depositary') and sold in a
public offering an aggregate of 1,839,500 Depositary Convertible Exchangeable
Preferred Shares
 
                                      F-14

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE N--SHAREHOLDERS' EQUITY--(CONTINUED)

(the 'Depositary Shares') at a price of $20 per share. Each Depositary Share
represents 1/10th share of Preferred Stock and has a cumulative dividend rate of
$1.70 per annum, payable quarterly, and may be converted into common stock at
the option of the holders at an initial price of $16.875 per share of common
stock.
 
     The Depositary Shares are redeemable in whole or in part at any time, at
the option of the Company, at redemption prices ranging from $21.36 to $20.00
plus dividends accrued and unpaid to the redemption date, provided certain
redemption requirements are met which are based on the market price of the

Company's common stock.
 
     The entire issue of Depositary Shares (in multiples of ten) and the entire
issue of Preferred Stock is exchangeable, at the option of the Company, on any
dividend payment date for the Company's 8-1/2% Convertible Subordinated
Debentures due October 1, 2014 (the '8-1/2% Debentures') at the rate of $20.00
principal amount of 8-1/2% Debentures for each Depositary Share. At any time
following the occurrence of certain change in control transactions, each holder
of Depositary Shares, the Preferred Stock, or of 8-1/2% Debentures, as the case
may be, has the right to cause the Company to exchange the Depositary Shares (in
multiples of ten), the Preferred Stock or the 8-1/2% Debentures, as the case may
be, for the Company's Subordinated Debentures due October 1, 2014 (the 'Reset
Debentures').
 
     As long as the Preferred Stock, the 8-1/2% Debentures, or the Reset
Debentures are outstanding, the Company will be subject to limitations on the
payment of certain common stock dividends and other distributions and on the
purchase, redemption, or other acquisition of capital stock. No common stock
dividends may be paid unless the Preferred Stock dividends are current. The
Company has reserved 2,180,148 shares of common stock for the conversion of the
Preferred Stock.
 
     On June 10, 1992, the Company announced it would not pay the July 1, 1992
$0.425 per share quarterly dividend on its Depositary Shares which represent
shares of the Company's Preferred Stock. The Company has not paid the subsequent
quarterly dividends. As of January 1, 1996, the dividend was cumulatively
fifteen quarters in arrears, representing a total dividend arrearage of $11.7
million. By the terms of the Certificate of Designations for the Company's
Preferred Stock, the Company is not legally obligated to pay any such arrearage.
The Company has consistently maintained that it is not in its best interest to
reinstate the dividend until the Company has generated consistent net income
from operations and continuation of such profitability can be reasonably
expected. Based upon recent results, the Company has been evaluating its
alternatives with regard to the Preferred Stock. The net earnings (loss) per
share calculation includes a provision for the Preferred Stock dividends in
arrears. No common stock dividends may be paid unless all Preferred Stock
dividend payments are current. As a result of the cumulative dividend being six
or more quarters in arrears, on July 15, 1994 the holders of the Preferred Stock
exercised their right to elect two directors. (See Note R.)
 
     In 1990, the Company adopted a Stockholder Rights Plan and declared a
dividend distribution of one Right for each outstanding share of common stock.
Each Right will entitle holders of the Company's common stock to buy
one-thousandth of a share of Series A Preferred Stock of the Company at an
exercise price of $43.00, subject to adjustment. The Rights will be exercisable
only if a person or group acquires beneficial ownership of 20% or more of the
common stock (other than pursuant to certain transactions involving the Company)
(an 'Acquiring Person') or announces a tender or exchange offer that would
result in such person or group beneficially owning 20% or more of the common
stock (other than a tender or exchange offer for all outstanding shares at a
price determined by the non-affiliated directors to be fair).
 
     If any person becomes the beneficial owner of 20% or more of the common
stock (other than pursuant to certain transactions involving the Company or a

tender or exchange offer for all outstanding shares at a price determined by the
non-affiliated directors to be fair), or an Acquiring Person engages in certain
'self-dealing' transactions including a merger in which the Company is the
surviving corporation, each Right not owned by such Acquiring Person will enable
its holder to purchase, at the Right's then-current exercise price, shares of
the
 
                                      F-15

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE N--SHAREHOLDERS' EQUITY--(CONTINUED)

common stock (or, in certain circumstances, cash, property or other securities
of the Company) having a value of twice the Right's exercise price. In addition,
if the Company is acquired in a merger or other business combination transaction
in which the Company is not the surviving corporation, or if the Company sells
or transfers 50% or more of its assets or earning power, each Right not owned by
such Acquiring Person will entitle its holder to purchase, at the Right's
then-current exercise price, common shares of the acquiring company having a
value of twice the Right's exercise price.
 
     The Rights will expire January 17, 2000 or they may be redeemed by the
Company at $.01 per share prior to that date. The Rights do not have voting or
dividend rights and, until they become exercisable, have no dilutive effect on
the earnings of the Company.
 
NOTE O--STOCK OPTIONS AND WARRANTS
 
     The Board of Directors and the shareholders adopted an Employee Stock
Option Plan in 1984 (the '1984 Plan'). During 1994, the 1984 Plan was amended to
extend the plan until April 20, 2004 and to increase the aggregate number of
shares available under the 1984 Plan. The 1984 Plan authorizes the Board of
Directors to grant to officers and employees of the Company and certain of its
subsidiaries options to purchase up to an aggregate of 1,589,997 common shares.
Stock options are exercisable in accordance with the determination of the Board
of Directors made at the time of their grant, and expire not more than ten years
after the date of grant. Stock options granted under the 1984 Plan in 1993, 1994
and 1995 were at 100% of market price.
 
     As of December 31, 1995, 241,029 shares remain available for future grants.
 
     Stock option activity pursuant to the 1984 Plan is summarized as follows:
 
<TABLE>
<CAPTION>
                                         1993          1994          1995
                                      ----------    ----------    -----------
<S>                                   <C>           <C>           <C>

Options outstanding:
  At January 1.....................      320,608       275,399        331,899
  Granted..........................      120,000       161,000        320,000
  Exercised........................      (14,800)      (97,000)       (60,575)
  Cancelled........................     (150,409)       (7,500)       (19,824)
                                      ----------    ----------    -----------
  At December 31...................      275,399       331,899        571,500
                                      ----------    ----------    -----------
                                      ----------    ----------    -----------
Options exercisable:
  At December 31...................      174,149       181,899        201,500
                                      ----------    ----------    -----------
                                      ----------    ----------    -----------
</TABLE>
 
<TABLE>
<S>                                   <C>           <C>           <C>
Option prices per share:
  Granted..........................   $3.25-7.38    $5.75-8.38    $5.75-11.88
  Exercised........................         3.00     3.25-5.63      3.00-6.25
  Cancelled........................    3.00-6.38     3.00-6.13      3.00-6.13
</TABLE>
 
     In 1992, the Board of Directors and the shareholders adopted the 1992
Senior Management Stock Option Plan (the '1992 Plan'), a variable stock option
plan. Under the 1992 Plan 800,000 shares were reserved and options for 800,000
shares were issued and outstanding at December 31, 1993. These options vest over
three years and expire after ten years. The initial exercise prices were $5.625
for 700,000 shares and $3.25 for 100,000 shares, respectively, the market prices
on the dates granted. The exercise prices were adjusted downward on a pro-rata
basis as the trading price of the stock increased above the initial exercise
price so that the exercise price would be $.01 when the trading price of the
stock was $19.00.
 
     Generally accepted accounting principles ('GAAP') for variable stock option
plans required the Company to record a compensation expense accrual measured by
the difference between the market price of the common
 
                                      F-16

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE O--STOCK OPTIONS AND WARRANTS--(CONTINUED)

stock underlying an option and the option price as of December 31, 1993. The
sharp rise in the price of the Company's common stock during the fourth quarter
of 1993, therefore, required a charge to earnings.
 
     The Company believed that the application of GAAP could have resulted in

large and repeated future distortion to reported quarterly earnings of the
Company, based on fluctuations in the stock price so long as the 1992 Plan
remained in effect. Therefore, on January 26, 1994, the Board of Directors of
the Company ('Board') terminated the 1992 Plan, subject to shareholder approval.
In connection with the termination of the 1992 Plan, the Company recorded an
accrued liability on its balance sheet at December 31, 1993 in the amount of
$4,046,000 and recorded a non-recurring, non-cash charge to earnings. In
addition, in connection with the termination of the 1992 Plan, the Company
granted an aggregate of 449,732 shares of common stock to the holders of the
cancelled options, also subject to shareholder approval. In the second quarter
of 1994, subsequent to the approval by the shareholders, the Company eliminated
the accrued liability of $4,046,000 and increased shareholders' equity by the
same amount for the common stock issued. In 1995, 12,677 of the granted shares
were reacquired by the Company at no cost per the terms of the 1992 Plan.
 
     Also, on January 26, 1994 the Board adopted the 1994 Senior Management
Stock Option Plan (the '1994 Plan'), subject to shareholder approval. Each
holder of options under the 1992 Plan was granted new options with an option
exercise price of $9.00, the trading price of the common stock of the Company at
the time of the Board actions. The shareholders approved the 1994 Plan in June
1994. As of December 31, 1995, there are outstanding options to purchase 742,592
shares under the 1994 Plan. During 1995, the shareholders adopted the 1995
Non-Employee Directors Stock Option Plan (the '1995 Plan'). The 1995 Plan
provides for the automatic granting annually to each non-employee director
options immediately exercisable into 2,000 shares of common stock at the fair
market value on the grant date. Options were granted on July 1, 1995 and will be
granted on each January 1 thereafter. The maximum number of share options under
the 1995 Plan is 160,000. As of December 31, 1995, there were outstanding
options to purchase 16,000 shares at an exercise price of $8.00 per share.
 
     On July 7, 1988, in consideration for entering into a credit agreement, the
Company issued warrants to purchase 785,732 shares of common stock at an
exercise price of $4.50 per share. One half of the warrants issued on July 7,
1988 were repurchased on May 25, 1989 for $400,000. On December 11, 1991, the
Company issued warrants to purchase 25,000 shares of common stock at an exercise
price of $4.375 per share. On November 17, 1993, the Company issued warrants
relating to the 8% Debentures to purchase 150,000 shares of common stock at an
exercise price of $9.50 per share.
 
NOTE P--RELATED PARTY TRANSACTIONS
 
     The Company has retained the legal services of Shereff, Friedman, Hoffman &
Goodman, LLP in recent years. One of the Company's directors is a partner of
Shereff, Friedman, Hoffman & Goodman, LLP. The total amount of fees paid to
Shereff, Friedman, Hoffman & Goodman, LLP in 1994 and 1995 were approximately
$0.4 million and $0.3 million, respectively, exclusive of the director's fees
paid to Martin Nussbaum, a partner in the firm of Shereff, Friedman, Hoffman &
Goodman, LLP, as compensation for his service as Chairman of the Executive
Committee of the Board of Directors.
 
     The Company has retained the insurance brokerage services of Rollins Hudig
Hall ('RHH') in recent years. One of the Company's directors is the President
and Chief Executive Officer of Rollins Real Estate/Investment, a division of
RHH. The total amount of insurance premiums paid to RHH in 1994 and 1995 were

approximately $1.4 million and $1.3 million, respectively.
 
     In 1994, the Company sold its minority interest in Galoob Toys Canada,
Inc., which continues to act as the Company's distributor in Canada and which
accounted for less than 5% of the Company sales.
 
                                      F-17

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE Q--DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
 
     The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
 
     o Current Assets and Current Liabilities
       The carrying value of cash, cash equivalents, accounts receivables,
       short-term borrowings, accounts payable and accrued expenses approximate
       fair value because of their short maturity.
 
     o Long-Term Debt
       The fair value of the Company's long-term debt is estimated based on the
       quoted market price of the underlying common stock which would be 
       received upon conversion. At December 31, 1995, the carrying amount and 
       estimated fair value of long-term debt are $14.0 million and $17.8 
       million, respectively.
 
NOTE R--SUBSEQUENT EVENTS
 
     On February 12, 1996, the Company announced that it was calling for
redemption of its 8% Convertible Subordinated Debentures originally due November
30, 2000 (the 'Debentures'), and was commencing an exchange offer for its
Depositary Convertible Exchangeable Preferred Shares (the 'Preferred Shares').
 
     Under the terms of the redemption, the $14,000,000 Debentures now
outstanding will be redeemed on or about March 22, 1996, unless converted into
the Company's Common Stock by the holders prior to the redemption date. Until
the redemption date, the Debentures are convertible into an aggregate of
1,511,872 shares of Common Stock at the rate of $9.26 principal amount for each
share of Common Stock. The Company became entitled to redeem the Debentures when
the average closing price of its Common Stock for twenty consecutive days
exceeded 150% of the conversion price.
 
     Under the terms of the exchange offer, the Company will offer to exchange
1.85 shares of Common Stock for each of the 1,839,500 Preferred Shares currently
outstanding. The exchange offer has an expiration date of March 29, 1996, and is
conditioned on, among other things, the receipt of valid tenders from the
holders of at least 75 percent of the outstanding Preferred Shares.

 
NOTE S--SEGMENT INFORMATION
 
     The Company's operations are in one industry segment: the sale of toys
primarily to major retail outlets. The Company operates in two primary
geographic areas, the U.S. and Europe, and there are no sales between geographic
areas.
 
                                      F-18

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE S--SEGMENT INFORMATION--(CONTINUED)

     Information about the Company's operations in different geographic
locations are as follows:
 
<TABLE>
<CAPTION>
                                            1993        1994        1995
                                           -------    --------    --------
                                                   (IN THOUSANDS)
<S>                                        <C>        <C>         <C>
United States
  Non-affiliated customer revenue.......   $88,821    $119,702    $139,373
  Earnings (loss) from operations.......    (1,341)      6,383       9,837
  Identifiable assets...................    61,706      87,653     111,639
Foreign
  Non-affiliated customer revenue.......    45,513      59,090      80,671
  Earnings (loss) from operations.......    (7,874)      2,939       3,152
  Identifiable assets...................     9,299      13,113       8,445
Consolidated
  Net revenues..........................   134,334     178,792     220,044
  Earnings (loss) from operations.......    (9,215)      9,322      12,989
  Net proceeds from Nintendo award......        --      12,124          --
  Interest expense......................    (1,836)     (2,609)     (3,429)
  Other income, net.....................       136         365         439
                                           -------    --------    --------
  Earnings (loss) before income taxes...   (10,915)     19,202       9,999
  Identifiable assets...................   $71,005    $100,766    $120,084
</TABLE>
 
NOTE T--QUARTERLY FINANCIAL DATA (UNAUDITED)
 
     Quarterly financial data for 1994 and 1995 are summarized in the following
table:
 
<TABLE>
<CAPTION>

                                                NET       NET EARNINGS
                         NET        GROSS     EARNINGS     (LOSS) PER
                       REVENUES    MARGIN      (LOSS)     COMMON SHARE
                       --------    -------    --------    ------------
                          (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                    <C>         <C>        <C>         <C>
1994
lst Quarter.........   $ 30,235    $13,472    $ (1,648)      $(0.25)
2nd Quarter.........     33,720     13,939       9,753         0.91
3rd Quarter.........     50,273     22,653       3,909         0.30
4th Quarter.........     64,565     33,572       6,410         0.55
 
1995
1st Quarter.........   $ 33,341    $11,849    $ (4,171)      $(0.49)
2nd Quarter.........     38,219     13,258      (4,087)       (0.48)
3rd Quarter.........     65,518     28,870       6,837         0.58
4th Quarter.........     82,966     45,233      10,820         0.93
 
1996
1st Quarter.........   $ 37,522    $16,185    $ (4,115)      $(2.71)
2nd Quarter.........     49,201     22,758         387         0.02
</TABLE>
 
                                      F-19

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                         (IN THOUSANDS, EXCEPT SHARES)
 
<TABLE>
<CAPTION>
                                  JUNE 30,      DECEMBER 31,     JUNE 30,
                                    1995            1995           1996
                                 -----------    ------------    -----------
                                 (UNAUDITED)     (AUDITED)      (UNAUDITED)
<S>                              <C>            <C>             <C>
            ASSETS
Current Assets:
  Cash and cash equivalents...     $ 1,106        $  2,030       $   2,920
  Accounts receivable, net....      43,189          68,402          61,773
  Inventories.................      18,004          17,491          20,686
  Tooling and related costs...       8,095           8,311          12,983
  Prepaid expenses and other
     assets...................      12,610          10,348          10,861
                                 -----------    ------------    -----------
     Total current assets.....      83,004         106,582         109,223
Land, building and equipment,
  net.........................       8,233           8,913          10,081
Other assets..................       3,511           4,589           5,390
                                 -----------    ------------    -----------
                                   $94,748        $120,084       $ 124,694
                                 -----------    ------------    -----------
                                 -----------    ------------    -----------
 
LIABILITIES AND SHAREHOLDERS'
             EQUITY
Current Liabilities:
  Notes payable...............     $17,147        $ 15,071       $  34,644
  Accounts payable............      12,768          17,141          13,785
  Accrued expenses............       9,467          14,547           8,493
  Income taxes payable........         272             731             372
  Current portion of long-term
     debt.....................         213           4,422           4,318
                                 -----------    ------------    -----------
     Total current
       liabilities............      39,867          51,912          61,612
Long-term debt................      18,309          14,000              --
Shareholders' equity:
  Preferred stock
     Authorized 1,000,000
       shares
     Issued and outstanding
       183,950 shares, 183,950
       shares and 0 shares of
       $17 Convertible
       Exchangeable Preferred

       Stock at $200
       liquidation value per
       share..................      36,790          36,790              --
  Common stock, par value $.01
     per share
     Authorized 50,000,000
       shares
     Issued and outstanding
       10,070,889 shares,
       10,089,961 shares and
       15,119,651 shares......         101             101             151
  Additional paid-in
     capital..................      31,638          31,579         105,774
  Retained earnings
     (deficit)................     (31,510)        (13,851)        (42,396)
  Cumulative translation
     adjustment...............        (447)           (447)           (447)
                                 -----------    ------------    -----------
     Total shareholders'
       equity.................      36,572          54,172          63,082
                                 -----------    ------------    -----------
                                   $94,748        $120,084       $ 124,694
                                 -----------    ------------    -----------
                                 -----------    ------------    -----------
</TABLE>
 
             The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                     F-20

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                     SIX MONTHS ENDED
                                                         JUNE 30,
                                           ------------------------------------
                                                 1995                1996
                                           ----------------    ----------------
                                                       (UNAUDITED)
<S>                                        <C>                 <C>
Net revenues............................       $     71,560        $     86,723
Costs of products sold..................             46,453              47,780
                                           ----------------    ----------------
Gross margin............................             25,107              38,943
                                           ----------------    ----------------
Operating expenses:
  Advertising and promotion.............              9,662              12,411
  Other selling and administrative......             12,332              13,253
  Royalties, research and development...             10,093              15,502
                                           ----------------    ----------------
Total operating expenses................             32,087              41,166
Earnings (loss) from operations.........             (6,980)             (2,223)
Interest expense........................             (1,387)             (1,596)
Other income (expense), net.............                109                  91
                                           ----------------    ----------------
Earnings (loss) before income taxes.....             (8,258)             (3,728)
Provision for income taxes..............                 --                  --
                                           ----------------    ----------------
Net earnings (loss).....................             (8,258)             (3,728)
Preferred stock dividends:
  Paid..................................                                      6
  In arrears............................              1,564                  15
Charge related to the exchange of
  preferred stock for common............                 --              24,279
                                           ----------------    ----------------
Net earnings (loss) applicable to common
  shares................................       $    ( 9,822)       $    (28,028)
                                           ----------------    ----------------
                                           ----------------    ----------------
Common shares and common share
  equivalents outstanding--Average......             10,064              12,774
Net earnings (loss) per common share:
  Primary...............................       $      (0.98)       $      (2.19)
  Fully diluted.........................       $      (0.98)       $      (2.19)
</TABLE>
 
             The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                     F-21

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                         (IN THOUSANDS, EXCEPT SHARES)
 
<TABLE>
<CAPTION>
                                             SIX MONTHS ENDED
                                                 JUNE 30,
                                           --------------------
                                             1995        1996
                                           --------    --------
                                               (UNAUDITED)
<S>                                        <C>         <C>
Cash flow from operating activities:
  Net earnings (loss)...................   $ (8,258)   $ (3,728)
  Adjustments to reconcile net earnings
     (loss) to net cash provided by
     (used in) operating activities:
     Depreciation.......................        130         350
     Changes in assets and liabilities:
       Accounts receivable..............     14,695       6,629
       Inventories......................     (1,180)     (3,195)
       Tooling and related costs........        284      (4,672)
       Prepaid expenses and other
        assets..........................     (9,067)     (2,148)
       Accounts payable.................     (2,205)     (3,356)
       Accrued expenses.................     (5,461)     (5,727)
       Income taxes payable.............       (227)       (359)
                                           --------    --------
     Net cash (used in) provided by
      operating activities..............    (11,289)    (16,206)
                                           --------    --------
Cash flow from investing activities:
  Investment in land, building and
     equipment, net.....................         37      (1,518)
                                           --------    --------
     Net cash (used in) provided by
      investing activities..............         37      (1,518)
                                           --------    --------
Cash flow from financing activities:
  Net borrowings under notes payable....     10,176      19,573
  Repayments under long-term debt
     agreements.........................       (105)       (104)
  Proceeds from issuance of common
     stock..............................         62         875
  Redemption of preferred stock.........         --        (462)
  Costs associated with the conversion
     of debentures and the preferred
     shares exchange....................         --      (1,268)
                                           --------    --------
  Net cash (used in) provided by

     financing activities...............     10,133      18,614
                                           --------    --------
Increase (decrease) in cash and cash
  equivalents...........................     (1,119)        890
Cash and cash equivalents at beginning
  of period.............................      2,225       2,030
                                           --------    --------
Cash and cash equivalents at end of
  period................................   $  1,106    $  2,920
                                           --------    --------
                                           --------    --------
</TABLE>

Supplemental disclosure of non-cash activity:
    During the six months ended June 30, 1996, $14,000 of the
     Company's 8% convertible subordinated debentures were
     converted into 1,511,872 shares of its common stock.
     Deferred loan costs and accrued interest amounting to
     approximately $505, net, were debited to additional
     paid-in capital. See Note E.
    During the six months ended June 30, 1996, 1,822,899
     depositary shares of the Company's preferred stock were
     exchanged for 3,359,432 shares of its common stock. See
     Note F.
 
             The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                     F-22

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                         SIX MONTHS ENDED JUNE 30, 1996
                                  (UNAUDITED)
 
NOTE A--CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
     The condensed consolidated balance sheets as of June 30, 1995 and 1996 and
the condensed consolidated statements of operations for the six month periods
ended June 30, 1995 and 1996 and the condensed consolidated statements of cash
flows for the six month periods ended June 30, 1995 and 1996 have been prepared
by the Company without audit. In the opinion of management, all adjustments
(which include only normal recurring adjustments) necessary to present fairly
the financial position, results of operations and cash flows at June 30, 1995
and 1996 and for all periods presented have been made.
 
     Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted. It is suggested that these condensed consolidated financial
statements be read in conjunction with the financial statements and notes
thereto for the year ended December 31, 1995 included elsewhere in this
prospectus. Certain amounts in the financial statements of prior years have been
reclassified to conform with the current year's presentation.
 
     The results of operations for the six month periods ended June 30, 1995 and
1996 are not necessarily indicative of the operating results for the full year.
 
NOTE B--LEGAL RECOVERY
 
     For the six month period ended June 30, 1996, other selling and
administrative expenses were reduced by $2.3 million received in settlement of a
claim for damages. This benefit was partially offset by $2.0 million of unusual
legal expenses incurred during the six month period ended June 30, 1996, related
to this claim and a lawsuit where the Company is the plaintiff.
 
NOTE C--INVENTORIES
 
<TABLE>
<CAPTION>
                                                      JUNE 30,
                                 DECEMBER 31,    ------------------
                                     1995         1995       1996
                                 ------------    -------    -------
                                           (IN THOUSANDS)
<S>                              <C>             <C>        <C>
Finished goods................     $ 17,023      $17,120    $19,589
Raw materials and parts.......          468          884      1,097
                                 ------------    -------    -------
                                   $ 17,491      $18,004    $20,686
                                 ------------    -------    -------
                                 ------------    -------    -------

</TABLE>
 
NOTE D--TOOLING AND RELATED COSTS
 
     Effective beginning January 1, 1996, the Company changed the timing of its
annual amortization of tooling, packaging design and sample costs. These annual
costs are now being amortized on a percentage of sales basis rather than the
previous straight-line basis. The Company believes this change improves the
matching of costs and revenues within an annual period. The effect of this
change in timing was to decrease costs of products sold and net loss by
approximately $1,500,000 or $.12 per common share for the six months ended June
30, 1996. This change in estimate will result in no impact on net income on an
annual basis.
 
     Research and development expenses incurred amount to $4,466,000 and
$5,063,000 for the six months ended June 30, 1995 and 1996, respectively.
 
NOTE E--LONG-TERM DEBT
 
     In February 1996, the Company issued a call for the redemption of its 8%
Convertible Subordinated Debentures originally due November 30, 2000 (the
'Debentures'). This call resulted in the conversion on March 15, 1996, of all
$14,000,000 Debentures at $9.26 per share and the issuance of 1,511,872 new
shares of common stock.
 
                                      F-23

<PAGE>

                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                         SIX MONTHS ENDED JUNE 30, 1996
                                  (UNAUDITED)
 
NOTE F--SHAREHOLDER'S EQUITY
 
     In February 1996, the Company offered to exchange 1.85 shares of its common
stock for each Depositary Exchangeable Preferred Share (the 'Depositary Shares')
outstanding. Each Depositary Share represents 1/10th of a share of $17.00
Convertible Exchangeable Preferred Stock. This inducement offer was accepted by
the owners of 98% of the Depositary Shares resulting in the issuance of
3,336,433 shares of common stock on March 29, 1996. Generally accepted
accounting principles require a non-cash charge to reduce Net Earnings
Applicable to Common Shares in the calculation of Earnings Per Share for the
fair value of the securities issued in excess of the existing conversion rate of
approximately 1.185 common shares. This charge amounted to $24,279,000 and had
the effect of increasing the net loss per common share by $1.90 from $.29 to
$2.19 in the six months ended June 30, 1996.
 
     Of the remaining 2% Depositary Shares, approximately 1% of the shares were
converted using the conversion rate of approximately 1.185 common shares and the
remaining 1% were redeemed in cash for approximately $462,000.
 

NOTE G--RECENT ACCOUNTING PRONOUNCEMENT
 
     The FASB issued a new standard, SFAS No. 123, 'Accounting for Stock-Based
Compensation' which contains a fair value-based method for valuing stock-based
compensation that entities may use, which measures compensation cost at the
grant date based on the fair value of the award. Compensation is then recognized
over the service period, which is usually the vesting period. Alternatively, the
standard permits entities to continue accounting for employee stock options and
similar equity instruments under APB Opinion 25, 'Accounting for Stock Issued to
Employees.' Entities that continue to account for stock options using APB
Opinion 25 are required to make pro forma disclosures of net income and earnings
per share, as if the fair value-based method of accounting defined in SFAS No.
123 had been applied. The Company has determined to continue to account for
stock options using APB Opinion 25 and will make required pro forma disclosures
in the notes to its consolidated financial statements. The Company will be
required to adopt the new standard for the year ending December 31, 1996.
 
                                      F-24

<PAGE>

            ------------------------------------------------------
            ------------------------------------------------------
 
     NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED IN CONNECTION
WITH THIS OFFERING TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER
THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION
OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY OR ANY OF THE UNDERWRITERS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE
SUBSEQUENT TO THE DATE HEREOF. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO
SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE COMMON
STOCK OFFERED HEREBY OR BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS UNLAWFUL, OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANYONE TO WHOM IT IS UNLAWFUL TO
MAKE SUCH OFFER OR SOLICITATION.

                            ------------------------
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                  PAGE
                                                  ----
<S>                                               <C>
Prospectus Summary.............................     3
Risk Factors...................................     7
Use of Proceeds................................    12
Dividend Policy................................    12
Price Range of Common Stock....................    13
Capitalization.................................    14
Selected Consolidated Financial Data...........    15
Management's Discussion and Analysis of
  Financial Condition and Results of
  Operations...................................    16
Business.......................................    22
Management.....................................    33
Principal and Selling Stockholders.............    41
Certain Relationships and Related
  Transactions.................................    42
Description of Capital Stock...................    42
Underwriting...................................    45
Legal Matters..................................    46
Experts........................................    46
Available Information..........................    46
Index to Consolidated Financial Statements.....   F-1
</TABLE>
 
            ------------------------------------------------------
            ------------------------------------------------------

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


                                     [LOGO]
 


                                2,392,866 SHARES
                                       OF
                                  COMMON STOCK


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

                                   PROSPECTUS

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



                       GERARD KLAUER MATTISON & CO., LLC

                            WILLIAM BLAIR & COMPANY

                           JEFFERIES & COMPANY, INC.




                                          , 1996
 
            ------------------------------------------------------
            ------------------------------------------------------

<PAGE>

                                    PART II

                   INFORMATION NOT REQUIRED IN THE PROSPECTUS
 
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
 
     The following table sets forth the estimated costs and expenses in
connection with the issuance and distribution of the securities being
registered, other than underwriting discounts. All of the following costs and
expenses are estimated except the Securities and Exchange Commission
Registration Fee and the NASD Filing Fee.
 
<TABLE>
<S>                                                              <C>
Securities and Exchange Commission Registration Fee............  $  27,104
NASD Filing Fee................................................  $   8,360
Printing and Engraving Expenses................................  $   *
Counsel Fees and Expenses......................................  $   *
Financial Advisory Fee.........................................  $   *
Accountants' Fees and Expenses.................................  $   *
Blue Sky Fees and Expenses.....................................  $   *
Transfer Agent and Registrar Fees and Expenses.................  $   *
NYSE Listing Fee...............................................  $   *
Miscellaneous..................................................  $   *
                                                                 ---------
Total..........................................................  $   *
                                                                 ---------
                                                                 ---------
</TABLE>
 
- ------------------
* To be filed by amendment
 
     The Company will pay all expenses of the Company and the Selling
Stockholder (other than underwriting discounts on shares of Common Stock sold by
the Selling Stockholder) relating to this offering.
 
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
 
     The indemnification of officers and directors of the Company is governed by
Section 145 of the General Corporation Law of the State of Delaware (the 'DGCL')
and the Certificate of Incorporation and By-Laws of the Company. Among other
things, the DGCL permits indemnification of a director, officer, employee or
agent in civil, criminal, administrative or investigative actions, suits or
proceedings (other than an action by or in the right of the corporation) to
which such person is a party or is threatened to be made a party by reason of
the fact of such relationship with the corporation or the fact that such person
is or was serving in a similar capacity with another entity at the request of
the corporation against expenses (including attorneys' fees), judgments, fines
and amounts paid in settlement actually and reasonably incurred by him if such
person acted in good faith and in a manner he reasonably believed to be in or
not opposed to the best interests of the corporation, and, with respect to any

criminal action or proceeding, if he had no reasonable cause to believe his
conduct was unlawful. No indemnification may be made in any such suit to any
person adjudged to be liable to the corporation unless and only to the extent
that the Delaware Court of Chancery or the court in which the action was brought
determines that, despite the adjudication of liability, such person is under all
circumstances, fairly and reasonably entitled to indemnity for such expenses
which such court shall deem proper. Under the DGCL, to the extent that a
director, officer, employee or agent is successful, on the merits or otherwise,
in the defense of any action, suit or proceeding or any claim, issue or matter
therein (whether or not the suit is brought by or in the right of the
corporation), he shall be indemnified against expenses (including attorneys'
fees) actually and reasonably incurred by him. In all cases in which
indemnification is permitted (unless ordered by a court), it may be made by the
corporation only as authorized in the specific case upon a determination that
the applicable standard of conduct has been met by the party to be indemnified.
The determination must be made by a majority vote of a quorum consisting of the
directors who were not parties to the action or, if such a quorum is not
obtainable, or even if obtainable, if a quorum of disinterested directors so
directs, by independent legal counsel in a written opinion, or by the
stockholders. The statute authorizes the corporation to pay expenses incurred by
an officer or director in advance of a final disposition of a proceeding upon
receipt of an undertaking by or on behalf of the person to whom the advance will
be made, to repay the advances if it shall ultimately be determined that he was
 
                                      II-1

<PAGE>

not entitled to indemnification. The DGCL provides that indemnification and
advances of expenses permitted thereunder are not to be exclusive of any rights
to which those seeking indemnification or advancement of expenses may be
entitled under any By-Law, agreement, vote of stockholders or disinterested
directors, or otherwise. The DGCL also authorizes the Company to purchase and
maintain liability insurance on behalf of its directors, officers, employees and
agents regardless of whether the Company would have the statutory power to
indemnify such persons against the liabilities insured.
 
     The Certificate of Incorporation of the Company (the 'Certificate')
provides that no director of the Company shall be personally liable to the
Company or its stockholders for monetary damages for breach of fiduciary duty as
a director, except for liability (i) for any breach of the director's duty of
loyalty to the Company or its stockholders, (ii) for acts or omissions not in
good faith or which involve intentional misconduct or a knowing violation of
law, (iii) for paying a dividend or approving a stock repurchase in violation of
Section 174 of the DGCL or (iv) for any transaction from which the director
derived an improper personal benefit.
 
     The Certificate also provides that directors, officers, employees and
others shall be indemnified to the fullest extent authorized by the DGCL, as in
effect (or, to the extent indemnification is broadened, as it may be amended),
against any and all expense, liability and loss (including attorneys' fees,
judgments, penalties, fines, ERISA excise taxes and judgments, fines and amounts
paid or to be paid in settlement) from threatened, pending or completed actions,
suits or proceedings, whether civil, criminal, administrative or investigative.

The Certificate further provides that, to the extent permitted by the DGCL,
expenses so incurred by any such person in defending an action, suit or
proceeding shall, at his request, be paid by the Company in advance of the final
disposition of such action or proceeding.
 
     The Certificate provides that the right to indemnification and the payment
of expenses incurred in defending a proceeding in advance of its final
disposition shall not be exclusive of any other right which any person may have
or acquire under any statute, provision of the Certificate or By-Laws of the
Company, agreement, vote of stockholder or disinterested directors, or
otherwise.
 
     The Company has obtained directors' and officers' liability and company
reimbursement insurance which, among other things (i) provides for payment on
behalf of its officers and directors against loss as defined in the policy
stemming from acts committed by directors and officers in their capacity as such
and (ii) provides for payment on behalf of the Company against such loss but
only when the Company shall be required or permitted to indemnify directors or
officers for such loss pursuant to statutory or common law or pursuant to duly
effective Certificate or By-Law provisions.
 
     Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the 'Act'), may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing provisions, or
otherwise, the Company has been advised that in the opinion of the Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
liabilities (other than the payment by the Company of expenses incurred or paid
by a director, officer or controlling person of the Company in the successful
defense of any action, suit or proceeding) is asserted by such director, officer
or controlling person in connection with the securities being registered, the
Company will, unless in the opinion of its counsel the matter has been settled
by controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
 
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
 
     In a November 1993 private placement, the Company raised $14,000,000
through the sale of its 8% Convertible Subordinated Debentures due 2000 (the
'Debentures'). The Debentures mature on November 30, 2000 and are convertible
into 1,511,872 shares of common stock of the Company ('Common Stock') based on
the current $9.26 conversion price. In connection with the sale of the
Debentures, the Company paid a commission to its investment banker of $560,000
and issued it warrants to purchase 150,000 shares of Common Stock, at an
exercise price of $9.50 per share. The issuance of the above securities was
deemed to be exempt from registration under the Act, in reliance on Section 4(2)
thereof or Regulation D promulgated thereunder, as transactions by an issuer not
involving any public offering.
 
                                      II-2

<PAGE>


     On February 12, 1996, the Company issued a call for the redemption of its
Debentures. In connection with the redemption, holders of Debentures exercised
their right to convert the Debentures into Common Stock at the rate of $9.26
principal amount for each share of Common Stock. This resulted in the conversion
of all of the Debentures in to 1,511,872 shares of Common Stock at $9.26 per
share. The issuance of the above securities was deemed to be exempt from
registration under the Act, in reliance on Section 3(a)(9) thereof.
 
     On February 28, 1996, the Company commenced an exchange offer for its
Depositary Convertible Exchangeable Preferred Shares (the 'Depositary Shares'),
offering to exchange 1.85 shares of Common Stock for each outstanding Depositary
Share. The exchange offer was accepted by the holders of 98% of the Depositary
Shares, resulting in the issuance of 3,336,433 shares of Common Stock on March
29, 1993, the expiration date of the offer. The issuance of the above securities
was deemed to be exempt from registration under the Act, in reliance of Section
3(a)(9) thereof.
 
     On May 10, 1996, the Company elected to redeem all of its outstanding
Depositary Shares, in accordance with the terms under which they were issued. In
connection with the redemption, certain holders of the Depositary Shares
exercised their right to convert their Depositary Shares into shares of Common
Stock at the rate of 1.185 shares of Common Stock per Depositary Share. This
resulted in the issuance of approximately 3.3 million shares of Common Stock on
the Redemption Date. The issuance of the above securities was deemed to be
exempt from registration under the Act, in reliance on Section 3(a)(9) thereof.
 
 ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
 
     (a) The following exhibits are filed as part of the Registration Statement:

<TABLE>
<S>           <C>   <C>
  1.1+         --   Form of Underwriting Agreement.
  3.1(1)       --   Certificate of Incorporation.
  3.2(1)       --   By-laws.
  4.1(2)       --   Form of Certificate for Shares of Common Stock of
                    Registrant.
  4.2(a)(3)    --   Warrant Agreement, dated as of July 7, 1988,
                    between the Registrant and Wells Fargo Bank and
                    warrants issued to Wells Fargo Bank.
  4.2(b)(4)    --   Warrant Agreement, dated as of December 11, 1991,
                    by and between the Registrant and Shereff,
                    Friedman, Hoffman and Goodman, LLP.
  4.2(c)(4)    --   Warrant Agreement, dated as of November 17, 1993,
                    by and between the Registrant and Gerard Klauer
                    Mattison & Co., Inc.
  4.3(5)       --   Form of Rights Agreement, dated as of January 17,
                    1990, between the Registrant and Mellon Securities
                    Trust Company.
  5.1+         --   Opinion of Weil, Gotshal & Manges LLP.
 10.1(a)(6)*   --   Amended and Restated 1984 Employee Stock Option
                    Plan.
 10.1(b)(7)*   --   1994 Senior Management Stock Option Plan.

 10.1(c)(8)*   --   Form of Agreement between each of Mark Goldman,
                    William Catron, Louis Novak, Gary Niles, Ronald
                    Hirschfeld and H. Alan Gaudie and the Registrant.
 10.1(d)(9)*   --   Form of Amendment No. 1 between each of Mark
                    Goldman, William Catron, Louis Novak, Gary Niles,
                    Ronald Hirschfeld and H. Alan Gaudie and the
                    Registrant.
 10.1(e)(10)   --   1995 Non-Employee Directors' Stock Option Plan.
 10.2(10)*     --   Lewis Galoob Toys, Inc. Savings and Retirement
                    Plan (Formerly the Lewis Galoob Toys, Inc. Profit
                    Sharing) (Amendment and Restatement effective
                    January 1, 1987).
 10.3(9)*      --   Severance Agreement, dated October 27, 1994,
                    between Mark Goldman and the Registrant.
 10.4(a)(12)*  --   Agreement, dated July 15, 1995, between William G.
                    Catron and the Registrant.
 10.4(b)(12)*  --   Agreement, dated July 15, 1995, between Loren
                    Hildebrand and the Registrant.
 10.4(c)(12)*  --   Agreement, dated July 15, 1995, between Ronald
                    Hirschfeld and the Registrant.
 10.4(d)(12)*  --   Agreement, dated July 15, 1995, between Gary J.
                    Niles and the Registrant.
 10.4(e)(12)*  --   Agreement, dated July 15, 1995, between Louis R.
                    Novak and the Registrant.
 10.5(9)       --   Amended and Restated Loan and Security Agreement,
                    dated as of March 31, 1995, by and among the
                    Registrant and Congress Financial Corporation
                    (Central).
 10.6(a)(13)   --   License Agreement, dated June 16, 1986, by and
                    between Funmaker, as Licensor and the Registrant,
                    as Licensee.
</TABLE>
 
                                      II-3


<PAGE>

<TABLE>
<S>           <C>   <C>
 10.7(b)(14)   --   License Agreement, dated May 4, 1990, by and among
                    the Registrant as Licensee, Codemasters Software
                    Company, Ltd. and Camerica Corporation, Limited.
 10.7(c)(14)   --   Amendment No. 1 dated June 1991 to License
                    Agreement dated May 4, 1990.
 10.7(d)(14)   --   Amendment No. 2 dated December 23, 1991 to License
                    Agreement, dated May 4, 1990.
 10.7(e)(14)   --   European License Agreement, dated December 23,
                    1991, by and between Codemasters Software Company,
                    Ltd. and the Registrant.
 10.7(f)(14)   --   Third Amendment to United States License and First
                    Amendment to European License, dated November 4,
                    1992.
 10.7(g)(9)    --   Fourth Amendment to United States License
                    Agreement, dated October 14, 1994.
 10.8(13)      --   Agreement of Purchase and Sale, dated October 22,
                    1986, by and between ATC Building Company, as
                    Seller, and the Registrant, as Buyer.
 10.9(a)(1)    --   Lease Agreement, dated March 12, 1987, by and
                    between Lincoln Alvarado and Patrician Associates,
                    Inc., as Lessor, and the Registrant, as Lessee.
 10.9(b)(11)   --   Amendment No. 1 to Lease Agreement.
 10.9(c)(10)   --   Lease Agreement, dated December 1, 1995, by and
                    between 200 Fifth Avenue Associates, as Lessor,
                    and the Registrant, as Lessee.
 11            --   Statement of Computation of Per Share Earnings.
 21            --   Subsidiaries of the Registrant.
 23.1          --   Consent of Price Waterhouse LLP.
 23.2+         --   Consent of Weil, Gotshal & Manges LLP (included in
                    its opinion which appears as Exhibit 5.1).
 24(12)        --   Power of Attorney.
</TABLE>
 
- ------------------
 
(1) Incorporated by reference to the Registrant's Amendment No. 1 to
    Registration Statement on Form 8-B, filed with the Securities and Exchange
    Commission (the 'Commission') on January 11, 1988.
 
(2) Incorporated by reference to the Registrant's Registration Statement on Form
    S-3, filed with the Commission on February 26, 1990.
 
(3) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1987, filed with the Commission on August 2, 1988.
 
(4) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1993, filed with the Commission on March 31, 1994.
 
(5) Incorporated by reference to the Registrant's Registration Statement on Form
    8-A, filed with the Commission on January 23, 1990.

 
(6) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56585, filed with the Commission on November 23,
    1994.
 
(7) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56587, filed with the Commission on November 23,
    1994.
 
(8) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56589, filed with the Commission on November 23,
    1994.
 
(9) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1994, filed with the Commission on March 31, 1995.
 
(10) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1995, filed with the Commission on March 11, 1996.
 
(11) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1991, filed with the Commission on March 30, 1992.
 
(12) (included on signature page to this Registration Statement)
 
(13) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1986, filed with the Commission on March 31, 1987.
 
(14) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1992, filed with the Commission on March 31, 1993.
 
+ To be filed by amendment.
 
* Indicates exhibits relating to executive compensation.
 
                                      II-4

<PAGE>

     (b)  Financial Statements Schedules
 
     Schedule II--Valuation and Qualifying Accounts and Reserves for the years
ended December 31, 1995, 1994 and 1993.
 
     All other schedules are omitted because they are not applicable or the
required information is shown in the Company's consolidated financial statements
or the notes thereto.
 
ITEM 17. UNDERTAKINGS.
 
     Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the 'Act'), may be permitted to directors, officers and
controlling persons of the Registrant under the General Corporation Law of the
State of Delaware or pursuant to the Registrant's Certificate of Incorporation
or By-Laws or otherwise, the Registrant has been advised that in the opinion of

the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
 
     The Registrant hereby undertakes that:
 
          (1) for purposes of determining any liability under the Act, the
     information omitted from the form of prospectus filed as part of this
     registration statement in reliance upon Rule 430A under the Act and
     contained in a form of prospectus filed by the Registrant pursuant to Rule
     424(b)(1) or (4) or 497(h) under the Act shall be deemed to be part of this
     registration statement as of the time it was declared effective;
 
          (2) for the purpose of determining any liability under the Securities
     Act of 1933, each post-effective amendment shall be deemed to be a new
     registration statement relating to the securities offered therein, and the
     offering of such securities at that time shall be deemed to be the initial
     bona fide offering thereof.
 
                                      II-5

<PAGE>

                                   SIGNATURES
 
     Pursuant to the requirements of the Act, the Registrant has duly caused
this Registration Statement on Form S-1 to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of South San Francisco,
State of California, on the 25th day of September, 1996.
 
                                          LEWIS GALOOB TOYS, INC.
 
                                          By:         /s/ MARK D. GOLDMAN
                                              ----------------------------------
                                                       Mark D. Goldman
                                               President and Chief Executive
                                                         Officer
 
                               POWER OF ATTORNEY
 
     KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints each of Mark D. Goldman and H. Alan Gaudie, or
any of them, each acting alone, his true and lawful attorney-in-fact and agent
with full powers of substitution and resubstitution, for such person and in his
name, place and stead, in any and all capacities, in connection with the
Registrant's Registration Statement on Form S-1 under the Securities Act of
1933, including to sign the Registration Statement and any and all amendments or
supplements to the Registration Statement, including any and all stickers and
post-effective amendments to the Registration Statement and to sign any and all
additional registration statements relating to the same offering of securities
as those that are covered by the Registration Statement that are filed pursuant
to Rule 462(b) under the Securities Act of 1933, and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission and any applicable securities exchange or
securities self-regulatory body, granting unto said attorneys-in-fact and
agents, each acting alone, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully, to all intents and purposes, as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or his substitute or substitutes, may lawfully do or cause to be done by
virtue hereof.
 
     Pursuant to the requirements of the Act, this Registration Statement has
been signed below by the following persons in the capacities and on the dates
indicated.
 
<TABLE>
<CAPTION>
          SIGNATURE                      TITLES                    DATE
- ------------------------------  -------------------------  --------------------
<S>                             <C>                        <C>
     /s/ MARK D. GOLDMAN        President, Chief             September 25, 1996
- ------------------------------  Executive Officer and
       Mark D. Goldman          Director
 


      /s/ ROGER KOWALSKY        Executive Vice President     September 25, 1996
- ------------------------------  and Chief Financial
        Roger Kowalsky          Officer and Director
 

     /s/ ANDREW CAVANAUGH       Director                     September 25, 1996
- ------------------------------
       Andrew Cavanaugh
 

   /s/ PAUL A. GLIEBE, JR.      Director                     September 25, 1996
- ------------------------------
     Paul A. Gliebe, Jr.
 

    /s/ SCOTT R. HELDFOND       Director                     September 25, 1996
- ------------------------------
      Scott R. Heldfond
 

       /s/ S. LEE KLING         Director                     September 25, 1996
- ------------------------------
         S. Lee Kling
</TABLE>
 
                                      II-6

<PAGE>

                                                                     SCHEDULE II
 
                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
                                 (in thousands)
 
<TABLE>
<CAPTION>
                                          ADDITIONS
                            BALANCE AT    CHARGED TO                   BALANCE
                            BEGINNING     COSTS AND                    AT END
DESCRIPTION                 OF PERIOD      EXPENSES     DEDUCTIONS    OF PERIOD
- -------------------------   ----------    ----------    ----------    ---------
<S>                         <C>           <C>           <C>           <C>
Year ended 12/13/93
- -------------------------
Provisions for returns
and allowance............     $6,031       $  5,516      $  6,298      $ 5,249
 
Year ended 12/31/94
- -------------------------
Provisions for returns
and allowance............      5,249         11,979         9,131        8,097
 
Year ended 12/31/95
- -------------------------
Provisions for returns
and allowance............      8,097         12,707        10,822        9,982
</TABLE>
 
See Note B of Notes to Consolidated Financial Statements.
 
                                      S-1

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
Exhibit                  Description
- -------                  -----------
<S>           <C>   <C>
  1.1+         --   Form of Underwriting Agreement.
  3.1(1)       --   Certificate of Incorporation.
  3.2(1)       --   By-laws.
  4.1(2)       --   Form of Certificate for Shares of Common Stock of
                    Registrant.
  4.2(a)(3)    --   Warrant Agreement, dated as of July 7, 1988,

                    between the Registrant and Wells Fargo Bank and
                    warrants issued to Wells Fargo Bank.
  4.2(b)(4)    --   Warrant Agreement, dated as of December 11, 1991,
                    by and between the Registrant and Shereff,
                    Friedman, Hoffman and Goodman, LLP.
  4.2(c)(4)    --   Warrant Agreement, dated as of November 17, 1993,
                    by and between the Registrant and Gerard Klauer
                    Mattison & Co., Inc.
  4.3(5)       --   Form of Rights Agreement, dated as of January 17,
                    1990, between the Registrant and Mellon Securities
                    Trust Company.
  5.1+         --   Opinion of Weil, Gotshal & Manges LLP.
 10.1(a)(6)*   --   Amended and Restated 1984 Employee Stock Option
                    Plan.
 10.1(b)(7)*   --   1994 Senior Management Stock Option Plan.
 10.1(c)(8)*   --   Form of Agreement between each of Mark Goldman,
                    William Catron, Louis Novak, Gary Niles, Ronald
                    Hirschfeld and H. Alan Gaudie and the Registrant.
 10.1(d)(9)*   --   Form of Amendment No. 1 between each of Mark
                    Goldman, William Catron, Louis Novak, Gary Niles,
                    Ronald Hirschfeld and H. Alan Gaudie and the
                    Registrant.
 10.1(e)(10)   --   1995 Non-Employee Directors' Stock Option Plan.
 10.2(10)*     --   Lewis Galoob Toys, Inc. Savings and Retirement
                    Plan (Formerly the Lewis Galoob Toys, Inc. Profit
                    Sharing) (Amendment and Restatement effective
                    January 1, 1987).
 10.3(9)*      --   Severance Agreement, dated October 27, 1994,
                    between Mark Goldman and the Registrant.
 10.4(a)(12)*  --   Agreement, dated July 15, 1995, between William G.
                    Catron and the Registrant.
 10.4(b)(12)*  --   Agreement, dated July 15, 1995, between Loren
                    Hildebrand and the Registrant.
 10.4(c)(12)*  --   Agreement, dated July 15, 1995, between Ronald
                    Hirschfeld and the Registrant.
 10.4(d)(12)*  --   Agreement, dated July 15, 1995, between Gary J.
                    Niles and the Registrant.
 10.4(e)(12)*  --   Agreement, dated July 15, 1995, between Louis R.
                    Novak and the Registrant.
 10.5(9)       --   Amended and Restated Loan and Security Agreement,
                    dated as of March 31, 1995, by and among the
                    Registrant and Congress Financial Corporation
                    (Central).
 10.6(a)(13)   --   License Agreement, dated June 16, 1986, by and
                    between Funmaker, as Licensor and the Registrant,
                    as Licensee.
</TABLE>
 


<PAGE>

<TABLE>
<S>           <C>   <C>
 10.7(b)(14)   --   License Agreement, dated May 4, 1990, by and among
                    the Registrant as Licensee, Codemasters Software
                    Company, Ltd. and Camerica Corporation, Limited.
 10.7(c)(14)   --   Amendment No. 1 dated June 1991 to License
                    Agreement dated May 4, 1990.
 10.7(d)(14)   --   Amendment No. 2 dated December 23, 1991 to License
                    Agreement, dated May 4, 1990.
 10.7(e)(14)   --   European License Agreement, dated December 23,
                    1991, by and between Codemasters Software Company,
                    Ltd. and the Registrant.
 10.7(f)(14)   --   Third Amendment to United States License and First
                    Amendment to European License, dated November 4,
                    1992.
 10.7(g)(9)    --   Fourth Amendment to United States License
                    Agreement, dated October 14, 1994.
 10.8(13)      --   Agreement of Purchase and Sale, dated October 22,
                    1986, by and between ATC Building Company, as
                    Seller, and the Registrant, as Buyer.
 10.9(a)(1)    --   Lease Agreement, dated March 12, 1987, by and
                    between Lincoln Alvarado and Patrician Associates,
                    Inc., as Lessor, and the Registrant, as Lessee.
 10.9(b)(11)   --   Amendment No. 1 to Lease Agreement.
 10.9(c)(10)   --   Lease Agreement, dated December 1, 1995, by and
                    between 200 Fifth Avenue Associates, as Lessor,
                    and the Registrant, as Lessee.
 11            --   Statement of Computation of Per Share Earnings.
 21            --   Subsidiaries of the Registrant.
 23.1          --   Consent of Price Waterhouse LLP.
 23.2+         --   Consent of Weil, Gotshal & Manges LLP (included in
                    its opinion which appears as Exhibit 5.1).
 24(12)        --   Power of Attorney.
</TABLE>
 
- ------------------
 
(1) Incorporated by reference to the Registrant's Amendment No. 1 to
    Registration Statement on Form 8-B, filed with the Securities and Exchange
    Commission (the 'Commission') on January 11, 1988.
 
(2) Incorporated by reference to the Registrant's Registration Statement on Form
    S-3, filed with the Commission on February 26, 1990.
 
(3) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1987, filed with the Commission on August 2, 1988.
 
(4) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1993, filed with the Commission on March 31, 1994.
 
(5) Incorporated by reference to the Registrant's Registration Statement on Form
    8-A, filed with the Commission on January 23, 1990.

 
(6) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56585, filed with the Commission on November 23,
    1994.
 
(7) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56587, filed with the Commission on November 23,
    1994.
 
(8) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56589, filed with the Commission on November 23,
    1994.
 
(9) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1994, filed with the Commission on March 31, 1995.
 
(10) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1995, filed with the Commission on March 11, 1996.
 
(11) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1991, filed with the Commission on March 30, 1992.
 
(12) (included on signature page to this Registration Statement)
 
(13) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1986, filed with the Commission on March 31, 1987.
 
(14) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1992, filed with the Commission on March 31, 1993.
 
+ To be filed by amendment.
 
* Indicates exhibits relating to executive compensation.
[{"type": "S-1", "sequence": "1", "description": "REGISTRATION STATEMENT", "secsgml_size_bytes": 338906}]
{"company-data": {"conformed-name": "GALOOB LEWIS TOYS INC /DE/", "cik": "0000751968", "assigned-sic": "3944", "irs-number": "941716574", "state-of-incorporation": "DE", "fiscal-year-end": "1231"}, "filing-values": {"form-type": "S-1", "act": "33", "file-number": "333-12953", "film-number": "96636313"}, "business-address": {"street1": "500 FORBES BLVD", "city": "SOUTH SAN FRANCISCO", "state": "CA", "zip": "94080", "phone": "4159521678"}}
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 27, 1996

                                                     REGISTRATION NO. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
 
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                            ------------------------
 
                                    FORM S-1
                             REGISTRATION STATEMENT
                                     UNDER
                           THE SECURITIES ACT OF 1933

                            ------------------------
 
                            LEWIS GALOOB TOYS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                            ------------------------
DELAWARE                        5040                     94-1716574
(STATE OR OTHER JURISDICTION  (PRIMARY STANDARD INDUSTRIAL   (I.R.S. EMPLOYER
    OF INCORPORATION OR        CLASSIFICATION CODE NUMBER)  IDENTIFICATION NO.)
       ORGANIZATION)
------------------------
 
                              500 FORBES BOULEVARD
                     SOUTH SAN FRANCISCO, CALIFORNIA 94080
                                 (415) 952-1678
              (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
       INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

                            ------------------------
 
                            WILLIAM G. CATRON, ESQ.
                  EXECUTIVE VICE PRESIDENT AND GENERAL COUNSEL
                            LEWIS GALOOB TOYS, INC.
                              500 FORBES BOULEVARD
                     SOUTH SAN FRANCISCO, CALIFORNIA 94080
                                 (415) 952-1678
           (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
                   INCLUDING AREA CODE, OF AGENT FOR SERVICE)

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

                                   Copies to:
STEPHEN M. BESEN, ESQ.                 JEFFREY S. MARCUS, ESQ.
      WEIL, GOTSHAL & MANGES LLP               MORRISON & FOERSTER LLP
           767 FIFTH AVENUE                  1290 AVENUE OF THE AMERICAS
       NEW YORK, NEW YORK 10153                NEW YORK, NEW YORK 10104
            (212) 310-8000                          (212) 468-8000
------------------------
 
    APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
 
    If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: / /
 
    If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
 
    If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier registration statement for the same
offering. / /
 
    If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /

                            ------------------------
 
                        CALCULATION OF REGISTRATION FEE
PROPOSED
                                                             MAXIMUM OFFERING    PROPOSED MAXIMUM
          TITLE OF EACH CLASS                 AMOUNT TO         PRICE PER           AGGREGATE           AMOUNT OF
     OF SECURITIES TO BE REGISTERED         BE REGISTERED        SHARE(1)         OFFERING PRICE     REGISTRATION FEE
Common Stock, $.01 par value............    2,751,796(2)         $28.563           $78,599,550           $27,104
(1) Estimated solely for purposes of calculating the registration fee. Pursuant
    to Rule 457(c), equals the average of the high and low sales prices of the
    Common Stock on the New York Stock Exchange on September 20, 1996.

(2) Includes 358,930 shares of Common Stock which the Underwriters have an
    option to purchase from the Company to cover over-allotments, if any.

                            ------------------------
 
    THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
================================================================================
LEWIS GALOOB TOYS, INC.

                             CROSS-REFERENCE SHEET
                   PURSUANT TO ITEM 501(b) OF REGULATION S-K
FORM S-1 ITEM NUMBER AND HEADING     CAPTION OR LOCATION IN PROSPECTUS
     -----------------------------------  -----------------------------------
1.  Forepart of the Registration
       Statement and Outside Front Cover
       Page of Prospectus...............  Facing Page of Registration
                                            Statement; Cross-Reference Sheet;
                                            Outside Front Cover Page of
                                            Prospectus
 
 2.  Inside Front and Outside Back Cover
       Pages of Prospectus..............  Inside Front Cover Page and Outside
                                            Back Cover Page of Prospectus
 
 3.  Summary Information, Risk Factors
       and Ratio of Earnings to Fixed
       Charges..........................  Prospectus Summary; Risk Factors;
                                            Not Applicable
 
 4.  Use of Proceeds....................  Prospectus Summary; Use of Proceeds
 
 5.  Determination of Offering Price....  Not Applicable
 
 6.  Dilution...........................  Not Applicable
 
 7.  Selling Security Holders...........  Outside Front Cover Page; Principal
                                            and Selling Stockholders
 
 8.  Plan of Distribution...............  Outside Front Cover Page;
                                            Underwriting
 
 9.  Description of Securities to be
       Registered.......................  Outside Front Cover Page;
                                            Prospectus Summary; Dividends;
                                            Price Range of Common Stock;
                                            Description of Capital Stock
 
10.  Interests of Named Experts and
       Counsel..........................  Legal Matters; Experts
 
11.  Information with Respect to the
       Registrant.......................  Outside Front Cover Page;
                                            Prospectus Summary; Risk Factors;
                                            Dividend Policy; Price Range of

                                            Common Stock; Capitalization;
                                            Selected Consolidated Financial
                                            Data; Management's Discussion and
                                            Analysis of Financial Condition
                                            and Results of Operations;
                                            Business; Management; Principal
                                            and Selling Stockholders; Certain
                                            Transactions; Description of
                                            Capital Stock; Index to Financial
                                            Statements
 
12.  Disclosure of Commission Position
       on Indemnification for Securities
       Act Liabilities..................  Not Applicable
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT.
A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION.  THESE SECURITIES MAY
NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME
THE REGISTRATION STATEMENT BECOMES EFFECTIVE.  THIS PROSPECTUS SHALL
NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY
NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH
SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION
OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.

               SUBJECT TO COMPLETION, DATED SEPTEMBER 27, 1996

PROSPECTUS
 
                                2,392,866 SHARES
 
                                    [LOGO]
 
                                  COMMON STOCK

                            ------------------------
 
     Of the 2,392,866 shares of Common Stock offered hereby, 2,000,000 shares
are being issued and sold by Lewis Galoob Toys, Inc. (the 'Company') and 392,866
shares are being sold by the Selling Stockholder. See 'Principal and Selling
Stockholders.' The Company will not receive any proceeds from the sale of shares
by the Selling Stockholder.
 
     The Common Stock is traded on the New York Stock Exchange, Inc. (the
'NYSE') under the symbol 'GAL.' On September 26, 1996, the closing price per
share of Common Stock, as reported by the NYSE, was $29 3/4.

                            ------------------------
 
    THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. SEE 'RISK
                         FACTORS' BEGINNING ON PAGE 7.

                            ------------------------
 
         THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
          SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
           COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION
              OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
                 ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
                      REPRESENTATION TO THE CONTRARY IS A
                               CRIMINAL OFFENSE.
PROCEEDS TO

                                    PRICE TO          UNDERWRITING        PROCEEDS TO           SELLING
                                     PUBLIC           DISCOUNTS(1)         COMPANY(2)        STOCKHOLDER(2)
Per Share....................     $                   $                   $                   $
Total(3).....................     $                   $                   $                   $
(1) In connection with this offering, the Company and the Selling Stockholder
    have agreed to indemnify the Underwriters against certain liabilities,
    including liabilities under the Securities Act of 1933, as amended. See
    'Underwriting.'
 
(2) Before deducting expenses of this offering payable by the Company estimated
    at $         . Does not include payment to the Company of an aggregate of
    $1,700,000 upon the exercise by the Selling Stockholder of warrants
    concurrently with this offering.
 
(3) The Company has granted to the Underwriters a 45-day option to purchase up
    to 358,930 additional shares of Common Stock solely to cover
    over-allotments, if any, on the same terms and conditions as set forth
    above. If such option is exercised in full, the total Price to Public,
    Underwriting Discounts, Proceeds to Company and Proceeds to Selling
    Stockholder will be $         , $         , $         and $         ,
    respectively. See 'Underwriting.'

                            ------------------------
 
     The shares of Common Stock are offered by the Underwriters, subject to
prior sale, when, as and if delivered to and accepted by the Underwriters, and
subject to the right of the Underwriters to reject any order in whole or in part
and certain other conditions. It is expected that delivery of certificates for
the shares of Common Stock will be made at the offices of Bear, Stearns
Securities Corp., 1 Metrotech Center No., Brooklyn, New York 11201, as agent for
the Representatives, on or about             , 1996.
 
GERARD KLAUER MATTISON & CO., LLC
 
                            WILLIAM BLAIR & COMPANY
 
                                                       JEFFERIES & COMPANY, INC.

                            ------------------------
 
               THE DATE OF THIS PROSPECTUS IS             , 1996
[PICTURES OF TOYS]
 
     The Galoob logo and name are trademarks of the Company. Micro
Machines(Registered), Action Fleet(Trademark), Double Takes(Trademark) and
DOUBLE Double Takes(Trademark) are trademarks of the Company. Dragon
Flyz(Registered) and Sky Dancers(Registered) are trademarks licensed to the
Company by Abrams Gentile Entertainment Inc. Star Wars(Trademark) is a trademark
licensed to the Company by Lucasfilm Ltd. ('Lucasfilm'). Jonny Quest(Trademark)
is a trademark licensed to the Company by Turner Home Entertainment, Inc.
('Turner'). Pound Puppies(Registered) and Pound Pur-r-ries(Registered) are
trademarks licensed to the Company by Pound Puppies, Inc. Anastasia(Registered)
is a trademark licensed to the Company by Twentieth Century Fox Licensing and
Merchandising ('Fox'). Men in Black(Registered) and Starship
Troopers(Registered) are trademarks licensed to the Company by Sony Signatures
Licensing ('Sony'). All other trademarks appearing in this Prospectus are the
property of their respective holders.
 
     IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE NYSE OR OTHERWISE. SUCH STABILIZING, IF
COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
 
                                       2
PROSPECTUS SUMMARY
 
     The following summary is qualified in its entirety by reference to, and
should be read in conjunction with, the more detailed information (including the
consolidated financial statements and the notes thereto) appearing elsewhere in
this Prospectus. Each prospective investor is urged to read this Prospectus in
its entirety and should carefully consider the matters set forth in 'Risk
Factors.' Except for the historical information contained herein, the discussion
in this Prospectus contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in the section entitled 'Risk
Factors' and elsewhere in this Prospectus. Unless otherwise indicated, all
information in this Prospectus assumes no exercise of the Underwriters'
over-allotment option. See 'Underwriting.'
 
                                  THE COMPANY
 
     Founded in 1957, the Company is a leading international toy company that
designs, develops, markets and sells a variety of high-quality toy products in
an expanding number of product categories. The Company believes it is a leading
innovator in the toy industry as evidenced by: its award-winning Sky Dancers,
the world's first flying doll, introduced in late 1994; its Double Takes line of
Micro Machines transforming playsets, introduced in 1995; its line of Star Wars
Action Fleet toys representing a new scale in the male action category; and
Dragon Flyz, the world's first fully articulated flying male action figure. The
Company's Micro Machines line, introduced in 1987, is the most comprehensive
line of miniature scale play for boys in the United States, embracing
traditional vehicle, military and male action play patterns. The Company's Sky
Dancers line has been the number-one selling mini-doll in the United States in
1995 and 1996, and Dragon Flyz became the second best selling male action line
in the United States within weeks of its national introduction in June.
 
     The Company's 1996 product offerings consist of six product lines: Micro
Machines, Star Wars Action Fleet, Dragon Flyz, Jonny Quest, Sky Dancers, and
Pound Puppies. In addition to extensions of these product lines, the Company's
1997 product offerings are expected to include new product lines based on three
entertainment properties: Men In Black, a new science fiction adventure comedy
film scheduled to be released by Sony in the summer of 1997; Starship Troopers,
a new science fiction adventure film scheduled to be released by Sony in the
summer of 1997; and Anastasia, a new animated film scheduled to be released by
Fox in the fall of 1997. In connection with the scheduled re-release of the Star
Wars movie trilogy in early 1997, the Company plans to introduce new Star Wars
Micro Machines and Action Fleet toys. In addition, the Company intends to
aggressively pursue licensing rights in connection with the release of the new
Star Wars movie trilogy scheduled to start in 1999.
 
     The Company's products are sold in more than 50 countries worldwide. These
products are principally sold direct to retailers in the United States and to
toy distributors outside of the United States. Since 1993, the Company's
revenues have grown approximately 64% from approximately $134 million in 1993 to
approximately $220 million in 1995. In 1995, approximately one-third of the

Company's revenues were derived from international sales which have increased by
approximately 77% since 1993.
 
     Although the Company's sales have increased significantly since 1993, its
market share in 1995 was only approximately one percent of the total $13.4
billion U.S. wholesale toy shipments and, therefore, management believes there
is substantial opportunity for continued growth. The recent consolidations among
both toy companies and toy retailers have also provided increased growth
opportunities for the Company. The Company believes that the consolidation of
the industry into fewer larger toy companies combined with the Company's proven
success in developing and marketing licensed products make the Company a
relatively more attractive licensee to toy inventors and other licensors. In
addition, as a result of industry concentration, the Company has become a
relatively more attractive supplier to retailers that do not wish to be
dependent on a few dominant toy companies. Toy retailer concentration has also
been advantageous to the Company as it has reduced the need to support a large,
expensive sales and distribution organization to service numerous small
customers. This also enables the Company to ship product, manage account
relationships and track retail sales as effectively as much larger competitors.
 
                                       3
These industry trends and developments, combined with the successful
implementation of the Company's growth strategy, lead the Company to believe
that it is well positioned for future growth. The key elements of the Company's
growth strategy are as follows:
 
o Build The Company's Core Brand--Micro Machines.  The Company seeks to continue
  expanding its Micro Machines brand as the most comprehensive universe of
  miniature scale play for boys. The Company intends to accomplish this by
  extending Micro Machines into additional play patterns, such as the Micro
  Machines Exploration line for 1997, and to continue acquiring and exploiting
  new entertainment licenses to keep Micro Machines at the leading edge of boys'
  play.
 
o Enter New Product Categories.  The Company has entered and intends to continue
  to enter into new toy categories. Entering 1993, the Company competed
  primarily in only one category of the toy industry (excluding video
  games)--miniature vehicles, which generated approximately $240 million of
  total U.S. wholesale toy shipments in that year. Currently, the Company
  competes in four categories that generated approximately $2.1 billion of the
  total U.S. wholesale toy shipments in 1995. The Company considers entering new
  categories which have the following characteristics: (i) low barriers to entry
  such that there is no dominant competitor; and (ii) potential to create
  product lines that can become multi-year brands based upon collectibility and
  thematic extendability.
 
o Expand Profit Margins On Rising Sales.  A key goal of the Company is to expand
  profit margins while continuing to increase sales, thereby increasing the rate
  of profit growth faster than the rate of sales growth. The Company seeks to
  increase profit margins by: (i) increasing gross margins; (ii) achieving
  economies of scale on increasing sales volume, thereby reducing operating

  expenses as a percentage of sales; and (iii) leveraging its investments in
  product development, tooling and marketing over the longer life spans of its
  multi-year brands.
 
o Develop Strategic Alliances With Major Content Providers.  Over the past three
  years, the Company has developed important relationships with four major
  entertainment companies, Lucasfilm, Fox, Sony and Turner, which have licensed
  to the Company the rights to make toys based on certain of their properties.
  The Company intends to continue to aggressively pursue opportunities to expand
  its relationships with these entertainment companies and to form additional
  alliances with other entertainment companies in order to assure access to a
  continuous flow of quality entertainment properties that have potential to
  generate successful toy product lines.
 
o Leverage International Distribution Networks.  The Company believes it has
  developed a strong network of distributors in its key markets outside the
  United States and through such network has the ability to increase its
  international sales. While Europe has traditionally accounted for the highest
  percentage of the Company's international sales, the Company continues to
  build its worldwide distribution network and sees the potential for growth in
  new markets such as Mexico and Latin America, the Pacific Rim and the Middle
  East.
 
     The Company, which commenced operations in 1957, was incorporated under the
laws of the State of California in 1968. The Company was reincorporated in the
State of Delaware in 1987. The Company's Board of Directors has approved a
resolution to change the Company's name to Galoob Toys, Inc. and intends to seek
stockholder approval of such change at the Company's 1996 annual stockholders'
meeting currently scheduled to be held on October 30, 1996. The Company's
principal executive offices are located at 500 Forbes Boulevard, South San
Francisco, California 94080 and its telephone number is (415) 952-1678.
 
                                       4
THE OFFERING
Common Stock Offered by the
  Company..........................  2,000,000
 
Common Stock Offered by the Selling
  Stockholder......................  392,866 shares
 
Common Stock to be Outstanding
  after the Offering(1)............  17,540,017 shares
 
NYSE Symbol for the Common Stock...  GAL
 
Use of Proceeds to the Company.....  To prepay indebtedness under its
                                     short-term credit facilities, to
                                     repay the mortgage on the Company's

                                     headquarters and for working
                                     capital and general corporate
                                     purposes, which could include
                                     payments to acquire entertainment
                                     license rights or other license
                                     rights for future toy products and
                                     properties.
- ------------------
(1) Excludes (i) 1,495,210 shares of Common Stock reserved for issuance upon
    exercise of stock options outstanding at August 30, 1996 and (ii) 75,000
    shares of Common Stock reserved for issuance upon exercise of warrants
    outstanding at August 30, 1996. See 'Capitalization,' 'Management' and
    'Description of Capital Stock.'
 
                                       5
SUMMARY CONSOLIDATED FINANCIAL DATA
                       (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
     The information set forth below should be read in conjunction with
'Selected Consolidated Financial Data,' 'Management's Discussion and Analysis of
Financial Condition and Results of Operations' and the Company's consolidated
financial statements and related notes thereto included elsewhere in this
Prospectus.
SIX MONTHS ENDED
                                               YEAR ENDED DECEMBER 31,               JUNE 30,
                                           --------------------------------    --------------------
                                             1993        1994        1995        1995        1996
                                           --------    --------    --------    --------    --------
STATEMENTS OF OPERATIONS DATA:
Net revenues............................   $134,334    $178,792    $220,044    $ 71,560    $ 86,723
Gross margin............................     59,187      83,636      99,210      25,107      38,943
Earnings (loss) from operations.........     (9,215)      9,322      12,989      (6,980)     (2,223)
Net proceeds from Nintendo award........         --      12,124          --          --          --
Interest expense........................     (1,836)     (2,609)     (3,429)     (1,387)     (1,596)
Earnings (loss) before income taxes.....    (10,915)     19,202       9,999      (8,258)     (3,728)
Net earnings (loss).....................    (10,924)     18,424       9,399      (8,258)     (3,728)
Preferred stock dividends...............      3,127       3,127       3,127       1,564          21
Charge related to exchange of preferred
  stock for common......................         --          --          --          --      24,279
Net earnings (loss) applicable to common
  shares................................   $(14,051)   $ 15,297    $  6,272    $ (9,822)   $(28,028)
                                           ========    ========    ========    ========    ========
Common shares and common shares
  equivalents outstanding-- average.....      9,548      10,111      10,451      10,064      12,774
Net earnings (loss) per common share(1):

  Primary...............................   $  (1.47)   $   1.51    $   0.60    $  (0.98)   $  (2.19)
                                           ========    ========    ========    ========    ========

  Fully diluted.........................   $  (1.47)   $   1.41    $   0.60    $  (0.98)   $  (2.19)
                                           ========    ========    ========    ========    ========
DECEMBER 31,               JUNE 30, 1996
                            ---------------     -----------------------------
                                 1995             ACTUAL       AS ADJUSTED(2)
                            ---------------     -----------    --------------
BALANCE SHEET DATA:
Working capital..........      $  54,670         $  47,611        $105,083
Total assets.............        120,084           124,694         143,204
Short-term debt..........         19,493            38,962              --
Long-term debt...........         14,000                --              --
Shareholders' equity.....         54,172            63,082         120,554
- ------------------
(1) For a discussion of the impact on net earnings of certain unusual,
    non-recurring items, see 'Management's Discussion and Analysis of Financial
    Condition and Results of Operations.'
 
(2) Adjusted to reflect the sale of 2,000,000 shares of Common Stock offered by
    the Company in this offering based on an assumed offering price of $29 3/4
    per share, the last reported sale price of the Common Stock on September 26,
    1996 (after deducting the underwriting discounts and estimated offering
    expenses payable by the Company), the proceeds from the exercise of warrants
    by the Selling Stockholder and the anticipated application of the estimated
    net proceeds therefrom. See 'Use of Proceeds' and 'Capitalization.'
 
                                       6
RISK FACTORS
 
     Prospective investors should carefully consider the following risk factors,
in addition to the other information in this Prospectus, prior to making an
investment decision. Certain statements in this Prospectus that are not
historical are forward-looking, including known and unknown risks and
uncertainties. Many factors, including the risk factors identified below, could
cause the actual results, performance or achievements of the Company to be
materially different from any future results, performance or achievements that
may be expressed or implied by such forward-looking statements.
 
DEPENDENCE ON LIMITED NUMBER OF PRODUCT LINES
 
     The Company derives a substantial portion of its revenue from a limited

number of product lines. Although, in recent years, its product portfolio has
been significantly broadened and diversified, a decrease in popularity of a
particular product line or key products within a given product line during any
year could have a material adverse effect on the Company's business, financial
condition and results of operations. Sales of Micro Machines and all girls'
product lines (primarily consisting of sales of Sky Dancers), represented 63%
and 8% of the Company's revenue in 1994, and 44% and 40% of the Company's
revenue in 1995, respectively. Micro Machines is an established brand that has
been marketed continuously since 1987. The Company's success in girls' toys is
relatively recent dating back to the introduction of Sky Dancers in 1994.
Although at the present time demand remains strong for Micro Machines, Sky
Dancers and the Company's new product lines (Dragon Flyz and Pound Puppies),
there can be no assurance that any of these products will retain their current
popularity. See 'Business--Products' and 'Management's Discussion and Analysis
of Financial Condition and Results of Operations.'
 
CONSUMER PREFERENCES AND NEW PRODUCT INTRODUCTIONS
 
     Consumer preferences in the toy industry are continuously changing and are
difficult to predict. Relatively few products achieve market acceptance, and
even when they do achieve commercial success, products often have short life
cycles. There can be no assurance that (i) new products or product lines will be
introduced by the Company or, if introduced by the Company, will achieve any
significant degree of market acceptance, (ii) acceptance, if achieved, will be
sustained for any significant amount of time or (iii) such products' life cycles
will be sufficient to permit the Company to recover research, development,
licensing, manufacturing, marketing and other costs associated therewith.
Failure of new product lines or product innovations to achieve or sustain market
acceptance could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the success of many
of the Company's entertainment-related products is dependent on the popularity
generated by movies, television programs and other media events. There can be no
assurance that these movies, television programs or other media events will be
produced as scheduled, that they will be popular and successful or that such
entertainment media will result in substantial promotional value to the
Company's products. See 'Business--Advertising and Promotion.'
 
LICENSING AND RELATED RIGHTS
 
     The Company produces substantially all of its products under licenses from
other parties. Some of these licenses confer rights to exploit original concepts
developed by toy inventors and designers. Other licenses, referred to as
entertainment licenses, permit the Company to manufacture and market toys based
on characters or properties which develop their own popular identity through
exposure in various media such as movies, television programs, cartoons and
books. Most entertainment licenses extend for one to three years and are often
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. There can be no assurance that the Company's revenue from a
licensed product will exceed the minimum guaranteed payments required to be made
by the Company to licensors. The Company pays royalties to its licensors which
typically range from 2% to 16% of net sales. As of June 30, 1996, minimum future
guaranteed payments aggregated approximately $3,653,000. Royalties expense
totaled approximately $10,439,000, $16,326,000 and $13,498,000 for the
six months ended June 30, 1996 and in 1995 and 1994,

respectively. As a result of increased competition among toy companies for
licenses, in certain instances the Company has paid, and may in the future be
required to pay, higher royalties and higher advances and/or minimum guaranteed
payments in order to obtain attractive properties for the development of product
lines. Because the Company produces substantially all of its products under
licenses, the failure to enter into such licensing arrangements or to retain
 
                                       7
license rights could have a material adverse effect on the Company's business,
financial condition and results of operations.
 
     The Company is an active participant in the market for entertainment
licenses. A determination to acquire an entertainment license must usually be
made before the commercial introduction of the property in which a licensed
character or property appears, and these license arrangements usually require
the payment of non-refundable advances or guaranteed minimum royalties.
Accordingly, the success of an entertainment licensing program is dependent upon
the ability of management to assess accurately the future success and popularity
of the properties that it is evaluating, to bid for products on a selective
basis in accordance with such evaluation, and to capitalize on the properties
for which it has obtained licenses in an expeditious manner. There can be no
assurance that the Company will be able to continue to enter into entertainment
licensing arrangements in the future for successful and popular properties on
terms that are acceptable to the Company.
 
     Since October 1992, the Company has had a license from Lucasfilm Ltd. to
produce Micro Machines products based on the popular Star Wars movie trilogy.
This license expires on December 31, 1997. Although the Company believes its
relationship with Lucasfilm is excellent, there can be no assurance that
Lucasfilm will choose to renew or extend the Company's Star Wars license for
1998 and beyond. If the Company is unable to renew or extend the Star Wars
license or if it is unable to renew or extend it for all of the current products
lines, the loss of all or part of such license could have a material adverse
effect on the Company's business, financial condition and results of operations.
See 'Business--Licensing Strategy.'
 
DEPENDENCE ON MAJOR CUSTOMERS
 
     Like other major toy companies, the Company is dependent upon toy retailers
and mass merchandisers to sell its products. The United States market accounted
for over 60% of the Company's revenues in each of the last three years. The
retail toy industry in the United States is highly concentrated, with the top
five retailers accounting for more than 50% of United States retail toy sales in
1995. For the year ended December 31, 1995, approximately 49% of the Company's
worldwide net revenues were from these five retailers, two of which were the
Company's largest customers accounting for approximately 31% of worldwide net
revenues. The Company does not have long-term written contracts with its retail
customers. An adverse change in, or termination of, the Company's relationship
with or the financial viability of one or more of its major customers could have
a material adverse effect on the Company's business, financial condition and
results of operations. Increased concentration could enhance the remaining toy

retailers' ability to negotiate more favorable terms and prices from the
Company. See 'Business--Sales, Marketing and Distribution.'
 
DEPENDENCE ON KEY PERSONNEL
 
     The Company's operations and prospects are dependent in large part on its
executive management group. Although the core of the current executive
management group has been very stable and in place since 1991, there can be no
assurance that the Company will be able to retain all of the members of its
executive management group. There is strong competition for skilled, competent
personnel in the toy industry. Although the Company has been successful in
retaining and hiring management personnel, no assurance can be made that the
Company can continue to do so in the future.
 
DEPENDENCE ON KEY MANUFACTURERS
 
     During the last four years, the Company has concentrated its sourcing of
products from a limited number of high-quality manufacturers in China. In 1995,
four companies manufactured approximately 88% of the Company's products and a
single manufacturer, Harbour Ring International Ltd. and its affiliates
('Harbour Ring'), produced approximately 60% of the Company's products. The
Company believes that its relationships with Harbour Ring and its other key
manufacturers are excellent. However, because the Company does not have control
over these unaffiliated manufacturers, there can be no assurance that Harbour
Ring and the Company's other key manufacturers will continue to dedicate
sufficient production capacity to satisfy the Company's production requirements
and specifications. Any interruption of the Company's manufacturing arrangements
with Harbour Ring or the Company's other key manufacturers could cause a delay
in production of the Company's products for delivery to its customers and could
have a material adverse effect on the Company's business, financial condition
and results of operations. While the Company believes that alternative
 
                                       8
manufacturers exist in the event of a substantial interruption in manufacturing
arrangements with the existing key manufacturers, there can be no assurance that
alternative arrangements could be timely provided on terms acceptable to the
Company.
 
SEASONALITY; PAYMENT TERMS
 
     Toy industry sales are highly seasonal and driven by disproportionate
customer demand for toys to be sold during the Christmas holiday season.
Approximately two-thirds of the Company's shipments typically occur in the
second half of the year. As a result, the Company's operating results vary
significantly from quarter to quarter within any given year. Orders placed with
the Company for shipment are cancelable until the time of shipment. The
combination of seasonal demand and the potential for order cancellation makes
accurate forecasting of future sales difficult and causes the Company to believe
backlog may not be an accurate indicator of the Company's future sales.
Similarly, comparison between fiscal periods of successive years may not be
indicative of results of operations for any given full year. The seasonality

creates significant peaks in working capital requirements.
 
     Further, similar to other toy companies, many of the Company's sales occur
on terms that permit payment considerably more than 90 days after shipment of
merchandise, increasing the Company's need for working capital beyond that which
would be required if terms of payment were shorter. See 'Management's Discussion
and Analysis of Financial Condition and Results of Operations--Liquidity,
Financial Resources and Capital Expenditures.'
 
FOREIGN OPERATIONS
 
     All of the Company's products are manufactured to its specifications by
nonaffiliated parties located in China and, to a lesser extent, other foreign
locations. Therefore, the Company could be adversely affected by political or
economic unrest or disruptions affecting business in such countries. The Company
does not carry insurance for political or economic unrest or disruptions for
several reasons, including, but not limited to, costs of such insurance and the
limited insurance coverage available. The political unrest in 1989 in China had
an insignificant impact on the manufacturing and shipping of the Company's
products. There can be no assurance that in the future the Company will not be
adversely affected by political or economic disruptions in China or other
foreign locations.
 
     Further, changes in tariffs could have an adverse effect on the cost of
goods imported from China. While China is currently accorded Most Favored Nation
('MFN') status by the United States, this status is subject to annual review
(which was last renewed in June 1996) and could be revoked prospectively for any
given year. Current MFN tariffs on toys imported into the United States are
zero, and the loss of MFN status for China would result in a substantial
increase in tariffs applicable to toys imported from China. This increase in
duty would be large enough that it could have a material adverse effect on the
Company's business, financial condition and results of operations. Products
shipped from China to other countries would not be affected by China's loss of
MFN status with the United States without similar actions being taken by the
other importing countries. Moreover, many other toy companies also source
products from China and could be affected to similar degrees.
 
     The Company can also be subject to the imposition of retaliatory tariffs or
other import restrictions as a result of a trade dispute between China and the
United States. Generally, trade negotiations over matters in dispute between the
two countries have been difficult but have been resolved without the imposition
of trade retaliation. In the past, proposed retaliation by the United States has
not included increased tariffs or other trade restrictions applicable to toys
imported from China. It is possible, however, that some future trade dispute
could result in substantial increases in tariffs or other restrictions on
imports, such as quotas, of toys from China. These increased tariffs or other
restrictions could be imposed under Section 301 of the Trade Act of 1974, as
amended, whether or not the trade dispute itself involved toys. Such increased
tariffs or other trade restrictions could have a material adverse effect on the
Company's business, financial condition and results of operations.
 
     The impact on the Company of any political or economic unrest or
disruptions in China, the loss of China's MFN status or the imposition of
retaliatory trade restrictions on products manufactured in China would depend on

several factors, including, but not limited to, the Company's ability to (i)
procure alternative manufacturing sources satisfactory to the Company, (ii)
retrieve its tooling located in China, (iii) relocate its production in
sufficient time to meet demand, and (iv) pass cost increases likely to be
incurred as a result of such factors to the Company's customers through product
price increases. As a result, any political or economic unrest or
 
                                       9
disruptions in China, the loss of China's MFN status or the imposition of
retaliatory trade restrictions on products manufactured in China could have a
material adverse effect on the Company's business, financial condition and
results of operations. See 'Business--Manufacturing.'
 
     In 1994, certain quotas on toy products made in China were introduced in
the European Economic Community. The quotas did not have a material impact on
the Company's business in 1995 and, although no assurance can be given, are not
expected to have a material impact on the Company's business in the foreseeable
future.
 
     In addition, the Company's subsidiary, Galco International Toys, N.V.
('Galco') is located in Hong Kong. On July 1, 1997, ownership of Hong Kong,
currently a dependency of the United Kingdom, will revert back to China. At the
present time, the Company is unable to predict the effect, if any, that such
change will have on the Company's or Galco's business, financial condition or
results of operations. In addition, changes in the relationship between the
United States dollar and the Hong Kong dollar may have an impact on the cost of
goods purchased from manufacturers.
 
COMPETITION
 
     The toy industry is highly competitive. The Company competes with several
larger domestic and foreign toy companies, such as Hasbro, Inc. ('Hasbro') and
Mattel, Inc. ('Mattel'), and many smaller companies in all aspects of its
business, including the design and development of new toys, the procurement of
licenses, the improvement and expansion of previously introduced products and
product lines and the marketing and distribution of its products, including
obtaining adequate shelf space. Some of these companies have longer operating
histories, broader product lines and greater financial resources and advertising
budgets than the Company. In addition, it is common in the toy industry for
companies to market products which are similar to products being successfully
marketed by competitors. See 'Business--Competition.'
 
INVENTORY MANAGEMENT; DISTRIBUTION
 
     Many of the Company's significant customers use, to some extent, inventory
management systems to track sales of particular products and rely on reorders
being rapidly filled by suppliers, rather than maintaining large on-hand
inventories to meet consumer demand. While these systems reduce a retailer's
investment in inventory, they increase pressure on suppliers like the Company to
fill orders promptly and shift a portion of the retailer's inventory risk onto
the supplier. Production of excess products by the Company to meet anticipated

demand could result in increased inventory carrying costs for the Company. In
addition, if the Company fails to anticipate the demand for products, it may be
unable to provide adequate supplies of popular toys to retailers in a timely
fashion, particularly during the Christmas season, and may consequently lose
potential sales.
 
     The Company utilizes warehouse facilities primarily in Union City,
California for storage of its products. Disruptions in shipments from Asia or
from the Union City facility could have a material adverse effect on the
business, financial condition and results of operations of the Company.
 
RAW MATERIALS PRICES
 
     The principal raw materials in most of the Company's products are
petrochemical resin derivatives, such as polyethylene and high impact
polystyrene, and paper. The prices for such raw 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 customers.
 
POTENTIAL PRODUCT LIABILITY
 
     The Company is engaged in a business which could result in possible claims
for injury or damage resulting from its products. However, the Company is not a
defendant in any product liability lawsuit. While the Company currently
maintains product liability insurance, there can be no assurance that it will be
able to maintain such insurance on acceptable terms or that any such insurance
will provide adequate protection against potential liabilities. A successful
claim brought against the Company resulting in a final judgment in excess of its
 
                                       10
insurance coverage could have a material adverse effect on the Company's
business, financial condition and results of operations. See
'Business--Government Regulations.'
 
GOVERNMENT REGULATIONS
 
     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 Product Safety Commission (the 'CPSC') to protect consumers
from hazardous toys and other articles. The CPSC has the authority to exclude
from the market articles which are found to be unsafe or hazardous and can
require a manufacturer to recall such products under certain circumstances.
Similar laws exist in some states and cities in the United States and in Canada
and Europe. The Company's products are designed and tested to meet or exceed all
applicable regulatory and voluntary toy industry safety standards. The Company
emphasizes the safety and reliability of its products and has established a

strong quality assurance and control program to meet the Company's objective of
delivering high quality, safe products. While the Company believes that it is,
and will continue to be, in compliance in all material respects with applicable
laws, rules and regulations, there can be no assurance that the Company's
products will not be found to violate such laws, rules and regulations, or that
more restrictive laws, rules or regulations will not be adopted in the future
which could make compliance more difficult or expensive or otherwise adversely
affect the Company's business or prospects. Moreover, sales of the Company's
products have significantly increased over the past year and several of the
Company's products are new. The claims experience with respect to product
safety, therefore, is difficult to predict. For the foregoing reasons, there can
be no assurance that the Company will not be subject to material liabilities on
account of product liability claims in the future. See 'Business--Government
Regulations.'
 
INTELLECTUAL PROPERTY RIGHTS
 
     Most of the Company's products are copyrighted and sold under trademarks.
In addition, certain products incorporate patented devices or designs. The
Company or its licensors customarily seek protection of major patents,
trademarks and copyrights in the United States and certain other countries.
These intellectual property rights can be significant assets of the Company.
Although the Company believes its rights to these properties are adequately
protected, the loss of certain of its rights for particular product lines may
have a material adverse effect on the Company's business, financial condition
and results of operations. See 'Business--Intellectual Property Rights.'
 
ANTI-TAKEOVER PROVISIONS
 
     The Company's Certificate of Incorporation ('Certificate') and By-Laws
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
stockholders, and requiring the vote of holders of 80% of the voting power of
the Company in order to remove directors, amend the By-Laws and approve certain
business combinations with 'Related Persons.' In addition, the Company has a
shareholder rights plan which under certain circumstances, including the
acquisition of 20% or more of the Common Stock by a person, gives the holders of
rights the right to acquire shares of Common Stock with a value equal to two
times the exercise price of the rights. Such provisions may 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
stockholders might consider to be in their best interests, including offers or
attempted takeovers that might otherwise result in such stockholders receiving a
premium over the market price for the Common Stock. In addition, such provisions
are expected to discourage certain types of coercive takeover practices and
inadequate takeover bids and to encourage persons seeking to acquire control of
the Company first to negotiate with the Company before making a bid for the
Common Stock at a premium over the market price of the Common Stock. Such
provisions may also adversely affect the market price of, and the voting and
other rights of the holders of, Common Stock. See 'Description of Capital
Stock--Certain Provisions of the Company's Certificate of Incorporation and
By-Laws.' In addition, the Company intends to enter into agreements with certain

of its executive officers providing for, among other things, severance payments
if the officer's employment is terminated following a change of control. See
'Management--Severance Agreements with Management.' Each of the items described
above could have the effect of deterring transactions that would result in a
change of control.
 
                                       11
USE OF PROCEEDS
 
     The Company intends to use the net proceeds of this offering (including the
proceeds from the exercise of the Warrants (as defined herein) to acquire
392,866 shares of Common Stock), estimated to be approximately $57 million
(based on an assumed offering price of $29 3/4 per share), for the reduction of
indebtedness aggregating approximately $43 million under its short-term credit
facility (as of August 30, 1996), to repay a mortgage on the Company's
headquarters aggregating approximately $4 million, and for working capital and
general corporate purposes, which could include payments to acquire
entertainment license rights or other license rights for future toy products and
properties.The Company may also use a portion of the net proceeds to acquire
other businesses or product lines which the Company believes will complement its
existing business, although the Company has no present intention, understanding
or agreement with respect to any such acquisitions. The credit facility matures
on March 31, 1997, and bears interest at an annual rate of 1% over the prime
rate as announced from time to time by CoreStates Bank N.A., which is currently
9.25%. The mortgage on the Company's headquarters matures on November 30, 1996,
and bears interest at an annual fixed rate of 10.3%. The Company will not
receive any proceeds from the sale of Common Stock by the Selling Stockholder
but will receive an aggregate of $1.7 million from the exercise of warrants to
purchase Common Stock (the 'Warrants') held by the Selling Stockholder.
 
                                DIVIDEND POLICY
 
     The Company has not declared or paid any cash dividends on the Common Stock
since its initial public offering in 1984. The Board of Directors of the Company
has no current plans to pay cash dividends on the Common Stock. The Company's
existing credit facility prevents the Company from paying cash dividends on the
Common Stock without consent of its lender. See 'Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity, Financial
Resources and Capital Expenditures.' In addition, future dividend policy will
depend on the Company's earnings, capital requirements, financial condition and
other factors considered relevant by the Board of Directors.
 
                                       12
PRICE RANGE OF COMMON STOCK
 
     The Common Stock of the Company is listed on the NYSE under the symbol GAL.
The following table sets forth the high and low closing sale prices for the

Common Stock, as reported on the NYSE, Composite Tape. The reported last sale of
Common Stock on the NYSE on September 26, 1996, was $29 3/4.
FISCAL
 YEAR                                                        HIGH    LOW
- ------                                                       ----    ---
1994    First Quarter.....................................   $10 1/2 $ 6 1/8
        Second Quarter....................................     6 7/8   5 1/2
        Third Quarter.....................................     8 1/2   6 1/8
        Fourth Quarter....................................     7 3/8   4 3/4
 
1995    First Quarter.....................................   $ 7 3/4 $ 5 1/4
        Second Quarter....................................     8 3/8   6
        Third Quarter.....................................     9 1/2   6 1/2
        Fourth Quarter....................................    13 3/4   9 1/4
 
1996    First Quarter.....................................   $20 1/4 $10 1/2
        Second Quarter....................................    28 1/4  18 7/8
        Third Quarter (through September 26, 1996)........    30 1/2  22 3/8
As of August 30, 1996, there were approximately 1,300 holders of record of the
Common Stock, excluding beneficial owners of shares registered in nominee or
street name.
 
                                       13
CAPITALIZATION
 
     The following table sets forth the actual capitalization of the Company at
June 30, 1996, and as adjusted to reflect (i) the sale by the Company of
2,000,000 shares of Common Stock offered hereby (at an assumed public offering
price of $29 3/4 per share) and the application of the estimated net proceeds
therefrom to repay certain indebtedness as described in 'Use of Proceeds' and
(ii) the exercise by the Selling Stockholder of Warrants to purchase an
aggregate of 392,866 shares of Common Stock concurrently with this offering.
JUNE 30, 1996
                                                     -----------------------
                                                      ACTUAL     AS ADJUSTED
                                                     --------    -----------
                                                         (IN THOUSANDS)
Short-term debt(1) (including current portion of
  long-term debt).................................   $ 38,962     $      --
                                                     --------    -----------
                                                     --------    -----------
Long-term debt....................................         --            --
Shareholders' equity:
  Common Stock, $.01 par value; 50,000,000 shares
     authorized; 15,119,651 and 17,512,517 shares
     issued and outstanding, actual and as
     adjusted(2)..................................        151           175
  Additional paid-in capital......................    105,774       163,222
  Retained earnings (deficit).....................    (42,396)      (42,396)
  Cumulative translation adjustment...............       (447)         (447)
                                                     --------    -----------
     Total shareholders' equity...................     63,082       120,554
                                                     --------    -----------
     Total capitalization.........................   $ 63,082     $ 120,554
                                                     --------    -----------
                                                     --------    -----------
- ------------------
(1) The Company is party to a credit agreement which makes available to the
    Company a maximum credit line of $60,000,000 through March 31, 1997. For
    additional information on short-term debt, see 'Management's Discussion and
    Analysis of Financial Condition and Results of Operations--Liquidity,
    Financial Resources and Capital Expenditures.'
 
(2) Actual and as adjusted outstanding shares do not include (i) 1,360,250
    shares of Common Stock reserved for issuance upon exercise of outstanding
    stock options or (ii) 100,000 shares of Common Stock reserved for issuance
    upon exercise of outstanding warrants not being exercised in connection with
    this offering.
 

                                       14
SELECTED CONSOLIDATED FINANCIAL DATA
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
     The selected consolidated financial data for each of the five years ended
December 31, 1995 are derived from the audited consolidated financial statements
of the Company. The selected consolidated financial data for the six months
ended June 30, 1995 and June 30, 1996 are derived from the unaudited financial
statements of the Company for such periods and, in the opinion of management,
includes all adjustments, consisting only of normal recurring adjustments,
necessary for a fair statement of the results for the unaudited interim periods.
Results for the six months ended June 30, 1996 are not necessarily indicative of
results for any other period or the entire year. The selected consolidated
financial data set forth below should be read in conjunction with the Company's
consolidated financial statements and related notes thereto included elsewhere
in the Prospectus and 'Management's Discussion and Analysis of Financial
Condition and Results of Operations.'
SIX MONTHS ENDED
                                                                 YEAR ENDED DECEMBER 31,                          JUNE 30,
                                                 --------------------------------------------------------    -------------------
                                                   1991        1992        1993        1994        1995       1995        1996
                                                 --------    --------    --------    --------    --------    -------    --------
STATEMENT OF OPERATIONS DATA:
Net revenues..................................   $150,636    $166,280    $134,334    $178,792    $220,044    $71,560    $ 86,723
Costs of products sold........................     86,455      90,823      75,147      95,156     120,834     46,453      47,780
                                                 --------    --------    --------    --------    --------    -------    --------
Gross margin..................................     64,181      75,457      59,187      83,636      99,210     25,107      38,943
                                                 --------    --------    --------    --------    --------    -------    --------
Operating expenses:
  Advertising and promotion...................     22,848      22,826      23,537      30,616      31,240      9,662      12,411
  Other selling and administrative............     24,663      25,224      22,031      22,913      30,768     12,332      13,253
  Royalties, research and development.........     19,648      26,124      18,788      20,785      24,213     10,093      15,502
  Variable stock option plan expense..........         --          --       4,046          --          --         --          --
                                                 --------    --------    --------    --------    --------    -------    --------
Total operating expenses......................     67,159      74,174      68,402      74,314      86,221     32,087      41,166
                                                 --------    --------    --------    --------    --------    -------    --------
Earnings (loss) from operations...............     (2,978)      1,283      (9,215)      9,322      12,989     (6,980)     (2,223)
Expenses related to resignation of former
  officer.....................................     (3,807)     (2,152)         --          --          --         --          --
Net proceeds from Nintendo award..............         --          --          --      12,124          --         --          --
Interest expense..............................     (1,775)     (1,550)     (1,836)     (2,609)     (3,429)    (1,387)     (1,596)
Other income, net.............................      1,020         210         136         365         439        109          91
                                                 --------    --------    --------    --------    --------    -------    --------
Earnings (loss) before income taxes...........     (7,540)     (2,209)    (10,915)     19,202       9,999     (8,258)     (3,728)
Provision for income taxes....................         --         238           9         778         600         --          --
                                                 --------    --------    --------    --------    --------    -------    --------

Net earnings (loss)...........................     (7,540)     (2,447)    (10,924)     18,424       9,399     (8,258)     (3,728)
Preferred stock dividends paid................      3,127         782          --          --          --         --           6
Preferred stock dividends in arrears..........         --       2,345       3,127       3,127       3,127      1,564          15
Charge related to the exchange of preferred
  stock for common............................         --          --          --          --          --         --      24,279
                                                 --------    --------    --------    --------    --------    -------    --------
Net earnings (loss) applicable to common
  shares......................................   $(10,667)   $ (5,574)   $(14,051)   $ 15,297    $  6,272    $(9,822)   $(28,028)
                                                 ========    ========    ========    ========    ========    =======    ========
Net earnings (loss) per common share:
  Primary.....................................   $  (1.14)   $  (0.59)   $  (1.47)   $   1.51    $   0.60    $ (0.98)   $  (2.19)
                                                 ========    ========    ========    ========    ========    =======    ========
  Fully diluted...............................   $  (1.14)   $  (0.59)   $  (1.47)   $   1.41    $   0.60    $ (0.98)   $  (2.19)
                                                 ========    ========    ========    ========    ========    =======    ========
Common shares and common share equivalents
  outstanding--average........................      9,325       9,400       9,548      10,111      10,451     10,064      12,774
DECEMBER 31,                               JUNE 30,
                                                 --------------------------------------------------------    -------------------
                                                   1991        1992        1993        1994        1995       1995        1996
                                                 --------    --------    --------    --------    --------    -------    --------
BALANCE SHEET DATA:
Working capital...............................   $ 29,127    $ 27,070    $ 30,813    $ 53,219    $ 54,670    $43,137    $ 47,611
Total assets..................................     64,016      71,604      71,005     100,766     120,084     94,748     124,694
Long-term debt................................      5,244       4,944      18,608      18,414      14,000     18,309          --
Shareholders' equity..........................     35,092      32,246      22,162      44,768      54,172     36,572      63,082
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
     The following 'Management's Discussion and Analysis of Financial Condition
and Results of Operations' contains forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those discussed herein. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in the section
entitled 'Risk Factors' and elsewhere in this Prospectus.
 
OVERVIEW
 
     Founded in 1957, the Company is a leading international toy company that
designs, develops, markets and sells a variety of high-quality, innovative toy
products in an expanding number of product categories. The Company's toy
products currently fall into four categories: miniature vehicles and male action
figures for boys, and miniature dolls and plush toys for girls.

 
     From 1990 through 1993, the Company had a period of declining revenues and
suffered net losses. Commencing in 1991, the Company installed a new management
team, led by Mark Goldman, and began implementing a recovery plan designed to
reposition the Company, return the Company to profitability and enable it to
capitalize on its growth strategy. The recovery plan focused on three key goals:
(i) to restore and expand the Company's core business of the Micro Machines
product line, (ii) to focus on growth opportunities in new product areas such as
the male action figure category and girls' product lines and (iii) to reduce the
Company's cost structure and lower its break-even point. Due to the relatively
long lead time for new products and product lines in the toy industry, the
recovery plan was designed to turn the Company around over a three-year period
and return the Company to profitability in 1994.
 
     Since 1993, the Company's revenues have grown approximately 64% from
approximately $134 million in 1993 to approximately $220 million in 1995. This
trend has continued with revenues for the first six months of 1996, increasing
21% over the comparable period in 1995. In addition, in each of 1994 and 1995,
the Company had record sales and earnings during the important fourth quarter.
The Company believes that its operating performance over the past two years
demonstrates that its recovery plan has succeeded and that the Company is now
well positioned for future growth.
 
     The successful implementation of its recovery plan has enabled the Company
to restructure its balance sheet to improve its liquidity and cash flow. In
March 1995, the Company renegotiated its existing credit facility to extend the
maturity by two years, increase availability from $40 million to $60 million and
decrease the annual interest rate by one percent. In February 1996, the Company
gave notice of its intention to redeem its 8% Convertible Subordinated
Debentures due 2000 (the 'Debentures'). As a result, the $14 million aggregate
principal amount of outstanding Debentures was converted into an aggregate of
approximately 1.5 million shares of Common Stock. In addition, in March 1996, an
offer by the Company to exchange shares of its Common Stock for its outstanding
shares of Depositary Convertible Exchangeable Preferred Stock (the 'Depositary
Shares') resulted in 98% of the holders of Depositary Shares converting such
shares into an aggregate of approximately 3.3 million shares of Common Stock.
The remainder of such Depositary Shares were either redeemed or converted into
Common Stock in June 1996. As a result of the foregoing, the Company reduced its
outstanding indebtedness and the aggregate liquidation preference of preferred
stock outstanding by approximately $51 million, increased shareholders' equity
by approximately $12 million, reduced annual interest payments by $1.1 million
and eliminated annual preferred stock dividend obligations of $3.1 million.
 
     The Company's products are sold in over 50 countries worldwide. In general,
the Company sells its products directly to retailers in the United States and to
toy distributors outside the United States. Approximately one-third of the
Company's revenues are generated from sales of its products outside of the
United States. Although the Company sells approximately one-half of its unit
volume outside the United States, its sales revenue and gross margins are lower
on its international sales because international prices are lower as the
distributor is responsible for the cost of importing, promoting and reselling
the product and takes ownership and risk of loss on the product at the time of
delivery in Hong Kong or other Far East locations. Accordingly, because of the
different pricing between the products sold in the U.S. and internationally, the

mix of sales between U.S. and international customers will affect the revenues
and gross margins of the Company. While the Company has historically realized
lower gross margins on international sales of its toys, the operating expenses
associated with those international sales are typically less than the operating
expenses associated with domestic sales.
 
                                       16
Revenues are recognized as product is shipped. The Company provides
reserves for defective returns and other allowances at the time of shipment as a
percentage of sales, based upon historical experience. Many of the Company's
shipments of products to U.S. customers are made on terms that permit payment
considerably more than 90 days after shipment of merchandise. Products sold to
markets outside of the United States, however, are generally manufactured and
sold based upon orders accompanied by letters of credit that entitle the Company
to draw payment thereunder within 30 days of shipment.
 
     Transactions involving Galco, which were in Hong Kong dollars, have been
translated into U.S. dollars in accordance with Statement of Financial
Accounting Standards ('SFAS') No. 52, Foreign Currency Translation. All asset
and liability accounts of Galco have been translated using rates of exchange in
effect at the balance sheet date. Revenues and expenses are translated at the
weighted average of exchange rates in effect during the year. Gains or losses
from foreign currency translation adjustments are charged or credited directly
to a separate component of shareholders' equity.
 
     Costs incurred for tooling and package design are deferred and amortized
over the expected life of the products, which typically ranges from one to two
years.
 
  Results of Operations
 
     The following table sets forth certain operating data (as a percentage of
the Company's net revenues) for the years ended December 31, 1993, 1994 and 1995
and the six months ended June 30, 1995 and 1996:
YEAR ENDED             SIX MONTHS
                                      DECEMBER 31,          ENDED JUNE 30,
                                 -----------------------    --------------
                                 1993     1994     1995     1995     1996
                                 -----    -----    -----    -----    -----
Net revenues..................   100.0%   100.0%   100.0%   100.0%   100.0%
Cost of products sold.........    56.0     53.2     54.9     64.9     55.1
                                 -----    -----    -----    -----    -----
Gross margin..................    44.0     46.8     45.1     35.1     44.9
Advertising and promotion
  expenses....................    17.5     17.1     14.2     13.6     14.3
Other selling and
  administrative expenses.....    16.4     12.8     14.0     17.2     15.3

Royalties, research and
  development expenses........    14.0     11.7     11.0     14.1     17.9
Variable stock option plan
  expenses....................     3.0       --       --       --       --
                                 -----    -----    -----    -----    -----
Earnings (loss) from
  operations..................    (6.9)     5.2      5.9     (9.8)    (2.6)
Net proceeds from Nintendo
  award.......................      --      6.8       --       --       --
Interest expense..............    (1.3)    (1.5)    (1.5)    (1.9)    (1.8)
Other income, net.............     0.1      0.2      0.2      0.2      0.1
Provision for income taxes....      --     (0.4)    (0.3)      --       --
                                 -----    -----    -----    -----    -----
Net earnings (loss)...........    (8.1)%   10.3%     4.3%   (11.5)%   (4.3)%
 =====  =====   =====    =====    =====
Net earnings (loss) have been affected by certain unusual, non-recurring
items. A comparison of the net earnings (loss) per common share and the net
earnings (loss) per common share adjusted to exclude unusual items is set forth
below.
SIX MONTHS ENDED
                                            YEAR ENDED DECEMBER 31,                    JUNE 30,
                                           --------------------------    ------------------------------------
                                            1993      1994      1995           1995                1996
                                           ------    ------    ------    ----------------    ----------------
Net earnings (loss) per common share on
  a primary basis, as reported..........   $(1.47)   $ 1.51    $ 0.60         $(0.98)             $(2.19)
Net earnings (loss) per common share on
  a primary basis, adjusted to exclude
  unusual items.........................   $(1.05)   $ 0.34    $ 0.60         $(0.98)             $(0.29)
The unusual items excluded are as follows: (i) variable stock option plan
expense of $4,046 in 1993, (ii) net proceeds from Nintendo award of $11,810
(after taxes) in 1994, and (iii) a one-time charge related to the exchange of
preferred stock for Common Stock of $24,279 in 1996.
 
                                       17
Six Months Ended June 30, 1996 and 1995
 
     Net revenues increased 21% to $86.7 million in the six months ended June
30, 1996 as compared to $71.6 million in the six months ended June 30, 1995. The
growth in net sales in the first six months of 1996 was attributable to domestic
sales which increased 54%, rising to $56.3 million. International sales
decreased 13% to $30.4 million, reflecting slower first quarter sales prior to
the second quarter recovery that led to record international second quarter

sales of $19.5 million.
 
     The Company's worldwide sales of boys' toys increased 38% in the first six
months of 1996 as compared to the first six months of 1995. The growth in net
sales of the boys' toys line of business for the six months ended June 30, 1996
was primarily attributable to the following: (i) worldwide sales of Micro
Machines, led by the recently introduced Star Wars Action Fleet, an extensive
line of Star Wars vehicles, playsets and miniature action figures, increased by
38% versus the comparable period from the previous year, and (ii) in March 1996,
the Company initiated sales of Dragon Flyz, a line of flying articulated action
figures plus vehicles and accessories. This increase was offset by the
anticipated decrease in sales of boys' toys based on Biker Mice from Mars.
 
     The Company's worldwide sales of girls' toys increased 17% for the six
months ended June 30, 1996 as compared to the six months ended June 30, 1995.
The increase was led principally by the Pound Puppies line.
 
     Gross margins were $38.9 million in the first six months of 1996, an
increase of $13.8 million from the first six months of 1995. This increase was
due to higher sales volume and an increase in the gross margin rate to 44.9% in
the first six months of 1996 from 35.1% in the first six months of 1995. The
increase in the gross margin rate was attributable to the following: (i)
economies of scale associated with the efficient utilization of tooling, (ii)
reduced product costs, (iii) a change in product mix, and (iv) a different mix
of sales between domestic and international markets. The Company's gross margin
rate on domestic sales is significantly greater than foreign sales because the
Company's prices on foreign sales are lower than on domestic sales as the
foreign customer is responsible for the cost of importing and promoting the
products. To improve the matching of costs and revenues, in January 1996, the
Company revised the timing of its amortization of tooling and packaging design
costs. These costs are now being amortized on a percentage of annual sales basis
rather than the previous straight-line basis. This change also contributed
approximately $1.5 million to gross margin for the six month ended June 30,
1996. This amount will reverse for the second half of the year.
 
     Advertising and promotion expenses were $12.4 million, or 14.3% of net
revenues, for the six months ended June 30, 1996, as compared to $9.7 million,
or 13.6% of net revenues, in the same period of 1995. The higher expenses were
primarily a result of a planned increase in domestic television advertising
expenses and the higher percentage relates to the different mix of domestic and
international sales.
 
     Other selling and administrative expenses were $13.3 million for the six
months ended June 30, 1996, as compared to $12.3 million in the six months ended
June 30, 1995. These expenses for the six months ended June 30, 1996 were
reduced by $2.3 million received in settlement of a claim for damages. This
benefit was partially offset by $2.0 million of unusual legal expenses incurred
during the six months ended June 30, 1996, related to this claim and a lawsuit
where the Company is the plaintiff. Additionally, the Company incurred higher
planned personnel costs during the six months ended June 30, 1996.
 
     Royalties, research and development expenses were $15.5 million for the six
months ended June 30, 1996, as compared to $10.1 million in the six months ended
June 30, 1995. The increase was due to higher royalty expenses associated with

increased sales volume and the write-off of royalty advances associated with
discontinued products as well as increased research and development expenses
associated with the expansion of the Company's lines of toys.
 
     Interest expense was $1.6 million for the six months ended June 30, 1996,
as compared to $1.4 million in the six months ended June 30, 1995. The increase
was due primarily to higher average borrowings outstanding during the six month
period partially offset by a lower average interest rate and the retirement of
the Debentures.
 
     No tax recovery was reported because of the cumulative net operating loss
brought forward into the year. At December 31, 1995, the Company had net
operating loss carryforwards of approximately $7.3 million and unused federal
tax credits of approximately $1.8 million available to reduce taxes in future
periods. At December 31, 1995 and June 30, 1996, the Company maintained a
valuation reserve on its net deferred tax asset. There is no assurance that the
deferred tax valuation allowance established in accordance with Statement of
Financial Accounting Standards Number 109, 'Accounting for Income Taxes', of
$5.2 million at December 31, 1995 will not continue to be required. The Company
will continue to periodically evaluate this reserve on a quarterly basis. For a
discussion of various factors which could impact the Company's future
profitability and its ability to recognize and utilize its net operating loss
carryforwards and federal tax credits, see 'Risk Factors.'
 
                                       18
Years Ended December 31, 1995 and 1994
 
     Net revenues in 1995 were $220.0 million which represented a 23% increase
from 1994 net revenues of $178.8 million. The strong sales growth for 1995 was
attributable to two principal factors: (i) record international sales of $80.7
million, an increase of 35% from 1994, and (ii) an increase in worldwide sales
of girls' toys by more than 500% to $88.0 million, which represented 40% of net
revenues as compared to only 8% of net revenues in 1994. The girls' toys line
increase was due to the introduction of the popular Sky Dancers flying dolls and
the My Pretty DollHouse line of miniature houses and accessories.
 
     The Company's boys' toys business declined 22% in 1995 as compared to 1994
as a result of the discontinuance of the Biker Mice from Mars line to domestic
retailers and a decline in consumer demand for the Z-Bots and Power Rangers
segments of Micro Machines. The Company had anticipated such discontinuance and
sales declines in these products. However, the Company's worldwide Micro
Machines sales in 1995, excluding Z-Bots and Power Rangers, grew by 15% over
1994. Micro Machines, through the fourth quarter of 1995, had twelve consecutive
quarters of U.S retail sales growth.
 
     Gross margin was $99.2 million in 1995, an increase of 18.6% or $15.6
million from 1994. The increase was due to higher sales volume offset slightly
by a lower gross margin rate. The gross margin rate decreased to 45.1% in 1995
from 46.8% in 1994 due mainly to three factors. First, tooling and packaging
design costs were a higher percent of revenues in 1995 as compared to 1994 in
support of the Company's expanded product line. Second, international sales as a

percentage of worldwide revenues were higher in 1995 compared to 1994. Third,
sharp price increases on plastics and packaging materials in the third and
fourth quarters of 1995 occurred too late in the year for the Company to pass
such increases on to its customers. The reduced gross margin rate was partially
offset by the elimination of duty on toys imported into the United States from
China.
 
     Advertising and promotion expenses were $31.2 million or 14.2% of net
revenues in 1995 as compared to $30.6 million or 17.1% of net revenues in 1994.
The decrease in advertising and promotion expenses as a percent of net revenues
was a result of higher marketing efficiencies domestically, coupled with the
effects of the higher sales growth rate internationally where the Company's
distributors absorb their own advertising costs. Other selling and
administrative expenses were $30.8 million in 1995 as compared to $23.0 million
in 1994. The increase in expenses was due mainly to higher planned personnel
costs as a result of the Company's growth and product line expansion, higher
freight costs, and higher legal expenses. Royalties, research and development
expenses increased to $24.2 million in 1995 as compared to $20.8 million in
1994. The increase in 1995 was due to higher royalty expenses associated with
increased sales volume as well as increased research and development expenses
due to expansion of the number of product lines. Although total operating
expenses increased by $11.9 million in 1995 as compared to 1994, operating
expenses as a percent of net revenues declined to 39.2% in 1995 from 41.6% in
1994.
 
     Earnings from operations were $13.0 million, an increase of 39% from 1994
earnings from operations of $9.3 million, reflecting the growth of net revenues
of 23% and lower operating expenses as a percent of net revenue.
 
     In 1994, the net proceeds of $12.1 million from the Nintendo award
represents the receipt of the Company's share of proceeds from its litigation
with Nintendo of America, Inc. The amount was reflected in 1994 results and had
no impact on 1995 results.
 
     Interest expense was $3.4 million in 1995 as compared to $2.6 million in
1994. The increase was due primarily to higher average borrowings needed to fund
working capital to support higher sales, offset by a slightly lower interest
rate in 1995 as compared to 1994 on the Company's revolving credit facility.
 
     Income tax expense for 1995 and 1994 includes provisions for federal, state
and foreign income taxes, after taking into account the available net operating
loss carryforwards from prior years. At December 31, 1995, the Company has
federal net operating loss carryforwards of approximately $7.3 million and
unused federal tax credits of approximately $1.8 million available to reduce
taxes in future periods.
 
                                       19
Years Ended December 31, 1994 and 1993
 
     Net revenues, including both toy sales and sales of the Game Genie video
game enhancer, were $178.8 million in 1994, which represented a 33% increase

from net revenues of $134.3 million in 1993. Worldwide toy sales increased 72%
in 1994 as compared to 1993 with domestic toy sales increasing 103% and
international toy sales increasing 33% during such period.
 
     In 1994, sales of Micro Machines products grew significantly for the second
consecutive year. Net sales in 1994 climbed to $113.0 million, a 59% increase
over 1993 levels. Much of the growth in the Micro Machines line was attributable
to licensed products such as Star Wars, Star Trek and Power Rangers. The
Company's Biker Mice From Mars action figures, introduced in late 1993,
generated 1994 sales of $41.4 million as compared to $4.3 million in 1993. In
addition, shipments of two new product lines late in 1994, Sky Dancers, a flying
doll, and My Pretty DollHouse, generated sales of $3.3 million and $3.0 million,
respectively. Game Genie sales were $4.2 million in 1994 as compared to $32.8
million in 1993. This decrease in Game Genie sales reflected the normal maturity
cycle for such products and such decline was expected.
 
     Gross margin totaled $83.6 million in 1994, an increase of $24.4 million or
41.3% from 1993. This increase was due to higher sales volume and a higher gross
margin rate. The gross margin rate improved to 46.8% in 1994 from 44.0% in 1993
due to three factors. First, the international gross margin rate was higher due
to a change in product mix. Second, the percent of U.S. sales to worldwide sales
was greater. Third, while tooling, packaging design and other costs in the
aggregate were higher in 1994 compared to 1993, they were lower as a percent of
sales in 1994 compared to 1993.
 
     Advertising and promotion expenses were $30.6 million or 17.1% of net
revenues in 1994 compared to $23.5 million or 17.5% of net revenues in 1993. The
higher expenses were primarily a result of an increase in planned domestic
television advertising expense in connection with the Company's expanded product
lines. Other selling and administrative expenses were $23.0 million in 1994
compared to $22.0 million in 1993. This increase was due mainly to incentive
compensation which was reinstated based on the Company's 1994 performance.
Royalties, research and development expenses were $20.8 million in 1994 as
compared to $18.8 million in 1993. This increase was due to higher royalty
expenses associated with increased sales volume.
 
     The $4.0 million expense in 1993 related to the variable stock option plan
was a one-time charge.
 
     Although total operating expenses (excluding the expenses related to the
variable stock option plan) increased by $10.0 million in 1994 as compared to
1993, operating expenses as a percent of net revenues declined from 47.9% in
1993 to 41.6% in 1994.
 
     Earnings from operations were $9.3 million in 1994 as compared to a loss of
$9.2 million in 1993, reflecting the growth of net revenues of 33%, the
increased gross profit rate and lower operating expenses as a percent of
revenues.
 
     In 1994, the net proceeds of $12.1 million from the Nintendo award
represents the receipt of the Company's share of proceeds from its litigation
with Nintendo. This amount was reflected in 1994 results and had no impact on
1993 results.
 

     Interest expense in 1994 was $2.6 million compared to $1.8 million in 1993.
$1.0 million of such increase was due to the Company's Debentures being
outstanding for the full year compared to being outstanding for less than two
months in 1993. Interest was reduced by lower average borrowings under the
Company's line of credit in 1994, although interest rates were higher.
 
     The income tax expense for 1994 includes provisions for federal, state and
foreign income taxes, after taking into account the available net operating loss
carryforwards from prior years. In 1993, the tax provision represented only
foreign income taxes as there was no taxable U.S. income. At December 31, 1994,
the Company had federal net operating loss carryforwards of approximately $11.5
million and unused federal tax credits of approximately $1.7 million available
to reduce taxes in future periods.
 
  Liquidity, Financial Resources and Capital Expenditures
 
     Demand for the Company's products is greatest in the third and fourth
quarters of the year. As a result collections of accounts typically peak in the
fourth quarter and early first quarter of the following year. Due to the
seasonality of its revenues and collections, the Company's working capital
requirements fluctuate significantly during the year. The Company's seasonal
financing requirements are usually highest during the fourth quarter of each
calendar year.
 
                                       20
On March 31, 1995, the Company entered into an amended and restated loan
and security agreement (the 'Credit Agreement') with Congress Financial
Corporation (Central) (the 'Lender'). The Credit Agreement extends through March
31, 1997 and provides a revolving line of credit of $40 million secured by
substantially all the assets of the Company, with provision to increase the line
to $60 million at the option of the Company. Borrowing availability is
determined by a formula based on qualified assets. The annual interest rate is
equal to the prime rate of CoreStates Bank N.A. as announced from time to time
plus 1%. At June 30, 1996, approximately $34.6 million was outstanding and $5.1
million was available to borrow under the Credit Agreement. The Company intends
to use the proceeds of this offering to repay amounts outstanding under the
Credit Agreement. However, the Company does not intend to reduce the
availability under the Credit Agreement and may, from time to time, reborrow
amounts available under the Credit Agreement for working capital and general
corporate purposes. See 'Use of Proceeds.' Upon the expiration of the Credit
Agreement, the Company intends to replace the Credit Agreement with a new credit
facility.
 
     During 1995, the Company used $7.1 million of cash in its operating
activities. This resulted primarily from a $10.5 million increase in accounts
receivable due to increased sales and to a $4.9 million increase in prepaid
expenses reflecting advances made to licensors of future products.
 
     During the six months ended June 30, 1996, the Company used $16.2 million
of cash in its operating activities. This usage resulted from the net loss,
increases in inventories, tooling and related costs and prepaid expenses and

other assets, and from decreases in accounts payable and accrued expenses. These
changes reflect the Company's normal seasonal pattern and the increase in sales
volume.
 
     Working capital was $47.6 million at June 30, 1996 compared to $43.1
million at June 30, 1995 and $54.7 million at December 31, 1995 compared to
$53.2 million at December 31, 1994. The ratio of current assets to current
liabilities was 1.8 to 1.0 at June 30, 1996 compared to 2.1 to 1.0 at June 30,
1995 and 2.1 to 1.0 at December 31, 1995 compared to 2.4 to 1.0 at December 31,
1994.
 
     Capital expenditures for 1995 were approximately $1.0 million. The Company
had no material commitments for capital expenditures at June 30, 1996. However,
the Company expects that total capital expenditures for 1996 will be
approximately twice the 1995 amount.
 
     The Company believes that its cash flow from operations, cash on hand and
borrowings under the Credit Agreement, together with the net proceeds to the
Company from this offering, will be sufficient to meet its working capital and
capital expenditure requirements and provide the Company with adequate liquidity
to meet its anticipated operating needs for the foreseeable future. However, the
financing of any significant future product or property acquisitions (including
up-front licensing payments), may require additional debt or equity financing.
 
  Recent Accounting Pronouncement
 
     The FASB issued a new standard, SFAS No. 123, 'Accounting for Stock-Based
Compensation,' which contains a fair value-based method for valuing stock-based
compensation that entities may use, which measures compensation cost at the
grant date based on the fair value of the award. Compensation is then recognized
over the service period, which is usually the vesting period. Alternatively, the
standard permits entities to continue accounting for employee stock options and
similar equity instruments under APB Opinion 25, 'Accounting for Stock Issued to
Employees.' Entities that continue to account for stock options using APB
Opinion 25 are required to make pro forma disclosures of net income and earnings
per share, as if the fair value-based method of accounting defined in SFAS No.
123 had been applied. The Company has determined to continue to account for
stock options using APB Opinion 25 and will make required pro forma disclosures
in the notes to its consolidated financial statements. The Company will be
required to adopt the new standard for the year ending December 31, 1996.
 
  Impact of Inflation
 
     The cost of the Company's operations is influenced to the extent of any
price increases in the cost of raw materials. In management's opinion, other
than the sharp increases in prices of plastics and packaging materials
experienced in the third and fourth quarters of 1995, general inflation did not
have a material impact on the Company's business in 1995. The Company did not
implement any substantial price increases in 1995 or 1994 on continuing product
lines.
 
                                       21
BUSINESS
 
     The following 'Business' section contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in the
section entitled 'Risk Factors' and elsewhere in this Prospectus.
 
GENERAL
 
     Founded in 1957, the Company is a leading international toy company that
designs, develops, markets and sells a variety of high-quality toy products in
an expanding number of product categories. The Company believes it is a leading
innovator in the toy industry as evidenced by: its award-winning Sky Dancers,
the world's first flying doll, introduced in late 1994; its Double Takes line of
Micro Machines transforming playsets, introduced in 1995; its line of Star Wars
Action Fleet toys representing a new scale in the male action category; and
Dragon Flyz, the world's first fully articulated flying male action figure. The
Company's Micro Machines line, introduced in 1987, is the most comprehensive
line of miniature scale play for boys in the United States, embracing
traditional vehicle, military and male action play patterns. The Company's Sky
Dancers line has been the number-one selling mini-doll in the United States in
1995 and 1996, and Dragon Flyz became the fourth best selling male action line
in the United States within weeks of its national introduction in June.
 
     The Company's 1996 product offerings consist of six product lines: Micro
Machines, Star Wars Action Fleet, Dragon Flyz, Jonny Quest, Sky Dancers, and
Pound Puppies. In addition to extensions of these product lines, the Company's
1997 product offerings are expected to include new product lines based on three
entertainment properties: Men In Black, a new science fiction adventure comedy
film scheduled to be released by Sony in the summer of 1997; Starship Troopers,
a new science fiction adventure film scheduled to be released by Sony in the
summer of 1997; and Anastasia, a new animated film scheduled to be released by
Fox in the fall of 1997. In connection with the scheduled re-release of the Star
Wars movie trilogy in early 1997, the Company plans to introduce new Star Wars
Micro Machines and Action Fleet toys. In addition, the Company intends to
aggressively pursue licensing rights in connection with the release of the new
Star Wars movie trilogy scheduled to start in 1999.
 
     The Company's products are sold in more than 50 countries worldwide. These
products are principally sold direct to retailers in the United States and to
toy distributors outside of the United States. Since 1993, the Company's
revenues have grown approximately 64% from approximately $134 million in 1993 to
approximately $220 million in 1995. In 1995, approximately one-third of the
Company's revenues were derived from international sales which have increased by
approximately 77% since 1993.
 
     Although the Company's sales have increased significantly since 1993, its
market share in 1995 was only approximately one percent of the total $13.4
billion U.S. wholesale toy shipments and, therefore, management believes there
is substantial opportunity for continued growth. The recent consolidations among
both toy companies and toy retailers have also provided increased growth
opportunities for the Company. The Company believes that the consolidation of

the industry into fewer larger toy companies combined with the Company's proven
success in developing and marketing licensed products make the Company a
relatively more attractive licensee to toy inventors and other licensors. In
addition, as a result of industry concentration, the Company has become a
relatively more attractive supplier to retailers that do not wish to be
dependent on a few dominant toy companies. Toy retailer concentration has also
been advantageous to the Company as it has reduced the need to support a large,
expensive sales and distribution organization to service numerous small
customers. This also enables the Company to ship product, manage account
relationships and track retail sales as effectively as much larger competitors.
 
INDUSTRY OVERVIEW
 
     According to the Toy Manufacturers of America, Inc. ('TMA'), an industry
trade group, total domestic shipments of toys, excluding video games and
accessories, were approximately $13.4 billion in 1995. According to the TMA, the
United States is the world's largest toy market, followed by Japan and Western
Europe. The Company estimates that the two largest U.S. toy companies, Mattel
and Hasbro, collectively hold a dominant share of the domestic non-video toy
market. In addition, hundreds of smaller companies compete in the design
 
                                       22
and development of new toys, the procurement of licenses, the improvement and
expansion of previously introduced products and product lines and the marketing
and distribution of toy products.
 
     A substantial majority of the toys sold in the U.S. are manufactured,
either in whole or in part, overseas where labor rates are comparatively low.
The largest foreign producer markets are China and, to a lesser extent, other
countries in the Far East.
 
     Toy manufacturers sell their products either directly to retailers, or to
wholesalers who carry the product lines of many manufacturers. Retail toy sales
have become increasingly concentrated through a small number of large chains,
such as Toys 'R' Us, Inc. ('Toys 'R' Us'), Wal-Mart Stores, Inc. ('Wal-Mart'),
Kmart Corporation, Target Stores, Inc., a division of Dayton-Hudson Corp., and
Kaybee Toys, Inc., a division of Consolidated Stores Inc., which generally
feature a large selection of toys, some at discount prices, and seek to maintain
lean inventories to reduce their own inventory risk. According to the TMA, the
top five U.S. toy retailers collectively hold more than half of the retail
domestic market for toy sales, and their collective market share has grown in
recent years.
 
GROWTH STRATEGY
 
     The Company believes its recent success has left it well positioned for
future growth. The key elements of the Company's growth strategy are as follows:
 
o Build The Company's Core Brand--Micro Machines.  The Company seeks to continue
  expanding its Micro Machines brand as the most comprehensive universe of
  miniature scale play for boys. The Company intends to accomplish this by

  extending Micro Machines into additional play patterns, such as the Micro
  Machines Exploration line (Micro Machines that float in water) for 1997, and
  to continue acquiring and exploiting new entertainment licenses to keep Micro
  Machines at the leading edge of boys' play.
 
o Enter New Product Categories.  The Company has entered and intends to continue
  to enter into new toy categories. Entering 1993, the Company competed
  primarily in only one category of the toy industry (excluding video
  games)--miniature vehicles, which generated approximately $240 million of
  total U.S. wholesale toy shipments in that year. In 1995, the Company competed
  in four categories that generated approximately $2.1 billion of the total U.S.
  wholesale toy shipments. The Company considers entering new categories which
  have the following characteristics: (i) low barriers to entry such that there
  is no dominant competitor; and (ii) potential to create product lines that can
  become multi-year brands based upon collectibility and thematic extendability.
  The Company believes that developing product lines with multi-year lives helps
  sustain growth rates because each year's new product introductions add to a
  continuing base of multi-year products instead of merely replacing the sales
  volume lost as each of the previous year's product life cycles come to an end.
  In addition, management believes that there is significant potential for
  future product innovation, and intends to aggressively develop new products
  and product line extensions. As a result, the Company intends to continue to
  make significant investments in new products and product development.
 
o Expand Profit Margins On Rising Sales.  A key goal of the Company is to expand
  profit margins while continuing to increase sales, thereby increasing the rate
  of profit growth faster than the rate of sales growth. The Company seeks to
  increase profit margins by: (i) increasing gross margins; (ii) achieving
  economies of scale on increasing sales volume thereby reducing operating
  expenses as a percent of sales; and (iii) leveraging its investments in
  product development, tooling and marketing over the longer life spans of its
  multi-year brands. In addition, the Company plans to leverage its
  relationships with key manufacturers to increase efficiency and reduce costs.
  For example, the Company increasingly allows its key manufacturers to
  participate in the design and engineering process for its products allowing
  the Company to reduce the lead time to develop and deliver new products and
  enabling the Company's development personnel to concentrate more on developing
  new product concepts rather than design and engineering.
 
o Develop Strategic Alliances With Major Content Providers.  Over the past three
  years, the Company has developed important relationships with four major
  entertainment companies, Lucasfilm, Fox, Sony and Turner, which have licensed
  to the Company rights to make toys based on certain of their properties. The
  Company intends to continue to aggressively pursue opportunities to expand its
  relationships with these entertainment companies and to form additional
  alliances with other entertainment companies in order to assure access to a
  continuous flow 
 
                                       23
of quality entertainment properties that have potential to generate successful
  toy product lines. The Company's first major entertainment alliance was

  initiated in 1992 with Lucasfilm to give the Company the right to use the
  popular Star Wars trilogy in certain of its product lines. Subsequently, the
  Company has entered into important alliances with Fox, to obtain exclusive
  worldwide first rights to licensed toys based on all Fox theatrical and
  television properties (excluding the Fox Children's Network) to 2004
  (inclusive of renewal rights) and Turner with respect to the worldwide master
  toy license for The Real Adventures of Jonny Quest. In 1996, the Company
  entered into agreements with Sony with respect to licenses for two Sony
  properties, Starship Troopers, produced by TriStar Pictures and Walt Disney
  Motion Picture Group, and Men in Black, produced by Columbia Pictures and
  Amblin Entertainment. The Company's 1997 product offerings are expected to
  include products based on each of the entertainment properties referred to
  above. See '--Licensing Strategy.'
 
o Leverage International Distribution Networks.  Management believes that
  markets outside the United States, including Western Europe and Japan in
  particular, present significant continuing growth opportunities for the
  Company. The Company's products are sold in over 50 countries worldwide and
  the Company believes that it has one of the leading international presences
  among U.S. toy companies. Unlike many of its major U.S. competitors, the
  Company sells its products internationally through a network of leading
  distributors in their respective markets. The Company believes it has
  developed strong relationships with its key distributors outside of the United
  States and such distributors have a good reputation in, and knowledge of, the
  markets they serve. The Company believes that the success of its products in
  foreign markets continues to bolster distributor confidence in the
  marketability of the Company's products, resulting in a greater commitment by
  the distributors to the Company's products, and, in turn, greater sales for
  the Company. In addition, the Company believes that it has significantly
  reduced many of the risks associated with international sales by dealing with
  a variety of leading toy distributors in certain of its markets, requiring the
  Company's distributors to promote the Company's products in their markets and
  bear the costs of such promotion, requiring the Company's distributors to pay
  for the Company's products through letters of credit and requiring the
  distributors to bear the cost of transportation as well as the risk of damage
  or loss upon delivery to the distributors from the Far East. While Europe has
  traditionally accounted for the highest percentage of the Company's
  international sales, the Company continues to build its worldwide network and
  has seen growth in new markets such as Mexico and Latin America, the Pacific
  Rim and the Middle East. In addition, management believes that the
  international expansion of certain major U.S. toy retailers offers
  opportunities for the Company to leverage its existing relationships with such
  retailers.
 
     There can be no assurance that the Company will be able to implement all or
any part of its growth strategy or, if the Company is able to implement such
strategy, that it will be successful. For a discussion of important factors that
could affect the Company's ability to successfully implement its strategy in the
future, see 'Risk Factors.'
 
PRODUCTS
 
     The Company's 1996 product offerings consist of six product lines: Micro
Machines, Star Wars Action Fleet, Dragon Flyz, Jonny Quest, Sky Dancers, and

Pound Puppies. In addition to extensions of its current product lines, the
Company's 1997 product offerings are expected to include new product lines based
on three entertainment properties: Men In Black, a new science fiction adventure
comedy film scheduled to be released by Sony in the summer of 1997; Starship
Troopers, a new science fiction adventure film scheduled to be released by Sony
in the summer of 1997; and Anastasia, a new animated film that is scheduled to
be released by Fox in the fall of 1997. In connection with the re-release of the
Star Wars movie trilogy scheduled for February 1997, the Company is also
planning to introduce new Micro Machines and Action Fleet vehicles based on its
Star Wars license.
 
                                       24
The following chart sets forth the Company's product lines for 1996 and
proposed product lines for 1997:
CATEGORIES                                                            PRODUCTS
                                           1996                                            1997
                      ----------------------------------------------  ----------------------------------------------
BOYS
Micro Machines Scale  Basic (Collections, Playsets, Double Takes      Basic (Collections, 10th Year Collections,
                      Playsets)                                       Playsets, Double Takes Playsets, DOUBLE Double
                                                                      Takes)

                      Exploration (Sea Collection)                    Exploration (Sea Collection, Low Priced
                                                                      Playsets, DOUBLE Double Takes Playsets)

                      Military (Collections, Playsets, Double Takes   Military (Collections, Playsets, Double Takes
                      Playset)                                        Playsets, DOUBLE Double Takes Playsets)

                      Jonny Quest (Collections, Playsets)             Jonny Quest (Collections, Playsets)
                      Action (Collections, James Bond 007, Indiana    Action (Predator, Terminator 2, Star Trek)
                      Jones, Aliens and Predators)

                      Space (Star Trek, Babylon 5, Aliens and         Space (Vehicle Collections, Playset)
                      Predator)
                                                                      Racing Licenses (Indianapolis 500, U.S.A.
                                                                      500).

                      Star Wars (Collections, Droids, X-Ray Fleet,    Star Wars (Collections, Figure Collections,
                      Shadows of the Empire, Playsets, Transforming   Figure Heads with Figure, Epic Collections
                      Action Sets)                                    with Vehicles and Figures, X-Ray Fleet, 20th
                                                                      Anniversary Die Cast Vehicles, Adventure Gear;
                                                                      Transforming Action Sets, Double Takes
                                                                      Playset)

                                                                      Men in Black

                                                                      Starship Troopers

Action Fleet          Star Wars (Battle Packs Vehicle with Figures,   Star Wars (Battle Packs, Vehicle Collections,
                      Ice Planet Hoth Playset, The Death Star         Imperial/Rebel Flight Controller, Series X
                      Playset)                                        Prototype Vehicles, Hoth/Death Star/Yavin
                                                                      Playsets)

                                                                      Starship Troopers (Battle Packs, Vehicle/Bug
                                                                      Collections, Tethered RC Bug/Drop Ship)
                                                                      Aliens and Predators

Male Action Figures   Dragon Flyz (Assortment, Figure, Gremwing,      Dragon Flyz (F.I.S.T. Force Figures,
                      Dragon Launcher)                                Assortment, Sky Dragons Assortments, Gremwing,
                                                                      Battle Blazers, Deluxe Raptor, Doomfrye

                                                                      Deluxe)

                      Jonny Quest (Assortment, Figure with Vehicle,   Jonny Quest (Real World, Deluxe QuestWorld,
                      Rover and Porpoise Sub, Cybercopter)            Aerohawk, Wave Ranger, Ice Runner, Quest
                                                                      Rover/Quest Porpoise; Quest Cyber Gyrobug,
                                                                      Quest Race Car; QuestWorld Cybercopter, Shadow
                                                                      Slayer)

                                                                      Men in Black (Figures, Alien Figures, Edgar
                                                                      with Kay, Van Figure, LTD Electric Vehicle,
                                                                      Tethered RC, Playset)
                                                                      Starship Troopers

GIRLS
Mini Dolls            Sky Dancers                                     Sky Dancers
                      Fairy Flyers (Doll, Doll and Animal, Carousel)  Pretty Scent
                      Basic Sky Dancers (Doll, Bent Leg, Magic        Sky Dancers Animated Adventures
                      Swan/Pegasus Flying Princess, Assortment)       Flying Fairy Tales
                      Pretty Lights (Doll, Multiple Doll)             Sparkle Dome
                                                                      Anastasia

Plush Toys            Pound Puppies                                   Pound Puppies
                      Puppies or Pur-r-ries                           Pure Breds--Puppies or Kittens
                      Wrinkle Pup                                     Pound Bunnies
                      Mommy and Pups/Kitties                          Mom & Babies
                      Brush'n Style Puppy                             Feature Puppies (Wiggle'n Walk, Fashion,
                                                                      Brush'n Style, Feed'n Cuddle)
 
Fashion Dolls                                                         Anastasia
25
BOYS' PRODUCTS
 
o  MICRO MACHINES
 
   Now in its ninth year, the Micro Machines line is the most comprehensive line
   of minature scale play for boys in the United States, embracing traditional
   vehicle, military and male action play patterns. The Company continues to
   grow and expand its segments of Micro Machines miniature vehicles (1/100
   scale), figures, playsets and accessories. Additions to the basic, space,
   military and licensed segments have created more than 40 playsets, 500
   vehicles and 130 collections for 1996. Enhanced by the introduction of
   innovative new segments, such as Double Takes, a transforming playset
   featuring two action play environments in one toy, and Exploration, Micro
   Machines that float in water, the 1996 line presents the most comprehensive
   universe of miniature play for children in the brand's history. Micro
   Machines also features products based on the popular Star Wars trilogy. Other
   Micro Machines licensed properties include Star Trek, Aliens, Indiana Jones
   and Predator.
 

o  ACTION FLEET
 
   In 1996, the Company introduced Action Fleet, an innovative scale segment of
   vehicles, figures and playsets that are larger than Micro Machines but less
   than one-half the size of traditional male action figures. Action Fleet
   features five-to-seven inch long vehicles and fully poseable one to one and
   one-half inch tall figures, which are compatible with separate Action Fleet
   playsets. Based on the successful expansion of the Micro Machines Star Wars
   brand, the initial introduction of the Action Fleet line consists of
   vehicles, figures and playsets from the Star Wars movie trilogy.
 
o  DRAGON FLYZ
 
   In 1996, the Company also introduced Dragon Flyz, the first poseable flying
   action figures for boys. Inspired by the Company's successful Sky Dancers
   flying dolls for girls, this line consists of articulated action figures that
   fly with the help of special dragon shaped launchers. Dragon Flyz will be
   supported domestically and internationally by an independently produced
   animated syndicated television show, which began airing in the U.S. in
   September 1996. Dragon Flyz became the second best selling male action line
   in the United States within weeks of its national introduction in June.
 
o  JONNY QUEST
 
   The Company's Jonny Quest product line, also introduced in 1996, results from
   the Company's worldwide master toy license with Turner for The Real
   Adventures of Jonny Quest property. The Real Adventures of Jonny Quest is
   based on the updated reintroduction of the classic 1960's animated television
   property from Hanna-Barbera cartoons and Turner. The Company's Jonny Quest
   product line features both real-world and futuristic, virtual-reality
   QuestWorld figures and vehicles in both the traditional male action scale and
   Micro Machines scale. The Real Adventures of Jonny Quest is being supported
   across all Turner Broadcasting divisions and airing a total of 21 times
   weekly in September 1996 on Turner Network Television, Turner Broadcasting
   System and The Cartoon Network.
 
o  MEN IN BLACK
 
   In the spring of 1997, the Company plans to introduce new product lines based
   on the characters in Columbia Pictures' and Amblin Entertainment's science
   fiction adventure comedy scheduled to be released in the summer of 1997 in
   both the traditional male action scale and Micro Machines scale.
 
o  STARSHIP TROOPERS
 
   In the spring of 1997, the Company plans to introduce new product lines based
   on the science fiction adventure Starship Troopers in the Micro Machines
   scale, Action Fleet scale and male action scale. Starship Troopers, which is
   being produced under an arrangement between TriStar Pictures and Walt Disney
   Motion Pictures Group, is expected to be released in the summer of 1997.
 
                                       26
GIRLS' PRODUCTS
 
o  SKY DANCERS
 
   First introduced in late 1994, the award-winning Sky Dancers line is one of
   the most successful new girls' toy concepts in recent years and has been the
   number one selling mini-doll in the United States in 1995 and 1996. Featured
   on the cover of The New York Times Magazine, the innovative Sky Dancers line
   of dolls and playsets features the first known girls' doll that flies. These
   collectible ballerina dolls fly utilizing a special launcher with pull-cord
   action created in various themes. The playsets included Magic Rolling
   Launchers in the shape of a swan and pegasus. The Sky Dancers flying doll and
   accessory line has been extended to include new segments, including Pretty
   Lights with light-up flying dolls and launchers; smaller-size Fairy Flyers
   flying dolls, pets and Magical Flying Carousel playset; Fairy Tale Couples;
   and the Flying Princess doll with graceful fluttering wings. Sky Dancers are
   also featured in a new independently produced animated syndicated television
   show, which began airing in the U.S. in September 1996.
 
o  POUND PUPPIES
 
   In 1996, the Company also reintroduced a small-scale version of Pound Puppies
   and Pound Pur-r-ries, one of the most successful plush toy lines of the
   1980's. The Company has created a new miniature scale and added new themes to
   expand the line. The Company will also introduce Brush 'n Style, a puppy that
   has long furry ears that allow little girls to create a variety of
   'hair-styles' using the fancy hair accessories that are included with the
   puppy.
 
o  ANASTASIA
 
   In the fall of 1997, the Company plans to introduce a new line of miniature
   and fashion dolls based on the characters in Anastasia. Anastasia, which will
   be the first animated film from Fox's The Animation Studio, re-explores the
   classic legend of the lost princess Anastasia, the surviving daughter of
   Russia's last Czar and is scheduled for a fall 1997 release.
 
LICENSING STRATEGY
 
     The Company produces substantially all of its products under licenses from
other parties. Some of these licenses confer rights to exploit original concepts
or products developed by toy inventors and designers. Other licenses, referred
to as entertainment licenses, permit the Company to design, develop, manufacture
and market toys based on characters or properties which have their own popular
identity, often through exposure in various media such as television programs,
movies, cartoons and books. Normally most entertainment licenses extend for one
to three years and are typically 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. Licenses for original ideas
from toy inventors or designers typically extend for either a set number of
years or the commercial life of the product. The Company typically obtains the
domestic and international rights for the licensed products.
 

     The Company is an active participant in the market for entertainment
licenses. A determination to acquire an entertainment license must usually be
made before the commercial introduction of the property in which a licensed
character or property appears, and these license arrangements usually require
the payment of non-refundable advances or guaranteed minimum royalties.
Accordingly, the success of an entertainment licensing program is dependent upon
the ability of management to assess accurately the future success and popularity
of the properties that it is evaluating, to bid for products on a selective
basis in accordance with such evaluation, and to capitalize on the properties
for which it has obtained licenses in an expeditious manner.
 
     In October 1992, the Company first obtained a license from Lucasfilm to
produce three collections of vehicles based on the Star Wars trilogy. As a
result of the Company's continued success with the Star Wars products, Lucasfilm
has extended and expanded the Company's right to produce Star Wars toys
including the innovative Action Fleet line of vehicles, figures and playsets
introduced in 1996. In February 1997, Lucasfilm is scheduled to re-release its
classic Star Wars trilogy in theaters across the United States with enhanced
digital sound and previously unreleased footage. The Company expects that such
re-release may have a positive impact on the sales of its Star Wars products
although no assurance can be made that the re-release will occur as scheduled or
that it will impact the Company's sales of Star Wars products. The Company's
Star Wars license from Lucasfilm expires on December 31, 1997. Although the
Company believes its relationship with Lucasfilm is
 
                                       27
excellent, there can be no assurance that Lucasfilm will choose to renew or
extend the Company's Star Wars license. In addition, Lucasfilm currently intends
to begin releasing a new Star Wars movie trilogy commencing in 1999. The Company
intends to aggressively pursue renewal of its current Star Wars license for 1998
as well as licenses in connection with the release of the new trilogy in 1999.
However, if the Company is unable to renew or extend the Star Wars license or if
it is unable to renew or extend it for all of the current products lines, the
loss of all or part of such license could have a material adverse effect on the
business, financial condition and results of operations of the Company. See
'Risk Factors--Licensing and Related Rights.'
 
     As part of its strategic licensing program, the Company has signed an
agreement with Fox that gives the Company the exclusive worldwide first rights
to license toys based on all new Fox theatrical and television properties
(excluding the Fox Children's Network) to the year 2004 (including renewal
rights granted to the Company). The agreement fulfills a key growth objective by
forming an alliance with a powerful content provider and assures access to a
continuous flow of quality entertainment properties from Twentieth-Century Fox
Film Corporation, Fox Animation Studios, Twentieth-Century Fox Television, Fox
Broadcasting Company, Fox Family Films, Fox 2000 Pictures, and Fox Searchlight
Pictures. Pursuant to this agreement, the Company has determined to produce toys
based on the full-length animated feature film Anastasia due to be released in
the fall of 1997.
 
     In addition to the Fox agreement, the Company has signed a worldwide master

toy license agreement with Turner for The Real Adventures of Jonny Quest and has
already begun to ship its Jonny Quest line of action figures and vehicles. The
Company has also been awarded the worldwide master toy license by Sony for
TriStar Pictures' science fiction adventure Starship Troopers(Trademark), which
is being produced under an arrangement between TriStar Pictures and the Walt
Disney Motion Pictures Group and is expected to be released in the summer of
1997. In addition, Sony has issued the Company the worldwide master toy license
for Columbia Pictures' and Amblin Entertainment's science fiction adventure
comedy Men in Black, which is also expected to be released in the summer of
1997. The Company's 1997 product lines are expected to feature products based on
the Starship Troopers and Men in Black motion pictures.
 
     The Company pays royalties to its licensors which typically range from 2%
to 16% of net sales. The Company also frequently guarantees payment of a minimum
royalty. As of June 30, 1996 minimum future guaranteed payments aggregated
approximately $3,653,000. Royalties expense totaled approximately $10,439,000,
$16,326,000 and $13,498,000 for the six months ended June 30, 1996 and in 1995
and 1994, respectively. As a result of increased competition among toy companies
for licenses, in certain instances the Company has paid, and may in the future
be required to pay, higher royalties and higher minimum guaranteed payments in
order to obtain attractive properties for the development of product lines. See
'Risk Factors-- Licensing and Related Rights.'
 
SALES, MARKETING AND DISTRIBUTION
 
  Domestic
 
     The Company markets and sells its products throughout the world, with sales
to customers in the United States aggregating 63%, 66% and 66% of consolidated
net sales in 1995, 1994 and 1993, respectively.
 
     The Company sells its products in the United States directly to specialty
toy retailers, discount and chain stores, catalog and mail order companies,
department stores, variety stores and independent distributors which purchase
the products directly from the Company and ship them to retail outlets. In 1995
and 1994, Toys 'R' Us accounted for approximately 20% and 21% of the Company's
consolidated net sales, respectively. Wal-Mart accounted for approximately 11%
of net sales in 1995.
 
     The Company has a sales staff of six people, supplemented by several
manufacturers' representative organizations in the United States that act as
independent contractors. The Company's sales staff and the manufacturers'
representatives offer the Company's products through the use of samples and
promotional materials at toy shows and by making regular customer sales calls.
The Company presents its products directly to key retail accounts. The Company
also directly introduces and markets to customers new products and extensions to
previously marketed product lines by participating in the major trade shows in
New York, Hong Kong and Europe and through the maintenance of a showroom in New
York City. Manufacturers' representatives utilized
 
                                       28
by the Company receive commissions, which were approximately 0.8%, 1.0% and 1.3%
of net sales in 1995, 1994 and 1993, respectively.
 
     The Company utilizes warehouse facilities primarily in Union City,
California for storage of its products. Disruptions in shipments from Asia or
from the Union City facility could have a material adverse effect on the
business, financial condition and results of operations of the Company.
 
     The Company does not sell its products on consignment and ordinarily
accepts returns only for defective merchandise. Returns have historically not
been significant. In certain instances, where retailers are unable to resell the
quantity of products which they have purchased from the Company, the Company
may, in accordance with industry practice, assist retailers in selling such
excess inventory by offering credits and other price concessions.
 
     The Company plans to establish a new subsidiary to design, develop and sell
lines of toys that will not be advertised on television by the Company. These
products which are known as 'F.O.B.' within the industry will be sold on an
international and domestic basis, and will be primarily based on the Company's
advertised product lines, including its entertainment licensed products.
 
  International
 
     The Company has an extensive international sales program. The Company, in
conjunction with its wholly-owned subsidiary Galco International Toys, N.V.
('Galco'), located in Hong Kong, actively sells its products in over 50
countries and sells directly to approximately 60 separate, independent toy
distributors, each of which is domiciled in the respective country to which
sales are made. While the dollar volume of international sales accounted for
approximately one-third of total Company sales in 1995, approximately one-half
of all of the Company's toys sold were shipped to countries outside the United
States. This is due to the fact that international sale prices to distributors
are significantly lower than U.S. domestic sale prices to retail accounts since
international distributors are responsible for all importation, warehousing,
marketing, promotional and selling related costs.
 
     The Company believes that it has significantly reduced many of the risks
associated with international sales by dealing with leading toy distributors in
certain of its markets, requiring the Company's distributors to promote the
Company's products in their markets and bear the costs of such promotion,
requiring the Company's distributors to pay for the Company's products through
letters of credit and requiring the distributors to bear the cost of
transportation as well as the risk of damage or loss upon delivery to the
distributors in the Far East. The Company's risks are further reduced because
its distributors bear the cost and risk of carrying inventory in the Company's
products and the credit risk of collecting receivables from their retail
customers.
 
     Sales by the Company to foreign customers are ordinarily denominated in
U.S. dollars and, accordingly, the Company's revenues are not affected by
fluctuations in monetary exchange rates. However, the value of the U.S. dollar
in relation to the value of other currencies of the countries into which the
Company's products are sold may have a positive or negative impact on the
Company's sales volume over time, depending on the change in relationship of the

respective currencies because the Company's products compete with products for
which wholesale prices are denominated in the local currency.
 
ADVERTISING AND PROMOTION
 
     The Company's advertising and promotion expenses are significant. Although
a portion of the Company's advertising budget is expended for newspaper
advertising, magazine advertising, catalogs and other promotional materials, the
Company allocates the bulk of its advertising budget to television. As is common
practice in the toy industry, the Company advertises on national network,
syndicated, cable and local spot television. The Company often pre-tests
advertisements to evaluate their effectiveness on the target market. The bulk of
the Company's advertising and promotions occur in the early spring leading up to
Easter and the fall season leading up to Christmas. The Company's retail
customers also provide advertising for the Company's products and may, from time
to time, receive a credit allowance in connection with such advertising. With
respect to entertainment licenses, the Company believes it benefits from
advertising and promotion from the major studios with respect to their
entertainment properties and their promotion tie-ins.
 
                                       29
RESEARCH AND DEVELOPMENT
 
     The Company employs its own designers and engineers and also utilizes the
services of independent designers and engineers on an ongoing basis. The Company
presents its designers with toy concepts licensed or, to a lesser extent,
originated by it, and the designers create renderings of the proposed product.
Designs are then presented to the Company's engineers, who, using the
renderings, perform mechanical drawings and engineering services and create
prototypes for new products. Prototypes for proposed products are continuously
reviewed by the Company's management, including representatives of marketing,
sales and manufacturing, prior to final acceptance. Character licensors usually
retain the right to approve the products being marketed by the Company.
 
     The Company spent approximately $7,886,000, $7,288,000 and $7,451,000 on
research and development activities in 1995, 1994 and 1993, respectively, and
$5,063,000 in the first six months of 1996, in each case exclusive of amounts
paid to certain inventors and designers who receive royalties as licensors. Such
amounts do not include approximately $12,388,000, $7,149,000 and $4,502,000
incurred in 1995, 1994, 1993, respectively, and $3,350,000 incurred in the first
six months of 1996 for tooling and package design.
 
MANUFACTURING
 
     The Company's products are manufactured to its specifications by
nonaffiliated third party manufacturers, usually located in the Far East. Over
80% of the Company's products were produced in China in 1995. See 'Risk
Factors--Foreign Operations.' These manufacturers are responsible for all
aspects of the production of the Company's products in accordance with Company
product specifications.
 

     The Company's manufacturing is currently performed by 21 manufacturers,
some of whom derive a substantial percentage of their business from the Company.
During the last four years, the Company has reduced the number of its
manufacturers and concentrated its sourcing of products from a limited number of
high quality manufacturers. In 1995, four companies manufactured approximately
88% of the Company's products and a single group, Harbour Ring, produced
approximately 60% of the Company's products. The Company believes that its
relationships with Harbour Ring and its other key manufacturers are excellent.
It is anticipated in 1996 that manufacturers' production will be similarly
concentrated as in 1995. See 'Risk Factors--Dependence on Key Manufacturers.'
 
     The Company, through its wholly-owned subsidiary Galco, maintains close
contact with the Company's manufacturers and subcontractors and monitors the
quality of the products produced. Galco's employees arrange with manufacturers
for the production, shipment and delivery of products, monitor the quality of
the products produced, and undertake certain elements of the design and
development of new products. Decisions related to the choice of manufacturer are
based on price, quality of merchandise, reliability and the ability of a
manufacturer to meet the Company's timing requirements for delivery. Generally,
tooling is owned by the Company but may be utilized by different manufacturers
if the need arises for alternate sources of production.
 
     The Company does not carry insurance for political or economic unrest or
disruption for several reasons, including, but not limited to, costs of such
insurance and the limited insurance coverage available. The impact on the
Company from such unrest or disruption would depend on several factors,
including, but not limited to, the nature, extent and location of such unrest or
disruption and the Company's ability to: (i) procure alternative manufacturing
sources outside of the country involved; (ii) retrieve its tooling; (iii)
relocate its production in sufficient time to meet demand; and (iv) pass cost
increases likely to be incurred as a result of such factors to the Company's
customers through product price increases. See 'Risk Factors--Foreign
Operations.'
 
     Transactions in which the Company purchases goods from manufacturers are
mostly denominated in Hong Kong dollars and, accordingly, fluctuations in Hong
Kong monetary exchange rates may have an impact on cost of goods. However, in
recent years, the value of the Hong Kong dollar has had a continuing stable
relationship to the value of the U.S. dollar and the Company has not experienced
any significant foreign currency fluctuations. Inflationary pressure in China
could have an effect on the cost of product sourced from China.
 
     The principal raw materials used in the production and sale of the
Company's products are plastics and paper products. The Company believes that an
adequate supply of raw materials used in the manufacture of its products are
readily available from existing and alternate sources. See 'Risk Factors--Raw
Material Prices.'
 
                                       30
INTELLECTUAL PROPERTY RIGHTS
 

     Most of the Company's products are copyrighted and sold under trademarks
owned by or licensed to the Company. In addition, certain products incorporate
patented devices or designs. The Company or its licensors customarily seek
protection of major product patents, trademarks and copyrights in the United
States and certain other countries. These intellectual property rights can be
significant assets of the Company. Although the Company believes it is
adequately protected, the loss of certain of its rights for particular product
lines may have a material adverse effect on its business, financial condition
and results of operations.
 
COMPETITION
 
     The toy industry is highly competitive. The Company competes with several
larger domestic and foreign toy companies, such as Hasbro and Mattel, and many
smaller companies in all aspects of its business, including the design and
development of new toys, the procurement of licenses, the improvement and
expansion of previously introduced products and product lines, and the marketing
and distribution of its products including obtaining adequate shelf space. Some
of these companies have longer operating histories, broader product lines and
greater financial resources and advertising budgets than the Company. In
addition, it is common in the toy industry for companies to market products
which are similar to products being successfully marketed by competitors. The
Company believes that the strength of its management team, the quality of its
products, its relationships with inventors, designers and licensors, its
distribution channels and its overhead and operational controls allow the
Company to compete effectively in the marketplace. See 'Business Research and
Development' and 'Business--Sales, Marketing and Distribution.'
 
SEASONALITY AND BACKLOG
 
     Toy industry sales are highly seasonal and driven by disproportionate
customer demand for toys to be sold during the Christmas holiday season.
Approximately two-thirds of the Company's shipments typically occur in the
second half of the year. As a result, the Company's operating results vary
significantly from quarter to quarter within any given year. Orders placed with
the Company for shipment are cancelable until the time of shipment. The
combination of seasonal demand and the potential for order cancellation makes
accurate forecasting of future sales difficult and causes the Company to believe
backlog may not be an accurate indicator of the Company's future sales.
Similarly, comparison between fiscal periods of successive years may not be
indicative of results of operations for any given full year. The seasonality
creates significant peaks in working capital requirements. See 'Risk
Factors--Seasonality; Payment Terms.'
 
GOVERNMENT REGULATIONS
 
     The Company is subject to the provisions of, among other laws, the Federal
Hazardous Substances Act and the Federal Consumer Product Safety Act. These laws
empower the CPSC to protect consumers from hazardous toys and other articles.
The CPSC has the authority to exclude from the market articles which are found
to be unsafe or hazardous and can require a manufacturer to recall such products
under certain circumstances. Similar laws exist in some states and cities in the
United States and in Canada and Europe. The Company's products are designed and
tested to meet or exceed all applicable regulatory and voluntary toy industry

safety standards. The Company emphasizes the safety and reliability of its
products and has established a strong quality assurance and control program to
meet the Company's objective of delivering high-quality, safe products. The
Company believes that all of its products meet or exceed applicable safety
standards in the United States and other jurisdictions. See 'Risk
Factors--Government Regulations; --Potential Product Liability.'
 
PROPERTIES
 
     The Company's principal executive offices are located at 500 Forbes
Boulevard, South San Francisco, California, where the Company owns a building
with approximately 136,000 square feet. The Company occupies approximately
67,000 square feet of office space and leases the remaining approximately 69,000
square feet of warehouse space to third parties. The Company also has 125,000
square feet of warehouse space at Union City, California, under a lease which
expires in 1997, with rights to renew for an additional five-year term. The
Company is considering various alternatives to renewing the Union City,
California lease and believes that adequate facilities will be available to the
Company. The Company has a showroom, consisting of approximately 17,200 square
feet, which is located at 1107 Broadway, New York, New York, under a lease that
expires in 2006,
 
                                       31
and office and warehouse space in Hong Kong consisting of approximately 30,000
square feet under leases which expire at varying dates through 1998. The
Company's properties will be expanded as necessary to support future growth
levels in the Company's business.
 
EMPLOYEES
 
     As of August 30, 1996, the Company had 236 employees; 137 in the United
States and 99 in the Far East. Nine of the Company's warehouse employees, some
of whom are employed only on a seasonal basis, are subject to a collective
bargaining agreement which expires May 31, 1998. The Company believes that its
labor relations are satisfactory.
 
LEGAL PROCEEDINGS
 
  Licensing Litigation
 
     In June 1995, the Company filed a declaratory judgment action in United
States District Court for the Northern District of California. The suit names
Clemens V. Hedeen, Jr., Patti Jo Hedeen, and various affiliated entities, as
defendants, and seeks a determination that the Company is not obligated to pay
royalties to the defendants under their license agreement on certain specific
products sold under the Company's 'Micro Machines' name and trademark.
Defendants filed a cross-complaint for breach of this license agreement claiming
damages for past royalties allegedly due but not paid under the license
agreement, and claiming entitlement to additional royalties on future sales of
such products. Defendants also are asking the court to order that the Company
cease the manufacture and sale of certain portions of the Micro Machines product

line, and convey to the defendants certain rights to the Micro Machines product
line, including patent and trademark rights. Defendants also claim the license
agreement to be terminated for the non-payment of the royalties at issue. The
defendants filed a motion for summary judgment, which was denied by the court in
late 1995. The Company's complaint is presently being amended to address
additional issues between the parties. Although there can be no assurance of the
outcome of this matter, the Company believes that it has meritorious factual and
legal claims in connection with this matter.
 
     In October 1995, the Company filed a breach of contract action in the
United States District Court for the Northern District of California. The suit
names Abrams Gentile Entertainment Inc. and Up, Up and Away as defendants, and
alleges damages for the licensing, marketing and sale of products that are in
violation of the Company's rights as licensee under its Sky Dancers and Dragon
Flyz license agreements with Abrams Gentile Entertainment, Inc. The defendants
have filed a number of counterclaims, including breach of contract, interference
with contractual relationships, misappropriation of copyright, unfair
competition and trade libel. The Company's attempt to obtain a partial temporary
restraining order was denied by the court in December 1995 on the basis that
equitable relief was not appropriate and that the Company could be adequately
compensated through legal damages. The Company is pursuing its damage claim, and
a trial date is yet to be established. Although there can be no assurance of the
outcome of this matter, the Company believes that it has meritorious factual and
legal claims in connection with this matter.
 
  Manufacturer Litigation
 
     In January 1991, the Company, through its wholly owned subsidiary, Galco,
filed a lawsuit in Hong Kong against Kader Industrial Co., Ltd. ('Kader'),
alleging damages suffered by both Galco and the Company as a result of Kader's
defective manufacturing of two lead doll items for the Company's Bouncin' Babies
toy line in 1990. Kader filed counterclaims alleging breach of 17 individual
contracts. In August 1996, the trial court rendered a decision in favor of Kader
on the general issue of liability in this matter, including an award based on
Kader's counterclaims which is estimated to be approximately $250,000, plus
prejudgment interest. In addition, the court awarded certain litigation costs to
Kader, the amount of which will be determined in future proceedings and could
substantially exceed the amount of the damages awarded. The Company is presently
considering whether it will seek an appeal in this matter.
 
     Although there can be no assurance of the outcome of these matters, in the
opinion of management of the Company, none of the three above matters of
litigation is likely to have a material adverse effect on the business,
financial condition and results of operations of the Company.
 
                                       32
MANAGEMENT
 
EXECUTIVE OFFICERS AND DIRECTORS
 
     The executive officers and members of the Board of Directors of the Company

(the 'Board') and their respective positions are as follows:
NAME                             AGE   POSITION
- ------------------------------   ---   -----------------------------------
Mark D. Goldman...............   45    President, Chief Executive Officer
                                       and Director
William G. Catron.............   50    Executive Vice President, General
                                       Counsel, Chief Administrative
                                       Officer and Secretary
Loren Hildebrand..............   57    Executive Vice President, Sales
Ronald Hirschfeld.............   46    Executive Vice President,
                                       International Sales and Marketing
Roger Kowalsky................   62    Executive Vice President, Chief
                                       Financial Officer and Director
Gary J. Niles.................   56    Executive Vice President, Marketing
                                       and Product Acquisition
Louis R. Novak................   48    Executive Vice President and Chief
                                       Operating Officer
John C. Beuttell..............   49    Senior Vice President,
                                       Marketing--Male Action
Jay B. Foreman................   34    Senior Vice President, F.O.B.
                                       Business
H. Alan Gaudie................   55    Senior Vice President, Finance and
                                       Assistant Secretary
Ronnie Soong..................   50    Managing Director of Galco
Terrell (Mark) Taylor.........   55    Senior Vice President, Product
                                       Design
Andrew J. Cavanaugh...........   49    Director
Paul A. Gliebe, Jr............   62    Director
Scott R. Heldfond.............   50    Director
S. Lee Kling..................   67    Director
Mark D. Goldman, a Director of the Company, has served as President and
Chief Executive Officer of the Company since June 1991. From 1987 to 1991, Mr.
Goldman served as Executive Vice President and Chief Operating Officer. Prior to
1987, Mr. Goldman served in various executive capacities at Ages Entertainment
Software, Inc. (formerly Sega Enterprises, Inc.) and Mattel, Inc.
 
     William G. Catron has served as Executive Vice President, General Counsel
and Chief Administrative Officer since May 1992 and as Corporate Secretary of
the Company since June 1995. From 1985 to 1992, Mr. Catron was Senior Vice
President, Assistant General Counsel for Paramount Pictures Corporation. Prior
to 1985, Mr. Catron served in various executive capacities at Ages Entertainment
Software, Inc. (formerly Sega Enterprises, Inc.) and Mattel, Inc.
 
     Loren Hildebrand has served as Executive Vice President, Sales of the
Company since April 1994. From 1992 to 1994, Mr. Hildebrand was President of
Creative Consultants and from 1991 to 1992 he was Executive Vice President of
Bandai U.S. Inc., a toy manufacturer. From 1989 to 1992, Mr. Hildebrand was
Executive Vice President and a partner in Toy Soldiers, Inc., a start-up

company. Prior to 1989, Mr. Hildebrand was a consultant for Worlds of Wonder and
Executive Vice President, Sales, Merchandising and Distribution for Mattel, Inc.
 
     Ronald Hirschfeld has served as Executive Vice President, International
Sales and Marketing of the Company since February 1994. From 1989 to 1994, Mr.
Hirschfeld served as Senior Vice President, International Sales and Marketing.
Prior to 1989, Mr. Hirschfeld served as Senior Vice President, International
Operations from 1987 to 1989 and has held various positions with the Company
since 1978.
 
                                       33
Roger Kowalsky has served as Executive Vice President and Chief Financial
Officer of the Company since June 1996 and a Director of the Company since June
1994. From 1989 to 1996, Mr. Kowalsky served as Director of the Vermont Studio
Center, an organization dedicated to visual artists and writers. From 1983 to
1986, Mr. Kowalsky served as Senior Vice President, Finance & Administration for
Yale Materials Handling Corporation. Prior to such time, from 1969 to 1982, Mr.
Kowalsky worked at Pullman Inc., rising to Executive Vice President, Finance &
Administration and President of Pullman Trailmobile, a subsidiary of Pullman
Inc.
 
     Gary J. Niles has served as Executive Vice President, Marketing and Product
Acquisition of the Company since February 1992. From 1989 to 1992, Mr. Niles
served as Senior Vice President, Toys-Boys Division. Before joining the Company,
Mr. Niles was an executive with U.A.C., Ltd., a division of Universal Matchbox,
Revell Incorporated and Ages Entertainment Software, Inc. (formerly Sega
Enterprises, Inc.).
 
     Louis R. Novak has served as Executive Vice President and Chief Operating
Officer of the Company since February 1992. From 1989 to 1992, Mr. Novak served
as Senior Vice President, Operations. From 1986 to 1989 he was Senior Vice
President, Worldwide Product Operations for Coleco Industries, Inc. Prior to
1986, Mr. Novak was an executive with All American Gourmet Company, Inc., a
manufacturer of frozen food products, and for Mattel, Inc.
 
     John C. Beuttell has served as Senior Vice President, Marketing-Male Action
of the Company since February 1996. From 1993 to 1996, Mr. Beuttell served as
the Executive Vice President, International Marketing at YES! Entertainment.
From 1991 to 1993, Mr. Beuttell was a principal at JB Marketing Consulting. From
1988 to 1991, Mr. Beuttell served as Vice President of Sales and Marketing for a
toy company called TSR, Inc.
 
     Jay B. Foreman has been Senior Vice President, F.O.B. Business of the
Company since May 1996. From 1992 to 1996, Mr. Foreman served as Executive Vice
President-U.S. Operations of Play By Play Toys & Novelties, Inc. From 1990 until
1992, Mr. Foreman served as Co-General Manager of the Toys and Novelties
Division of Pizza Management, Inc.
 
     H. Alan Gaudie has served as Senior Vice President, Finance of the Company
since April 1992 and Assistant Secretary since June 1995. From 1985 to 1992, Mr.
Gaudie served as Corporate Controller, Vice President, Senior Vice President and

acting Chief Financial Officer.
 
     Ronnie Soong has served as Managing Director of Galco since May 1995. From
1993 to 1995, Mr. Soong served as General Manager of Galco. From 1989 to 1993,
Mr. Soong was General Manager of Zindart Industrial Co., Ltd. Prior to 1989, Mr.
Soong was the General Manager of Buddy L (HK) Ltd. from 1989 to 1993 and an
executive with the Ertl Company in Taiwan from 1987 to 1989.
 
     Terrell (Mark) Taylor has served as Senior Vice President, Product Design
of the Company since November 1995. From 1988 to 1995, Mr. Taylor served as
Senior Vice President, Product Design for Mattel, Inc. From 1987 to 1988, Mr.
Taylor served as Vice President with Entertech/LJN Toys. Prior to 1987, Mr.
Taylor served in various executive capacities at Playmates Toys, Tomy Toys, and
Mattel, Inc. In addition, Mr. Taylor was a principal partner with Taylor/Salari
Design.
 
     Andrew J. Cavanaugh, a Director of the Company, since 1993, serves as a
Senior Vice President Corporate Human Resources of Estee Lauder Inc. Mr.
Cavanaugh has been affiliated with Estee Lauder in an executive capacity since
1988. Prior to undertaking his current position, Mr. Cavanaugh served as a
Senior Consultant with Coopers & Lybrand, New York City, from 1986 through 1988,
and Senior Vice President Administration of Paramount Pictures Corporation from
1984 through 1986.
 
     Paul A. Gliebe, Jr., a Director of the Company since 1986, has been a Vice
President of Smith Barney Inc. since 1974. Smith Barney Inc. has provided
investment-related services to the Company in the past and during the current
fiscal year.
 
     Scott R. Heldfond, a Director of the Corporation since 1986, has served as
Managing Director of Hales Capital Advisors, LLC, an insurance industry merchant
bank firm, since January 1995. Mr. Heldfond also serves as a consultant to Aon
Risk Services (successor entity to Rollins Hudig Hall and DSI Insurance
Services), an insurance broker. From 1992 to 1994 he was president and CEO of
Rollins Real Estate/Investment and prior thereto was president and CEO of DSI
Insurance Services. The Company has retained Aon in the past and during the
current fiscal year.
 
                                       34
S. Lee Kling, a Director of the Company since 1991, has served since 1991
as Chairman of the Board of Kling Rechter & Company, a merchant banking company
which operates in partnership with Barclays Bank PLC. Mr. Kling served as
Chairman of the Board of Landmark Bancshares Corporation, a bank holding company
in St. Louis, Missouri ('Landmark'), until December 1991 when Landmark merged
with Magna Group, Inc. Mr. Kling had served in such capacity with Landmark since
1974 and had also served as Chief Executive Officer of Landmark from 1974
through October 1990 except for the period from May 1978 to January 1979 when he
served as Assistant Special Counselor on Inflation for the White House and
Deputy for Ambassador Robert S. Strauss. Mr. Kling serves on the Boards of
Directors of Magna Group, Inc., Falcon Products, Co., Bernard Chaus Inc.,
E-Systems, Inc., Top Air Manufacturing, Inc., National Beverage Corp. and

Hanover Direct, Inc.
 
COMMITTEES OF THE BOARD OF DIRECTORS
 
     The Board has an Executive Committee, an Audit Committee and a Compensation
Committee.
 
     The Executive Committee is comprised of Andrew J. Cavanaugh, Mark Goldman
and S. Lee Kling. The Executive Committee has the authority to act in place of
the Board on all matters which would otherwise come before the Board except for
such matters which are required by law or by the Company's Certificate of
Incorporation or By-Laws to be acted upon exclusively by the Board. In addition,
the Executive Committee has the responsibility to nominate persons for election
as directors of the Corporation.
 
     The Audit Committee is comprised of S. Lee Kling, Scott R. Heldfond, and
Paul A. Gliebe, Jr. The Audit Committee is responsible for reviewing the
Company's financial statements, recommending the appointment of the Company's
independent auditors and reviewing the overall scope of the audit.
 
     The Compensation Committee is comprised of Andrew J. Cavanaugh, Scott R.
Heldfond and S. Lee Kling. The Compensation Committee is responsible for
reviewing the compensation arrangements relating to senior officers of the
Company and administering and making recommendations to the Board regarding the
bonus and incentive compensation plans for the senior officers of the Company.
The Compensation Committee also administers the Company's Amended and Restated
1984 Employee Stock Option Plan, the 1994 Senior Management Stock Option Plan
and the 1995 Non-Employee Directors' Stock Option Plan.
 
                                       35
EXECUTIVE COMPENSATION
 
     The following table summarizes the compensation paid by the Company and its
subsidiaries, as well as certain other compensation paid or accrued, to the
Chief Executive Officer of the Company and the other five most highly
compensated executive officers of the Company who earned in excess of $100,000
for the Company's fiscal years ended December 31, 1993, 1994 and 1995 (each
person appearing in the table is referred to as a 'Named Executive'):
 
                           SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION                             LONG-TERM
                                     ---------------------------------------------              COMPENSATION
                                                                        OTHER           -----------------------------
                                             SALARY      BONUS         ANNUAL                            ALL OTHER
NAME AND PRINCIPAL POSITION          YEAR      ($)        ($)      COMPENSATION($)      OPTIONS(#)    COMPENSATION($)
- ----------------------------------   ----    -------    -------    ---------------      ----------    ---------------
Mark D. Goldman                      1995    400,000    750,000         0                 200,000          3,980(2)

  President and Chief                1994    400,000    600,000         0                 229,630(1)       3,760(2)
  Executive Officer                  1993    319,500          0         0                  29,630          3,540(2)

Gary J. Niles                        1995    300,000    360,000         0                       0          1,440(4)
  Executive Vice President,          1994    261,055    316,800         0                 157,870(3)       1,440(4)
  Marketing and Product              1993    212,623          0         0                  20,370          1,440(4)
  Acquisition

Louis R. Novak                       1995    272,803    334,567         0                       0            870(6)
  Executive Vice President and       1994    261,055    316,800         0                 157,870(5)         870(6)
  Chief Operating Officer            1993    256,797          0         0                  20,370            510(6)

Loren Hildebrand                     1995    230,063    282,150         0                       0          2,250(8)
  Executive Vice President,          1994    159,375    275,000(7)      0                 100,000            840(8)
  Sales

William G. Catron                    1995    236,729    217,745         0                       0            870(12)
  Executive Vice President,          1994    226,535    206,640         0                  86,111(11)        870(12)
  General Counsel, Chief             1993    214,813     25,000(9)      27,429(10)         11,111            870(12)
  Administrative Officer and
  Secretary

Ronald Hirschfeld                    1995    235,073    216,222         0                       0          1,440(13)
  Executive Vice President,          1994    223,634    203,425         0                  86,111(11)        510(13)
  International Sales and            1993    198,021          0         0                  11,111            510(13)
  Marketing
- ------------------
 (1) Represents 229,630 options granted pursuant to the 1994 Senior Management
     Stock Option Plan (the '1994 Plan'). Does not include 129,311 shares of
     Common Stock granted in connection with the termination of the 1992 Senior
     Management Stock Option Plan (the '1992 Plan').
 
 (2) This amount represents $3,980 in premiums paid by the Company with respect
     to term life insurance in 1995, $3,760 in premiums paid by the Company with
     respect to term life insurance in 1994 and $3,540 in premiums paid by the
     Company with respect to term life insurance in 1993.
 
 (3) Represents 157,870 options granted pursuant to the 1994 Plan. Does not
     include 88,900 shares of Common Stock granted in connection with the
     termination of the 1992 Plan.
 
 (4) This amount represents $1,440 in premiums paid by the Company with respect
     to term life insurance in each of 1993, 1994 and 1995.
 
 (5) Represents 157,870 options granted pursuant to the 1994 Plan. Does not
     include 88,900 shares of Common Stock granted in connection with the
     termination of the 1992 Plan.
 
                                              (Footnotes continued on next page)
 
                                       36
(Footnotes continued from previous page)

 (6) This amount represents $870 in premiums paid by the Company with respect to
     term life insurance in each of 1994 and 1995 and $510 in premiums paid by
     the Company with respect to term life insurance in 1993.
 
 (7) This amount includes a $50,000 bonus paid to the Named Executive in
     connection with the Named Executive's hiring.
 
 (8) This amount represents $2,250 in premiums paid by the Company with respect
     to term life insurance in 1995 and $840 in premiums paid by the Company
     with respect to term life insurance in 1994.
 
 (9) This amount represents a bonus paid to the Named Executive in connection
     with the Named Executive's hiring.
 
(10) This amount includes an automobile allowance (which is provided to all
     senior officers of the Company) paid by the Company in 1993 in the amount
     of $14,400 and fees paid by the Company to the Company's accountants in the
     amount of $7,700 in 1993 in connection with the Named Executive's hiring.
 
(11) Represents 86,111 options granted pursuant to the 1994 Senior Management
     Stock Option Plan. Does not include 48,491 shares of Common Stock granted
     in connection with the termination of the 1992 Plan.
 
(12) This amount represents $870 in premiums paid by the Company with respect to
     term life insurance in each of 1993, 1994 and 1995.
 
(13) This amount represents $1,440 in premiums paid by the Company with respect
     to term life insurance in 1995 and $510 paid by the Company with respect to
     term life insurance premiums paid in 1994 and 1993.
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
     The members of the Compensation Committee are set forth under
'Management--Committees of the Board of Directors' and their relationship with
the Company is set forth under 'Management--Executive Officers and Directors.'
None of the members of the Compensation Committee has served as a member of the
compensation committee of another entity so as to create any compensation
committee interlock. No members of the Compensation Committee are employed by
the Company.
 
OPTION GRANTS IN LAST FISCAL YEAR
 
     The following table sets forth certain information regarding options
granted to the Named Executives during the Company's 1995 fiscal year:
INDIVIDUAL GRANTS                   
                                -------------------------------------------------------    POTENTIAL REALIZABLE VALUE
                                SHARES OF                                                               AT

                                  COMMON        % OF TOTAL                                   ASSUMED ANNUAL RATES OF
                                  STOCK       OPTIONS GRANTED                              STOCK PRICE APPRECIATION FOR
                                UNDERLYING    TO EMPLOYEES IN    EXERCISE                         OPTION TERM(1)
                                 OPTIONS        FISCAL YEAR       PRICE      EXPIRATION    ----------------------------
NAME                            GRANTED(#)     (OF 320,000)       ($/SH)        DATE       5%($)(3)           10%($)(4)
- -----------------------------   ----------    ---------------    --------    ----------    --------           ---------
Mark D. Goldman..............     200,000(2)        62.5%          6.125       4/18/05      770,396           1,952,335
Gary J. Niles................           0            N/A             N/A        N/A          N/A                 N/A
Louis R. Novak...............           0            N/A             N/A        N/A          N/A                 N/A
Loren Hildebrand.............           0            N/A             N/A        N/A          N/A                 N/A
William G. Catron............           0            N/A             N/A        N/A          N/A                 N/A
Ronald Hirschfeld............           0            N/A             N/A        N/A          N/A                 N/A
- ------------------
(1) Potential realizable value is based on the assumed annual growth rates for
    each of the grants shown over their option term. The dollar amounts in these
    columns are for illustrative purposes only as required by the rules of the
    Securities and Exchange Commission and, therefore, are not intended to
    forecast future financial performance or possible future appreciation, if
    any, in the price of the shares of Common Stock. Prospective investors are
    cautioned against drawing any conclusions from the appreciation data shown,
    aside from the
 
                                              (Footnotes continued on next page)
 
                                       37
(Footnotes continued from previous page)

    fact that optionees will realize value from their option grants only if the
    price of the shares of Common Stock appreciates, which would benefit all
    stockholders commensurately.
 
(2) Options granted under the Amended and Restated 1984 Employee Stock Option
    Plan.
 
(3) The projected stock price would be $9.98 per share.
 
(4) The projected stock price would be $15.89 per share.
 
     Without the prior consent of the Company, the Named Executives may not sell
or otherwise transfer the shares of Common Stock acquired upon the exercise of
any option listed in the above table for seven months following the date that a
participant exercises such option. If at any time during the first six months of
such seven-month period, the optionee ceases to be an employee of the Company,
the Company will have the right to repurchase, at the exercise price therefor,
the shares of Common Stock which the optionee had acquired upon such option
exercise. Unexercised options will automatically terminate on the date that an
optionee ceases to serve as an employee of the Company unless such termination
of the optionee's employment with the Company results from his or her

retirement, death or disability.
 
     The Company does not currently grant stock appreciation rights.
 
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
 
     The following table sets forth information with respect to the options
exercised by the Named Executives during the 1995 fiscal year and the
unexercised options held by the Named Executives as of the end of the Company's
1995 fiscal year.
NUMBER OF SECURITIES
                                                                    UNDERLYING UNEXERCISED           VALUE OF UNEXERCISED
                                     SHARES                       OPTIONS AT FISCAL YEAR END         IN-THE-MONEY OPTIONS
                                   ACQUIRED ON                               (#)                   AT FISCAL YEAR-END($)(1)
                                    EXERCISE         VALUE       ----------------------------    ----------------------------
NAME                                   (#)        REALIZED($)    EXERCISABLE    UNEXERCISABLE    EXERCISABLE    UNEXERCISABLE
- --------------------------------   -----------    -----------    -----------    -------------    -----------    -------------
Mark D. Goldman.................           0              0        244,754         209,876         823,074        1,152,159
Gary J. Niles...................       2,500          7,500        156,080           6,790         442,320           18,673
Louis R. Novak..................           0              0        151,080           6,790         415,470           18,673
Loren Hildebrand................           0              0         50,000          50,000         300,000          300,000
William G. Catron...............           0              0         82,408           3,703         226,622           10,183
Ronald Hirschfeld...............      13,125         44,844         82,408           3,703         226,622           10,183
- ------------------
(1) The closing sales price of the Common Stock on the New York Stock Exchange
    on December 31, 1995 was $11.75 per share.
 
CERTAIN EMPLOYEE PLANS
 
     On July 29, 1996, subject to stockholder approval, the Compensation
Committee adopted and the Board ratified the 1996 Share Incentive Plan (the
'Incentive Plan'). The Incentive Plan is intended to provide incentives which
will attract, motivate and retain highly competent persons as key employees of
the Company and its subsidiaries, by providing them opportunities to acquire
shares of stock or to receive monetary payments based on the value of such
shares as described below. The Incentive Plan is intended to assist in aligning
the interests of the Company's key employees to those of its stockholders.
 
     The Incentive Plan provides for the grant of any or all of the following
types of benefits: (1) stock options including incentive stock options and
non-qualified stock options; (2) stock appreciation rights; (3) stock awards,
including restricted stock; (4) performance awards; and (5) stock units
(collectively, 'Benefits'). Benefits may be granted singly, in combination, or
in tandem as determined by the Compensation Committee. Stock awards, stock
options, performance awards and stock units may, as determined by the
Compensation Committee in its discretion, constitute performance-based awards.
 

     The Incentive Plan makes available for Benefits an aggregate amount of
1,850,000 shares of Common Stock, of which (i) 1,000,000 shares of Common Stock
have been designated for executive management and (ii) 850,000 shares of Common
Stock have been designated for all key employees. The maximum number of shares
 
                                       38
of Common Stock with respect to which Benefits may be granted (or measured) to
any individual participant may not exceed 500,000.
 
     On July 29, 1996, subject to stockholder approval, the Compensation
Committee adopted and the Board ratified the 1996 Long Term Compensation Plan.
The 1996 Long Term Compensation Plan is intended to enhance stockholder value
over the longer term by providing executive management with meaningful financial
rewards for exceptional corporate performance that results in increases in the
Company's earnings. The payment of compensation pursuant to the 1996 Long Term
Compensation Plan is dependent on the Company achieving a cumulative earnings
per share goal (as set forth in the 1996 Long Term Compensation Plan) for the
period of July 1, 1996 through December 31, 1998 (the 'Performance Period')
based upon a specific annual growth rate from the Company's 1995 earnings.
Achieving the specified goal will enable members of executive management to earn
an award of three (3) times their annual salary as of July, 1996 (the 'Targeted
Award'). In addition, exceeding such goal by at least 50% will enable members of
executive management to earn an award equal to 125% of their Targeted Award. The
maximum amount of compensation that any member of executive management may
receive pursuant to the 1996 Long Term Compensation Plan with respect to the
Performance Period is $1.875 million. The number of employees currently eligible
to participate in the 1996 Long Term Compensation Plan is seven.
 
     The Company will seek stockholder approval of both the Incentive Plan and
the 1996 Long Term Compensation Plan at its annual stockholders' meeting, which
is currently scheduled to be held on October 30, 1996.
 
SEVERANCE AGREEMENTS WITH MANAGEMENT
 
     On October 27, 1994, the Company entered into a severance agreement (the
'Severance Agreement') with Mark Goldman, effective as of July 13, 1994. The
Severance Agreement sets forth severance benefits which are payable if Mr.
Goldman's employment is terminated for various reasons, including termination by
him of his employment following a change in control of the Company, as follows
(the 'Severance Payment'):
 
          (i) If Mr. Goldman is terminated without cause (as defined in the
     Severance Agreement) prior to a Change in Control (as defined in the
     Severance Agreement), or if Mr. Goldman terminates his employment for good
     reason (as defined in the Severance Agreement) prior to a Change in
     Control, the Severance Agreement provides that the Company shall pay to Mr.
     Goldman a lump sum payment equal to (a) two times Mr. Goldman's annualized
     current base compensation and (b) the greater of (1) two times the greater
     of (x) the incentive compensation bonus (excluding stock options or shares
     issued pursuant to a stock option, restricted stock or similar plan or
     long-term incentive bonuses) paid to Mr. Goldman for the previous year's

     performance or (y) the incentive compensation bonus (excluding stock
     options or shares issued pursuant to a stock option, restricted stock or
     similar plan or long-term incentive bonuses) that would be payable to Mr.
     Goldman if performance relative to plan for the current year was the same
     as performance relative to plan year-to-date (such performance is to be
     measured by the ratio of year-to-date actual performance divided by
     year-to-date plan performance; the index(es) of performance shall be the
     same as the most recent annual cash incentive compensation plan approved by
     the Board of Directors) (the amount equal to the greater of the amounts
     described in clauses (x) and (y) shall be hereinafter referred to as the
     'Annual Bonus'); or (2) five hundred thousand dollars ($500,000).
 
          (ii) If Mr. Goldman is terminated by the Company within twenty-four
     (24) months following a Change in Control (as defined in the Severance
     Agreement), or if Mr. Goldman terminates his employment for good reason (as
     defined in the Severance Agreement) within twenty-four (24) months
     following a Change in Control, the Severance Agreement provides that the
     Company shall pay to Mr. Goldman a lump sum payment equal to (a) three
     times Mr. Goldman's annualized current base compensation, (b) the greater
     of (1) three times the Annual Bonus or (2) five hundred thousand dollars
     ($500,000) and (c) three times the car allowance in effect for Mr. Goldman
     at the time of termination and a lump sum amount equal to three times the
     insurance and maintenance cost incurred for said vehicle during Mr.
     Goldman's last full year of employment with the Corporation. Furthermore,
     the Severance Agreement provides that the Company shall continue to provide
     Mr. Goldman with certain fringe benefits for a period of three years
     following the date of Mr. Goldman's termination, subject to mitigation by
     Mr. Goldman.
 
                                       39
(iii) If Mr. Goldman is terminated for cause, or if Mr. Goldman
     terminates his employment other than for good reason (as defined in the
     Severance Agreement), the Severance Agreement provides that the Company
     must pay to Mr. Goldman his unpaid compensation for services prior to
     termination and the value of any accrued unused vacation pay to the date of
     termination.
 
     The maximum Severance Payment that the Company would have been required to
make under the Severance Agreement if such amount became payable in fiscal 1995
was approximately $3,515,824. The Severance Agreement contains a 'gross-up'
provision pursuant to which any Severance Payment, which would be subject to
certain excise taxes occuring as a result of a Change in Control, would include
an additional gross-up payment resulting in Mr. Goldman's retaining an amount
equal to the Severance Payment minus all ordinary taxes on such payment.
 
     Mr. Goldman is employed by the Company as its President and Chief Executive
Officer without an employment agreement. The Company has purchased a life
insurance policy in a $2,000,000 face amount for Mr. Goldman who designated the
beneficiary of such insurance.
 
     It is currently anticipated that each of the six Executive Vice Presidents

of the Company will enter into a Severance and Change in Control Agreement (the
'Severance and Change in Control Agreement') with the Company, which provides,
among other things, that if the executive is terminated other than for Cause (as
such term will be defined in the Severance and Change in Control Agreement) the
executive is entitled to continue to receive his salary and certain benefits
(excluding continuation of any bonus) for a period of up to twelve (12) months.
These severance payments may be reduced in the event that the executive com-
mences regular full-time employment during such period. If there is a Change
in Control (as such term will be defined in the Severance and Change in Control
Agreement) and the executive's employment is terminated within twelve (12)
months of such Change in Control, voluntarily or involuntarily (other than for
Cause), the above-described severance package is replaced with a lump sum
payment equal to three (3) times such executive's annual salary, bonus and
certain benefits, plus the continuation of certain benefits for a thirty-six
(36) month period of time. In addition, if the executive's employment is
terminated involuntarily, other than for Cause, during the next twelve (12)
months following the first anniversary of the Change in Control, the executive
is entitled to continue to receive his salary and certain benefits (excluding
continuation of any bonus) for a period of up to twenty-four (24) months. Any
payment or benefit received pursuant to the Severance and Change in Control
Agreement would be reduced to the extent that such payment or benefit will be
subject to certain excise taxes occuring as a result of a Change in Control.
 
DIRECTOR COMPENSATION
 
     Directors who are not full-time employees of the Company receive an annual
fee of $15,000 plus $500 for each meeting of the Board or any committee thereof
attended by such director. In addition, non-employee directors are automatically
granted an option to purchase 2,000 shares of Common Stock on January 1 of each
year under the 1995 Non-Employee Directors' Stock Option Plan adopted June 20,
1995. Non-employee directors received options immediately exercisable into 2,000
shares of Common Stock on July 1, 1995 and January 1, 1996. All directors are
reimbursed by the Company for out-of-pocket expenses incurred by them as
directors of the Company.
 
                                       40
PRINCIPAL AND SELLING STOCKHOLDERS
 
     The following table sets forth certain information as of August 30, 1996,
with respect to the Common Stock of the Company beneficially owned by (a) each
director of the Company, (b) all persons known by the Company to be the
beneficial owner of more than 5% of the Common Stock of the Company, (c) the
Named Executives, (d) all executive officers and directors of the Company as a
group and (e) the Selling Stockholder.
SHARES                                          SHARES
                                                     BENEFICIALLY               SHARES               BENEFICIALLY
                                                    OWNED PRIOR TO              BEING                   OWNED
                                                     OFFERING(2)               OFFERED              AFTER OFFERING

                                           --------------------------------    --------    --------------------------------
NAME OF BENEFICIAL OWNER(1)                    NUMBER           PERCENT                        NUMBER           PERCENT
- ----------------------------------------   --------------    --------------                --------------    --------------
American Express Financial
  Corporation(3)........................        1,235,100          8.2%              --         1,235,100          7.0%
Wells Fargo Foundation(4)...............          392,866          2.5%         392,866                 0            0
William G. Catron(5)....................          127,017            *               --           127,017            *
Andrew J. Cavanaugh(6)..................            5,700            *               --             5,700            *
Paul A. Gliebe, Jr.(6)..................            6,350            *               --             6,350            *
Mark D. Goldman(7)......................          609,041          3.9%              --           609,041          3.4%
Scott R. Heldfond(6)....................            7,450            *               --             7,450            *
Loren Hildebrand(8).....................          110,080            *               --           110,080            *
Ronald Hirschfeld(9)....................           99,044            *               --            99,044            *
S. Lee Kling(6).........................            9,000            *               --             9,000            *
Roger Kowalsky(6).......................            6,550            *               --             6,550            *
Gary J. Niles(10).......................          193,311          1.3%              --           193,311          1.1%
Louis R. Novak(10)......................          178,447          1.2%              --           178,447          1.0%
All executive officers and directors as
  a group
  (consisting of 16 persons)(11)........        1,413,641          8.7%               0         1,413,641          7.6%
- ------------------
  *  Less than 1%.
 
 (1) Unless otherwise indicated, address is Company's address at 500 Forbes
     Boulevard, South San Francisco, California 94080.
 
 (2) This table identifies persons having sole voting and/or investment power
     with respect to the shares of Common Stock set forth opposite their names
     as of August 30, 1996, according to the information furnished to the
     Company by each of them. A person is deemed to be the beneficial owner of
     shares of Common Stock that can be acquired by such person within 60 days
     from the date of this Prospectus upon the conversion of convertible
     securities or the exercise of warrants or options. Percentage of Beneficial
     Ownership is based on a total of 15,147,151 shares of Common Stock
     outstanding and assumes in each case that the person only, or group only,
     exercised his or its rights to purchase all shares of Common Stock
     underlying convertible securities, options or warrants.
 
 (3) Address is IDS Tower 10, Minneapolis, MN 55440.
 
 (4) Address is 420 Montgomery Street, 12th Floor, San Francisco, CA 94104.
     Includes warrants to purchase 392,866 shares of Common Stock, all of which
     will be exercised and sold pursuant to the offering.
 
 (5) Includes options to purchase 96,191 shares of Common Stock.
 
 (6) Includes options to purchase 4,000 shares of Common Stock.
 
 (7) Includes options to purchase 454,630 shares of Common Stock.
 
 (8) Includes options to purchase 110,080 shares of Common Stock.

 
                                              (Footnotes continued on next page)
 
                                       41
(Footnotes continued from previous page)

 (9) Includes options to purchase 22,008 shares of Common Stock.
 
(10) Includes options to purchase 167,950 shares of Common Stock.
 
(11) Includes an aggregate of options to purchase 1,105,000 shares of Common
     Stock.
 
                 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     Louis R. Novak, Executive Vice President and Chief Operating Officer of the
Company, borrowed money from the Company on July 31, 1995 and April 15, 1996 and
on each occasion executed a note payable to the Company. The first note, dated
July 31, 1995, is in the principal amount of $57,042 and bears interest at the
rate of 8.75%. The second note, dated April 15, 1996, is in the principal amount
of $60,647 and bears interest at the rate of 8.5%. Both notes are due on demand
and are secured by Common Stock owned by Mr. Novak. Mr. Novak repaid this
indebtedness on September 4, 1996.
 
     On August 29, 1996, Mark D. Goldman, President, Chief Executive Officer and
Director of the Company, borrowed $950,000 in connection with the purchase of a
personal residence and executed a note payable to the Company, which is secured
by a second mortgage on such residence. The note will bear no interest unless
Mr. Goldman's employment with the Company is terminated and, at such time, the
note will bear interest at one percent per annum in excess of the Prime Rate
charged by Citibank F.S.B. During the term of Mr. Goldman's employment with the
Company, in accordance with the Internal Revenue Code of 1986, as amended (the
'Code'), interest will be imputed at the applicable federal rate as determined
under the Code. Commencing on the first day of September 1996, principal in the
amount of $100 shall be paid on the first of each month. The balance of the
principal shall be paid on the earlier to occur of (i) August 29, 2006 or (ii)
one year from the date Mr. Goldman's employment with the Company is terminated.
 
                          DESCRIPTION OF CAPITAL STOCK
 
     The Company has an authorized capital of 50,000,000 shares of Common Stock
$.01 par value, and 1,000,000 shares of preferred stock, par value $1.00 per
share. As of August 30, 1996, 15,147,151 shares of Common Stock were
outstanding, held of record by approximately 1,300 persons.
 
COMMON STOCK
 

     The holders of Common Stock are entitled to one vote per share on all
matters voted on by stockholders, including the election of directors. Except as
otherwise required by law or provided in any resolution adopted by the Board
with respect to any series of preferred stock of the Company, the holders of
Common Stock exclusively possess all voting power. Subject to any preferential
rights of any outstanding series of preferred stock of the Company, the holders
of Common Stock are entitled to such dividends as may be declared from time to
time by the Board from funds available for distribution to such holders. No
holder of Common Stock has any preemptive right to subscribe to any securities
of the Company of any kind or class or any cumulative voting rights.
 
CERTAIN PROVISIONS OF THE COMPANY'S CERTIFICATE OF INCORPORATION AND BY-LAWS
 
  General
 
     The Company's Certificate and the By-Laws of the Company contain several
provisions that will make difficult the acquisition of control of the Company by
means of a tender offer, open market purchases, proxy fight or otherwise. These
provisions are expected to discourage certain types of coercive takeover
practices and inadequate takeover bids and to encourage persons seeking to
acquire control of the Company first to negotiate with the Company. The Company
believes that the benefits of increased protection of the Company's potential
ability to negotiate with the proponent of an unfriendly or unsolicited proposal
to take over or restructure the
 
                                       42
Company outweigh the disadvantages of discouraging such proposals because, among
other things, negotiation of such proposals could result in an improvement of
their terms.
 
     Set forth below is a summary of certain provisions in the Certificate and
the By-Laws. The description is intended as a summary only and is qualified in
its entirety by reference to the Certificate and the By-Laws.
 
  Preferred Stock
 
     The Certificate authorizes the issuance of 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 stockholders.
 
  Shareholder Rights Plan
 
     The Company has a shareholder rights plan which, under certain
circumstances, including the acquisition of 20% or more of the Common Stock by a
person, gives the holders of rights the right to acquire shares of Common Stock
having a value of twice the exercise price of the rights.
 
  Board of Directors
 
     The Certificate and the By-Laws provide for a Board divided into three

classes of directors serving staggered three-year terms. With respect to the
present Board, the term of the first class of directors will expire at the 1997
annual meeting of stockholders, the term of the second class of directors will
expire at the 1998 annual meeting of stockholders and the term of the third
class of directors will expire at the 1996 annual meeting of stockholders. The
Certificate and the By-Laws provide that the number of directors will be fixed
from time to time exclusively by the Board, and a majority of the Board then in
office may fill any vacancies on the Board. These rights would be subject to the
voting rights of holders of any issue of preferred stock of the Company. The
Certificate also provides that, subject to the rights of the holders of
preferred stock of the Company, directors may be removed only for cause and only
by the affirmative vote of holders of at least 80% of the voting power of the
Company ('Voting Stock'), voting together as a single class.
 
  Stockholder Actions and Special Meetings
 
     The Certificate provides that stockholder action can be taken only at an
annual or special meeting of stockholders and prohibits stockholder action by
written consent in lieu of a meeting. The Certificate and the By-Laws provide
that, subject to the rights of holders of any series of preferred stock, special
meetings of stockholders can be called only by the Board, the Chairman of the
Board, the President of the Company or a committee of the Board whose power and
authority include the power to call such a meeting or at the request of a
majority of the Board. Subject to the rights of holders of any series of
preferred stock, stockholders are not permitted to call a special meeting or to
require that the Board call a special meeting of stockholders.
 
     The By-Laws establish an advance notice procedure with regard to business
introduced by a stockholder to be brought before an annual meeting of
stockholders of the Company which is not specified in the notice of annual
meeting. In addition, pursuant to the Certificate, the By-Laws establish an
advance notice procedure with regard to nominations for the election of
directors by a stockholder.
 
     The Certificate requires the vote of not less than 80% of the Voting Stock
to approve certain business combinations with any person which beneficially owns
at least 25% or more of the outstanding Voting Stock of the Company (a 'Related
Person') unless (1) the directors of the Company by a two-thirds vote of all
directors in office have approved in advance the acquisition of Voting Stock
that caused the Related Person to become a Related Person or have approved the
business combination or (2) such Related Person has been a Related Person for at
least three years prior to the business combination.
 
  Amendment of Certain Provisions of the Certificate and By-Laws
 
     Subject to the voting rights of holders of any issue of preferred stock of
the Company, the Certificate and the By-Laws contain provisions requiring the
affirmative vote of the holders of at least 80% of the Voting Stock to amend
certain provisions of the Certificate and certain provisions of the By-Laws
relating to the classified board,
 
                                       43
fixing the number of directors, removal of directors, filling vacancies on the
Board, requiring that any stockholder action be taken only at an annual or
special meeting of stockholders and prohibiting the calling of special meetings
by stockholders.
 
  Section 203 of the Delaware General Corporation Law
 
     The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law ('DGCL'). Section 203 provides, with certain exceptions,
that a Delaware corporation may not engage in any of a broad range of business
combinations with a person or affiliate or associate of such person who is an
'interested stockholder' for a period of three years from the date such person
became an interested stockholder unless: (i) the transaction resulting in a
person's becoming an interested stockholder, or the business combination, is
approved by the board of directors of the corporation before the person becomes
an interested stockholder; (ii) the interested stockholder acquires 85% or more
of the outstanding voting stock of the corporation in the same transaction which
makes it an interested stockholder (excluding certain employee stock option
plans); or (iii) on or after the date the person becomes an interested
stockholder, the business combination is approved by the corporation's board of
directors and by the holders of at least 66 2/3% of the corporation's
outstanding voting stock at an annual or special meeting, excluding shares owned
by the interested stockholder. An 'interested stockholder' is defined as any
person that is (x) the owner of 15% or more of the outstanding voting stock of
the corporation or (y) an affiliate or associate of the corporation and was the
owner of 15% or more of the outstanding voting stock of the corporation at any
time within the three year period immediately prior to the date on which it is
sought to be determined whether such person is an interested stockholder.
 
  Directors' Liability
 
     The Certificate contains provisions to (i) eliminate the personal liability
of its directors for monetary damages resulting from breaches of their fiduciary
duty (other than breaches of the duty of loyalty, acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of law,
violations under Section 174 of the DGCL or for any transaction from which the
director derived an improper personal benefit) and (ii) indemnify its directors
and officers to the fullest extent permitted by Section 145 of the DGCL,
including circumstances in which indemnification is otherwise discretionary.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to directors, officers and controlling persons of the Company, the
Company has been advised that, in the opinion of the Commission, such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. The Company believes that these provisions are
necessary to attract and retain qualified persons as directors and officers.
 
AMENDMENT TO THE COMPANY'S CERTIFICATE OF INCORPORATION
 
     On July 29, 1996, the Board approved a resolution authorizing an amendment
to the Certificate of Incorporation of the Company to change the Company's name
to Galoob Toys, Inc. The Company will seek stockholder approval of this
amendment to its Certificate of Incorporation at its annual stockholders'
meeting, which is currently scheduled to be held on October 30, 1996.

 
TRANSFER AGENT AND REGISTRAR
 
     Continental Stock Transfer & Trust Company, 2 Broadway, New York, New York
is the transfer agent and registrar for the Common Stock.
 
                                       44
UNDERWRITING
 
     The several underwriters named below (the 'Underwriters'), for whom Gerard
Klauer Mattison & Co., LLC ('GKM'), William Blair & Company, L.L.C. and
Jefferies & Company, Inc. are acting as representatives (the 'Representatives'),
have severally agreed, subject to the terms and conditions set forth in the
underwriting agreement by and among the Company, the Selling Stockholder and the
Representatives (the 'Underwriting Agreement'), to purchase from the Company and
the Selling Stockholder, and the Company and the Selling Stockholder have agreed
to sell to the Underwriters, the respective number of shares of Common Stock set
forth opposite each Underwriter's name below.
NUMBER
                        UNDERWRITERS                             OF SHARES
- ------------------------------------------------------------   --------------
Gerard Klauer Mattison & Co., LLC...........................
William Blair & Company, L.L.C..............................
Jefferies & Company, Inc....................................
 
                                                               --------------
     Total..................................................        2,392,866
The nature of the Underwriters' obligations under the Underwriting
Agreement is such that all shares of Common Stock being offered, excluding
shares covered by the over-allotment option granted to the Underwriters, must be
purchased if any are purchased. In the event of a default by any Underwriter,
the Underwriting Agreement provides that, in certain circumstances, purchase
commitments of the nondefaulting Underwriters may be increased or such
Underwriting Agreement may be terminated.
 
     The Representatives have advised the Company and the Selling Stockholder
that the Underwriters propose to offer the shares of Common Stock directly to
the public initially at the public offering price set forth on the cover page of
this Prospectus and to selected dealers at such price less a concession of not
more than $       per share. Additionally, the Underwriters may allow, and such
dealers may reallow, a concession not in excess of $       per share to certain
other dealers. After the public offering of the Common Stock, the public
offering price and other selling terms may be changed by the Representatives.
 

     The Company has granted the Underwriters an option, exercisable within 45
days after the date of this Prospectus, to purchase up to an additional 358,930
shares of Common Stock, at the same price per share to be paid by the
Underwriters for the other shares offered hereby. If the Underwriters purchase
any of such additional shares pursuant to this option, each Underwriter will be
committed to purchase such additional shares in approximately the same
proportion as set forth in the table above. The Underwriters may exercise the
option only for the purpose of covering over-allotments, if any, made in
connection with the distribution of the shares of Common Stock offered hereby.
 
     The Company, the Company's directors and executive officers and the Selling
Stockholder have agreed, subject to certain exceptions, not to offer, sell,
contract to sell or otherwise dispose of any shares of Common Stock or any right
to acquire Common Stock for a period of 90 days after the date of this
Prospectus without the written consent of GKM.
 
     The Company and the Selling Stockholder have agreed to indemnify the
Underwriters and their controlling persons against certain liabilities,
including liabilities under the Securities Act of 1933, as amended (the
'Securities Act'), or to contribute to payments the Underwriters may be required
to make in respect thereof.
 
     The Company has retained the financial advisory services of GKM in recent
years. In connection with the sale of the Debentures in 1993, GKM received a fee
for its services, which included warrants to purchase 150,000 shares of Common
Stock, at an exercise price of $9.50. GKM has been listed as a selling
stockholder under an effective registration statement to sell shares of Common
Stock, which are issuable upon conversion of the warrants it received as part of
its compensation in connection with the sale of the Debentures. GKM currently
holds warrants to purchase 75,000 shares of Common Stock and has agreed not to
sell such shares for a period of 90 days after the date of this Prospectus. In
connection with the Company's offer to exchange shares of Common Stock for
outstanding shares of Depositary Shares in March 1996, GKM provided financial
advisory services to
 
                                       45
the Company and delivered a fairness opinion, for which the Company paid GKM
fees and expense reimbursement totaling $728,901.
 
                                 LEGAL MATTERS
 
     The validity, authorization and issuance of the Common Stock offered hereby
will be passed upon for the Company by Weil, Gotshal & Manges LLP, New York, New
York. Certain legal matters with respect to the offering will be passed upon for
the Underwriters by Morrison & Foerster LLP, New York, New York.
 
                                    EXPERTS
 
     The consolidated financial statements as of December 31, 1995 and 1994 and
for each of the three years in the period ended December 31, 1995 included in
this Prospectus have been so included in reliance on the report of Price

Waterhouse LLP, independent accountants, given on the authority of said firm as
experts in auditing and accounting.
 
                             AVAILABLE INFORMATION
 
     The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the 'Exchange Act'), and in accordance
therewith, files reports, proxy statements and other information with the
Securities and Exchange Commission (the 'Commission'). These reports, proxy
statements and other information filed by the Company can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024 of the Commission's office at 450 Fifth Street N.W., Washington, D.C.
20549, and at its regional offices located at Suite 1400, Citibank Center, 500
West Madison Street, Chicago, Illinois 60661 and at Suite 1300, Seven World
Trade Center, New York, New York 10048. Copies of such material can be obtained
from the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. In addition, the Commission
maintains a web site at http://www.sec.gov that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the Commission. The Company's Common Stock is listed on the
New York Stock Exchange and copies of reports, proxy statements and other
information concerning the Company can be inspected at the offices of the New
York Stock Exchange at 20 Broad Street, New York, New York 10005.
 
     The Company has filed with the Commission a Registration Statement on Form
S-1 and schedules and exhibits thereto under the Securities Act with respect to
the Common Stock offered hereby. This Prospectus, which constitutes a part of
the Registration Statement, does not contain all the information set forth in
the Registration Statement and the exhibits and schedules thereto, certain
portions of which are omitted in accordance with the rules and regulations of
the Commission. Statements made in this Prospectus as to the contents of any
contract, agreement, or other document referred to are not necessarily complete.
With respect to each such contract, agreement or other document filed with the
Commission as an exhibit to the Registration Statement, reference is made to the
copy of such contract, agreement or document filed as an exhibit to the
Registration Statement for a more complete description of the matter involved,
and each such statement shall be deemed qualified in its entirety by such
reference. For further information with respect to the Company and the Common
Stock offered hereby, reference is made to such Registration Statement and the
exhibits and schedules thereto.
 
CAUTIONARY STATEMENT FOR PURPOSES OF THE 'SAFE HARBOR' PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
 
     This Prospectus includes 'forward-looking statements' within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. All
statements other than statements of historical fact, including without
limitation those with respect to the Company's objectives, plans and strategy
set forth under Business-- Growth Strategy and those preceded by or that include
the words 'believes,' 'expects,' 'anticipates,' 'intends,' 'is scheduled to' or
similar expressions, are forward-looking statements. Although the Company
believes that the expectations reflected in such forward-looking statement are
reasonable, it can give no assurance that those expectations will prove to have
been correct. Important factors that could cause actual results to differ

materially from the Company's expectations ('Cautionary Statements') are
disclosed in this Prospectus in conjunction with the forward-looking statements
and under 'Risk Factors,' and all written and oral forward-looking statements
attributable to the Company or persons acting on its behalf are expressly
qualified in their entirety by those Cautionary Statements.
 
                                       46
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
                                                               -------
Financial Statements:

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

Consolidated Financial Statements:

Consolidated Balance Sheets--December 31, 1994 and December
  31, 1995..................................................       F-3

Consolidated Statements of Operations for the years ended
  December 31, 1993, 1994 and 1995..........................       F-4

Consolidated Statements of Changes in Shareholders' Equity
  for the years ended December 31, 1993, 1994 and 1995......       F-5

Consolidated Statements of Cash Flows for the years ended
  December 31, 1993, 1994 and 1995..........................       F-6

Notes to Consolidated Financial Statements for the years
  ended December 31, 1993, 1994 and 1995.... ...............   F-7  to
                                                                  F-19

Consolidated Balance Sheets--June 30, 1995, December 31,
  1995 and June 30, 1996 (unaudited)........................      F-20

Consolidated Statements of Operations for the six months
  ended June 30, 1995 and 1996 (unaudited)..................      F-21

Consolidated Statements of Cash Flows for the six months
  ended June 30, 1995 and 1996 (unaudited)..................      F-22

Notes to Consolidated Financial Statements for the six
  months ended June 30, 1995 and 1996 (unaudited)...........   F-23 to
                                                                  F-24
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and Shareholders of Lewis Galoob Toys, Inc.
 
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of Lewis
Galoob Toys, Inc. and its subsidiaries at December 31, 1994 and 1995, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1995, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
 
                                          PRICE WATERHOUSE LLP
 
San Francisco, California
February 8, 1996
(except as to Note R,
which is as of February 12, 1996)
 
                                      F-2
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                         (IN THOUSANDS, EXCEPT SHARES)
DECEMBER 31,
                                                     --------------------
                                                       1994        1995
                                                     --------    --------
ASSETS
Current Assets:
  Cash and cash equivalents.......................   $  2,225    $  2,030
  Accounts receivable, net........................     57,883      68,402
  Inventories.....................................     16,824      17,491
  Tooling and related costs.......................      8,379       8,311
  Prepaid expenses and other assets...............      5,492      10,348
                                                     --------    --------
     Total current assets.........................     90,803     106,582
Land, building and equipment, net.................      8,400       8,913
Other assets......................................      1,563       4,589
                                                     --------    --------
                                                     $100,766    $120,084
                                                     --------    --------
                                                     --------    --------
 
       LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
  Notes payable...................................   $  6,971    $ 15,071
  Accounts payable................................     14,973      17,141
  Accrued expenses................................     14,939      14,547
  Income taxes payable............................        499         731
  Current portion of long-term debt...............        202       4,422
                                                     --------    --------
     Total current liabilities....................     37,584      51,912
Long-term debt....................................     18,414      14,000
Shareholders' equity:
  Preferred stock.................................
     Authorized 1,000,000 shares..................
     Issued and outstanding 183,950 shares of $17
      convertible exchangeable preferred stock at 
      $200 liquidation value per share............     36,790      36,790
  Common Stock, par value $.01 per share..........
     Authorized 50,000,000 shares.................
     Issued and outstanding 10,055,089 shares in
      1994 and 10,089,961 shares in 1995..........        101         101
  Additional paid-in capital......................     31,506      31,579
  Retained earnings (deficit).....................    (23,182)    (13,851)
  Cumulative translation adjustment...............       (447)       (447)
                                                     --------    --------

     Total shareholders' equity...................     44,768      54,172
                                                     --------    --------
                                                     $100,766    $120,084
                                                     --------    --------
                                                     --------    --------
The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
 
                                      F-3
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
                                           --------------------------------
                                             1993        1994        1995
                                           --------    --------    --------
Net revenues............................   $134,334    $178,792    $220,044
Costs of products sold..................     75,147      95,156     120,834
                                           --------    --------    --------
Gross margin............................     59,187      83,636      99,210
                                           --------    --------    --------
Operating expenses:
  Advertising and promotion.............     23,537      30,616      31,240
  Other selling and administrative......     22,031      22,913      30,768
  Royalties, research and development...     18,788      20,785      24,213
  Variable stock option plan expense....      4,046          --          --
                                           --------    --------    --------
Total operating expenses................     68,402      74,314      86,221
                                           --------    --------    --------
Earnings (loss) from operations.........     (9,215)      9,322      12,989
Net proceeds from Nintendo award........         --      12,124          --
Interest expense........................     (1,836)     (2,609)     (3,429)
Other income, net.......................        136         365         439
                                           --------    --------    --------
Earnings (loss) before income taxes.....    (10,915)     19,202       9,999
Provision for income taxes..............          9         778         600
                                           --------    --------    --------
Net earnings (loss).....................    (10,924)     18,424       9,399
Preferred stock dividends in arrears....      3,127       3,127       3,127
                                           --------    --------    --------
Net earnings (loss) applicable to common
  shares................................   $(14,051)   $ 15,297    $  6,272
                                           --------    --------    --------
                                           --------    --------    --------
Common shares and common share
  equivalents outstanding--average......      9,548      10,111      10,451
Net earnings (loss) per common share:
  Primary...............................   $  (1.47)   $   1.51    $   0.60
  Fully Diluted.........................      (1.47)       1.41        0.60
The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                      F-4
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
                         (IN THOUSANDS, EXCEPT SHARES)
PREFERRED STOCK      COMMON STOCK      ADDITIONAL   RETAINED   CUMULATIVE
                                        -----------------   -----------------    PAID-IN     EARNINGS   TRANSLATION
                                        SHARES     AMTS       SHARES     AMTS    CAPITAL     (DEFICIT)  ADJUSTMENT    TOTAL
                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
Balance at 12/31/92.................... 183,950   $36,790    9,472,057   $95     $ 26,425    $(30,652)    $ (412)    $32,246
 
Net loss...............................      --        --           --    --           --     (10,924)        --     (10,924)
 
Common stock issued....................      --        --       89,800     1          343          --         --         344
 
Warrants issued........................      --        --           --    --          525          --         --         525
 
Common stock received in exchange for
  shares issued and cancelled..........      --        --       (2,500)   --           --         (20)        --         (20)
 
Cumulative translation adj. and
  other................................      --        --           --    --           --          --         (9)         (9)
                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
 
Balance at 12/31/93.................... 183,950    36,790    9,559,357    96       27,293     (41,596)      (421)     22,162
 
Net earnings...........................      --        --           --    --           --      18,424         --      18,424
 
Common stock issued, net...............      --        --       47,000     1          161          --         --         162
 
Termination of 1992 Plan...............      --        --      449,732     4        4,042          --         --       4,046
 
Common stock received in exchange for
  shares issued and cancelled..........      --        --       (1,000)   --           10         (10)        --          --
 
Cumulative translation adj. and
  other................................      --        --           --    --           --          --        (26)        (26)
                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
 
Balance at 12/31/94.................... 183,950    36,790   10,055,089   101       31,506     (23,182)      (447)     44,768
 
Net earnings...........................      --        --           --    --           --       9,399         --       9,399
 
Common stock issued, net...............      --        --       58,751    --          228          --         --         228
 
Common stock received in exchange for
  shares issued and cancelled..........      --        --      (11,202)   --         (155)        (68)        --        (223)
 
Reclamation of shares..................      --        --      (12,677)   --           --          --         --          --

                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
 
Balance at 12/31/95.................... 183,950   $36,790   10,089,961   $101    $ 31,579    $(13,851)    $ (447)    $54,172
                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
                                        -------   -------   ----------   ----   ----------   --------   ----------   -------
The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                     F-5
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                         (IN THOUSANDS, EXCEPT SHARES)
YEARS ENDED DECEMBER 31,
                                           --------------------------------
                                             1993        1994        1995
                                           --------    --------    --------
Cash flow from operating activities:
  Net earnings (loss)...................   $(10,924)   $ 18,424    $  9,399
  Adjustments to reconcile net earnings
     (loss) to net cash used in
     operating activities:
     Depreciation.......................        682         628         528
     Variable stock option plan
       accrual..........................      4,046          --          --
     Changes in assets and liabilities:
       Accounts receivable..............      2,523     (24,500)    (10,519)
       Inventories......................        691      (3,845)       (667)
       Tooling and related costs........     (2,212)     (3,359)         68
       Prepaid expenses and other
          current assets................        285       1,849      (4,856)
       Accounts payable.................      1,449       4,140       2,168
       Accrued expenses.................     (3,002)         67        (392)
       Income taxes payable.............       (549)        217         232
       Other assets.....................       (437)       (168)     (3,026)
                                           --------    --------    --------
     Net cash (used in) provided by
       operating activities.............     (7,448)     (6,547)     (7,065)
                                           --------    --------    --------
Cash flow from investing activities:
  Investment in land, building and
     equipment, net.....................        (82)       (466)     (1,041)
                                           --------    --------    --------
     Net cash (used in) provided by
       investing activities.............        (82)       (466)     (1,041)
                                           --------    --------    --------
Cash flow from financing activities:
  Net borrowings (repayments) under
     notes payable......................     (5,698)      6,971       8,100
  Borrowings under long-term debt
     agreement..........................     14,000          --          --
  Repayments under long-term debt
     agreements.........................       (191)       (194)       (194)
  Proceeds from issuance of common
     stock, net.........................        324         162           5
  Other, net............................         (9)        (26)         --
                                           --------    --------    --------

     Net cash provided by (used in)
       financing activities.............      8,426       6,913       7,911
                                           --------    --------    --------
Increase (decrease) in cash and cash
  equivalents...........................        896        (100)       (195)
Cash and cash equivalents at beginning
  of year...............................      1,429       2,325       2,225
                                           --------    --------    --------
Cash and cash equivalents at end of
  year..................................   $  2,325    $  2,225    $  2,030
                                           --------    --------    --------
                                           --------    --------    --------
Supplemental disclosure of non-cash activity:
    In 1994, the Company issued 449,732 shares of common stock in
     connection with the termination of the 1992 Senior Management Stock
     Option Plan. (See Note O).
Supplemental disclosure of cash flow
  information:
  Cash paid for interest................   $  1,604    $  2,656    $  3,050
  Cash paid for income taxes............   $    574    $    822    $    390

 
             The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                     F-6
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
 
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Organization and Business
 
     The Company has been engaged in business since 1957 and was originally
incorporated in California on November 6, 1968 and reincorporated in Delaware on
August 28, 1987. The Company is engaged in the design, development, marketing
and distribution of high quality toys worldwide. The Company's products are
primarily manufactured in the People's Republic of China.
 
  Consolidation
 
     The consolidated financial statements include the accounts of the Company
and its subsidiaries, principally Galco International Toys, N.V. ('Galco'). All
significant intercompany accounts have been eliminated in consolidation. Certain
amounts in the financial statements of prior years have been reclassified to
conform with the current year's presentation.
 
  Revenue Recognition
 
     The Company records a transaction as a sale when inventory is shipped to
the customer and title passes. The Company provides for returns using a
percentage of gross sales, based on historical experience.
 
  Foreign Currency Translation
 
     The financial statements of Galco have been translated into U.S. dollars in
accordance with Statement of Financial Accounting Standards ('SFAS') No. 52,
Foreign Currency Translation. All asset and liability accounts have been
translated using rates of exchange in effect at the balance sheet date. Revenues
and expenses are translated at the weighted average of exchange rates in effect
during the year. Gains or losses from foreign currency translation adjustments
are charged or credited directly to a separate component of shareholders'
equity.
 
  Use of Estimates
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
  Cash and Cash Equivalents
 
     Cash equivalents consist primarily of marketable securities with original

maturities of less than ninety days.
 
  Concentration of Credit Risk
 
     Accounts receivable primarily represent balances due from customers. The
Company performs credit evaluations of each of its customers and maintains
allowances for potential credit losses. Such losses have generally been within
management's expectations.
 
  Inventories
 
     Inventories are stated at lower of cost (first-in, first-out) or market.
 
  Tooling and Related Costs
 
     Costs incurred for tooling and package design are deferred and amortized
over the life of the products, which range from one to two years.
 
                                      F-7
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

  Prepaid Expenses
 
     Prepaid expenses include costs such as those incurred in the creation of
television commercials which are deferred and amortized over their lives which
is estimated to be one year or the period the commercial is used, if shorter. On
January 1, 1995, the Company implemented SOP 93-7 'Reporting on Advertising
Costs.' Implementation of the new standard had no material impact on the
financial statements. Prepaid expenses also include prepaid insurance, prepaid
samples, prepaid advertising media, and royalty advances.
 
  Land, Building and Equipment
 
     Land, building and equipment are stated at cost. Depreciation is provided
using the straight-line method over the estimated useful lives of the respective
assets. Amortization of leasehold improvements is provided using the
straight-line method over the estimated useful lives of the assets, or the term
of the applicable lease, whichever is less. Estimated useful lives are 35 years
for building and building improvements, 1 to 12 years for leasehold
improvements, 5 years for office furniture, fixtures and equipment (including
computer equipment), and 3 to 6 years for vehicles.
 
     For the year ended December 31, 1995, the Company implemented SFAS No. 121
'Accounting for the Impairment of Long-Lived Assets'. Implementation of SFAS No.
121 has been determined to have no material impact on the financial statements.
 

  Research and Development
 
     Research and development is expensed as it is incurred. Total expenses for
the year 1993, 1994 and 1995 were $7,451,000, $7,288,000 and $7,886,000,
respectively.
 
  Income Taxes
 
     In 1993, the Company retroactively adopted SFAS 109, 'Accounting for Income
Taxes'. SFAS 109 prescribes an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in the Company's financial
statements or tax returns. In estimating future tax consequences, SFAS 109
generally considers all expected future events other than enactments of changes
in the tax law or rates. Previously, the Company used the SFAS 96 asset and
liability approach that gave no recognition to future events other than the
recovery of assets and settlement of liabilities at their carrying amounts.
Adoption of SFAS 109 did not have a material effect on the financial statements.
 
  Earnings Per Share
 
     Primary earnings per share is based on the net earnings (loss) applicable
to common shares, after providing for the dividends in arrears on the preferred
stock, for the year divided by the weighted average number of common and common
equivalent shares outstanding. Primary earnings per share for the years ended
December 31, 1994 and 1995 have been adjusted by common equivalent shares
resulting from the assumed exercise of common stock options and stock warrants.
Primary earnings per share for the year ended 1993 has not been adjusted by
common equivalent shares since the effect would be anti-dilutive. Fully diluted
earnings per share for the year ended 1994 includes the effect of the assumed
conversion of the $17 Convertible Exchangeable Preferred Stock and the 8%
Convertible Subordinated Debentures into common stock. Fully diluted earnings
per share for the years ended December 31, 1995 and 1993 were the same as
primary earnings per share since the effect of the assumed conversion is
anti-dilutive.
 
                                      F-8
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

  Recent Accounting Pronouncement
 
     In 1995, the FASB issued a new standard, SFAS No. 123, 'Accounting for
Stock-Based Compensation', which contains a fair value-based method for valuing
stock-based compensation that entities may use, which measures compensation cost
at the grant date based on the fair value of the award. Compensation is then
recognized over the service period, which is usually the vesting period.

Alternatively, the standard permits entities to continue accounting for employee
stock options and similar equity instruments under APB Opinion 25, 'Accounting
for Stock Issued to Employees'. Entities that continue to account for stock
options using APB Opinion 25 are required to make pro forma disclosures of net
income and earnings per share, as if the fair value-based method of accounting
defined in SFAS No. 123 had been applied. The Company has not determined which
method it will follow in the future. The Company will be required to adopt the
new standard for the year ending December 31, 1996.
 
NOTE B--ACCOUNTS RECEIVABLE, NET
DECEMBER 31,
                                                     ------------------
                                                      1994       1995
                                                     -------    -------
                                                       (IN THOUSANDS)
Trade receivables.................................   $65,757    $76,834
Provisions for:
  Advertising allowances..........................    (2,900)    (5,800)
  Return of defective goods.......................      (900)      (700)
  Markdowns and discounts.........................    (3,400)    (2,975)
  Doubtful accounts...............................      (897)      (507)
                                                     -------    -------
     Net trade receivables........................    57,660     66,852
Other receivables.................................       223      1,550
                                                     -------    -------
                                                     $57,883    $68,402
                                                     -------    -------
                                                     -------    -------
NOTE C--INVENTORIES
DECEMBER 31,
                                                     ------------------
                                                      1994       1995
                                                     -------    -------
                                                       (IN THOUSANDS)
Finished goods....................................   $15,596    $17,023
Raw materials and parts...........................     1,228        468
                                                     -------    -------
                                                     $16,824    $17,491
                                                     -------    -------
                                                     -------    -------
F-9
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE D--LAND, BUILDING AND EQUIPMENT, NET
DECEMBER 31,
                                                     ----------------
                                                      1994      1995
                                                     ------    ------
                                                      (IN THOUSANDS)
Land and building.................................   $9,564    $9,567
Office furniture, fixtures and equipment..........    4,360     4,646
Leasehold improvements............................      787     1,267
Vehicles..........................................      104       104
                                                     ------    ------
                                                     14,815    15,584
Less accumulated depreciation.....................    6,415     6,671
                                                     ------    ------
                                                     $8,400    $8,913
                                                     ------    ------
                                                     ------    ------
NOTE E--NOTES PAYABLE
 
     On March 31, 1995, the Company entered into an amended and restated loan
and security agreement (the 'New Agreement') with Congress Financial Corporation
(Central) (the 'Lender'). The New Agreement extends through March 31, 1997 and
provides a line of credit of $40 million, with provision to increase the line to
$60 million at the option of the Company. Borrowing availability is determined
by a formula based on qualified assets. The interest is at prime rate plus 1%.
In consideration for entering into the New Agreement, the Company paid a
$100,000 fee; additional fees will be paid if the Company exercises its option
to increase the line. The Company has also agreed to pay an unused line fee of
0.25% and certain management fees. The New Agreement provides that the preferred
dividend payment may not be made without the prior consent of the Lender. The
deferred loan fee is included in other assets and is being amortized using a
straight-line method over the term of the loan.
 
     The maximum outstanding borrowings, average outstanding balances and
weighted average rates of interest for notes payable were as follows:
DECEMBER 31,
                                                     ------------------
                                                      1994       1995

                                                     -------    -------
                                                       (IN THOUSANDS)
Maximum outstanding at month end..................   $18,209    $30,235
Average outstanding amount during the year........     4,184     14,211
Weighted average interest rate for the year.......      11.2%      10.4%
F-10
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE F--INCOME TAXES
 
     Earnings (loss) before income taxes and the provision for income taxes are
as follows:
DECEMBER 31,
                                           -----------------------------
                                             1993       1994       1995
                                           --------    -------    ------
                                                  (IN THOUSANDS)
Earnings (loss) before income taxes:
  Domestic..............................   $(10,806)   $18,861    $9,288
  Foreign...............................       (109)       341       711
                                           --------    -------    ------
                                           $(10,915)   $19,202    $9,999
                                           --------    -------    ------
                                           --------    -------    ------
Provision for income taxes:
Current:
  Federal...............................   $     --    $   490    $  187
  State.................................         --        201       278
  Foreign...............................          9         87       135
                                           --------    -------    ------
                                                  9        778       600
Deferred:
  Federal...............................         --         --        --
  State.................................         --         --        --
  Foreign...............................         --         --        --
                                           --------    -------    ------
                                           $      9    $   778    $  600
                                           --------    -------    ------
                                           --------    -------    ------
Deferred tax liabilities (assets) consist of the following:
DECEMBER 31,
                                           ----------------------------
                                            1993       1994       1995
                                           -------    -------    ------
                                                  (IN THOUSANDS)
Prepaid expenses........................   $ 2,065    $ 1,586    $2,475
Other temporary differences.............       647        705       766
                                           -------    -------    ------
Gross deferred tax liabilities..........     2,712      2,291     3,241
                                           -------    -------    ------
Accrued expenses........................    (1,377)      (939)     (613)
Defectives provision....................      (560)      (315)     (245)
Other temporary differences.............    (1,936)    (2,970)   (3,244)
Net operating loss carryforwards........   (11,128)    (4,037)   (2,567)
Research and development tax credit
  carryforward..........................      (765)      (765)     (765)
Other...................................      (765)      (944)   (1,027)
                                           -------    -------    ------
Gross deferred tax assets...............   (16,531)    (9,970)   (8,461)
                                           -------    -------    ------
Deferred tax assets valuation
  allowance.............................    13,819      7,679     5,220
                                           -------    -------    ------
                                           $    --    $    --    $   --
                                           -------    -------    ------
                                           -------    -------    ------
A deferred tax valuation allowance has been recorded for the net operating
loss carryforwards and other credits which may not be utilized. The net change
in the valuation allowance for deferred tax assets was an increase (decrease) of
$1,648,000, ($6,140,000) and ($2,459,000) in 1993, 1994 and 1995, respectively.
 
     At December 31, 1995, the Company had federal net operating loss
carryforwards for income tax purposes of approximately $7,300,000. The
carryforwards expire in different years through the year 2008. The Company also
has federal minimum tax credit carryforwards of $1,028,000 that are allowed to
be carried forward indefinitely and federal research and development credits of
$765,000, which will expire in different years
 
                                      F-11
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 

NOTE F--INCOME TAXES--(CONTINUED)

through the year 2003. If certain substantial changes in the Company's ownership
should occur, there would be an annual limitation on the amount of operating
loss carryforwards which can be utilized.
 
     The provision for income taxes differs from the provisions determined by
applying the applicable U.S. statutory federal income tax rates to pretax income
as a result of the following differences:
YEARS ENDED DECEMBER 31,
                                           ---------------------------
                                           1993       1994       1995
                                           -----      -----      -----
Federal income taxes (benefit) at the
  U.S. statutory rate...................   (34.0%)     35.0%      35.0%
Increase (decrease) in income taxes
  resulting from:
  Effects of U.S. and foreign income
     taxes on foreign operations........     0.1       (0.2)      (1.1)
  State income taxes, net of loss
     carryforwards, less federal tax
     benefits...........................      --        0.9        2.8
  Benefit of reversing temporary
     differences for which benefits were
     not previously recorded............      --         --      (20.9)
  Loss carryback/carryforward...........    34.0      (31.6)     (13.8)
Other...................................      --         --        4.0
                                           -----      -----      -----
                                             0.1%       4.1%       6.0%
                                           -----      -----      -----
                                           -----      -----      -----
During 1993, the Company settled with the Internal Revenue Service ('IRS')
and the California Franchise Tax Board ('CFTB') regarding audits of the years
1982 through 1990 for federal purposes and 1983 through 1989 for California
purposes. The Company adequately provided for the amounts settled with the IRS
and the CFTB.
 
     No domestic deferred taxes have been provided on unremitted earnings of the
foreign subsidiary. All such earnings are expected to be reinvested in the
subsidiary. Undistributed earnings for which the Company has not provided taxes,
which may be payable on distribution, were approximately $5,200,000 as of
December 31, 1995. No foreign taxes will be withheld on the distribution of the
untaxed earnings.
 
NOTE G--LEASES
 
     The Company leases its domestic warehouse and showroom facilities, and its
facilities in Hong Kong. The leases have been classified as operating leases and

are for terms expiring at various dates through 2000. Under the terms of the
facility leases, rents are adjusted annually for changes in the consumer price
index and increases in property taxes. The Company has a lease option on the
domestic warehouse to renew for one five-year term.
 
     Future minimum lease payments for all noncancellable operating leases as of
December 31, 1995 (in thousands) are as follows:
YEARS ENDING
DECEMBER 31,
- -------------------------
1996.....................   $  972
1997.....................      869
1998.....................      772
1999.....................      636
2000.....................      323
                            ------
                            $3,572
                            ------
                            ------
Net rental expense for the years ended December 31, 1993, 1994 and 1995 was
$1,449,000, $1,515,000 and $1,988,164, respectively.
 
                                      F-12
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE H--ROYALTY CONTRACTS
 
     The Company has future minimum royalty guarantee payments as of December
31, 1995 (in thousands) as follows:
YEARS ENDING
DECEMBER 31,
- -------------------------
1996.....................   $3,067
1997.....................    1,915
1998.....................      340
1999.....................      500
                            ------
                            $5,822

                            ------
                            ------
NOTE I--ACCRUED EXPENSES
DECEMBER 31,
                                                     ------------------
                                                      1994       1995
                                                     -------    -------
                                                       (IN THOUSANDS)
Accrued advertising...............................   $   272    $    --
Accrued royalties.................................     6,039      6,003
Accrued compensation and commissions..............     3,875      4,814
Accrued freight and duty..........................     1,483        495
Accrued interest..................................     1,108      1,139
Accrued inventory purchase commitments............     1,320      1,450
Other accrued expenses............................       842        646
                                                     -------    -------
                                                     $14,939    $14,547
                                                     -------    -------
                                                     -------    -------
During 1995, the Company settled with the United States Customs Service
('Customs') regarding the audit of duty due on importations of goods into the
United States of the years 1988 through 1991. The Company adequately provided
for the amount settled with Customs.
 
NOTE J--LONG-TERM DEBT
DECEMBER 31,
                                                     ------------------
                                                      1994       1995
                                                     -------    -------
                                                       (IN THOUSANDS)
8% Convertible Subordinated Debentures due and
  payable on November 30, 2000, interest paid
  semi-annually...................................   $14,000    $14,000
Mortgage secured by headquarters land and
  building, payable in monthly installments of
  $55,314 (principal and interest) through
  November 30, 1996 when the remaining outstanding
  balance is due, interest rate 10.3%.............     4,616      4,422
                                                     -------    -------
                                                      18,616     18,422
Current portion...................................       202      4,422
                                                     -------    -------

                                                     $18,414    $14,000
                                                     -------    -------
                                                     -------    -------
On November 17, 1993, the Company issued in a private placement $14 million
in principal amount of 8% Convertible Subordinated Debentures (the '8%
Debentures'), at par. The interest is to be paid semi-annually. The 8%
Debentures mature on November 30, 2000 and are convertible into shares of the
Company's common
 
                                      F-13
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE J--LONG-TERM DEBT--(CONTINUED)

stock at $9.26 calculated based upon 115% of the average of the Company's
closing common stock price for the ten business days ending November 12, 1993.
In connection with the 8% Debentures, the Company paid a commission to its
investment bankers of $560,000 and issued warrants for 150,000 shares, which
were valued at $525,000 and recorded as additional paid-in capital. These
deferred loan costs are included in other assets and are amortized using a
straight-line method over the term of the loan. (See Note R.)
 
NOTE K--MAJOR CUSTOMERS
 
     The Company had transactions with one customer, Toys 'R' Us, Inc. that
accounted for approximately 21% of net revenues in 1993 and 1994, and 20% of net
revenues in 1995. Wal-Mart accounted for approximately 11% of net revenues in
1995.
 
NOTE L--PROFIT SHARING PLAN
 
     The Company has a 401(k) profit sharing plan covering all non-union
full-time employees. The plan is qualified under Section 401(a) of the Internal
Revenue Code so that contributions to the plan by the Company are not taxable
until distributed to employees. Contributions under the plan are at the
discretion of the Board of Directors and are subject to the amounts allowable
under applicable provisions of the Internal Revenue Code. No Company
contributions have been made in 1993, 1994 or 1995.
 
NOTE M--LITIGATION
 
     On May 17, 1990, the Company filed a complaint against Nintendo of America,
Inc. ('Nintendo') seeking a declaratory judgment and injunctive relief in the
United States District Court, Northern District of California (the 'District
Court'). This complaint sought confirmation of the Company's right to market,
distribute and sell its Game Genie product. On June 1, 1990, Nintendo filed a

complaint in the same District Court alleging copyright and trademark
infringement and seeking a preliminary and permanent injunction and unspecified
damages.
 
     On April 11, 1994, Nintendo paid the Company $16.1 million representing the
full damage award plus interest and related costs. The Company retained
approximately $12.1 million of this amount, and the Company's Game Genie
licensors were paid the remaining $4.0 million. Notwithstanding such payment, on
June 20, 1994, Nintendo filed a petition for a Writ of Certiorari with the
United States Supreme Court, which asked the Supreme Court to review the damage
award on a discretionary basis. On October 3, 1994, the Supreme Court rejected
Nintendo's petition and affirmed Galoob's right to the full damage award. There
is no further basis for appeal by Nintendo.
 
     Nintendo's original trademark claim and the Company's original anti-trust
cross-claim against Nintendo were severed from the copyright claims that were
adjudicated on July 3, 1991. On January 18, 1995 these claims were dismissed
with prejudice by Nintendo and Galoob, respectively. The Nintendo Game Genie
infringement lawsuit is now complete.
 
     The Company is involved in various other litigation and legal matters which
are being defended and handled in the ordinary course of business. None of these
matters is expected to result in outcomes having a material adverse effect on
the Company's consolidated financial position or results of operation.
 
NOTE N--SHAREHOLDERS' EQUITY
 
     In 1989, the Company issued 183,950 authorized shares of $17 Convertible
Exchangeable Preferred Stock with a $200 liquidation value (the 'Preferred
Stock') and deposited them with a U.S. Bank (the 'Depositary') and sold in a
public offering an aggregate of 1,839,500 Depositary Convertible Exchangeable
Preferred Shares
 
                                      F-14
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE N--SHAREHOLDERS' EQUITY--(CONTINUED)

(the 'Depositary Shares') at a price of $20 per share. Each Depositary Share
represents 1/10th share of Preferred Stock and has a cumulative dividend rate of
$1.70 per annum, payable quarterly, and may be converted into common stock at
the option of the holders at an initial price of $16.875 per share of common
stock.
 
     The Depositary Shares are redeemable in whole or in part at any time, at
the option of the Company, at redemption prices ranging from $21.36 to $20.00
plus dividends accrued and unpaid to the redemption date, provided certain
redemption requirements are met which are based on the market price of the

Company's common stock.
 
     The entire issue of Depositary Shares (in multiples of ten) and the entire
issue of Preferred Stock is exchangeable, at the option of the Company, on any
dividend payment date for the Company's 8-1/2% Convertible Subordinated
Debentures due October 1, 2014 (the '8-1/2% Debentures') at the rate of $20.00
principal amount of 8-1/2% Debentures for each Depositary Share. At any time
following the occurrence of certain change in control transactions, each holder
of Depositary Shares, the Preferred Stock, or of 8-1/2% Debentures, as the case
may be, has the right to cause the Company to exchange the Depositary Shares (in
multiples of ten), the Preferred Stock or the 8-1/2% Debentures, as the case may
be, for the Company's Subordinated Debentures due October 1, 2014 (the 'Reset
Debentures').
 
     As long as the Preferred Stock, the 8-1/2% Debentures, or the Reset
Debentures are outstanding, the Company will be subject to limitations on the
payment of certain common stock dividends and other distributions and on the
purchase, redemption, or other acquisition of capital stock. No common stock
dividends may be paid unless the Preferred Stock dividends are current. The
Company has reserved 2,180,148 shares of common stock for the conversion of the
Preferred Stock.
 
     On June 10, 1992, the Company announced it would not pay the July 1, 1992
$0.425 per share quarterly dividend on its Depositary Shares which represent
shares of the Company's Preferred Stock. The Company has not paid the subsequent
quarterly dividends. As of January 1, 1996, the dividend was cumulatively
fifteen quarters in arrears, representing a total dividend arrearage of $11.7
million. By the terms of the Certificate of Designations for the Company's
Preferred Stock, the Company is not legally obligated to pay any such arrearage.
The Company has consistently maintained that it is not in its best interest to
reinstate the dividend until the Company has generated consistent net income
from operations and continuation of such profitability can be reasonably
expected. Based upon recent results, the Company has been evaluating its
alternatives with regard to the Preferred Stock. The net earnings (loss) per
share calculation includes a provision for the Preferred Stock dividends in
arrears. No common stock dividends may be paid unless all Preferred Stock
dividend payments are current. As a result of the cumulative dividend being six
or more quarters in arrears, on July 15, 1994 the holders of the Preferred Stock
exercised their right to elect two directors. (See Note R.)
 
     In 1990, the Company adopted a Stockholder Rights Plan and declared a
dividend distribution of one Right for each outstanding share of common stock.
Each Right will entitle holders of the Company's common stock to buy
one-thousandth of a share of Series A Preferred Stock of the Company at an
exercise price of $43.00, subject to adjustment. The Rights will be exercisable
only if a person or group acquires beneficial ownership of 20% or more of the
common stock (other than pursuant to certain transactions involving the Company)
(an 'Acquiring Person') or announces a tender or exchange offer that would
result in such person or group beneficially owning 20% or more of the common
stock (other than a tender or exchange offer for all outstanding shares at a
price determined by the non-affiliated directors to be fair).
 
     If any person becomes the beneficial owner of 20% or more of the common
stock (other than pursuant to certain transactions involving the Company or a

tender or exchange offer for all outstanding shares at a price determined by the
non-affiliated directors to be fair), or an Acquiring Person engages in certain
'self-dealing' transactions including a merger in which the Company is the
surviving corporation, each Right not owned by such Acquiring Person will enable
its holder to purchase, at the Right's then-current exercise price, shares of
the
 
                                      F-15
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE N--SHAREHOLDERS' EQUITY--(CONTINUED)

common stock (or, in certain circumstances, cash, property or other securities
of the Company) having a value of twice the Right's exercise price. In addition,
if the Company is acquired in a merger or other business combination transaction
in which the Company is not the surviving corporation, or if the Company sells
or transfers 50% or more of its assets or earning power, each Right not owned by
such Acquiring Person will entitle its holder to purchase, at the Right's
then-current exercise price, common shares of the acquiring company having a
value of twice the Right's exercise price.
 
     The Rights will expire January 17, 2000 or they may be redeemed by the
Company at $.01 per share prior to that date. The Rights do not have voting or
dividend rights and, until they become exercisable, have no dilutive effect on
the earnings of the Company.
 
NOTE O--STOCK OPTIONS AND WARRANTS
 
     The Board of Directors and the shareholders adopted an Employee Stock
Option Plan in 1984 (the '1984 Plan'). During 1994, the 1984 Plan was amended to
extend the plan until April 20, 2004 and to increase the aggregate number of
shares available under the 1984 Plan. The 1984 Plan authorizes the Board of
Directors to grant to officers and employees of the Company and certain of its
subsidiaries options to purchase up to an aggregate of 1,589,997 common shares.
Stock options are exercisable in accordance with the determination of the Board
of Directors made at the time of their grant, and expire not more than ten years
after the date of grant. Stock options granted under the 1984 Plan in 1993, 1994
and 1995 were at 100% of market price.
 
     As of December 31, 1995, 241,029 shares remain available for future grants.
 
     Stock option activity pursuant to the 1984 Plan is summarized as follows:
1993          1994          1995
                                      ----------    ----------    -----------
Options outstanding:
  At January 1.....................      320,608       275,399        331,899
  Granted..........................      120,000       161,000        320,000
  Exercised........................      (14,800)      (97,000)       (60,575)
  Cancelled........................     (150,409)       (7,500)       (19,824)
                                      ----------    ----------    -----------
  At December 31...................      275,399       331,899        571,500
                                      ----------    ----------    -----------
                                      ----------    ----------    -----------
Options exercisable:
  At December 31...................      174,149       181,899        201,500
                                      ----------    ----------    -----------
                                      ----------    ----------    -----------
Option prices per share:
  Granted..........................   $3.25-7.38    $5.75-8.38    $5.75-11.88
  Exercised........................         3.00     3.25-5.63      3.00-6.25
  Cancelled........................    3.00-6.38     3.00-6.13      3.00-6.13
In 1992, the Board of Directors and the shareholders adopted the 1992
Senior Management Stock Option Plan (the '1992 Plan'), a variable stock option
plan. Under the 1992 Plan 800,000 shares were reserved and options for 800,000
shares were issued and outstanding at December 31, 1993. These options vest over
three years and expire after ten years. The initial exercise prices were $5.625
for 700,000 shares and $3.25 for 100,000 shares, respectively, the market prices
on the dates granted. The exercise prices were adjusted downward on a pro-rata
basis as the trading price of the stock increased above the initial exercise
price so that the exercise price would be $.01 when the trading price of the
stock was $19.00.
 
     Generally accepted accounting principles ('GAAP') for variable stock option
plans required the Company to record a compensation expense accrual measured by
the difference between the market price of the common
 
                                      F-16
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE O--STOCK OPTIONS AND WARRANTS--(CONTINUED)

stock underlying an option and the option price as of December 31, 1993. The
sharp rise in the price of the Company's common stock during the fourth quarter
of 1993, therefore, required a charge to earnings.
 
     The Company believed that the application of GAAP could have resulted in

large and repeated future distortion to reported quarterly earnings of the
Company, based on fluctuations in the stock price so long as the 1992 Plan
remained in effect. Therefore, on January 26, 1994, the Board of Directors of
the Company ('Board') terminated the 1992 Plan, subject to shareholder approval.
In connection with the termination of the 1992 Plan, the Company recorded an
accrued liability on its balance sheet at December 31, 1993 in the amount of
$4,046,000 and recorded a non-recurring, non-cash charge to earnings. In
addition, in connection with the termination of the 1992 Plan, the Company
granted an aggregate of 449,732 shares of common stock to the holders of the
cancelled options, also subject to shareholder approval. In the second quarter
of 1994, subsequent to the approval by the shareholders, the Company eliminated
the accrued liability of $4,046,000 and increased shareholders' equity by the
same amount for the common stock issued. In 1995, 12,677 of the granted shares
were reacquired by the Company at no cost per the terms of the 1992 Plan.
 
     Also, on January 26, 1994 the Board adopted the 1994 Senior Management
Stock Option Plan (the '1994 Plan'), subject to shareholder approval. Each
holder of options under the 1992 Plan was granted new options with an option
exercise price of $9.00, the trading price of the common stock of the Company at
the time of the Board actions. The shareholders approved the 1994 Plan in June
1994. As of December 31, 1995, there are outstanding options to purchase 742,592
shares under the 1994 Plan. During 1995, the shareholders adopted the 1995
Non-Employee Directors Stock Option Plan (the '1995 Plan'). The 1995 Plan
provides for the automatic granting annually to each non-employee director
options immediately exercisable into 2,000 shares of common stock at the fair
market value on the grant date. Options were granted on July 1, 1995 and will be
granted on each January 1 thereafter. The maximum number of share options under
the 1995 Plan is 160,000. As of December 31, 1995, there were outstanding
options to purchase 16,000 shares at an exercise price of $8.00 per share.
 
     On July 7, 1988, in consideration for entering into a credit agreement, the
Company issued warrants to purchase 785,732 shares of common stock at an
exercise price of $4.50 per share. One half of the warrants issued on July 7,
1988 were repurchased on May 25, 1989 for $400,000. On December 11, 1991, the
Company issued warrants to purchase 25,000 shares of common stock at an exercise
price of $4.375 per share. On November 17, 1993, the Company issued warrants
relating to the 8% Debentures to purchase 150,000 shares of common stock at an
exercise price of $9.50 per share.
 
NOTE P--RELATED PARTY TRANSACTIONS
 
     The Company has retained the legal services of Shereff, Friedman, Hoffman &
Goodman, LLP in recent years. One of the Company's directors is a partner of
Shereff, Friedman, Hoffman & Goodman, LLP. The total amount of fees paid to
Shereff, Friedman, Hoffman & Goodman, LLP in 1994 and 1995 were approximately
$0.4 million and $0.3 million, respectively, exclusive of the director's fees
paid to Martin Nussbaum, a partner in the firm of Shereff, Friedman, Hoffman &
Goodman, LLP, as compensation for his service as Chairman of the Executive
Committee of the Board of Directors.
 
     The Company has retained the insurance brokerage services of Rollins Hudig
Hall ('RHH') in recent years. One of the Company's directors is the President
and Chief Executive Officer of Rollins Real Estate/Investment, a division of
RHH. The total amount of insurance premiums paid to RHH in 1994 and 1995 were

approximately $1.4 million and $1.3 million, respectively.
 
     In 1994, the Company sold its minority interest in Galoob Toys Canada,
Inc., which continues to act as the Company's distributor in Canada and which
accounted for less than 5% of the Company sales.
 
                                      F-17
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE Q--DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
 
     The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
 
     o Current Assets and Current Liabilities
       The carrying value of cash, cash equivalents, accounts receivables,
       short-term borrowings, accounts payable and accrued expenses approximate
       fair value because of their short maturity.
 
     o Long-Term Debt
       The fair value of the Company's long-term debt is estimated based on the
       quoted market price of the underlying common stock which would be 
       received upon conversion. At December 31, 1995, the carrying amount and 
       estimated fair value of long-term debt are $14.0 million and $17.8 
       million, respectively.
 
NOTE R--SUBSEQUENT EVENTS
 
     On February 12, 1996, the Company announced that it was calling for
redemption of its 8% Convertible Subordinated Debentures originally due November
30, 2000 (the 'Debentures'), and was commencing an exchange offer for its
Depositary Convertible Exchangeable Preferred Shares (the 'Preferred Shares').
 
     Under the terms of the redemption, the $14,000,000 Debentures now
outstanding will be redeemed on or about March 22, 1996, unless converted into
the Company's Common Stock by the holders prior to the redemption date. Until
the redemption date, the Debentures are convertible into an aggregate of
1,511,872 shares of Common Stock at the rate of $9.26 principal amount for each
share of Common Stock. The Company became entitled to redeem the Debentures when
the average closing price of its Common Stock for twenty consecutive days
exceeded 150% of the conversion price.
 
     Under the terms of the exchange offer, the Company will offer to exchange
1.85 shares of Common Stock for each of the 1,839,500 Preferred Shares currently
outstanding. The exchange offer has an expiration date of March 29, 1996, and is
conditioned on, among other things, the receipt of valid tenders from the
holders of at least 75 percent of the outstanding Preferred Shares.

 
NOTE S--SEGMENT INFORMATION
 
     The Company's operations are in one industry segment: the sale of toys
primarily to major retail outlets. The Company operates in two primary
geographic areas, the U.S. and Europe, and there are no sales between geographic
areas.
 
                                      F-18
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995--(CONTINUED)
 
NOTE S--SEGMENT INFORMATION--(CONTINUED)

     Information about the Company's operations in different geographic
locations are as follows:
1993        1994        1995
                                           -------    --------    --------
                                                   (IN THOUSANDS)
United States
  Non-affiliated customer revenue.......   $88,821    $119,702    $139,373
  Earnings (loss) from operations.......    (1,341)      6,383       9,837
  Identifiable assets...................    61,706      87,653     111,639
Foreign
  Non-affiliated customer revenue.......    45,513      59,090      80,671
  Earnings (loss) from operations.......    (7,874)      2,939       3,152
  Identifiable assets...................     9,299      13,113       8,445
Consolidated
  Net revenues..........................   134,334     178,792     220,044
  Earnings (loss) from operations.......    (9,215)      9,322      12,989
  Net proceeds from Nintendo award......        --      12,124          --
  Interest expense......................    (1,836)     (2,609)     (3,429)
  Other income, net.....................       136         365         439
                                           -------    --------    --------
  Earnings (loss) before income taxes...   (10,915)     19,202       9,999
  Identifiable assets...................   $71,005    $100,766    $120,084
NOTE T--QUARTERLY FINANCIAL DATA (UNAUDITED)
 
     Quarterly financial data for 1994 and 1995 are summarized in the following
table:
NET       NET EARNINGS
                         NET        GROSS     EARNINGS     (LOSS) PER
                       REVENUES    MARGIN      (LOSS)     COMMON SHARE
                       --------    -------    --------    ------------
                          (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1994
lst Quarter.........   $ 30,235    $13,472    $ (1,648)      $(0.25)
2nd Quarter.........     33,720     13,939       9,753         0.91
3rd Quarter.........     50,273     22,653       3,909         0.30
4th Quarter.........     64,565     33,572       6,410         0.55
 
1995
1st Quarter.........   $ 33,341    $11,849    $ (4,171)      $(0.49)
2nd Quarter.........     38,219     13,258      (4,087)       (0.48)
3rd Quarter.........     65,518     28,870       6,837         0.58
4th Quarter.........     82,966     45,233      10,820         0.93
 
1996
1st Quarter.........   $ 37,522    $16,185    $ (4,115)      $(2.71)
2nd Quarter.........     49,201     22,758         387         0.02
F-19
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                         (IN THOUSANDS, EXCEPT SHARES)
JUNE 30,      DECEMBER 31,     JUNE 30,
                                    1995            1995           1996
                                 -----------    ------------    -----------
                                 (UNAUDITED)     (AUDITED)      (UNAUDITED)
ASSETS
Current Assets:
  Cash and cash equivalents...     $ 1,106        $  2,030       $   2,920
  Accounts receivable, net....      43,189          68,402          61,773
  Inventories.................      18,004          17,491          20,686
  Tooling and related costs...       8,095           8,311          12,983
  Prepaid expenses and other
     assets...................      12,610          10,348          10,861
                                 -----------    ------------    -----------
     Total current assets.....      83,004         106,582         109,223
Land, building and equipment,
  net.........................       8,233           8,913          10,081
Other assets..................       3,511           4,589           5,390
                                 -----------    ------------    -----------
                                   $94,748        $120,084       $ 124,694
                                 -----------    ------------    -----------
                                 -----------    ------------    -----------
 
LIABILITIES AND SHAREHOLDERS'
             EQUITY
Current Liabilities:
  Notes payable...............     $17,147        $ 15,071       $  34,644
  Accounts payable............      12,768          17,141          13,785
  Accrued expenses............       9,467          14,547           8,493
  Income taxes payable........         272             731             372
  Current portion of long-term
     debt.....................         213           4,422           4,318
                                 -----------    ------------    -----------
     Total current
       liabilities............      39,867          51,912          61,612
Long-term debt................      18,309          14,000              --
Shareholders' equity:
  Preferred stock
     Authorized 1,000,000
       shares
     Issued and outstanding
       183,950 shares, 183,950
       shares and 0 shares of
       $17 Convertible
       Exchangeable Preferred

       Stock at $200
       liquidation value per
       share..................      36,790          36,790              --
  Common stock, par value $.01
     per share
     Authorized 50,000,000
       shares
     Issued and outstanding
       10,070,889 shares,
       10,089,961 shares and
       15,119,651 shares......         101             101             151
  Additional paid-in
     capital..................      31,638          31,579         105,774
  Retained earnings
     (deficit)................     (31,510)        (13,851)        (42,396)
  Cumulative translation
     adjustment...............        (447)           (447)           (447)
                                 -----------    ------------    -----------
     Total shareholders'
       equity.................      36,572          54,172          63,082
                                 -----------    ------------    -----------
                                   $94,748        $120,084       $ 124,694
                                 -----------    ------------    -----------
                                 -----------    ------------    -----------
The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                     F-20
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SIX MONTHS ENDED
                                                         JUNE 30,
                                           ------------------------------------
                                                 1995                1996
                                           ----------------    ----------------
                                                       (UNAUDITED)
Net revenues............................       $     71,560        $     86,723
Costs of products sold..................             46,453              47,780
                                           ----------------    ----------------
Gross margin............................             25,107              38,943
                                           ----------------    ----------------
Operating expenses:
  Advertising and promotion.............              9,662              12,411
  Other selling and administrative......             12,332              13,253
  Royalties, research and development...             10,093              15,502
                                           ----------------    ----------------
Total operating expenses................             32,087              41,166
Earnings (loss) from operations.........             (6,980)             (2,223)
Interest expense........................             (1,387)             (1,596)
Other income (expense), net.............                109                  91
                                           ----------------    ----------------
Earnings (loss) before income taxes.....             (8,258)             (3,728)
Provision for income taxes..............                 --                  --
                                           ----------------    ----------------
Net earnings (loss).....................             (8,258)             (3,728)
Preferred stock dividends:
  Paid..................................                                      6
  In arrears............................              1,564                  15
Charge related to the exchange of
  preferred stock for common............                 --              24,279
                                           ----------------    ----------------
Net earnings (loss) applicable to common
  shares................................       $    ( 9,822)       $    (28,028)
                                           ----------------    ----------------
                                           ----------------    ----------------
Common shares and common share
  equivalents outstanding--Average......             10,064              12,774
Net earnings (loss) per common share:
  Primary...............................       $      (0.98)       $      (2.19)
  Fully diluted.........................       $      (0.98)       $      (2.19)
The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                     F-21
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                         (IN THOUSANDS, EXCEPT SHARES)
SIX MONTHS ENDED
                                                 JUNE 30,
                                           --------------------
                                             1995        1996
                                           --------    --------
                                               (UNAUDITED)
Cash flow from operating activities:
  Net earnings (loss)...................   $ (8,258)   $ (3,728)
  Adjustments to reconcile net earnings
     (loss) to net cash provided by
     (used in) operating activities:
     Depreciation.......................        130         350
     Changes in assets and liabilities:
       Accounts receivable..............     14,695       6,629
       Inventories......................     (1,180)     (3,195)
       Tooling and related costs........        284      (4,672)
       Prepaid expenses and other
        assets..........................     (9,067)     (2,148)
       Accounts payable.................     (2,205)     (3,356)
       Accrued expenses.................     (5,461)     (5,727)
       Income taxes payable.............       (227)       (359)
                                           --------    --------
     Net cash (used in) provided by
      operating activities..............    (11,289)    (16,206)
                                           --------    --------
Cash flow from investing activities:
  Investment in land, building and
     equipment, net.....................         37      (1,518)
                                           --------    --------
     Net cash (used in) provided by
      investing activities..............         37      (1,518)
                                           --------    --------
Cash flow from financing activities:
  Net borrowings under notes payable....     10,176      19,573
  Repayments under long-term debt
     agreements.........................       (105)       (104)
  Proceeds from issuance of common
     stock..............................         62         875
  Redemption of preferred stock.........         --        (462)
  Costs associated with the conversion
     of debentures and the preferred
     shares exchange....................         --      (1,268)
                                           --------    --------
  Net cash (used in) provided by

     financing activities...............     10,133      18,614
                                           --------    --------
Increase (decrease) in cash and cash
  equivalents...........................     (1,119)        890
Cash and cash equivalents at beginning
  of period.............................      2,225       2,030
                                           --------    --------
Cash and cash equivalents at end of
  period................................   $  1,106    $  2,920
                                           --------    --------
                                           --------    --------
Supplemental disclosure of non-cash activity:
    During the six months ended June 30, 1996, $14,000 of the
     Company's 8% convertible subordinated debentures were
     converted into 1,511,872 shares of its common stock.
     Deferred loan costs and accrued interest amounting to
     approximately $505, net, were debited to additional
     paid-in capital. See Note E.
    During the six months ended June 30, 1996, 1,822,899
     depositary shares of the Company's preferred stock were
     exchanged for 3,359,432 shares of its common stock. See
     Note F.
 
             The accompanying notes are an integral part of these
                      Consolidated Financial Statements.
                                      
                                     F-22
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                         SIX MONTHS ENDED JUNE 30, 1996
                                  (UNAUDITED)
 
NOTE A--CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
     The condensed consolidated balance sheets as of June 30, 1995 and 1996 and
the condensed consolidated statements of operations for the six month periods
ended June 30, 1995 and 1996 and the condensed consolidated statements of cash
flows for the six month periods ended June 30, 1995 and 1996 have been prepared
by the Company without audit. In the opinion of management, all adjustments
(which include only normal recurring adjustments) necessary to present fairly
the financial position, results of operations and cash flows at June 30, 1995
and 1996 and for all periods presented have been made.
 
     Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted. It is suggested that these condensed consolidated financial
statements be read in conjunction with the financial statements and notes
thereto for the year ended December 31, 1995 included elsewhere in this
prospectus. Certain amounts in the financial statements of prior years have been
reclassified to conform with the current year's presentation.
 
     The results of operations for the six month periods ended June 30, 1995 and
1996 are not necessarily indicative of the operating results for the full year.
 
NOTE B--LEGAL RECOVERY
 
     For the six month period ended June 30, 1996, other selling and
administrative expenses were reduced by $2.3 million received in settlement of a
claim for damages. This benefit was partially offset by $2.0 million of unusual
legal expenses incurred during the six month period ended June 30, 1996, related
to this claim and a lawsuit where the Company is the plaintiff.
 
NOTE C--INVENTORIES
JUNE 30,
                                 DECEMBER 31,    ------------------
                                     1995         1995       1996
                                 ------------    -------    -------
                                           (IN THOUSANDS)
Finished goods................     $ 17,023      $17,120    $19,589
Raw materials and parts.......          468          884      1,097
                                 ------------    -------    -------
                                   $ 17,491      $18,004    $20,686
                                 ------------    -------    -------
                                 ------------    -------    -------
NOTE D--TOOLING AND RELATED COSTS
 
     Effective beginning January 1, 1996, the Company changed the timing of its
annual amortization of tooling, packaging design and sample costs. These annual
costs are now being amortized on a percentage of sales basis rather than the
previous straight-line basis. The Company believes this change improves the
matching of costs and revenues within an annual period. The effect of this
change in timing was to decrease costs of products sold and net loss by
approximately $1,500,000 or $.12 per common share for the six months ended June
30, 1996. This change in estimate will result in no impact on net income on an
annual basis.
 
     Research and development expenses incurred amount to $4,466,000 and
$5,063,000 for the six months ended June 30, 1995 and 1996, respectively.
 
NOTE E--LONG-TERM DEBT
 
     In February 1996, the Company issued a call for the redemption of its 8%
Convertible Subordinated Debentures originally due November 30, 2000 (the
'Debentures'). This call resulted in the conversion on March 15, 1996, of all
$14,000,000 Debentures at $9.26 per share and the issuance of 1,511,872 new
shares of common stock.
 
                                      F-23
LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                         SIX MONTHS ENDED JUNE 30, 1996
                                  (UNAUDITED)
 
NOTE F--SHAREHOLDER'S EQUITY
 
     In February 1996, the Company offered to exchange 1.85 shares of its common
stock for each Depositary Exchangeable Preferred Share (the 'Depositary Shares')
outstanding. Each Depositary Share represents 1/10th of a share of $17.00
Convertible Exchangeable Preferred Stock. This inducement offer was accepted by
the owners of 98% of the Depositary Shares resulting in the issuance of
3,336,433 shares of common stock on March 29, 1996. Generally accepted
accounting principles require a non-cash charge to reduce Net Earnings
Applicable to Common Shares in the calculation of Earnings Per Share for the
fair value of the securities issued in excess of the existing conversion rate of
approximately 1.185 common shares. This charge amounted to $24,279,000 and had
the effect of increasing the net loss per common share by $1.90 from $.29 to
$2.19 in the six months ended June 30, 1996.
 
     Of the remaining 2% Depositary Shares, approximately 1% of the shares were
converted using the conversion rate of approximately 1.185 common shares and the
remaining 1% were redeemed in cash for approximately $462,000.
 

NOTE G--RECENT ACCOUNTING PRONOUNCEMENT
 
     The FASB issued a new standard, SFAS No. 123, 'Accounting for Stock-Based
Compensation' which contains a fair value-based method for valuing stock-based
compensation that entities may use, which measures compensation cost at the
grant date based on the fair value of the award. Compensation is then recognized
over the service period, which is usually the vesting period. Alternatively, the
standard permits entities to continue accounting for employee stock options and
similar equity instruments under APB Opinion 25, 'Accounting for Stock Issued to
Employees.' Entities that continue to account for stock options using APB
Opinion 25 are required to make pro forma disclosures of net income and earnings
per share, as if the fair value-based method of accounting defined in SFAS No.
123 had been applied. The Company has determined to continue to account for
stock options using APB Opinion 25 and will make required pro forma disclosures
in the notes to its consolidated financial statements. The Company will be
required to adopt the new standard for the year ending December 31, 1996.
 
                                      F-24
------------------------------------------------------
            ------------------------------------------------------
 
     NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED IN CONNECTION
WITH THIS OFFERING TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER
THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION
OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY OR ANY OF THE UNDERWRITERS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE
SUBSEQUENT TO THE DATE HEREOF. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO
SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE COMMON
STOCK OFFERED HEREBY OR BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS UNLAWFUL, OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANYONE TO WHOM IT IS UNLAWFUL TO
MAKE SUCH OFFER OR SOLICITATION.

                            ------------------------
 
                               TABLE OF CONTENTS
PAGE
                                                  ----
Prospectus Summary.............................     3
Risk Factors...................................     7
Use of Proceeds................................    12
Dividend Policy................................    12
Price Range of Common Stock....................    13
Capitalization.................................    14
Selected Consolidated Financial Data...........    15
Management's Discussion and Analysis of
  Financial Condition and Results of
  Operations...................................    16
Business.......................................    22
Management.....................................    33
Principal and Selling Stockholders.............    41
Certain Relationships and Related
  Transactions.................................    42
Description of Capital Stock...................    42
Underwriting...................................    45
Legal Matters..................................    46
Experts........................................    46
Available Information..........................    46
Index to Consolidated Financial Statements.....   F-1
------------------------------------------------------
            ------------------------------------------------------

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

                                     [LOGO]
 

                                2,392,866 SHARES
                                       OF
                                  COMMON STOCK

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

                                   PROSPECTUS

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

                       GERARD KLAUER MATTISON & CO., LLC

                            WILLIAM BLAIR & COMPANY

                           JEFFERIES & COMPANY, INC.

                                          , 1996
 
            ------------------------------------------------------
            ------------------------------------------------------
PART II

                   INFORMATION NOT REQUIRED IN THE PROSPECTUS
 
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
 
     The following table sets forth the estimated costs and expenses in
connection with the issuance and distribution of the securities being
registered, other than underwriting discounts. All of the following costs and
expenses are estimated except the Securities and Exchange Commission
Registration Fee and the NASD Filing Fee.
Securities and Exchange Commission Registration Fee............  $  27,104
NASD Filing Fee................................................  $   8,360
Printing and Engraving Expenses................................  $   *
Counsel Fees and Expenses......................................  $   *
Financial Advisory Fee.........................................  $   *
Accountants' Fees and Expenses.................................  $   *
Blue Sky Fees and Expenses.....................................  $   *
Transfer Agent and Registrar Fees and Expenses.................  $   *
NYSE Listing Fee...............................................  $   *
Miscellaneous..................................................  $   *
                                                                 ---------
Total..........................................................  $   *
                                                                 ---------
                                                                 ---------
- ------------------
* To be filed by amendment
 
     The Company will pay all expenses of the Company and the Selling
Stockholder (other than underwriting discounts on shares of Common Stock sold by
the Selling Stockholder) relating to this offering.
 
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
 
     The indemnification of officers and directors of the Company is governed by
Section 145 of the General Corporation Law of the State of Delaware (the 'DGCL')
and the Certificate of Incorporation and By-Laws of the Company. Among other
things, the DGCL permits indemnification of a director, officer, employee or
agent in civil, criminal, administrative or investigative actions, suits or
proceedings (other than an action by or in the right of the corporation) to
which such person is a party or is threatened to be made a party by reason of
the fact of such relationship with the corporation or the fact that such person
is or was serving in a similar capacity with another entity at the request of
the corporation against expenses (including attorneys' fees), judgments, fines
and amounts paid in settlement actually and reasonably incurred by him if such
person acted in good faith and in a manner he reasonably believed to be in or
not opposed to the best interests of the corporation, and, with respect to any

criminal action or proceeding, if he had no reasonable cause to believe his
conduct was unlawful. No indemnification may be made in any such suit to any
person adjudged to be liable to the corporation unless and only to the extent
that the Delaware Court of Chancery or the court in which the action was brought
determines that, despite the adjudication of liability, such person is under all
circumstances, fairly and reasonably entitled to indemnity for such expenses
which such court shall deem proper. Under the DGCL, to the extent that a
director, officer, employee or agent is successful, on the merits or otherwise,
in the defense of any action, suit or proceeding or any claim, issue or matter
therein (whether or not the suit is brought by or in the right of the
corporation), he shall be indemnified against expenses (including attorneys'
fees) actually and reasonably incurred by him. In all cases in which
indemnification is permitted (unless ordered by a court), it may be made by the
corporation only as authorized in the specific case upon a determination that
the applicable standard of conduct has been met by the party to be indemnified.
The determination must be made by a majority vote of a quorum consisting of the
directors who were not parties to the action or, if such a quorum is not
obtainable, or even if obtainable, if a quorum of disinterested directors so
directs, by independent legal counsel in a written opinion, or by the
stockholders. The statute authorizes the corporation to pay expenses incurred by
an officer or director in advance of a final disposition of a proceeding upon
receipt of an undertaking by or on behalf of the person to whom the advance will
be made, to repay the advances if it shall ultimately be determined that he was
 
                                      II-1
not entitled to indemnification. The DGCL provides that indemnification and
advances of expenses permitted thereunder are not to be exclusive of any rights
to which those seeking indemnification or advancement of expenses may be
entitled under any By-Law, agreement, vote of stockholders or disinterested
directors, or otherwise. The DGCL also authorizes the Company to purchase and
maintain liability insurance on behalf of its directors, officers, employees and
agents regardless of whether the Company would have the statutory power to
indemnify such persons against the liabilities insured.
 
     The Certificate of Incorporation of the Company (the 'Certificate')
provides that no director of the Company shall be personally liable to the
Company or its stockholders for monetary damages for breach of fiduciary duty as
a director, except for liability (i) for any breach of the director's duty of
loyalty to the Company or its stockholders, (ii) for acts or omissions not in
good faith or which involve intentional misconduct or a knowing violation of
law, (iii) for paying a dividend or approving a stock repurchase in violation of
Section 174 of the DGCL or (iv) for any transaction from which the director
derived an improper personal benefit.
 
     The Certificate also provides that directors, officers, employees and
others shall be indemnified to the fullest extent authorized by the DGCL, as in
effect (or, to the extent indemnification is broadened, as it may be amended),
against any and all expense, liability and loss (including attorneys' fees,
judgments, penalties, fines, ERISA excise taxes and judgments, fines and amounts
paid or to be paid in settlement) from threatened, pending or completed actions,
suits or proceedings, whether civil, criminal, administrative or investigative.

The Certificate further provides that, to the extent permitted by the DGCL,
expenses so incurred by any such person in defending an action, suit or
proceeding shall, at his request, be paid by the Company in advance of the final
disposition of such action or proceeding.
 
     The Certificate provides that the right to indemnification and the payment
of expenses incurred in defending a proceeding in advance of its final
disposition shall not be exclusive of any other right which any person may have
or acquire under any statute, provision of the Certificate or By-Laws of the
Company, agreement, vote of stockholder or disinterested directors, or
otherwise.
 
     The Company has obtained directors' and officers' liability and company
reimbursement insurance which, among other things (i) provides for payment on
behalf of its officers and directors against loss as defined in the policy
stemming from acts committed by directors and officers in their capacity as such
and (ii) provides for payment on behalf of the Company against such loss but
only when the Company shall be required or permitted to indemnify directors or
officers for such loss pursuant to statutory or common law or pursuant to duly
effective Certificate or By-Law provisions.
 
     Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the 'Act'), may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing provisions, or
otherwise, the Company has been advised that in the opinion of the Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
liabilities (other than the payment by the Company of expenses incurred or paid
by a director, officer or controlling person of the Company in the successful
defense of any action, suit or proceeding) is asserted by such director, officer
or controlling person in connection with the securities being registered, the
Company will, unless in the opinion of its counsel the matter has been settled
by controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
 
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
 
     In a November 1993 private placement, the Company raised $14,000,000
through the sale of its 8% Convertible Subordinated Debentures due 2000 (the
'Debentures'). The Debentures mature on November 30, 2000 and are convertible
into 1,511,872 shares of common stock of the Company ('Common Stock') based on
the current $9.26 conversion price. In connection with the sale of the
Debentures, the Company paid a commission to its investment banker of $560,000
and issued it warrants to purchase 150,000 shares of Common Stock, at an
exercise price of $9.50 per share. The issuance of the above securities was
deemed to be exempt from registration under the Act, in reliance on Section 4(2)
thereof or Regulation D promulgated thereunder, as transactions by an issuer not
involving any public offering.
 
                                      II-2
On February 12, 1996, the Company issued a call for the redemption of its
Debentures. In connection with the redemption, holders of Debentures exercised
their right to convert the Debentures into Common Stock at the rate of $9.26
principal amount for each share of Common Stock. This resulted in the conversion
of all of the Debentures in to 1,511,872 shares of Common Stock at $9.26 per
share. The issuance of the above securities was deemed to be exempt from
registration under the Act, in reliance on Section 3(a)(9) thereof.
 
     On February 28, 1996, the Company commenced an exchange offer for its
Depositary Convertible Exchangeable Preferred Shares (the 'Depositary Shares'),
offering to exchange 1.85 shares of Common Stock for each outstanding Depositary
Share. The exchange offer was accepted by the holders of 98% of the Depositary
Shares, resulting in the issuance of 3,336,433 shares of Common Stock on March
29, 1993, the expiration date of the offer. The issuance of the above securities
was deemed to be exempt from registration under the Act, in reliance of Section
3(a)(9) thereof.
 
     On May 10, 1996, the Company elected to redeem all of its outstanding
Depositary Shares, in accordance with the terms under which they were issued. In
connection with the redemption, certain holders of the Depositary Shares
exercised their right to convert their Depositary Shares into shares of Common
Stock at the rate of 1.185 shares of Common Stock per Depositary Share. This
resulted in the issuance of approximately 3.3 million shares of Common Stock on
the Redemption Date. The issuance of the above securities was deemed to be
exempt from registration under the Act, in reliance on Section 3(a)(9) thereof.
 
 ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
 
     (a) The following exhibits are filed as part of the Registration Statement:
1.1+         --   Form of Underwriting Agreement.
  3.1(1)       --   Certificate of Incorporation.
  3.2(1)       --   By-laws.
  4.1(2)       --   Form of Certificate for Shares of Common Stock of
                    Registrant.
  4.2(a)(3)    --   Warrant Agreement, dated as of July 7, 1988,
                    between the Registrant and Wells Fargo Bank and
                    warrants issued to Wells Fargo Bank.
  4.2(b)(4)    --   Warrant Agreement, dated as of December 11, 1991,
                    by and between the Registrant and Shereff,
                    Friedman, Hoffman and Goodman, LLP.
  4.2(c)(4)    --   Warrant Agreement, dated as of November 17, 1993,
                    by and between the Registrant and Gerard Klauer
                    Mattison & Co., Inc.
  4.3(5)       --   Form of Rights Agreement, dated as of January 17,
                    1990, between the Registrant and Mellon Securities
                    Trust Company.
  5.1+         --   Opinion of Weil, Gotshal & Manges LLP.
 10.1(a)(6)*   --   Amended and Restated 1984 Employee Stock Option
                    Plan.
 10.1(b)(7)*   --   1994 Senior Management Stock Option Plan.

 10.1(c)(8)*   --   Form of Agreement between each of Mark Goldman,
                    William Catron, Louis Novak, Gary Niles, Ronald
                    Hirschfeld and H. Alan Gaudie and the Registrant.
 10.1(d)(9)*   --   Form of Amendment No. 1 between each of Mark
                    Goldman, William Catron, Louis Novak, Gary Niles,
                    Ronald Hirschfeld and H. Alan Gaudie and the
                    Registrant.
 10.1(e)(10)   --   1995 Non-Employee Directors' Stock Option Plan.
 10.2(10)*     --   Lewis Galoob Toys, Inc. Savings and Retirement
                    Plan (Formerly the Lewis Galoob Toys, Inc. Profit
                    Sharing) (Amendment and Restatement effective
                    January 1, 1987).
 10.3(9)*      --   Severance Agreement, dated October 27, 1994,
                    between Mark Goldman and the Registrant.
 10.4(a)(12)*  --   Agreement, dated July 15, 1995, between William G.
                    Catron and the Registrant.
 10.4(b)(12)*  --   Agreement, dated July 15, 1995, between Loren
                    Hildebrand and the Registrant.
 10.4(c)(12)*  --   Agreement, dated July 15, 1995, between Ronald
                    Hirschfeld and the Registrant.
 10.4(d)(12)*  --   Agreement, dated July 15, 1995, between Gary J.
                    Niles and the Registrant.
 10.4(e)(12)*  --   Agreement, dated July 15, 1995, between Louis R.
                    Novak and the Registrant.
 10.5(9)       --   Amended and Restated Loan and Security Agreement,
                    dated as of March 31, 1995, by and among the
                    Registrant and Congress Financial Corporation
                    (Central).
 10.6(a)(13)   --   License Agreement, dated June 16, 1986, by and
                    between Funmaker, as Licensor and the Registrant,
                    as Licensee.
II-3
10.7(b)(14)   --   License Agreement, dated May 4, 1990, by and among
                    the Registrant as Licensee, Codemasters Software
                    Company, Ltd. and Camerica Corporation, Limited.
 10.7(c)(14)   --   Amendment No. 1 dated June 1991 to License
                    Agreement dated May 4, 1990.
 10.7(d)(14)   --   Amendment No. 2 dated December 23, 1991 to License
                    Agreement, dated May 4, 1990.
 10.7(e)(14)   --   European License Agreement, dated December 23,
                    1991, by and between Codemasters Software Company,
                    Ltd. and the Registrant.
 10.7(f)(14)   --   Third Amendment to United States License and First
                    Amendment to European License, dated November 4,
                    1992.
 10.7(g)(9)    --   Fourth Amendment to United States License
                    Agreement, dated October 14, 1994.
 10.8(13)      --   Agreement of Purchase and Sale, dated October 22,
                    1986, by and between ATC Building Company, as
                    Seller, and the Registrant, as Buyer.
 10.9(a)(1)    --   Lease Agreement, dated March 12, 1987, by and
                    between Lincoln Alvarado and Patrician Associates,
                    Inc., as Lessor, and the Registrant, as Lessee.
 10.9(b)(11)   --   Amendment No. 1 to Lease Agreement.
 10.9(c)(10)   --   Lease Agreement, dated December 1, 1995, by and
                    between 200 Fifth Avenue Associates, as Lessor,
                    and the Registrant, as Lessee.
 11            --   Statement of Computation of Per Share Earnings.
 21            --   Subsidiaries of the Registrant.
 23.1          --   Consent of Price Waterhouse LLP.
 23.2+         --   Consent of Weil, Gotshal & Manges LLP (included in
                    its opinion which appears as Exhibit 5.1).
 24(12)        --   Power of Attorney.
- ------------------
 
(1) Incorporated by reference to the Registrant's Amendment No. 1 to
    Registration Statement on Form 8-B, filed with the Securities and Exchange
    Commission (the 'Commission') on January 11, 1988.
 
(2) Incorporated by reference to the Registrant's Registration Statement on Form
    S-3, filed with the Commission on February 26, 1990.
 
(3) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1987, filed with the Commission on August 2, 1988.
 
(4) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1993, filed with the Commission on March 31, 1994.
 
(5) Incorporated by reference to the Registrant's Registration Statement on Form
    8-A, filed with the Commission on January 23, 1990.

 
(6) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56585, filed with the Commission on November 23,
    1994.
 
(7) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56587, filed with the Commission on November 23,
    1994.
 
(8) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56589, filed with the Commission on November 23,
    1994.
 
(9) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1994, filed with the Commission on March 31, 1995.
 
(10) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1995, filed with the Commission on March 11, 1996.
 
(11) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1991, filed with the Commission on March 30, 1992.
 
(12) (included on signature page to this Registration Statement)
 
(13) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1986, filed with the Commission on March 31, 1987.
 
(14) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1992, filed with the Commission on March 31, 1993.
 
+ To be filed by amendment.
 
* Indicates exhibits relating to executive compensation.
 
                                      II-4
(b)  Financial Statements Schedules
 
     Schedule II--Valuation and Qualifying Accounts and Reserves for the years
ended December 31, 1995, 1994 and 1993.
 
     All other schedules are omitted because they are not applicable or the
required information is shown in the Company's consolidated financial statements
or the notes thereto.
 
ITEM 17. UNDERTAKINGS.
 
     Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the 'Act'), may be permitted to directors, officers and
controlling persons of the Registrant under the General Corporation Law of the
State of Delaware or pursuant to the Registrant's Certificate of Incorporation
or By-Laws or otherwise, the Registrant has been advised that in the opinion of

the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
 
     The Registrant hereby undertakes that:
 
          (1) for purposes of determining any liability under the Act, the
     information omitted from the form of prospectus filed as part of this
     registration statement in reliance upon Rule 430A under the Act and
     contained in a form of prospectus filed by the Registrant pursuant to Rule
     424(b)(1) or (4) or 497(h) under the Act shall be deemed to be part of this
     registration statement as of the time it was declared effective;
 
          (2) for the purpose of determining any liability under the Securities
     Act of 1933, each post-effective amendment shall be deemed to be a new
     registration statement relating to the securities offered therein, and the
     offering of such securities at that time shall be deemed to be the initial
     bona fide offering thereof.
 
                                      II-5
SIGNATURES
 
     Pursuant to the requirements of the Act, the Registrant has duly caused
this Registration Statement on Form S-1 to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of South San Francisco,
State of California, on the 25th day of September, 1996.
 
                                          LEWIS GALOOB TOYS, INC.
 
                                          By:         /s/ MARK D. GOLDMAN
                                              ----------------------------------
                                                       Mark D. Goldman
                                               President and Chief Executive
                                                         Officer
 
                               POWER OF ATTORNEY
 
     KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints each of Mark D. Goldman and H. Alan Gaudie, or
any of them, each acting alone, his true and lawful attorney-in-fact and agent
with full powers of substitution and resubstitution, for such person and in his
name, place and stead, in any and all capacities, in connection with the
Registrant's Registration Statement on Form S-1 under the Securities Act of
1933, including to sign the Registration Statement and any and all amendments or
supplements to the Registration Statement, including any and all stickers and
post-effective amendments to the Registration Statement and to sign any and all
additional registration statements relating to the same offering of securities
as those that are covered by the Registration Statement that are filed pursuant
to Rule 462(b) under the Securities Act of 1933, and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission and any applicable securities exchange or
securities self-regulatory body, granting unto said attorneys-in-fact and
agents, each acting alone, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully, to all intents and purposes, as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or his substitute or substitutes, may lawfully do or cause to be done by
virtue hereof.
 
     Pursuant to the requirements of the Act, this Registration Statement has
been signed below by the following persons in the capacities and on the dates
indicated.
SIGNATURE                      TITLES                    DATE
- ------------------------------  -------------------------  --------------------
/s/ MARK D. GOLDMAN        President, Chief             September 25, 1996
- ------------------------------  Executive Officer and
       Mark D. Goldman          Director
 

      /s/ ROGER KOWALSKY        Executive Vice President     September 25, 1996
- ------------------------------  and Chief Financial
        Roger Kowalsky          Officer and Director
 

     /s/ ANDREW CAVANAUGH       Director                     September 25, 1996
- ------------------------------
       Andrew Cavanaugh
 

   /s/ PAUL A. GLIEBE, JR.      Director                     September 25, 1996
- ------------------------------
     Paul A. Gliebe, Jr.
 

    /s/ SCOTT R. HELDFOND       Director                     September 25, 1996
- ------------------------------
      Scott R. Heldfond
 

       /s/ S. LEE KLING         Director                     September 25, 1996
- ------------------------------
         S. Lee Kling
II-6
SCHEDULE II
 
                    LEWIS GALOOB TOYS, INC. AND SUBSIDIARIES

                 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
                                 (in thousands)
ADDITIONS
                            BALANCE AT    CHARGED TO                   BALANCE
                            BEGINNING     COSTS AND                    AT END
DESCRIPTION                 OF PERIOD      EXPENSES     DEDUCTIONS    OF PERIOD
- -------------------------   ----------    ----------    ----------    ---------
Year ended 12/13/93
- -------------------------
Provisions for returns
and allowance............     $6,031       $  5,516      $  6,298      $ 5,249
 
Year ended 12/31/94
- -------------------------
Provisions for returns
and allowance............      5,249         11,979         9,131        8,097
 
Year ended 12/31/95
- -------------------------
Provisions for returns
and allowance............      8,097         12,707        10,822        9,982
See Note B of Notes to Consolidated Financial Statements.
 
                                      S-1

                                 EXHIBIT INDEX
Exhibit                  Description
- -------                  -----------
1.1+         --   Form of Underwriting Agreement.
  3.1(1)       --   Certificate of Incorporation.
  3.2(1)       --   By-laws.
  4.1(2)       --   Form of Certificate for Shares of Common Stock of
                    Registrant.
  4.2(a)(3)    --   Warrant Agreement, dated as of July 7, 1988,

                    between the Registrant and Wells Fargo Bank and
                    warrants issued to Wells Fargo Bank.
  4.2(b)(4)    --   Warrant Agreement, dated as of December 11, 1991,
                    by and between the Registrant and Shereff,
                    Friedman, Hoffman and Goodman, LLP.
  4.2(c)(4)    --   Warrant Agreement, dated as of November 17, 1993,
                    by and between the Registrant and Gerard Klauer
                    Mattison & Co., Inc.
  4.3(5)       --   Form of Rights Agreement, dated as of January 17,
                    1990, between the Registrant and Mellon Securities
                    Trust Company.
  5.1+         --   Opinion of Weil, Gotshal & Manges LLP.
 10.1(a)(6)*   --   Amended and Restated 1984 Employee Stock Option
                    Plan.
 10.1(b)(7)*   --   1994 Senior Management Stock Option Plan.
 10.1(c)(8)*   --   Form of Agreement between each of Mark Goldman,
                    William Catron, Louis Novak, Gary Niles, Ronald
                    Hirschfeld and H. Alan Gaudie and the Registrant.
 10.1(d)(9)*   --   Form of Amendment No. 1 between each of Mark
                    Goldman, William Catron, Louis Novak, Gary Niles,
                    Ronald Hirschfeld and H. Alan Gaudie and the
                    Registrant.
 10.1(e)(10)   --   1995 Non-Employee Directors' Stock Option Plan.
 10.2(10)*     --   Lewis Galoob Toys, Inc. Savings and Retirement
                    Plan (Formerly the Lewis Galoob Toys, Inc. Profit
                    Sharing) (Amendment and Restatement effective
                    January 1, 1987).
 10.3(9)*      --   Severance Agreement, dated October 27, 1994,
                    between Mark Goldman and the Registrant.
 10.4(a)(12)*  --   Agreement, dated July 15, 1995, between William G.
                    Catron and the Registrant.
 10.4(b)(12)*  --   Agreement, dated July 15, 1995, between Loren
                    Hildebrand and the Registrant.
 10.4(c)(12)*  --   Agreement, dated July 15, 1995, between Ronald
                    Hirschfeld and the Registrant.
 10.4(d)(12)*  --   Agreement, dated July 15, 1995, between Gary J.
                    Niles and the Registrant.
 10.4(e)(12)*  --   Agreement, dated July 15, 1995, between Louis R.
                    Novak and the Registrant.
 10.5(9)       --   Amended and Restated Loan and Security Agreement,
                    dated as of March 31, 1995, by and among the
                    Registrant and Congress Financial Corporation
                    (Central).
 10.6(a)(13)   --   License Agreement, dated June 16, 1986, by and
                    between Funmaker, as Licensor and the Registrant,
                    as Licensee.
10.7(b)(14)   --   License Agreement, dated May 4, 1990, by and among
                    the Registrant as Licensee, Codemasters Software
                    Company, Ltd. and Camerica Corporation, Limited.
 10.7(c)(14)   --   Amendment No. 1 dated June 1991 to License
                    Agreement dated May 4, 1990.
 10.7(d)(14)   --   Amendment No. 2 dated December 23, 1991 to License
                    Agreement, dated May 4, 1990.
 10.7(e)(14)   --   European License Agreement, dated December 23,
                    1991, by and between Codemasters Software Company,
                    Ltd. and the Registrant.
 10.7(f)(14)   --   Third Amendment to United States License and First
                    Amendment to European License, dated November 4,
                    1992.
 10.7(g)(9)    --   Fourth Amendment to United States License
                    Agreement, dated October 14, 1994.
 10.8(13)      --   Agreement of Purchase and Sale, dated October 22,
                    1986, by and between ATC Building Company, as
                    Seller, and the Registrant, as Buyer.
 10.9(a)(1)    --   Lease Agreement, dated March 12, 1987, by and
                    between Lincoln Alvarado and Patrician Associates,
                    Inc., as Lessor, and the Registrant, as Lessee.
 10.9(b)(11)   --   Amendment No. 1 to Lease Agreement.
 10.9(c)(10)   --   Lease Agreement, dated December 1, 1995, by and
                    between 200 Fifth Avenue Associates, as Lessor,
                    and the Registrant, as Lessee.
 11            --   Statement of Computation of Per Share Earnings.
 21            --   Subsidiaries of the Registrant.
 23.1          --   Consent of Price Waterhouse LLP.
 23.2+         --   Consent of Weil, Gotshal & Manges LLP (included in
                    its opinion which appears as Exhibit 5.1).
 24(12)        --   Power of Attorney.
- ------------------
 
(1) Incorporated by reference to the Registrant's Amendment No. 1 to
    Registration Statement on Form 8-B, filed with the Securities and Exchange
    Commission (the 'Commission') on January 11, 1988.
 
(2) Incorporated by reference to the Registrant's Registration Statement on Form
    S-3, filed with the Commission on February 26, 1990.
 
(3) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1987, filed with the Commission on August 2, 1988.
 
(4) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1993, filed with the Commission on March 31, 1994.
 
(5) Incorporated by reference to the Registrant's Registration Statement on Form
    8-A, filed with the Commission on January 23, 1990.

 
(6) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56585, filed with the Commission on November 23,
    1994.
 
(7) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56587, filed with the Commission on November 23,
    1994.
 
(8) Incorporated by reference to the Registrant's Registration Statement on Form
    S-8, Registration No. 33-56589, filed with the Commission on November 23,
    1994.
 
(9) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
    ended December 31, 1994, filed with the Commission on March 31, 1995.
 
(10) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1995, filed with the Commission on March 11, 1996.
 
(11) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1991, filed with the Commission on March 30, 1992.
 
(12) (included on signature page to this Registration Statement)
 
(13) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1986, filed with the Commission on March 31, 1987.
 
(14) Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1992, filed with the Commission on March 31, 1993.
 
+ To be filed by amendment.
 
* Indicates exhibits relating to executive compensation.