<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                             ----------------------
                                  FORM 10-KSB

         X       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
       -----                 EXCHANGE ACT OF 1934

                  For the fiscal year ended December 31, 1998

           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
       _____            SECURITIES EXCHANGE ACT OF 1934

                        Commission File Number: 0-22464

                               KOALA CORPORATION
                (Name of Small Business Issuer in Its Charter)

            Colorado                                   84-1238908
(State of Other Jurisdiction of                     (I.R.S. Employer
Incorporation or Organization)                     Identification No.)


                       11600 East 53rd Avenue,   Unit D
                            Denver, Colorado 80239
                   (Address of Principal Executive Offices)

                                (303) 574-1000

               (Issuer's Telephone Number, Including Area Code)

      Securities Registered Under Section 12(b) of the Exchange Act: None

        Securities Registered under Section 12(g) of the Exchange Act:

                         Common Stock, $.10 par value
                               (Title of Class)

Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the issuer was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.

                            X    Yes         ___  No
                           ---                     

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. _______

State the issuer's revenues for its most recent fiscal year:  $19,100,765

As of February 5, 1999, the aggregate market value of the voting stock held by
nonaffiliates of the issuer computed by reference to the last quoted price at
which such stock sold on such date as reported by the Nasdaq National Market was
approximately $60,818,921.

As of February 5, 1999, there were outstanding 3,027,362 shares of the issuer's
Common Stock, $.10 par value.

                      DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's Proxy Statement for its 1999 Annual Meeting of
Shareholders are incorporated by reference into Part III of this Form 10-KSB.

                                       1
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                                     PART I


ITEM 1.   DESCRIPTION OF BUSINESS

This report contains forward-looking statements that describe the Company's
business and the expectations of the Company and management.  All statements,
other than statements of historical facts, included in this report that address
activities, events or developments that the Company expects, believes, intends
or anticipates will or may occur in the future, are forward-looking statements.
Forward-looking statements are inherently subject to risks and uncertainties,
many of which cannot be predicted with accuracy and some of which might not even
be anticipated.  Future events and actual results, financial and otherwise,
could differ materially from those set forth in or contemplated by the forward-
looking statements herein.  These risks and uncertainties include, but are not
limited to, those discussed in "Risk Factors" below.


                                    BUSINESS

  Koala Corporation ("Koala" or the "Company"), a Colorado corporation, is a
leading designer, producer and worldwide marketer of innovative commercial
products, systems and custom solutions that create attractive family-friendly
environments for businesses and other public venues. The Company produces family
convenience products, such as baby changing stations and high chairs; children's
activity products, such as activity tables and activity carpets; and children's
modular play equipment. The Company intends to capitalize on brand name
recognition established through its market-leading Koala Bear Kare Baby's
Changing Station, which has been installed in approximately 300,000 public
restrooms worldwide. The Company's sales have grown from $3.8 million in 1993 to
$19.1 million in 1998.  Net income has grown from $1.0 million in 1993 to $3.1
million in 1998.

  The Company markets its products, systems and custom solutions to a wide range
of businesses and public facilities that serve customers and visitors who bring
children to their establishments. The Company's customers include Walt Disney
World, The Mayo Clinic, Target Stores, McDonalds, Pizza Hut, Burger King
franchises and many other customers in the retail, health care, supermarket,
entertainment venue and numerous other markets. Management believes that the
Koala Bear Kare brand is widely recognized among family-friendly businesses and
their customers.

  The Company provides high-quality products with design features that cater to
the needs of its customers. The Company believes that competition in its various
product categories is fragmented and that Koala benefits from offering a broad
selection of branded products to its customers. The Company intends to continue
providing family-friendly products, systems and custom solutions through
strategic initiatives including: capitalizing on brand recognition; maximizing
market penetration; acquiring complementary businesses and products; maintaining
low cost, high quality production; developing new solutions and enhanced
products; and expanding its international marketing.

  On December 16, 1998, the Company purchased the assets of Park Structures, a
manufacturer and marketer of outdoor children's modular play equipment. Park
Structures sells its products to municipalities, parks, public and private
schools, day care centers and private developers. Park Structures' line of
children's outdoor modular play equipment complements the Company's existing
line of children's indoor modular play equipment, and the acquisition provides
additional market opportunities for the Company.


History

  The Company's predecessor was formed in 1987 to produce and market a newly
designed baby changing station. This product has formed the foundation for the
Company's growth, and the Company believes that it is the market leader in baby
changing station products in terms of units sold. During the 1990's, Koala has
developed from a single product company into a diversified designer, producer
and marketer of family convenience products, children's activity products and
children's modular play equipment. The Company introduced the Child Protection
Seat in 1991 and the Infant Seat Kradle in 1993. In 1994, the Company acquired
the rights to the Booster Buddy booster seat. The Company commenced its offering
of children's activity systems in 1996, following the acquisition of a producer
of activity products. This acquisition initiated the development of the Koala
Kare System, which allows businesses to create custom activity systems to suit
individual space requirements and customer needs. The Company continued to
expand its product offerings in 1997 through new product introductions,
including the Koala Highchair, and the acquisition of Delta Play, a custom
manufacturer of creatively themed, modular indoor children's play systems. With
the acquisition of Park Structures, the Company enters the outdoor children's
modular play market. As a result of the Company's product diversification
efforts, the Baby Changing Station, while continuing to be a growth opportunity
for the Company, represented less than half of Koala's sales in 1998.

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Industry Overview

  The Family Convenience and Children's Activity Market. The Company believes
that parents increasingly travel, shop and dine out with their children due to
societal changes and demographic trends, including the strict time constraints
of two-income and single parent households. A March 1998 national market
research study conducted for the Company by the Howell Research Group reported
that seven out of ten parents (68%) interviewed shopped with their children
either all the time (27%) or most of the time (41%). According to the study, the
impact of child-friendly facilities is very positive. The majority of women and
a large number of the men interviewed, who shopped at child-friendly stores,
shopped more frequently and spent more time and money at these stores. The
Company believes that businesses increasingly need to create an accommodating
and positive environment for children in order to attract customers, increase
sales and create customer loyalty. The Company has developed and acquired family
convenience and children's activity products to help businesses meet these
needs.

  The United States Department of Justice estimates that there are over
5,000,000 public facilities in the United States of the type targeted by the
Company, including restaurants, retail stores and shopping centers. The Company
estimates that the market for its children's activity products includes
approximately 1,500,000 facilities. The Company currently targets over 60
categories of facilities to purchase its family convenience and children's
activity products, including quick service restaurants, airports, stadiums,
convention centers, supermarkets and other retail establishments.

  The Children's Modular Play Market. The children's modular play market is
comprised of indoor and outdoor areas for child play. Customers for indoor
children's modular play equipment include many of the same businesses that
purchase family convenience and children's activity products, such as quick
service restaurants, shopping malls, day care centers and family entertainment
centers. The Company believes that many of the same demographic trends in the
family convenience and children's activity segments are driving demand for
indoor children's modular play products. In addition, the Company believes that
customers increasingly are looking for theming and custom-designed equipment in
order to create a unique family-friendly atmosphere for their businesses.

  The children's outdoor modular play market for products produced by Park
Structures includes municipalities, schools, parks, amusement parks, day care
centers and apartment complexes. The Company believes that this market has
expanded for a number of reasons. Unlike the products of Park Structures, many
existing outdoor play structures are not accessible to people with disabilities
or the structures or their underlying surfaces do not comply with current safety
codes. In addition, wood structures, which were popular in the 1970s and 1980s,
are not as popular today because of safety and maintenance concerns and because
they tend to deteriorate over time. Therefore, the Company believes that
municipal risk managers and others who control the buying decisions regarding
outdoor play systems are seeking to replace or expand their existing equipment.


Business Strategy

  The Company's primary business objective is to grow its sales and earnings by
continuing to develop as a leading provider of family-friendly products, systems
and solutions. The Company's key strategic initiatives are summarized below.

  Capitalize on Brand Name Recognition. The Company believes that the Koala Bear
Kare brand name has achieved significant recognition with businesses and their
customers through the reputation of its Koala Bear Kare Baby Changing Station.
The Company intends to continue to leverage this brand recognition through the
marketing of its other family convenience and children's activity products and
children's modular play systems under the Koala Bear Kare name.

  Maximize Market Penetration. The Company intends to continue to increase
market penetration through an integrated marketing effort that includes
manufacturer's representative and dealer sales, direct sales, trade shows and
trade magazine advertising. In 1997, the Company strengthened its existing
distribution network through the addition of approximately 200 new
manufacturer's representatives and over 800 new dealers. The Company also
intends to expand the cross-selling of its products to new and existing
customers and to expand the categories of facilities that purchase its products.

  Acquire Complementary Businesses and Products. The Company has established a
formal acquisition program and regularly evaluates strategic acquisitions as a
means of adding complementary businesses and product lines. The Company has
completed several acquisitions and believes that there are opportunities to
acquire products or business lines that would complement current operations,
expand current product offerings and provide additional opportunities to
leverage the Company's marketing efforts.

  Maintain Low Production Costs and High Quality. The Company has a "buy or
build" philosophy that seeks to maintain low production costs without
compromising quality. As a result, a substantial portion of its manufacturing
and assembly functions currently are outsourced, and certain design functions
are handled by the Company. The Company believes that outsourcing to qualified
suppliers where appropriate enables it to focus its resources on marketing and
sales while maintaining quality control through frequent contacts with its
suppliers.

                                       3
<PAGE>
 
  Develop New Solutions. Koala seeks to develop new solutions in order to meet
customer expectations and expand its business. For example, the Koala Highchair
was designed and developed with unique features in response to restaurants'
concerns about the cleanliness and ease of use provided by their existing
highchairs. The Company also continually seeks to improve and enhance its
existing products and systems in response to customer needs.

  Expand International Marketing. The Company sells its products worldwide.
Sales to customers outside of North America have increased from 12% of sales in
1996 to 18% of sales in 1998. The Company intends to continue the expansion of
its international marketing activities by adding dealers and locating Koala
employees in selected markets around the world to supervise international sales
activity. In addition, the Company plans to increase its international sales
through increased cross-selling of its products and the marketing of the outdoor
modular play equipment of Park Structures.


Park Structures

  Park Structures, formed in 1986 and based in South Florida, is a leading
manufacturer and marketer of children's outdoor modular play equipment for
municipalities and other governmental agencies, parks, public and private
schools, day care centers and private developers. For the year ended December
31, 1998, Park Structures had sales and operating income of $10.6 million
(unaudited) and $2.8 million (unaudited), respectively.  Park Structures'
products are sold on a national basis. The Company believes there is an
opportunity to market its existing products through the Park Structures
distribution channels and to market its products as well as the Park Structures
products both to domestic customers and to customers internationally. Park
Structures' markets represent a new distribution opportunity for the Company.
The Company believes that it will be able to increase the penetration of Park
Structures' products to larger municipal markets by employing the Company's
marketing and financial resources. Koala intends to explore the opportunity to
cross-sell its existing products into the Park Structures markets and to
introduce the Park Structures products to its children's activity and indoor
modular play customers.


Products

  The Company currently markets three groups of products: family convenience,
children's activity and children's modular play equipment products. These
products are sold to businesses and other customers located in all 50 states and
in approximately 50 foreign countries.

  Family Convenience Products. The Company currently markets the following
family convenience products: the Koala Bear Kare Baby Changing Station, the
Koala Bear Kare Child Protection Seat, the Koala Bear Kare Infant Seat Kradle,
the Booster Buddy booster seat and the Koala Bear Kare Highchair. The Company
also markets disposable sanitary paper liners to be used with its Baby Changing
Stations. All of these products, except for the Infant Seat Kradle and the
sanitary paper liners, are constructed out of durable polyethylene plastic and
are highly resistant to accidental damage or vandalism. These products are
described below.

     Koala Bear Kare Baby Changing Station. Introduced in 1987, the Baby
  Changing Station reinforced the need for publicly accessible baby changing
  tables. The changing station provides customers with a safer and more sanitary
  alternative to changing their children's diapers and encourages customers to
  stay in a place of business instead of leaving to take care of the baby.
  Management estimates that there have been approximately 300,000 units
  installed worldwide. The changing station fits in very small restrooms and is
  available in a vertical, horizontal or counter-top design to accommodate a
  variety of space requirements. A changing station unit is steel reinforced to
  provide added safety and weight capacity. Each unit features child protection
  straps with snap-lock fasteners that hold the child securely in place.
  Stations are equipped with built-in sanitary liner dispensers. Liners are
  biodegradable 3-ply paper and provide the same protection for an infant that
  toilet seat covers provide adults. The paper liners are sold separately to
  businesses with changing stations and provide the Company a recurring revenue
  stream from its customers.

     Koala Bear Kare Child Protection Seat. The Child Protection Seat is
  designed for parents who need to use a restroom or dressing room in a public
  place but are unable to fit their baby's stroller in the stall with them. The
  protection seat mounts on the wall or door of a public restroom stall or
  dressing room, offering customers a safer and more sanitary alternative to
  leaving a child unattended or on the floor. The baby is kept securely in place
  by child protection straps with snap-lock fasteners and a uniquely designed
  tilt-back, polyethylene seat. The unit's compact folding design fits easily in
  the smallest restrooms or dressing rooms and mounts to a variety of surfaces.

     Koala Bear Kare Infant Seat Kradle. The Infant Seat Kradle is effectively a
  highchair for infants who are too small for high chairs. This product permits
  parents in restaurants and other businesses to put their infant carriers or
  car seats at table height. The Infant Seat Kradle consists of a metal frame
  with a nylon mesh cradle and protection straps to hold the infant carrier
  securely in place. The unit folds into a flat profile for storage in tight
  spaces and, when open, takes up no more floor space than a highchair.

                                       4
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     Booster Buddy Booster Seat. The Booster Seat is designed to permit children
  from the ages of 2 to 7 to enjoy movies, sports, theater and other spectator
  events. The product reverses to provide two different height levels for
  children and is equipped with a cup holder, a candy/popcorn holder and built-
  in handle for easy carrying. The booster seat features an easy-cleaning
  lightweight molded polyethylene design weighing only three pounds. Seats stack
  together in an upright stand for easy storage and accessibility to patrons.

     Koala Bear Kare Highchair. The Highchair features a seamless molded
  polyethylene construction that prohibits food and dirt from collecting in
  hard-to-clean places, resulting in a more sanitary product. Its unique,
  recessed two-wheel design allows for smooth movement and easy maneuvering, yet
  eliminates accidental rolling. The polyethylene construction results in a
  longer life and easier cleaning than wooden highchairs. The highchair is
  stackable and easy to store.

  Children's Activity Products. The Company's children's activity products
consist of the Koala Bear Kare Block and Maze Activity Table, Koala Bear Kare
Wonder Wall and Koala Bear Kare Activity Center Carpet. These products, which
include manipulative activities and colorful blocks, letters, numbers and
designs, are designed for use in commercial waiting areas of businesses such as
grocery stores, auto dealers, retail stores, physicians and other professional
services providers. These products are solidly constructed to withstand heavy
use and include hygienic maintenance features. The Company markets these
products individually or under the name Koala Kare Systems. The Koala Kare
Systems allow businesses to create custom activity systems to suit individual
space requirements and customer needs. These systems range from individual
activity tables in doctor's offices to large children's activity or play areas
in supermarkets comprising several thousand square feet where children are
supervised in a controlled environment. Selected activity products with
interactive video machines and other interactive products create a children's
activity setting that allows parents to shop while their children are
entertained and educated in a safe, clean and child-friendly environment.

  Children's Modular Play Equipment. The Company currently markets modular and
custom themed children's indoor play equipment. The Company works with each
individual customer to create and produce custom designs that use traditional
modular components such as tunnels, walkways, ladders and ball pits either alone
or in combination to create a themed environment such as a pirate's ship or
jungle tree house. These products are designed for use in family entertainment
centers, quick-service restaurants and shopping malls.

  The acquisition of Park Structures has expanded the Company's product
offerings into children's outdoor modular play equipment. The Park Structures
division designs, manufactures and markets modular and custom outdoor play
equipment for municipalities and other governmental agencies, parks, public and
private schools, day care centers, developers and apartment complexes. The Park
Structures products consist of traditional modular outdoor playground equipment
such as decks, elevated climbing areas and slides. These components are
available in a wide variety of sizes, configurations and color options. The Park
Structures division custom designs its systems to meet customer requirements.


Marketing and Sales

  Family Convenience and Children's Activity Products. The Company's marketing
strategy for its family convenience and child activity products consists of
extending the Koala Bear Kare brand name, introducing new concepts and creating
new groups of customers for its products around a theme of Happy Faces in Public
Places. The Company uses a combination of dealer sales and direct sales to
market these products.

  Since 1995, the Company has increased its marketing budget in an effort to
increase sales of its products to a wider target market. In 1997, the Company
expanded its distribution network, which consists of manufacturer's sales
representatives and dealers, through the addition of approximately 200 new
manufacturer's sales representatives and over 800 new dealers. The
manufacturer's sales representatives promote the Company's products to the
dealers, who purchase the products from the Company and resell them to
customers. The manufacturer's representatives receive commissions from the sale
of the Company's products. Most dealers are not granted any exclusive rights for
products or territory. Dealer sales have accounted for a minority of the
Company's domestic sales and a majority of the Company's foreign sales. The
Company's current distribution network consists of approximately 2,100 dealers
served by approximately 300 manufacturer's sales representatives that serve
selected market segments. In addition, the Company markets directly to national
accounts who prefer to buy directly from manufacturers and other end users that
do not qualify as national accounts or are not served by dealers. International
dealers currently are served by factory sales managers who are experienced in
international sales. The Company intends to continue the expansion of its
international marketing activities by adding dealers and locating Koala
employees in selected markets around the world to supervise international sales
activity. In addition, the Company plans to increase its international sales
through increased cross-selling of its products and the marketing of the outdoor
modular play equipment of Park Structures.

  The Company supports its marketing and sales activities through attendance at
numerous national and international industry trade shows in various market
segments. The Company also invests in focused advertising in trade magazines to
promote its products to potential customers. The theme of this advertising
identifies the advantages to potential customers in being family-friendly to
promote increased business through increased customer loyalty.

                                       5
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  The Company conducts an active public relations program aimed at providing
information about the concept of being family-friendly and illustrating the
benefits of the Company's family convenience and children's activity products
for existing and prospective customers. The Company assists industry
publications in creating editorial content or news stories about the emerging
trends around families' decisions where to shop, eat or visit. In addition,
Company sales managers host educational seminars for decision makers at key
industry trade shows.

  Children's Modular Play Equipment. The Company markets and sells its custom
indoor modular play equipment through trade show attendance, trade journal
advertising and regular contact by Company salespeople with designers of
projects in various markets. Park Structures sells nationwide and
internationally through a network of approximately 40 independent dealers and
through an in-house sales person who covers six counties in South Florida. Park
Structures' marketing programs include attendance at national industry and
regional trade shows, a focused media advertising campaign, incentive programs
designed to stimulate growth and the publication of a catalogue depicting the
products and capabilities of Park Structures.


Design and Manufacturing

  The Company has a "buy or build" philosophy that seeks to maintain low
production costs either through outsourcing or using Company personnel where it
is more cost-effective and does not compromise quality. As a result, a
substantial portion of its manufacturing and assembly functions currently are
outsourced, and certain design functions are handled by the Company. The Company
believes that outsourcing to qualified suppliers where appropriate enables it to
focus its resources on marketing and sales while maintaining quality control
through frequent contacts with its suppliers.

  Family Convenience and Children's Activity Products. Koala develops the
concepts for its family convenience and children's activity products in response
to the needs of its customers. Following development of prototypes, the Company
outsources the design of the tooling for the production of these products to
independent designers. Product designs are incorporated into molds and tooling
owned by the Company. The Company provides these molds and tooling to its
suppliers in connection with the manufacture of the Company's products. In the
manufacturing process, components are molded to the Company's specifications
using various plastic molding processes, assembled and delivered to the Company
for shipment to customers. The Company uses a number of manufacturers for its
products. The Company believes that alternative sources of supply are available
for these products if necessary.

  Children's Modular Play Equipment. The Company's design engineers custom
design its children's indoor modular play systems using computer aided design
technologies applied to modular components. The Company owns all of the
significant molds and tooling used in the manufacture of specialized components
used in the play equipment. Components for these systems are manufactured to the
Company's specifications and purchased from outside vendors. The Company
fabricates certain metal and fiberglass components at its plant located near
Vancouver, British Columbia, Canada. These components are then assembled by the
Company at the plant and shipped to customers.

  The Company custom designs its children's outdoor play systems by applying
computer aided design technologies to modular components. The Company
subcontracts the plastic molding, fabrication and plastisol coating of deck
platforms and aluminum casting to outside subcontractors. The Company owns all
of the significant molds and tooling for these functions.  The Company
fabricates the majority of the steel playground parts and assembles its modular
play equipment at its plant located in Coral Springs, Florida. The Company
believes there are alternative sources of supply for the manufacture of the
modular play equipment components.


Competition

  Family Convenience Products. The Company's family convenience products are
marketed to commercial customers and not to consumers. Presently, the commercial
products division of Rubbermaid Incorporated and a number of other companies
sell family convenience products to the commercial markets. Management believes
that such competition has not had a material impact on the Company. The Company
is not aware of any companies marketing diaper changing stations intended for
the commercial market that have a greater market share than the Company. The
Company believes that there is an under-served market for family convenience
products. Koala believes that it is the only company focused on marketing a wide
variety of family convenience products to the commercial market. The Company
believes that its Koala Bear Kare products have brand name recognition that
provides the Company with a significant competitive advantage. The Company
competes principally on the basis of brand name recognition, quality, customer
service and price.

  Children's Activity Products. Competition in the children's activity product
area is mainly from small businesses that make similar products and from efforts
by individual businesses to create their own activity areas. The Company
competes in this market through its ability to offer custom designed products to
its customers under its Koala Kare Systems program and on the basis of product
quality and service.

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  Children's Modular Play Equipment. Competition in children's indoor modular
play equipment is primarily from Little Tikes Commercial Play Systems, Inc.
("Little Tikes"), a unit of Rubbermaid Incorporated, Miracle Recreation
Equipment Company and a number of other companies. The Company competes in the
children's indoor modular play market on the basis of quality, safety, service
and its ability to provide a custom themed unit designed to meet the unique
needs of the customer. Competition in children's outdoor modular play equipment
is primarily from Game Time, Inc., a subsidiary of PlayCore, Inc., Miracle
Recreation Equipment Company, Landscape Structures, Inc. and Little Tikes. The
Company believes that Park Structures competes on the basis of design, quality,
safety, price and customer service.

Product Warranties and Insurance

  For its family convenience and children's activity products, the Company
provides a replacement guarantee for one year from purchase protecting against
damage from natural disasters or vandalism, subject to a $100 deductible. The
Company also provides a five year limited warranty on parts and labor covering
any defects in workmanship. For its children's modular play equipment, the
Company provides warranties ranging from a one year limited warranty on parts
and labor covering defects in workmanship to a lifetime warranty on certain
metallic parts. The Company has experienced minimal returns and warranty claims.
The Company carries product liability insurance in an amount that the Company
deems adequate. Product liability claims against the Company and Park Structures
to date have been immaterial.

Patents and Trademarks

  The Company has registered various trademarks, including the "Koala Bear
Kare" name and several variations of the Koala Bear Kare logo that is featured
on the Company's products. The Company believes that the various Koala Bear Kare
trademarks are widely recognized and important to the Company. Each of the
Company's products marketed under this trademark prominently displays a blue and
white sticker with one of the Company's trademarks. The Company has also
registered the trademark "Booster Buddy" and the registration of the
trademarks "Delta Play" and "Happy Faces in Public Places" currently are
being sought. Park Structures does not have registered trademarks but believes
that it has proprietary rights to its play equipment designs.

  The Company holds design patents for certain of its products. These patents
prevent competitors from duplicating the design elements of the Company's
products, but the Company does not believe that such patents provide significant
barriers to entry.

Regulation

  Certain of the Company's products are subject to the provisions of, among
other laws, the Federal Consumer Product Safety Act and the Federal Hazardous
Substances Act (the "Acts"), which empower the Consumer Product Safety
Commission (the "CPSC") to require the repair, replacement or refund of the
purchase price of products that present a substantial risk of injury to the
public, and in the event the CPSC finds that no feasible consumer product safety
standard under the Acts would adequately protect the public, to order such
product banned. The CPSC may also issue civil and criminal penalties for knowing
violations of the Acts. Any such determination by the CPSC is subject to court
review. Similar laws exist in some states and cities in the United States and in
many jurisdictions throughout the world.

  The Company's indoor modular play equipment and the outdoor modular play
equipment of Park Structures are designed and inspected to meet the safety
guidelines of the CPSC and the American Society for Testing and Materials
("ASTM") for commercial playground systems. The Company conducts in-house
testing and inspection to ensure that they comply with the CPSC and ASTM
guidelines. Park Structures is a member of the International Play Equipment
Manufacturers Association ("IPEMA"), a member driven international trade
organization that represents and promotes an open market for manufacturers of
playground equipment.

  The Company's operations in the United States do not involve manufacturing or
other activities that would subject it to laws and regulations concerning
environmental issues. The Company's assembly plant in Vancouver, British
Columbia performs light fabrication activities utilizing paint, metal and
fiberglass. The Company has obtained the necessary permits to conduct these
activities, and the Company believes that they have been conducted in compliance
with Canadian environmental laws and regulations. Park Structures engages in
manufacturing and assembly operations at its leased facility in Florida. The
Company believes that the Park Structures operations are conducted in compliance
with federal and state environmental laws and regulations.

Employees

  The Company had approximately 150 full-time employees at December 31, 1998,
with 90 located in the United States and 60 located in Canada. The Company's
United States employees are not covered by any collective bargaining agreements.
In August 1998, the Company's Canadian employees held an election regarding
potential representation by the International Wood and Allied Workers of Canada
("IWA"). The election resulted in a sufficient vote to certify the union. The
Company has begun the collective bargaining process with the IWA. Management
believes that relations with its employees are good.

                                       7
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Foreign Operations

    The Company acquired the assets of Delta, a Canadian based provider of
modular play equipment, in June 1997.  The Company created a foreign subsidiary
to own and operate this business.   The subsidiary's sales, marketing,
administrative, manufacturing and distribution functions are decentralized.  The
President of Delta reports to the Chief Executive Officer of the Company.
Strategic planning, market development and resource allocation are the
responsibility of the President in conjunction with the Company's Chief
Executive Officer.  The Company believes that there is no greater known
significant risk attendant to the business conducted by the foreign subsidiary
than to that of the Company's domestic operations.


                                  RISK FACTORS

  In addition to the other information contained in this Form 10-KSB, the
following risk factors should be considered carefully in evaluating the Company
and its business before purchasing shares of Common Stock offered hereby. This
Form 10-KSB contains certain forward-looking statements that involve substantial
risks and uncertainties. When used in this Form 10-KSB, the words "may,"
"will," "expect," "anticipate," "continue," "estimate," "project,"
"intend," "believe" and similar expressions are intended to identify
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 (the "Securities Act") and Section 21E of the Securities Exchange
Act of 1934 (the "Exchange Act") regarding events, conditions and financial
trends that may affect the Company's future plan of operations, business
strategy, operating results and financial position.

Ability to Integrate and Manage Park Structures

  The Park Structures acquisition, which has expanded the Company's modular play
equipment product line, is the Company's largest acquisition to date. The
Company's ability to realize any long-term advantages from the Park Structures
acquisition will depend in large part on the Company's successful integration
and management of the operations of Park Structures. Risks relating to such
integration include increased seasonality associated with products sold by Park
Structures and the risk of loss of services of management or other employees of
Park Structures or significant dealers who sell the Park Structures products.
There can be no assurance that the Company will be able to successfully
integrate Park Structures, the failure of which could have a material adverse
effect on the Company's business, financial condition and results of operations.

Management of Growth

  The Company has recently experienced significant growth both internally and as
a result of acquisitions. A continuing period of significant growth could place
a strain on the Company's management, operations and other resources. The
Company's ability to manage its growth will require it to continue to invest in
its operational, financial and information systems and to attract, retain,
motivate and effectively manage its employees. The inability of the Company's
management to manage growth effectively could have a material adverse effect on
the Company's business, financial condition and results of operations. See
"Business."

Risks Associated with Acquisition Strategy

  A part of the Company's business strategy is to acquire other companies,
assets or product lines that complement or expand its existing business.
Acquisitions involve a number of risks that could materially affect the Company,
including the diversion of management's attention, the assimilation of the
operations and personnel of the acquired companies, the amortization of acquired
intangible assets and the potential loss of key personnel of the acquired
companies. Future acquisitions may entail the payment of consideration in excess
of book value, may result in the issuance of additional shares of the Company's
Common Stock or the incurrence of additional indebtedness, all of which could
have a dilutive effect on the Company's net income per share. In addition,
products offered by the Company following a future acquisition may have lower
gross profit margins than the Company's current product lines. There can be no
assurance that any acquisition by the Company will not have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company currently has no agreements or understandings with respect to any
potential acquisitions. See "Business--Business Strategy."

Limited Diversification; Uncertainty of Acceptance of New Products

  A substantial amount of the Company's sales since inception have been derived
from marketing the Koala Bear Kare Baby Changing Station. Although the Company
has diversified through the addition of other family convenience products,
children's activity products and children's modular play equipment and plans to
introduce additional products, the Baby Changing Station will continue to be an
important component of the Company's sales. Until the Company further
diversifies its business and products, changes in competition and other factors
affecting the market for the Baby Changing Station could have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, the possibility exists that any new products introduced by the
Company in the future will not be accepted in the marketplace. If this happens,
the Company's reputation may suffer, and the Company may incur substantial
losses due to production, marketing and other costs. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business--History" and "--Products."

                                       8
<PAGE>
 
Product Liability Risks

  The Company's products are designed for use with infants and children. The
children's modular play equipment industry, which the Company has recently
entered, may be subject to greater number of claims than the convenience
products industry. The Company carries product liability insurance in an amount
that management deems adequate to cover risks associated with its products.
There can be no assurance, however, that existing or future insurance coverage
will be sufficient to cover all product liability risks or that such insurance
will be available at favorable rates. Defending a product liability claim could
significantly divert management's attention. A partially or completely uninsured
claim against the Company, if successful, could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Business--Product Warranties and Insurance."

Competition

  The markets for the Company's products are highly competitive and include
numerous domestic and foreign competitors, including well-known manufacturers of
consumer and commercial child safety equipment, furniture and other juvenile
products that are substantially larger and have greater financial, marketing and
other resources than the Company. There can be no assurance there will not be
new entrants into the Company's markets or that the Company will be able to
compete successfully in the future. See "Business--Competition."

Dependence Upon Key Personnel

  The Company's future success will depend to a great extent upon the continued
service of certain senior management personnel and the Company's continuing
ability to attract, assimilate and retain highly qualified personnel.
Competition for such personnel is intense, and there can be no assurance that
the Company can retain its key personnel or that it can attract, assimilate and
retain such employees in the future. Although the Company has non-disclosure and
non-compete agreements with many of its employees, including its executive
officers, it does not have employment agreements with any of its executive
officers. The Company maintains a key-person life insurance policy in the amount
of $1 million on Mark A. Betker, its Chairman, Chief Executive Officer and
President. The loss of the services of Mr. Betker or other key personnel or the
inability to hire or retain qualified personnel in the future could have a
material adverse effect upon the Company's business, financial condition and
results of operations. See "Management."

Dependence Upon Outside Manufacturers

  A large number of the components for the Company's products are manufactured
to the Company's specifications by outside suppliers. The Company's ability to
assemble and distribute its products depends upon its ability to obtain an
adequate uninterrupted supply of component parts. Although the Company owns the
significant tooling and molds used in the manufacture of the Company's products,
it does not have any long term agreements or contracts with its suppliers, most
of which are the single source of supply to the Company. While the Company
believes that adequate alternative sources of supply of such component parts
could be located, there can be no assurance that any interruption in the supply
of such component parts to the Company because of the failure of a supplier, a
change to a new supplier or otherwise would not have a material adverse effect
on the Company's business, financial condition or results of operations.
Moreover, if the Company's tooling or molds are damaged, the Company could
suffer additional delays and costs until such tooling or molds are repaired or
replaced. Although the Company has business interruption insurance to protect
itself against such interruptions, such insurance may not prevent such
interruptions from having a material adverse effect upon the Company's business,
financial condition and results of operations. See "Business--Design and
Manufacturing."

Risks Associated with International Operations

  As part of its growth strategy, the Company is seeking opportunities to
further expand its products and systems distribution into international markets.
Sales to customers outside of North America accounted for approximately 18% of
the Company's sales in 1997 and 1998. In addition, the Company operates a
manufacturing and assembly facility in Vancouver, British Columbia, Canada. The
Company's international operations are subject to a wide range of general
business risks, including: fluctuations in currency exchange rates; unexpected
changes in legal and regulatory requirements; export restrictions, tariffs and
other trade barriers; political and economic instability; restrictions on
repatriation of funds or profits from foreign markets; longer payment cycles and
problems in collecting accounts receivable; difficulty in protecting the
Company's intellectual property; potentially adverse tax consequences, including
limitations on the Company's ability to claim a foreign tax credit against its
U.S. federal income taxes; and regulation by foreign regulatory authorities.
These and other factors associated with international operations may have a
material adverse effect on the Company's business, financial condition and
results of operations.

  The Company is subject to the Foreign Corrupt Practices Act ("FCPA"), which
generally prohibits U.S. companies and their intermediaries from bribing foreign
officials for the purpose of obtaining or keeping business. The Company may be
exposed to liability under the FCPA as a result of past or future actions taken
without the Company's knowledge by dealers and other intermediaries. Any
liability the Company incurs under the FCPA could be material.

                                       9
<PAGE>
 
Government Regulations

  Certain of the Company's products are subject to the provisions of the Federal
Consumer Product Safety Act and the Federal Hazardous Substances Act (the
"Acts") and the regulations promulgated thereunder. The Acts authorize the
Consumer Product Safety Commission (the "CPSC") to protect the public from
products that present a substantial risk of injury. The CPSC can require the
repurchase or recall by the manufacturer of articles which are found to be
defective and impose fines or penalties on the manufacturer. Similar laws exist
in some states and cities and in other countries in which the Company markets
its products. Any recall of its products could have a material adverse effect on
the Company. To date, the Company has not recalled any of its products. See
"Business--Regulation."

Trademarks; Lack of Patent Protection

  The Company owns several trademarks, including the Koala Bear Kare logo, to
identify the Company and its products and believes that such trademarks provide
a significant competitive advantage. Although the Company intends to vigorously
defend its trademarks, no assurance can be given either that such trademarks can
be defended or that such trademarks will not become commonly used. Further,
although the Company has design patents that cover the design and appearance of
certain of its existing products, such patents may not provide meaningful
protection against entry by competitors into the Company's markets. See
"Business--Patents and Trademarks."

Variability of Quarterly Operating Results

  The Company's sales and earnings may fluctuate from quarter to quarter based
on several factors such as the number of new commercial construction starts,
production delays, public budget processes, supply costs and general economic
conditions. Demand for the Company's products can vary significantly from
quarter to quarter due to revisions in customer budgets or schedules and other
factors beyond the Company's control. Due to all of the foregoing factors, it is
possible that in some future period, the Company's results of operations could
fall below the expectations of securities analysts and investors. In this event,
the market price of the Common Stock could be materially adversely affected.

Year 2000 Compliance

  Many currently installed computer systems and software products are coded to
accept only two-digit entries to represent years. For example, the year "1998"
would be represented by "98." These systems and products will need to be able
to accept four digit entries to distinguish years beginning with 2000 from prior
years. As a result, systems and products that do not accept four digit year
entries will need to be upgraded or replaced to comply with such "Year 2000"
requirements. The Company believes that its computer systems are Year 2000
compliant. There can be no assurance that the computer systems of vendors,
customers or other entities on which the Company relies will be Year 2000
compliant. There can be no assurance that unanticipated or undiscovered Year
2000 compliance problems will not have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."


ITEM 2.  DESCRIPTION OF PROPERTIES

  The Company leases approximately 900 square feet of office space in Denver,
Colorado for its corporate office, 5,000 square feet for its direct sales
operation and 15,000 square feet of office and warehouse space in Denver,
Colorado for sales, receiving and shipping operations. These leases expire in
2001. The Company leases a 67,000 square foot plant near Vancouver, British
Columbia, where it conducts its indoor modular play equipment manufacturing and
assembly operations. This lease expires in 2003. In addition, the Company leases
a 90,000 square foot facility in Coral Springs, Florida for the manufacturing
and assembly operations of its outdoor modular play equipment.  This lease
expires in 2002, with two options to renew the lease for additional five year
terms. The Company believes that its current facilities are adequate for its
existing needs.


ITEM 3.  LEGAL PROCEEDINGS

  The Company and Park Structures are and have been a party to litigation in the
ordinary course of their businesses. The Company does not believe that any
current litigation will have a material adverse effect upon its business,
financial condition or results of operations.

                                       10
<PAGE>
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

   There were no matters which were submitted to a vote of security holders
during the fourth quarter of the fiscal year ended December 31, 1998.

                                    PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS


The Common Stock of the Company trades on the Nasdaq National Market under the
symbol KARE. The following table sets forth, for the periods indicated, the high
and low sales prices for the Company's Common Stock for each quarter within the
last two fiscal years as reported by Nasdaq. These quotations reflect inter-
dealer prices, without retail markup, markdown or commissions and may not
represent actual transactions.
<TABLE>
<CAPTION>
 
                                                      SALES PRICE
                                                      -----------
                                                  LOW            HIGH
                                                  ---            ----
YEAR ENDED DECEMBER 31, 1997                                    
                                                       
<S>                                            <C>             <C>
First quarter..................                $10 3/4         $14 3/8
                                                       
Second quarter.................                $ 9 7/8         $16 3/8
                                                       
Third quarter..................                $14 5/8         $17 1/4
                                                       
Fourth quarter.................                $14 1/8         $18 1/4
 
 
YEAR ENDED DECEMBER 31, 1998
 
First quarter..................                $14             $18 3/4
                                                       
Second quarter.................                $15 3/4         $20 1/8
                                                             
Third quarter..................                $12 7/8         $16 7/8
                                                             
Fourth quarter.................                $10             $18 1/2
</TABLE>                        
                                  
    As of February 5, 1999, there were approximately 99 shareholders of record.

    The Company has never paid cash dividends on its Common Stock. The Company's
credit agreement contains a restrictive covenant that prohibits the payment of
dividends without the lender's consent.  The Company currently intends to retain
any earnings for use in its operations and does not anticipate payment of cash
dividends in the foreseeable future.

Recent Sales of Unregistered Securities

    Effective June 1, 1997,  the Company acquired the assets of Delta in
consideration for the payment of $4,180,609 in cash and the issuance of 40,000
shares of its Common Stock.  The Common Stock was issued to one sophisticated
purchaser in reliance upon the exemption provided by Section 4(2) of the
Securities Act of 1933.

                                       11
<PAGE>
 
ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

  With the exception of historical matters, the matters discussed herein are
forward-looking statements that involve risks and uncertainties. Forward-looking
statements include, but are not limited to, statements concerning anticipated
trends in sales and net income, the mix of the Company's sales, projections
concerning operations and available cash flow. The Company's actual results
could differ materially from the results discussed in such forward-looking
statements. Factors that could cause or contribute to such differences include
those discussed below, as well as those discussed in "Risk Factors" and
elsewhere in this Form 10-KSB.


Koala Overview

  Koala Corporation is a leading designer, producer and worldwide marketer of
innovative commercial products, systems and custom solutions that create
attractive family-friendly environments for businesses and other public venues.
The Company produces family convenience products, such as baby changing stations
and high chairs; children's activity products, such as activity tables and
activity carpets; and children's modular play equipment. The Company intends to
capitalize on brand name recognition established through its market-leading
Koala Bear Kare Baby Changing Station, which has been installed in approximately
300,000 public restrooms worldwide. The Company's sales have grown from $3.8
million in 1993 to $19.1 million in 1998.  Sales for the year ended December 31,
1998 represented a 40.2% increase from the same period in 1997. Net income has
grown from $1.0 million in 1993 to $3.1 million in 1998.  Net income for the
year ended December 31, 1998 represented a 27.2% increase from the same period
in 1997.

  The Company markets its products, systems and custom solutions to a wide range
of businesses and public facilities that serve customers and visitors who bring
children to their establishments. Koala markets its products through an
integrated program of direct sales and distribution through a network of
independent manufacturer's sales representatives and dealers. Since 1995, the
Company has increased its sales and marketing efforts through the addition of
manufacturer's sales representatives, dealers and Company sales representatives.

  The Company's sales have been derived primarily from the sale of its family
convenience products, which include Baby Changing Stations, disposable sanitary
liners for the Baby Changing Stations, Child Protection Seats, Infant Seat
Kradles and Booster Buddy seats. One of the Company's strategies has been to
reduce its dependence on Baby Changing Stations through the acquisition and
development of complementary products. In furtherance of this strategy, the
Company acquired certain assets of a manufacturer of commercial-use children's
activities products in March 1996 and the assets of Delta Play, Ltd., a provider
of custom children's indoor modular play equipment in June 1997. In December
1998, the Company further diversified its product offerings through the
acquisition of the assets of Park Structures, a producer of children's outdoor
modular play equipment. As a result of these acquisitions and introduction of
new products such as the Koala Highchair in 1997, sales of Baby Changing
Stations represented less than half of the Company's sales in 1998.

  The Company's gross profit margins are affected by product mix, with the Baby
Changing Station and other family convenience products and the children's
activity products typically providing higher gross profit margins than the
children's modular play equipment. The children's modular play equipment,
however, has higher average selling prices and contributes to the Company's
sales growth. In addition, sales made through dealers provide lower gross profit
margins than direct sales due to the expense associated with the manufacturer's
sales representatives and dealers. To the extent the Company acquires additional
companies or product lines, its gross profit margins may be lower than those
currently achieved from sales of the Company's current product lines due to a
number of factors that may include products with higher average selling prices
but lower gross margin percentages. Although new product introductions or
acquisitions may decrease the overall gross profit margins, the Company believes
that the addition of new products will provide opportunities for revenue
diversification and increased profitability, while also reducing the Company's
reliance on the Baby Changing Station.


Components of Sales and Expense

  The Company recognizes sales at the time its products are shipped. Cost of
sales consists of components manufactured for the Company and direct labor and
manufacturing overhead incurred by the Company. All major components for the
family convenience products and children's activity products currently are
manufactured and assembled by outside vendors. Direct labor and manufacturing
overhead relate to the assembly of the products. Prior to September 1996, the
Company performed the assembly operations for the Baby Changing Stations, Child
Protection Seats and Infant Seat Kradles.

  Selling, general and administrative expense consists primarily of commissions
paid to manufacturer's sales representatives and other miscellaneous selling
expenses, executive, sales and office salaries, related payroll taxes and
advertising expenses.

  The Company provides limited warranties for its products. The Company has
experienced minimal returns and warranty claims, and therefore no accrual has
been made for future claims.

                                       12
<PAGE>
 
Results of Operations

  The following table sets forth certain income statement data stated as a
percentage of sales:
<TABLE>
<CAPTION>
 
                                                                Years Ended December 31,
                                                                ------------------------
 
                                                                     1998        1997   
                                                                    ------      ------   
                                                                                        
<S>                                                              <C>          <C>       
Sales..........................................                      100.0%      100.0%  
                                                                                         
Cost of sales..................................                       45.2        40.6   
                                                                     -----       -----   
Gross profit...................................                       54.8        59.4   
                                                                                         
Selling, general and administrative expenses...                       28.7        31.0   
                                                                                        
Amortization of intangibles....................                        1.6         1.5   
                                                                     -----       -----   
Operating income...............................                       24.5        26.9   
                                                                                        
Other (income) expense.........................                       (0.4)       (0.8)  
                                                                     -----       -----   
Income before provision for income taxes                              24.9        27.7   
                                                                                        
Provision for income taxes.....................                        8.7         9.8   
                                                                     -----       -----   
                                                                                        
Net income.....................................                       16.2%       17.9%  
                                                                     =====       =====   
</TABLE>
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

    Sales increased 40.2%, or $5.5 million, to $19.1 million for the year ended
December 31, 1998 compared to $13.6 million for the year ended December 31,
1997. A majority of the increase resulted from sales of children's indoor
modular play equipment, a product line acquired effective June 1, 1997. The
sales and marketing programs that the Company implemented for the family
convenience and children's activity product lines also contributed to the
increased sales.

  Gross profit increased 29.4%, or $2.4 million, to $10.5 million for the year
ended December 31, 1998 compared to $8.1 million for the year ended December 31,
1997. As a percentage of sales, gross profit decreased in the 1998 period
compared to the 1997 period primarily because of a change in product mix that
included sales of children's modular play equipment along with a higher
proportion of sales of family convenience and children's activity products
through dealer channels, where lower gross profit margins are realized.

  Selling, general and administrative expense increased 29.6%, or $1.3 million
to $5.5 million for the year ended December 31, 1998 compared to $4.2 million
for the year ended December 31, 1997. Sales and marketing expense increased
42.1%, or $1.1 million to $3.6 million for the year ended December 31, 1998
compared to $2.5 million for the year ended December 31, 1997. These cost
increases were due to the inclusion of the children's indoor modular play
equipment line and higher expenses for various marketing programs, commissions
paid to manufacturer's sales representatives and salaries of sales and marketing
personnel added subsequent to the 1997 period, all of which were associated with
higher levels of sales. General and administrative expense increased 11.6%, or
$200,470, to $1.9 million for the year ended December 31, 1998 compared to $1.7
million for the year ended December 31, 1997. The increase was primarily the
result of the inclusion of the children's indoor modular play equipment line.

  The Company's effective tax rate was 35.0% and 35.5% for the year ended
December 31, 1998 and 1997, respectively. The decrease in the Company's
worldwide effective rate was primarily due to the benefit provided by the
foreign sales corporation that the Company established in February 1998.

  Net income increased 27.2%, or $663,000, to $3.1 million for the year ended
December 31, 1998 compared to $2.4 million for the year ended December 31, 1997.
As a percentage of sales, net income declined during the 1998 period compared to
the 1997 period primarily due to the inclusion of the children's modular play
equipment line in the product mix. Net income per share (diluted) increased
24.0%, or $.23, to $1.19 for the year ended December 31, 1998 compared to $.96
for the year ended December 31, 1997. The percentage increase in net income per
share (diluted) was lower than the percentage increase in net income as a result
of an increase of 50,857 shares in the weighted average number of shares
outstanding.

                                       13
<PAGE>
 
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996

  Sales increased 52.4%, or $4.7 million, to $13.6 million in 1997 compared to
$8.9 million in 1996, primarily as a result of seven months of operations from
the children's indoor modular play equipment line and continued strong demand
for the Company's other products. The sales and marketing strategy implemented
by the Company for its other product lines contributed to the additional sales
revenue for 1997 and also provided diversification of the Company's product
line. The Company continued to increase sales and marketing efforts through
focused marketing programs and the addition of sales personnel during 1997.

  Gross profit increased 42.1%, or $2.4 million, to $8.1 million in 1997
compared to $5.7 million for 1996. As a percentage of sales, gross profit
decreased in 1997 compared to 1996 primarily because of the change in product
mix with the addition of the children's indoor modular play equipment line along
with increased sales of products to dealers at lower margins. These gross margin
reductions were offset somewhat by lower costs of raw materials and component
parts and the change to subcontracted assembly in September 1996.

  Selling, general and administrative expenses for 1997 increased 46.3%, or $1.3
million, to $4.2 million in 1997 compared to $2.9 million for 1996. Sales and
marketing expense increased 76.4%, or $1.1 million, to $2.5 million in 1997
compared to $1.4 million in 1996. These increases were due to the inclusion of
the children's indoor modular play equipment line and the higher level of sales
achieved, and included costs for various marketing programs, commissions paid to
manufacturer's sales representatives and salaries of the sales and marketing
personnel added during 1997. General and administrative expense increased 17.3%,
or $254,000, to $1.7 million in 1997 compared to $1.5 million in 1996. The
relatively small increase in general and administrative expense compared to the
sales increase was primarily the result of cost reductions obtained by more
efficient management of administrative functions. These cost reductions offset
the cost increases resulting from the inclusion of general and administrative
expense associated with the children's indoor modular play equipment line for
seven months of 1997. The Company also incurred approximately $100,000 in non-
recurring personnel recruiting and employee relocation costs in 1996.

  The Company's effective tax rates were 35.5% in 1997 compared to 25.4% in
1996. The Company realized a tax benefit in 1996 from the tax deduction
generated by the exercise of non-qualified stock options by a former officer of
the Company.

  Net income increased 28.5%, or $540,000, to $2.4 million in 1997 compared to
$1.9 million in 1996. As a percentage of sales, net income decreased in 1997
compared to 1996 primarily due to the inclusion of children's indoor modular
play equipment in the product mix. Net income per share (diluted) for 1997
increased 28.0%, or $.21, to $.96 per share in 1997 compared to $.75 per share
in 1996. The percentage increase in net income per share was slightly lower than
the percentage increase in net income as a result of an increase of 24,883
shares in the weighted average number of shares outstanding.

Liquidity and Capital Resources

  The Company has historically financed its business activities primarily from
cash provided by operating activities. Cash provided by operating activities for
1997 and 1998 was $3.5 million and $1.7 million, respectively.  The decrease in
cash provided by operating activities for the year ended December 31, 1998
compared to the year ended December 31, 1997 resulted primarily from funding the
higher levels of working capital required to support the growth of the current
businesses and support the expansion of newly acquired businesses.
Specifically, the decrease resulted primarily from funding the combination of an
increase in accounts receivable due to the growth of the Company's sales, an
increase in inventories of raw materials and finished goods during the year
ended December 31, 1998, a decrease in accounts payable and increases in prepaid
expenses during the 1998 period and the receipt of a tax refund of $338,000 in
March 1997.

  Working capital as of December 31, 1998 and December 31, 1997 was $8.7 million
and $3.9 million, respectively, and cash balances were $6.5 million and $1.8
million, respectively, at the same dates.

  The Company has used its operating cash flow primarily to expand sales and
marketing activities, for acquisition and development of new products, for
capital expenditures and for working capital. Net cash used by investing
activities was $5.2 million in 1997, and $1.4 million for the year ended
December 31, 1998.  In 1997, $4.6 million was used to purchase the assets of
Delta Play, Ltd., with the balance primarily devoted to capital expenditures.
This is the principal reason for the decrease in working capital and cash
balances at December 31, 1997. Net cash used in the year ended December 31, 1998
relate to capital expenditures for leasehold improvements related to a new
facility in British Columbia, tooling, computer hardware, computer software,
patents and intangibles. The Company also paid $610,160 of additional
consideration under the earn-out provisions of the Delta Play, Ltd. purchase
agreement in August 1998.

  The Company obtained a $2.0 million unsecured line of credit from a bank in
June 1997. The Company borrowed $500,000 on the line to fund operations after
the acquisition of the children's modular play equipment line in July 1997 and
repaid the loan from subsequent cash flow in the same month. The interest rate
on amounts borrowed under the line of credit ranges from LIBOR plus 2.25% to
LIBOR plus 2.75%. There were no amounts outstanding under the credit facility as
of December 31, 1998.

                                       14
<PAGE>
 
  This line of credit was replaced by a new $15.0 million secured credit
facility entered into in connection with the Park Structures acquisition on
December 16, 1998. Management expects to use the credit facility periodically
for short-term working capital needs and for short-term financing of future
acquisitions.

  The Company funded the initial $13.5 million cash portion of the purchase
price for the Park Structures acquisition through a combination of the net
proceeds from the secondary public offering in December 1998 (approximately $4.8
million after deducting underwriting fees), existing cash balances and a portion
of the $15.0 million revolving credit facility from a bank. The credit facility
has a term of three years. Loans under the facility are secured by all of the
assets of the Company. The interest rate on amounts borrowed under the line of
credit range from LIBOR plus 2.15% to LIBOR plus 2.60%. The seller is also
entitled to receive up to an additional $4.0 million in cash (and $1.5 million
in Common Stock) if certain earnings targets are met.  The Company currently
expects that all of such additional consideration will become payable. Any such
payments will be funded primarily from short-term borrowings under the new
credit facility. The Company believes that the working capital provided by the
secondary public offering and cash flow from operations will be sufficient to
fund its operations for the foreseeable future.

Year 2000

  Historically, certain computerized systems have used two digits rather than
four to identify the year. Computer equipment and software, as well as devices
with imbedded technology, that are depended on time or date information may
recognize a date using "00" as the year 1900 rather than the year 2000,
possibly resulting in range of problems, from simple miscalculations to total
system failures. This problem is generally referred to as the "Year 2000"
issue.

  The Company has assessed its exposure to risks associated with the Year 2000
issue in terms of "internal" issues (systems and equipment which the Company
owns or controls), and "external" issues (systems and equipment of third
parties with whom the Company does business).

  Because the Park Structures acquisition was only recently completed on
December 16, 1998, the Company has not completed its evaluation of Park
Structures' Year 2000 issues. Park Structures has informed the Company that it
estimates that the cost to modify its computer systems to address Year 2000
issues will be less than $1,000 and that such remediation will be completed
prior to the Year 2000. Park Structures has informed the Company that it does
not anticipate any material disruption in its operations as a result of any Year
2000 issues. Park Structures does not have any information concerning the
potential impact of Year 2000 issues on any of its suppliers or customers.  The
Company plans to further evaluate the potential impact of Year 2000 issues on
Park Structures' suppliers and customers. The Year 2000 issue could have a
material adverse effect on Park Structures' operations and on the Company.

  The Company's other operations have only limited information technology
systems, consisting of separate local area networks at its headquarters and
Vancouver locations. These networks run accounting software at both locations
and design software at the Vancouver location. The Company has completed
assessment, remediation through the installation of Year 2000 compliant software
and independent testing of all application software and the operating systems at
both locations, and believes that its information technology systems are Year
2000 compliant. The cost to the Company to achieve this compliance was
approximately $40,000, which was used to purchase software and hardware and to
pay independent consultants. The Company funded these costs from available cash.
The Company believes such remediation is complete, and expects that no further
costs of remeditation will be required. Should such remediation prove
inadequate, the most likely worst case scenario would be a failure of the
Company's computer systems, which would likely cause significant delays in order
taking, receiving, order fulfillment and other core functions which would have a
material adverse affect on the Company. However, because the Company believes
its remediation of its computer systems will allow the Company to avoid the
risks associated with the Year 2000 issues, it has not developed a separate
contingency plan for a scenario in which the Company's remedial measures fail.
The Company does not believe that it has any systems or equipment other than its
information technology systems that would have a material adverse effect on the
Company if such systems were not Year 2000 compliant.

  The Company is also evaluating whether there may be third parties that could
materially adversely affect the Company through non-compliance with the Year
2000 issue. The Company has identified Park Structures, suppliers, customers,
its bank and national delivery services as the parties most likely to materially
adversely affect the Company through such non-compliance. The risks include the
failure of suppliers to timely deliver materials and finished products, the
failure of customers to remit payments timely, the failure of its bank to
process its funds or loss of data relating to the Company's funds and delays by
national delivery services in shipments of the Company's products. The most
likely worst case scenario for the Company would be a confluence of these events
coupled with other adverse effects on the economy generally that would impact
sales of the Company's products.  The Company has contacted its ten largest
suppliers and customers, its bank and national delivery services to ascertain
their Year 2000 readiness. To date, the Company has received responses from all
of the suppliers and customers, the bank and some of the national delivery
services. The respondents have indicated that they are at various stages of
assessment, remediation or testing of their systems relative to Year 2000
compliance. Based on the responses, the Company does not foresee significant
problems with the Year 2000 issue and has not developed a contingency plan to
deal with non-compliance issues. Nevertheless, the Company will continue to
monitor the responses from third parties as well as the Year 2000 issue in
general to ascertain whether additional actions or contingency plans may be
necessary. In addition, despite its efforts to address Year 2000 issues, the
Company could potentially experience disruptions to its 

                                       15
<PAGE>
 
operations, including those related to non-compliant systems used by third
parties. Such disruptions could have a material adverse effect on the Company.

New Accounting Standards

  The FASB issued SFAS No. 131, Disclosure about Segments of an Enterprise and
Related Information, on June 30, 1997. This statement establishes additional
standards for segment reporting in the financial statements and is effective for
the Company's fiscal year ended December 31, 1998. Management has complied with
the disclosure requirements of this statement.

   In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which is required to be adopted in years
beginning after June 15, 1998. Management does not anticipate that the adoption
of this statement will have a significant effect on earnings or the financial
position of the Company.


ITEM 7.  FINANCIAL STATEMENTS

   See Financial Statements beginning on page F-1.


ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

   The firm of Blanski Peter Kronlage & Zoch, P.C. acted as the Company's
independent auditors for the fiscal year ended December 31, 1996.  In April
1997, the Company's Board of Directors retained Ernst & Young LLP as the
Company's independent public accountants and replaced the Company's former
auditors, Blanski Peter Kronlage & Zoch, P.C.  There were no disagreements with
the former auditors on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure with respect to
the Company's financial statements for the fiscal year ended December 31, 1996
or up through the time of replacement which, if not resolved to the former
auditors' satisfaction, would have caused them to make reference to the subject
matter of the disagreement in connection with their report.  Prior to retaining
Ernst & Young LLP, the Company had not consulted with Ernst & Young LLP
regarding accounting principles.



                                    PART III


ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
         COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

   The information required by Item 9 is incorporated herein by reference to the
Company's proxy statement for its 1999 Annual Meeting of Shareholders, which
will be filed with Securities and Exchange Commission within 120 days of the
Company's fiscal year ended December 31, 1998.


ITEM 10. EXECUTIVE COMPENSATION

   The information required by Item 10 is incorporated herein by reference to
the Company's proxy statement for its 1999 Annual Meeting of Shareholders, which
will be filed with Securities and Exchange Commission within 120 days of the
Company's fiscal year ended December 31, 1998.


ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   The information required by Item 11 is incorporated herein by reference to
the Company's proxy statement for its 1999 Annual Meeting of Shareholders, which
will be filed with Securities and Exchange Commission within 120 days of the
Company's fiscal year ended December 31, 1998.

                                       16
<PAGE>
 
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

   The information required by Item 12 is incorporated herein by reference to
the Company's proxy statement for its 1999 Annual Meeting of Shareholders, which
will be filed with Securities and Exchange Commission within 120 days of the
Company's fiscal year ended December 31, 1998.


ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

<TABLE>
<CAPTION>
        
        Exhibit                                                     
          No.                                     Description 
         ----   -----------------------------------------------------------------------------------
    <S>         <C> 
          3.1   Articles of Incorporation of Koala Corporation (5)
          3.2   Bylaws of Koala Corporation (5)
          4.1   Specimen Common Stock Certificate (1)
         10.1   Incentive Stock Option Plan dated August 19, 1993 (1)
         10.2   Koala Corporation 1995 Stock Option Plan, as amended (5)
         10.3   Industrial Lease dated August 1, 1996 between Buckhead Industrial Properties, Inc. and Koala
                Corporation (2)
         10.4   Credit Agreement with U.S. Bank National Association (4)
         10.5   Agreement for Sale and Purchase of Assets dated June 23, 1997 between Delta Play, Ltd., et al and
                Koala Corporation (3)
         10.6   Registration Rights Agreement dated June 23, 1997 between Delta Play, Ltd., and Koala Corporation
                (4)
         10.7   Agreement for Sale and Purchase of Assets dated August 14, 1998 between Park Structures, Inc. et
                al and Koala Corporation (5)
         10.8   Indenture dated March 31, 1998 among Vanac Development Corp., Delta Play Company and Koala
                Corporation
         10.9   Form of Revolving Credit Agreement, dated December 16, 1998, between Koala Corporation
                and U.S. Bank National Association (5)
         21.1   Subsidiaries
         27.1   Financial Data Schedule
</TABLE>

___________

  (1) Incorporated by reference to the exhibits included in the Company's
      Registration Statement on Form SB-2, Registration No. 33-68482C.
  (2) Incorporated by reference to Exhibit 10.11 of the Company's Form 10-KSB
      for the year ended December 31, 1996.
  (3) Incorporated by reference to Exhibit 2.1 of the Company's Form 8-K/A filed
      on September 8, 1997.
  (4) Incorporated by reference to Exhibit 4.1 of the Company's Form 8-K/A filed
      on September 8, 1997.
  (5) Incorporated by reference to the exhibits included in the Company's
      Registration Statement on Form SB-2, Registration No. 333-61551.


(b)  Reports on Form 8-K

     On December 31, 1998, the Company filed a Form 8-K reporting Items 2,5 and
     7. Pro forma financial statements as of December 31, 1996 and 1997 and
     September 30, 1997 and 1998 and for the periods then ended were filed
     therein.

                                       17
<PAGE>
 
                                   SIGNATURES

In accordance with Section 13 of the Securities and Exchange Act of 1934, the
registrant caused this report on Form 10-KSB to be signed on its behalf by the
undersigned, thereunto duly authorized.

                                KOALA CORPORATION

Date:  February 19, 1999        By: /s/ Mark A. Betker
       -----------------        ----------------------

                                    Mark A. Betker, Chairman,
                                    Chief Executive Officer and President

Date:  February 19, 1999        By: /s/ Jeffrey L. Vigil
       -----------------            ---------------------

                                    Vice President of Finance and Administration
                                    (Principal Financial and Accounting Officer)



In accordance with the Exchange Act, this report on Form 10-KSB has been signed
below by the following persons on behalf of the Registrant and in the capacities
and on the dates indicated:

<TABLE> 
<CAPTION> 
     Signature                                   Title                                       Date
<S>                                 <C>                                                 <C> 
/s/ Mark A. Betker                  Chairman, Chief Executive Officer and               February 19, 1999 
-----------------------------       President (Principal Executive Officer)
Mark A. Betker                      and Director


/s/ Michael C. Franson              Director                                            February 19, 1999 
-----------------------------                                                           
Michael C. Franson


/s/ John T. Pfannenstein            Director                                            February 19, 1999 
-----------------------------                                                           
John T. Pfannenstein


/s/ Ellen Robinson
------------------------------      Director                                            February 19, 1999
Ellen Robinson
</TABLE> 

                                       18
<PAGE>
 
                               KOALA CORPORATION
                       CONSOLIDATED FINANCIAL STATEMENTS
                     YEARS ENDED DECEMBER 31, 1998 AND 1997

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
 
                                                                                              Page
                                                                                              ----
<S>                                                                                           <C>
                                                                        
          Independent Auditor's Report                                                        F-2
                                                                        
          Consolidated Balance Sheets                                                         F-3
                                                                        
          Consolidated Statements of Income                                                   F-4
                                                                        
          Consolidated Statements of Changes in Shareholders' Equity                          F-5
                                                                        
          Consolidated Statements of Cash Flows                                               F-6
                                                                        
          Notes to Consolidated Financial Statements                                          F-7
 
</TABLE>

                                      F-1
<PAGE>
 
SHAREHOLDERS AND
BOARD OF DIRECTORS
KOALA CORPORATION
DENVER, COLORADO

                        REPORT OF INDEPENDENT AUDITOR'S

We have audited the accompanying consolidated balance sheets of KOALA
CORPORATION (a Colorado corporation) as of December 31, 1998 and 1997, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of KOALA CORPORATION,
at December 31, 1998 and 1997, and the consolidated results of its operations
and its cash flows for the years then ended, in conformity with generally
accepted accounting principles.

                                                            ERNST & YOUNG LLP
Denver, Colorado

January 22, 1999

                                      F-2
<PAGE>
 
<TABLE>
<CAPTION>
KOALA CORPORATION
--------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
                                                                                December 31,                 December 31,
                                                                                    1998                        1997
                                                                             -----------------           -----------------
<S>                                                                           <C>                        <C> 
                              ASSETS
                              ------
Current Assets:
  Cash and cash equivalents                                                    $ 6,493,570                   $ 1,832,677
  Accounts receivable, trade ( less allowance for doubtful accounts            
     of $111,144 in 1998 and $45,703 in 1997)                                    5,781,256                     2,212,802
  Inventories                                                                    3,581,137                     1,103,355
  Prepaid expenses and other                                                       838,109                       504,957
                                                                               -----------                   -----------
Total current assets                                                            16,694,072                     5,653,791
                                                                               -----------                   -----------
Property and Equipment:                                                          2,991,182                     1,561,324
 Less accumulated depreciation                                                     559,068                       322,616
                                                                               -----------                   -----------
                                                                                 2,432,114                     1,238,708
                                                                               -----------                   -----------
Other Assets:
  Intangibles (net of accumulated amortization of $793,821
    in 1998 and $496,221 in 1997)                                               22,479,014                     8,064,301
                                                                               -----------                   -----------
                                                                                22,479,014                     8,064,301
                                                                               -----------                   -----------
                                                                               $41,605,200                   $14,956,800
                                                                               ===========                   ===========

                LIABILITIES & SHAREHOLDERS' EQUITY
                ----------------------------------
Current Liabilities:
  Accounts payable                                                             $ 1,721,886                   $ 1,312,518
  Accrued expenses and income taxes                                                375,219                       396,163
  Current portion of long-term debt (note 4)                                     5,865,043                             -
                                                                               -----------                   -----------
     Total current liabilities                                                   7,962,148                     1,708,681
                                                                               -----------                   -----------

Long Term Liabilities:
  Deferred income taxes                                                            645,000                       398,047
  Long-term debt, net of current portion (note 4)                               11,502,271                             -
                                                                               -----------                   -----------
     Total long-term liabilities                                                12,147,271                       398,047
                                                                              ------------                   -----------
                                                                              ------------                   -----------
Total Liabilities                                                               20,109,419                     2,106,728
                                                                              ------------                   -----------

Commitments and contingencies (note 7)

Shareholders' Equity:
  Preferred stock, no par value, 1,000,000 shares authorized;
     issued and outstanding - none                                                       -                             -
  Common stock, $.10 par value, 10,000,000 shared authorized;
     issued and outstanding - 2,847,362 in 1998 - 2,527,362 in 1997                284,736                       252,736
  Common stock to be issued, 77,118 shares (notes 2 and 6)                       1,297,903                             -
  Additional paid in capital                                                     9,620,174                     5,307,988
  Other comprehensive loss                                                        (121,160)                      (25,124)
  Retained earnings                                                             10,414,128                     7,314,472
                                                                               -----------                   -----------
Total shareholders' equity                                                      21,495,781                    12,850,072
                                                                               -----------                   -----------
                                                                               $41,605,200                   $14,956,800
                                                                               ===========                   ===========
</TABLE> 



                See notes to consolidated financial statements


                                      F-3
<PAGE>
 
<TABLE>
<CAPTION>

KOALA CORPORATION
------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME

                                                                                  Years ended December 31,
                                                                          1998                            1997
                                                                     --------------                  --------------
                                                                                               
<S>                                                                     <C>                            <C> 
Sales                                                                   $19,100,765                     $13,621,292
Cost of sales                                                             8,627,979                       5,528,542
                                                                        -----------                     -----------
Gross profit                                                             10,472,786                       8,092,750
                                                                                               
Selling, general and administrative expenses                              5,485,198                       4,230,988
Amortization of intangibles                                                 297,600                         200,861
                                                                        -----------                     -----------
Income from operations                                                    4,689,988                       3,660,901
                                                                        -----------                     -----------
Other (income) expense:                                                                        
  Interest income                                                           (78,712)                       (115,708)
                                                                        -----------                     -----------
Income before income taxes                                                4,768,700                       3,776,609
Provision for income taxes                                                1,669,044                       1,340,697
                                                                        -----------                     -----------
Net income                                                              $ 3,099,656                     $ 2,435,912
                                                                        ===========                     ===========
Net income per share - basic                                            $      1.22                     $      0.97
                                                                        ===========                     ===========
Weighted average shares outstanding - basic                               2,536,058                       2,503,654
                                                                        ===========                     ===========
Net income per share - diluted                                          $      1.19                     $      0.96
                                                                        ===========                     ===========
Weighted average shares outstanding - diluted                             2,599,005                       2,548,148
                                                                       ============                    ============
</TABLE> 



                See notes to consolidated financial statements


                                      F-4
<PAGE>
<TABLE>
<CAPTION>

KOALA CORPORATION
===================================================================================================================================
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY



                                                 Common Stock         Common    Additional                    Other
                                           -----------------------   Stock to    Paid-In      Retained    Comprehensive
                                              Shares      Amount     be Issued    Capital      Earnings        Loss        Total
                                           ----------   ----------  ----------  ----------    ----------  ------------  -----------

<S>                                        <C>          <C>         <C>         <C>          <C>           <C>          <C> 
Balance, December 31, 1996                  2,481,260     $248,126  $        0  $4,651,884   $ 4,878,560   $        0   $ 9,778,570
Net income                                                                                     2,435,912                  2,435,912
Foreign currency translation adjustment                                                                       (25,124)      (25,124)
                                                                                                                        -----------
Comprehensive income                                                                                                      2,410,788
Issuance of common stock for acquisition                                                                 
of Delta Play, Ltd.                            40,000        4,000                 596,000                                  600,000
Issuance of common stock for exercise           
of warrants                                     6,102          610                  60,104                                   60,714
                                           ----------   ----------  ----------  ----------   -----------   ----------   -----------
Balance, December 31, 1997                  2,527,362      252,736           0   5,307,988     7,314,472      (25,124)   12,850,072
                                           ----------   ----------  ----------  ----------   -----------   ----------   -----------
Net income                                                                                     3,099,656                  3,099,656
Foreign currency translation adjustment                                                                       (96,036)      (96,036)
                                                                                                                        -----------
Comprehensive income                                                                                                      3,003,620
Issuance of common stock for secondary        
offering, net of expenses                     320,000       32,000               4,312,186                                4,344,186
Common stock to be issued for                                                                            
acquisition of Park Structures                                       1,297,903                                            1,297,903
                                           ----------   ----------  ----------  ----------   -----------   ----------   -----------
Balance December 31, 1998                   2,847,362     $284,736  $1,297,903  $9,620,174   $10,414,128    ($121,160)  $21,495,781
                                           ==========   ==========  ==========  ==========   ===========   ==========   ===========
</TABLE>

                See notes to consolidated financial statements

                                      F-5

<PAGE>
 
<TABLE>
<CAPTION>

KOALA CORPORATION
--------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS

                                                                 Years ended December 31,
                                                                    1998           1997
                                                              --------------  --------------
<S>                                                          <C>                <C> 
Cash flows from operating activities:
  Net income                                                     $3,099,656      $2,435,912
  Adjustments to reconcile net income to
    net cash provided by operating activities:
      Depreciation                                                  238,269         163,133
      Amortization                                                  297,600         200,861
      Deferred income taxes                                         222,267         152,433

      (Increase) decrease in operating assets:
         Accounts receivable, trade                              (1,439,825)       (416,618)
         Refundable income taxes                                         -          263,677
         Inventory                                                 (910,071)       (106,791)
         Prepaid expenses                                          (250,959)       (313,293)

      Increase in operating liabilities:
         Accounts payable                                           342,466         818,509
         Accrued expenses and income taxes                           86,217         337,889
                                                               ------------    ------------
Net cash provided by operations                                   1,685,620       3,535,712
                                                               ------------   -------------

Cash flows from investing activities:
  Payments for capital expenditures                                (519,918)       (520,321)
  Purchase of Delta Play, Ltd., net of cash acquired               (610,260)     (4,634,802)
  Acquisition costs related to purchase of Park Structures         (131,367)             -
  Payments for patents and intangibles                              (89,869)        (21,730)
                                                               ------------    ------------
Net cash used by investing activities                            (1,351,414)     (5,176,853)
                                                               ------------    ------------

Cash flows from financing activities:
  Proceeds from the exercise of
   common stock warrants                                                 -           39,633
  Sale of common stock, net of expenses                           4,344,186              -
                                                               ------------    ------------
Net cash provided by financing activities                         4,344,186          39,633
                                                               ------------    ------------
Effect of exchange rate changes on cash and cash equivalents        (17,499)         (8,416)

Net increase (decrease) in cash and cash equivalents              4,660,893      (1,609,924)

Cash and cash equivalents at beginning of period                  1,832,677       3,442,601
                                                               ------------    ------------
Cash and cash equivalents at end of period                       $6,493,570      $1,832,677
                                                               ============    ============
</TABLE> 


                See notes to consolidated financial statements


                                      F-6

<PAGE>
 
                               KOALA CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                    YEARS ENDED DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------

1.   Summary of significant accounting policies:

     Nature of operations:

     Koala Corporation and its wholly owned subsidiaries (the "Company") is a
     leading designer, producer and worldwide marketer of innovative commercial
     products, systems and custom solutions that create attractive family-
     friendly environments for businesses and other public venues. The Company
     produces family convenience products, children's activity products and
     children's indoor and outdoor modular play equipment.


     Principles of consolidation:

     The consolidated financial statements include the accounts of Koala
     Corporation and all subsidiaries.  All significant inter-company accounts
     and transactions have been eliminated in consolidation.  The operations of
     Delta Play, Ltd. and Park Structures, Inc. are included in the accompanying
     financial statements from June 1, 1997 and December 16, 1998 respectively,
     the effective date of each acquisition (note 2).


     Use of estimates:

     Management uses estimates and assumptions in preparing financial statements
     in accordance with generally accepted accounting principles.  Those
     estimates and assumptions affect the reported amounts of assets and
     liabilities, the disclosure of contingent assets and liabilities, and the
     reported revenue and expenses.  Actual results could vary from the
     estimates that were used.


     Financial instruments:

     The fair value of financial instruments, consisting of investments in cash,
     cash equivalents, receivables, obligations under accounts payable, and debt
     instruments, is based on interest rates available to the Company and
     comparisons to quoted prices.  At December 31, 1998 and 1997, the fair
     value of these financial instruments approximates carrying value.

     Cash and cash equivalents include cash on hand, demand deposits, savings
     accounts, and short-term investments with original maturities of three
     months or less.  Cash and cash equivalents include financial instruments
     that potentially subject the Company to a concentration of credit risk.
     The Company places its cash and temporary cash investments with high credit
     quality institutions.  At times, cash held in the Company's primary bank
     may be in excess of the FDIC insurance limit.  Cash in money market mutual
     funds is not federally insured.  The Company performs periodic evaluations
     of the relative credit standing of these financial institutions.  As of
     December 31, 1998 and 1997, cash and cash equivalents consisted of the
     following:


<TABLE>
<CAPTION>
                                                        1998              1997
                                                        ----              ----
<S>                                                 <C>               <C>
Cash in primary banking institution                 $1,623,570        $  863,084
Cash in mutual funds and agencies                    4,870,000           969,593
                                                    ----------        ----------
                                                    $6,493,570        $1,832,677
                                                    ==========        ==========
</TABLE>

                                      F-7
<PAGE>
 
                               KOALA CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                    YEARS ENDED DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------

1.   Summary of significant accounting policies (continued):

     Inventories:

     Inventories are stated at the lower of cost (including manufacturing
     overhead applied to finished goods) or market (first-in, first-out).   As
     of December 31, 1998 and 1997, inventories consisted of the following:

<TABLE>
<CAPTION>
                                                         1998                  1997
                                                         ----                  ----
<S>                                                    <C>                    <C>
Raw materials                                          $2,832,314            $  605,066
Finished goods                                            748,823               498,289
                                                       ----------            ----------
                                                       $3,581,137            $1,103,355
                                                       ==========            ==========
</TABLE>

     Property and equipment:

     Property and equipment is stated at the lower of depreciated cost or net
     realizable value.  Depreciation and amortization is being provided on the
     straight-line method over the estimated useful life of the asset.  The
     following is a schedule of estimated useful lives of property and
     equipment:

          Furniture and fixtures                   7 years
          Tooling and molds                     6-10 years
          Shop and office equipment             3-10 years


     Intangibles:

     Acquisition intangibles represents trade names, trade marks, customer lists
     and patents from acquired companies and the excess of the cost of the
     companies acquired over the fair value of their net assets at the date of
     acquisition. The majority of acquisition intangible costs are being
     amortized using the straight-line method using estimated useful lives
     ranging from 5 to 30 years.  Acquisition intangible costs in the amount of
     $3,427,000, related to the Company's merger with JBJ Industries, Inc. in
     1993, is being amortized over 40 years.

     Costs of obtaining new patents and trademarks are capitalized and amortized
     on the straight line basis over 17 years for patents and 20 years for
     trademarks once approval is granted.  Costs are expensed if approval is
     denied.


     Revenue recognition:

     The Company recognizes revenues at the time its products are shipped.


     Research and development costs:

     Research and development costs are expensed when incurred.  The Company's
     research and development costs were not significant in 1998 or 1997.


     Advertising costs:

     Advertising costs are expensed when incurred.  Advertising expense for the
     periods ended December 31, 1998 and 1997 was $443,309 and $405,178,
     respectively.  Prepaid advertising costs at December 31, 1998 and 1997 was
     $227,332 and $35,724, respectively, and consist of costs of advertising
     which have not taken place.

                                      F-8
<PAGE>
 
                               KOALA CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                    YEARS ENDED DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------

1.   Summary of significant accounting policies (continued):

     Income taxes:

     The Company provides for deferred taxes on temporary differences arising
     from assets and liabilities whose bases are different for financial
     reporting and state, federal and foreign income tax purposes.  The
     differences relate primarily to depreciable and amortizable assets, certain
     accrued expenses and the allowance for uncollectible accounts.  For foreign
     corporate income taxes paid, the Company will utilize a foreign tax credit
     against the federal corporate income tax liability.


     Net income per share:

     The reconciliation of the weighted average shares outstanding for purposes
     of calculating basic earnings per share versus diluted earnings per share
     is as follows:
<TABLE>
<CAPTION>
 
                                     1998        1997
                                   ---------   ---------
<S>                                <C>         <C>
 Weighted average shares
outstanding for basic EPS          2,536,058   2,503,654
 
 Common stock equivalents for
unexercised stock options             62,947      44,494
                                   ---------   ---------
 
Weighted average shares
outstanding for diluted EPS        2,599,005   2,548,148
                                   =========   =========
</TABLE>

     The above reconciliation does not include 77,118 shares that will be issued
     on March 1, 1999 pursuant to the Park Structures acquisition (note 2).  The
     obligation to issue these shares was incurred on December 31, 1998 and,
     accordingly, its impact is immaterial for purposes of calculating basic and
     diluted earnings per share at December 31, 1998.


     Foreign currency translation:

     The financial statements of the Company's subsidiaries located outside the
     United States are measured using the local currency as the functional
     currency.  Assets and liabilities of these subsidiaries are translated at
     the rates of exchange at the balance sheet date.  The resultant translation
     adjustments are included in equity adjustment from translation, a separate
     component of shareholders' equity.  Income and expense items are translated
     at average rates of exchange.  Gains and losses on foreign currency
     transactions of these subsidiaries are included in net earnings.

2.   Acquisitions:

     Park Structures, Inc.:
     
     On December 16, 1998, the Company acquired substantially all of the assets
     of Park Structures, a provider of children's outdoor modular play systems
     based in Coral Springs, Florida.  The acquisition was effective December
     16, 1998 and was accounted for as a purchase.  Results of operations of
     Park Structures were included in the Company's consolidated statements of
     income beginning on the effective date.

     The initial consideration paid for Park Structures was $13,865,043, for
     which the Company issued a promissory note, net of a $400,000 holdback, for
     $13,465,043 (note 4).  Such promissory note was repaid on January 4, 1999
     using proceeds of the secondary public offering (note 5) and an advance on
     the line of credit (note 3).  In addition, preliminary

                                      F-9
<PAGE>
 
                               KOALA CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                    YEARS ENDED DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------

2.   Acquisitions (continued):

     acquisition costs of $131,479 were incurred and estimated asset adjustments
     of $1,088,518 were accrued.  The financial statements reflect a preliminary
     allocation of purchase price, to be finalized upon evaluation of certain
     intangibles acquired.  The initial consideration, acquisition costs and
     asset adjustments were allocated to tangible assets based on relative fair
     value, with the remaining balance allocated to trade names, trade marks and
     goodwill and recorded as intangible assets.

     The purchase agreement also provides for additional consideration in the
     form of cash and Company common stock if certain operating performance
     criteria were met by Park Structures for the year ending December 31, 1998
     and for the rolling twelve month period ending June 30, 1999.  For the
     December 31, 1998 earnout period, the additional consideration amounted to
     77,118 shares of common stock valued at $1,297,903 and cash of $2,703,829.
     For the June 30, 1999 earnout period, the maximum additional consideration
     is $1.0 million cash.  If minimum performance is not achieved, no
     additional consideration will be payable. The  additional consideration
     incurred for the 1998 earnout has been treated as goodwill and recorded to
     intangibles on the balance sheet.  Any additional consideration paid for
     the 1999 earnout will be treated as goodwill and recorded to intangibles on
     the balance sheet.

     The pro forma unaudited results of operations of the Company for the years
     ended December 31, 1998 and 1997 assuming consummation of the purchase of
     Park Structures as of January 1, 1998 and 1997 (excluding Delta pro forma
     for the five months prior to its purchase in June 1997) are as follows:

<TABLE>
<CAPTION>
                                                 Year ended               Year ended
                                             December 31, 1998         December 31, 1997
                                             --------------------------------------------
<S>                                               <C>                         <C>
          Sales                                   $29,048,996               $21,863,050
          Net income                              $ 3,942,491               $ 2,469,491
          Net income per share - diluted          $      1.35               $      0.86
</TABLE>

    Delta Play, Ltd.:

     On June 23, 1997, the Company acquired substantially all of the assets of
     Delta Play, Ltd. (Delta), a leading provider of custom indoor and outdoor
     modular play systems based in Delta, British Columbia.  The acquisition was
     effective June 1, 1997 and was accounted for as a purchase.  Results of
     operations of Delta were included in the Company's consolidated statements
     of income beginning on the effective date.

     As initial consideration, the Company paid $4,180,609 cash and issued
     40,000 shares of Koala Corporation common stock valued at $600,000.  In
     addition, costs related to the acquisition of approximately $455,559 were
     incurred.  In August 1998, the Company paid $610,160 in additional
     consideration pursuant to the earn-out provisions of the Delta purchase
     agreement.  The additional consideration paid was treated as goodwill and
     recorded to intangibles on the balance sheet.

     The pro forma unaudited results of operations of the Company for the year
     ended December 31, 1997, assuming consummation of the purchase of Delta as
     of January 1, 1997, is as follows:
<TABLE>
<CAPTION>
                                                    Year ended
                                                  December 31, 1997
                                                  -----------------
<S>                                                <C>
 
          Sales                                     $15,499,336
          Net income                                $ 2,513,770
          Net income per share - diluted            $      0.98
</TABLE>

                                      F-10
<PAGE>
 
                               KOALA CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                    YEARS ENDED DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------

3.   Credit facility:

     The Company obtained a $15.0 million secured line of credit on December 16,
     1998.  The line of credit is secured by substantially all of the assets of
     the Company. The line of credit may be used for short-term working capital
     needs and future acquisitions. There are no compensating balance
     requirements and the credit facility requires compliance with financial
     loan covenants related to debt levels compared to annualized cash flows
     from operations.  The credit facility terminates and is payable in full on
     December 16, 2001.  Interest payments are required at least every three
     months at a fluctuating rate per annum equal to the applicable "Reserve
     Adjusted LIBOR Rate".  A commitment fee in the amount of .25% is payable
     quarterly in arrears based on the average daily unused portion of the line.
     There were no amounts outstanding under the credit facility as of December
     31, 1998.

4.   Debt:

     On December 16, 1998, the Company issued a non-interest bearing promissory
     note in the amount of $13,465,043 for the purchase of the assets of Park
     Structures, Inc. and Park Structures Sales, Inc. (together "Park
     Structures") (note 2).  The promissory note was secured by an irrevocable
     letter of credit from a financial institution.  The promissory note was
     paid on January 4, 1999 by utilizing cash from the 1998 stock offering
     (note 5), cash on hand, and an advance on the Company's line of credit in
     the amount of $7,600,000.  Debt also includes $2,703,829 payable on March
     1, 1999 for the estimated cash portion of additional consideration,
     $1,088,518 payable on May 1, 1999 for estimated asset adjustments and
     $109,924 payable on May 1, 1999 for contractual holdbacks, all pursuant to
     the Park Structures purchase.

     The portion of debt that was paid with the cash proceeds of the stock
     offering plus cash on hand, totaling $5,865,043, has been classified as
     short-term.  The remaining obligation, totaling $11,502,271, is classified
     as long-term because the Company will utilize its existing line of credit
     to finance the payment of these obligations.  Principal payments on the
     line of credit are not due until its maturity on December 16, 2001 (note
     3).

5.   Common stock:

     On December 16, 1998, the Company completed a secondary public offering of
     1,200,000 shares of Koala Corporation common stock.  The Company sold
     320,000 shares of common stock, and a selling shareholder sold the
     remaining 880,000 shares.  The Company received proceeds, net of offering
     expenses, of $4,344,186 for the 320,000 shares of Company stock sold.
     Subsequent to December 31, 1998, these proceeds were used to pay a portion
     of the debt incurred in connection with the purchase of Park Structures
     (notes 2 and 4).

     On January 22, 1999, the Company's underwriters exercised their over-
     allotment option to purchase an additional 180,000 shares of the Company's
     common stock pursuant to the 1998 common stock offering.  The issuance of
     the shares resulted in net proceeds after underwriting fees of $2,734,200.
     The proceeds were used to reduce long-term debt that was incurred under the
     credit facility to purchase the assets of Park Structures.

6.   Supplemental financial information:

     Supplemental cash flow information:
<TABLE>
<CAPTION>
                                               1998                   1997                         
                                               ----                   ----                         
<S>                                          <C>                     <C>                           
          Interest received                  $   83,043              $104,839                      
                                             ==========              ========                      
          Interest paid                      $        0              $    989                      
                                             ==========              ========                      
          Income taxes paid                  $1,420,483              $872,304                      
                                             ==========              ========                       
</TABLE>

                                      F-11
<PAGE>
 
                               KOALA CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                    YEARS ENDED DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------

<TABLE>
<CAPTION> 

6.      Supplemental financial information (continued):
 
        Supplemental non-cash information:

              Non-cash investing activities:
                                                                            1998
                                                                            ----
<S>                                                                       <C>
                  Net assets acquired from Park                
                  Structures                                              $19,086,772 
                                                                          ===========
                                                               
                  Note payable and other amounts               
                  payable to Seller of Park  Structures                   $17,367,314
                                                                          ===========
                                                               
                  Common stock to be issued to                 
                  Seller of Park Structures                               $ 1,297,903
                                                                          ===========
</TABLE>


7.   Commitments and contingencies:

     Operating lease:

     The Company has entered into operating leases for facilities located in
     Denver, Colorado, New Orleans, Louisiana,  Coral Springs, Florida and
     Delta, British Columbia, Canada.

     The lease terms vary and run through May 31, 2003.  All leases call for
     monthly base rents, with the Company responsible for its share of common
     building operating costs, payable on a monthly basis.

     Facilities rent expense was $338,277 and $187,719 for years ending December
     31, 1998 and 1997, respectively.  Total minimum operating lease commitments
     for the years ending December 31 are:

<TABLE>
<CAPTION>
                                                             
                                                              Amount
                    Year Ending December 31,                  ------ 
                    ------------------------
<S>                                                          <C>
                              1999                            $  631,376
                              2000                               615,652
                              2001                               538,638
                              2002                               321,351
                       2003 and thereafter                       120,146
                                                              ----------
                                                              $2,227,163
                                                              ==========
</TABLE>

     Warranties:

     The Company provides a replacement guarantee for one year from purchase
     protecting against damage from natural disasters or vandalism subject to a
     $100 deductible.  The Company also provides a five year warranty on parts
     and labor covering any defects in workmanship.  The Company has experienced
     minimal returns and warranty claims; therefore, as of December 31, 1998 and
     1997, no accrual has been made for future claims.


8.   Stock options:

     The Company adopted a Stock Option Plan (1993 Plan) in August 1993.  The
     1993 Plan provides that options to purchase up to 100,000 shares of common
     stock may be granted.  The Company adopted a second plan in November 1995
     (1995 Plan) which provides that additional options to purchase up to
     400,000 shares of common stock may be granted.  The exercise price of each
     option is equal to the market price of the Company's stock on the date of
     grant.  The option term varies, as well as the vesting periods, at the
     discretion of the Board of Directors.

                                      F-12
<PAGE>
 
                               KOALA CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                    YEARS ENDED DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------

8.   Stock options (continued):

     In January 1998, the Company authorized the amendment and restatement of
     the 1995 Koala Corporation Stock Option Plan to grant an additional 250,000
     shares and allow the transfer of non-qualified stock options to family
     members without Board of Directors' approval or to non-employees with Board
     of Directors' approval.  The amendment and restatement was approved by the
     Company's shareholders' at its annual shareholders' meeting May 1998.

     The fair value of each option granted is estimated on the grant date using
     the Black-Scholes Model.  The following assumptions were made in estimating
     fair value:

<TABLE>
<CAPTION>
 
 
                                                      1998                     1997
                                                      ----                     ----
<S>                                                   <C>                        <C>  
Assumption                                      
----------                                      

Dividend yield                                        0.0%                    0.0%
Risk-free interest rate                         
     5 year                                           6.25%                   5.71%
Expected life                                       5 years                  5 years
Expected volatility                                   43.00%                  38.70%
</TABLE>


     The Company applies APB Opinion 25 in accounting for its stock based
     compensation plans.  Accordingly, no compensation cost has been recognized
     for the plan in 1998 and 1997.  Had compensation cost been determined on
     the basis of fair value pursuant to FASB Statement No. 123, net income and
     earnings per share would have been presented as follows:


<TABLE>
<CAPTION>

             Net income                              1998                    1997
             ----------                              ----                    ----
             <S>                                  <C>                     <C>
                As reported                         $3,099,656              $2,435,912
                                                    ==========              ==========
                                          
                Pro forma (FASB 123)                $2,742,162              $2,259,337
                                                    ==========              ==========
  
             Basic earnings per share
             ------------------------
 
                 As reported                        $     1.22              $     0.97
                                                    ==========              ==========
 
                 Pro forma (FASB 123)               $     1.08              $     0.90
                                                    ==========              ==========
 
 
              Diluted earnings per share
              --------------------------
 
                 As reported                        $     1.19              $     0.96
                                                    ==========              ==========
 
                 Pro forma (FASB 123)               $     1.05              $     0.89
                                                    ==========              ==========
</TABLE>
                                        

                                      F-13
<PAGE>
 
                               KOALA CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                    YEARS ENDED DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------


8.   Stock options (continued):

     Following is a summary of the status of the plans during 1998 and 1997:

<TABLE>
<CAPTION>
                                          Number of                 Weighted Average
                                            Shares                    Exercise Price
                                          ---------                   --------------
<S>                                       <C>                            <C> 
Outstanding 12/31/96                       250,000                       $11.25
                                        
    Granted  1997                            1,000                       $10.75
    Granted  1997                           22,000                       $13.00
    Granted  1997                           10,000                       $15.00
                                           -------
                                        
Outstanding 12/31/97                       283,000                       $11.52
                                        
    Granted  1998                           20,000                       $14.50
    Granted  1998                            2,000                       $16.00
    Forfeited  1998                        (10,000)                      $13.00
    Granted  1998                           44,000                       $16.25
    Granted  1998                            8,000                       $18.00
    Granted  1998                           16,000                       $20.00
    Granted  1998                           40,000                       $23.00
                                           -------
                                        
Outstanding 12/31/98                       403,000                       $13.77
                                           =======
</TABLE>                                
                                        
                                        
<TABLE>                                 
<CAPTION>                               
                                             1998                          1997
                                             ----                          ----
<S>                                       <C>                            <C> 
Options exercisable                        167,000                      103,000
                                          ========                     ========
 
Weighted average fair value  
of options granted during the year        $  18.62                     $  13.54
                                          ========                     ========
</TABLE>


     A summary of the status of fixed options outstanding at December 31, 1998
is as follows:

<TABLE>
<CAPTION>
                                           Outstanding Options           Exercisable Options
                                           -------------------           -------------------

                                     Weighted
                                      Average          Weighted                        Weighted
                                     Remaining         Average                          Average
                                   Contractual         Exercise                         Exercise
      Price           Number           Life             Price          Number           Price
      -----           ------           ----             -----          ------           -----
<S>                    <C>             <C>              <C>            <C>                <C>

     $ 9.25 to
       $11.25          151,000        7.0 years         $ 9.92         91,000          $ 9.93
 
     $13.00 to
       $15.00          142,000        7.5 years         $13.53         66,000          $13.29
 
     $16.00 to
       $23.00          110,000        9.5 years         $19.37         10,000          $17.60
 
</TABLE>

     The Company acquired Activities Unlimited in March 1996.  A portion of the
     purchase price was in the form of options to purchase Koala common stock.
     As of December 31, 1998 and 1997, 9,000  and 1,000 options had been granted
     under this agreement, respectively.

                                      F-14
<PAGE>
 
9.   Income taxes:

     The components of the provision for income tax were:

<TABLE>
<CAPTION>

                                                     ------------------------------------------------
                                                                            1998
                                                     ------------------------------------------------
                                                         Federal      Foreign     State      Total
                                                        ----------   ---------   -------   ----------
 
<S>                                                     <C>          <C>         <C>       <C>
Current tax expense                                     $1,153,496    $234,048   $59,233   $1,446,777
Deferred tax expense                                       216,860           -     5,407      222,267
                                                        ----------    --------   -------   ----------
Provision for income taxes                              $1,370,356    $234,048   $64,640   $1,669,044
                                                        ==========    ========   =======   ==========

                                                     ------------------------------------------------           
                                                                               1997
                                                     ------------------------------------------------
                                                         Federal      Foreign     State      Total
                                                        ----------   ---------   -------   ----------
 
Current tax expense                                     $  963,764    $159,798   $64,702   $1,188,264
Deferred tax expense                                       152,406           -        27      152,433
                                                        ----------    --------   -------   ----------
Provision for income taxes                              $1,116,170    $159,798   $64,729   $1,340,697
                                                        ==========    ========   =======   ==========
</TABLE>

     The tax effects of temporary differences that give rise to a significant
     portion of the deferred tax assets and liabilities at December 31, 1998 and
     1997 are as follows:

<TABLE>
<CAPTION>
                                                                             1998                  1997
                                                                             ----                  ----
Deferred tax assets:                                 
<S>                                                                        <C>                    <C>
  Allowance for doubtful accounts                                           $ 39,000              $ 14,314
                                                                            --------              --------
                                                     
Deferred tax liabilities:                            
  Depreciation                                                               214,000               154,204
  Amortization                                                               403,000               243,843
  Other                                                                       28,000                     -
                                                                            --------              --------
                                                                             645,000               398,047
                                                                            --------              --------
Net deferred tax liability                                                  $606,000              $383,733
                                                                            ========              ========
</TABLE>


     The effective tax rate differs from the statutory rate as follows:
<TABLE>
<CAPTION>
                                                                               1998                  1997
                                                                               ----                  ----
 
<S>                                                                            <C>                    <C>
Federal statutory rate                                                          34.0%                 34.0%
Foreign taxes in excess of federal statutory rate                                4.9                   4.6
Tax benefit of foreign tax credit                                               (4.9)                 (4.4)
State income taxes  net of federal effect                                        0.8                   1.7
Effect of difference in tax basis of goodwill                                   (0.8)                 (1.1)
Foreign sales corporation benefit                                               (1.1)                    -
Miscellaneous tax adjustments                                                    2.1                   0.7
                                                                                ----                  ----
Effective tax rate                                                              35.0%                 35.5%
                                                                                ====                  ====
</TABLE>
                                        

10.  Major suppliers:

     For the periods ended December 31, 1998 and 1997, the Company purchased a
     significant amount of component parts from three vendors which accounted
     for approximately 38% and 47% of the Company's total cost of sales,
     respectively.

                                      F-15
<PAGE>
 
                               KOALA CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                    YEARS ENDED DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------

11.  401(k) Plan:

     Effective January 1997, the Company adopted a 401(k) Plan for the benefit
     of substantially all of its U.S. employees meeting specified eligibility
     requirements.   The Plan permits contributions by the Company but does not
     require them.  The Company made no contributions to the Plan during 1997 or
     1998.


12.  Preferred stock:

     During 1996 the shareholders voted to amend the Articles of Incorporation
     to provide for the issuance of 1,000,000 shares of no par value preferred
     stock.  At December 31, 1998 and December 31, 1997, none were outstanding.
     The Board of Directors is granted authority to determine dividends and
     other rights and preferences for the preferred stock.


13.  Geographic and business segments:

     Business segments:

     The Company operates two business segments:  (1) Family Convenience and
     Children's Activity Products, and (2) Children's Modular Play Equipment.
     The Company's reportable segments are strategic business units that offer
     different products.  They are managed separately based on the fundamental
     differences in the operations.

     The Company's convenience and activity products include the flagship
     product, the baby changing station ("BCS"). Other significant products in
     this segment are the sanitary paper liners for the BCS, the child
     protection seat, the infant seat kradle, the high chair, block and bead
     tables and the wonder wall.  All of these products are manufactured by sub-
     contractors or purchased from third parties.  These products are sold
     direct and through distribution.

     The Company's modular play equipment includes both indoor and outdoor
     equipment.  The indoor play equipment is custom designed for the customer.
     A catalog is used to promote and advertise the outdoor play equipment,
     however, custom modifications are often made to accommodate the customers
     needs and desires.  These products are manufactured by the Company at its
     facilities located in Delta, British Columbia and Coral Springs, Florida.
     These products are sold direct and through manufacturers
     representatives/dealers.

     The Company evaluates the performance of its segments based primarily on
     operating profit before acquisition intangible amortization, corporate
     expenses and interest income and expense.  The Company allocates corporate
     expenses to individual segments based on segment sales.  Corporate expenses
     are primarily labor costs of executive management and  shareholders'
     relations costs.  The following table presents sales and other financial
     information by business segment:

<TABLE>
<CAPTION>
                     ------------------------------------------------------------------------------------
                                                                 1998
                     ------------------------------------------------------------------------------------
                                                   Convenience 
                                                   and Activity          Modular Play
                                                    Products              Equipment             Total
                                             ------------------------------------------------------------
                                     
<S>                                              <C>                 <C>                 <C>
Sales                                              $11,946,053         $ 7,154,712         $19,100,765
Operating income                                     3,661,275           1,028,713           4,689,988
Capital expenditures                                   294,036             225,882             519,918
Total assets                                       $15,209,446         $26,395,754         $41,605,200
</TABLE>

                                      F-16
<PAGE>
 
                               KOALA CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                    YEARS ENDED DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------

13.  Geographic and business segments (continued):


<TABLE>
<CAPTION>
                       -------------------------------------------------------------------------- 
                                                                1997
                       --------------------------------------------------------------------------- 
                                          Convenience 
                                        and Activity           Modular Play
                                           Products             Equipment             Total
                                     ------------------------------------------------------------
<S>                                     <C>                 <C>                 <C>
Total sales                                   $10,431,493          $3,189,799         $13,621,292
Operating income                                3,216,187             444,714           3,660,901
Capital expenditures                              467,591              52,730             520,321
Total assets                                  $ 8,590,940          $6,365,860         $14,956,800
</TABLE>

     Geographic area data:

     Geographically, sales, operating income and identifiable assets for non-
     domestic entities for the years ended December 31, 1998 and 1997 were
     $6,690,230 and $3,189,799, $1,133,917 and $671,641 and $2,737,443 and
     $1,931,400, respectively.  There were no material amounts of sales or
     transfers among geographic areas during 1998 or 1997.


14.  Comprehensive income:

     As of January 1, 1998, the Company adopted Statement No. 130,  Reporting
     Comprehensive Income.  Statement 130 establishes new rules for the
     reporting and display of comprehensive income and its components; however,
     the adoption of this Statement had no impact on the Company's net income or
     shareholders' equity.  Statement 130 requires foreign currency translation
     adjustments, which prior to adoption were reported separately in
     shareholders' equity, to be included in other comprehensive income.  Prior
     year financial statements have been reclassified to conform to the
     requirements of Statement 130.

                                      F-17