<PAGE>   1
 
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                       SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D. C. 20549
                            ------------------------
 
                                   FORM 10-K
[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934
 
     FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998; OR
 
[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934
 
     FOR THE TRANSITION PERIOD FROM                TO
 
                         COMMISSION FILE NUMBER 0-7024
 
                              THE FIRST YEARS INC.
             (Exact Name of Registrant as Specified in its Charter)
 
<TABLE>
<S>                                            <C>
                MASSACHUSETTS                                    04-2149581
       (State or Other Jurisdiction of                        (I.R.S. Employer
        Incorporation or Organization)                      Identification No.)
              ONE KIDDIE DRIVE,
             AVON, MASSACHUSETTS                                   02322
   (Address of Principal Executive Offices)                      (Zip Code)
</TABLE>
 
                                  508-588-1220
              (Registrant's Telephone Number, Including Area Code)
 
     Securities registered pursuant to Section 12(b) of the Act:
 
<TABLE>
<S>                                            <C>
             TITLE OF EACH CLASS                 NAME OF EACH EXCHANGE ON WHICH REGISTERED
                     NONE                                           NONE
</TABLE>
 
     Securities registered pursuant to Section 12(g) of the Act:
 
                          COMMON STOCK, $.10 PAR VALUE
                                (Title of Class)
 
     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.  Yes X      No __.
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K.     [X]
 
     The aggregate market value of the Common Stock held by nonaffiliates of the
Company was $112,250,758, based on the price at which the stock was sold over
the counter on the Nasdaq National Market, as reported at the close of business
on February 26, 1999.
 
     The number of shares of Registrant's Common Stock outstanding on December
31, 1998 was 10,440,014.
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<PAGE>   2
 
DOCUMENTS INCORPORATED BY REFERENCE
 
     The Company intends to file a definitive proxy statement pursuant to
Regulation 14A within 120 days of the end of the fiscal year ended December 31,
1998. The following sections of such definitive proxy statement are hereby
incorporated by reference into Items 10, 11, 12 and 13 of Part III of this Form
10-K: "Common Stock Ownership of Certain Beneficial Owners and Management;"
"Election of Directors;" "Executive Compensation" (other than the Board
Compensation Committee Report on Executive Compensation and the Performance
Chart); and "Compliance with Section 16(a) of the Securities Exchange Act of
1934."
<PAGE>   3
 
                                     PART I
 
ITEM 1.  BUSINESS
 
     The First Years Inc. (the "Company") is a leading developer and worldwide
marketer of a broad line of products for infants and toddlers. Major channels
through which the Company sells its products include mass merchants,
supermarkets, drug stores, department stores, wholesale clubs, convenience
stores, specialty stores, mail-order catalogs and catalog showrooms.
 
     The Company was incorporated in 1952 in Massachusetts under the name Kiddie
Products, Inc. The Company changed its name to The First Years Inc. in May,
1995, and is headquartered in Avon, Massachusetts.
 
     Except as expressly indicated or unless the context otherwise requires, as
used in this report, the "Company" means The First Years Inc. a Massachusetts
corporation, and its subsidiaries.
 
  Products
 
     The Company's product line, which contains approximately 300 items that
range in retail price from approximately $0.99 to $89.99, is categorized and
marketed into five distinct product categories as follows:
 
     Feeding & Soothing.  The Feeding & Soothing category is comprised of
bottles and accessories, nipples, pacifiers, teethers, bowls, drinking cups,
dishes, flatware, bibs, breast-feeding accessories and feeding sets. This
category includes the TumbleMates line of training cups, bowls, plates and
utensils, designed for serving, storing and transporting drinks and snacks, and
which features a system of interchangeable cups and lids. This category also
includes the Simplicity line of breast feeding accessories, the Flowright angled
feeding system of nipples and bottles, the Sure pacifier and the new All-In-One
highchair.
 
     Play & Discover.  The Play & Discover category consists of an extensive
line of entertaining, skill-developing toys for infants and toddlers including
crib toys, floor toys, hand-held toys, and large play items. The Play & Discover
category includes the Company's Washables line of 100% washable, dishwasher-safe
toys and its Firstronics line of hand-held electronic toys for children under
three years of age. In 1998, the Company introduced the 3-in-1 Gym to Walker
which received three prestigious awards from independent panels of child
development experts.
 
     Care & Safety.  The Care & Safety category consists of a broad line of
bathing and grooming accessories, home safety and monitoring products such as
door and cabinet latches, toilet-training products and products appropriate for
the health and hygiene needs of infants. This category includes the Crisp &
Clear Plus 900MHz Nursery Monitor.
 
     Winnie the Pooh.  The Winnie the Pooh category consists of over 65 basic
products including teethers, rattles, bibs, bottles, bathing accessories and
gift sets featuring Winnie the Pooh characters. In 1998, the Company introduced
numerous additional items in this category including Pooh PlayPals and Pooh
Sports Bottles.
 
     Sesame Street.  The Sesame Street category consists of over 30 basic
products including teethers, pacifiers, bottles, drinking cups, dishes,
flatware, healthcare products, car sun shade, hooded towels, rattles and a
toilet trainer.
                            ------------------------
 
     THE FIRST YEARS(R) Ideas Inspired by Parents(R), TumbleMates(R),
Firstronics(R), and Washables(R) are registered trademarks of The First Years
Inc., Simplicity(TM), Flowright(TM), All-In-One(TM), Sure(TM), Crisp & Clear
Plus(TM) and ComforTemp(TM) are trademarks of The First Years Inc. SESAME STREET
is a registered trademark of Children's Television Workshop, WINNIE THE POOH(R)
and POOH(R) are registered trademarks of Disney Enterprises, Inc.
 
                                       I-1
<PAGE>   4
 
PRODUCT DESIGN, DEVELOPMENT AND MARKETING
 
     The Company devotes substantial resources to product development. The
Company employs a staff of professionals engaged in the creation of new products
and uses a diverse group of outside designers and developers. For the past 18
years the Company's product line also has been designed in consultation with Dr.
T. Berry Brazelton, the well-known pediatrician and authority on child
development, and staff members of the Child Development Unit at Children's
Hospital in Boston, Massachusetts (the "CDU"), of which Dr. Brazelton is founder
and Director Emeritus.
 
     The Company spent approximately $3.3, $2.6 and $2.2 million on new product
development in 1998, 1997 and 1996, respectively. Most of the Company's new
products are shown at the Juvenile Products Manufacturers Association Trade
Show, in Dallas, Texas in the fall of each year, and a variety of other national
and international toy and baby fairs.
 
SALES
 
     The Company's products are sold nationally and internationally to a broad
spectrum of customers including mass merchants, national variety and drug
stores, supermarkets, wholesale clubs, convenience stores, toy specialty stores,
wholesale distributors, department stores, mail order catalogs and catalog
stores. The Company currently has customers in over 60 countries. Major
customers include Wal*Mart, Toys "R" Us, Target, Kmart, Kroger, Sears, Eckerd
Drugs, Rite Aid, Albertsons, and J.C. Penney.
 
     The Company's products are sold in the United States and Canada primarily
through the Company's internal sales staff and a network of 42 independent sales
representatives. The Company's sales staff is responsible for supervising and
training the sales representatives. Such training is conducted at the Company's
headquarters and throughout the United States.
 
     In August, 1997, the Company created a wholly-owned subsidiary, The First
Years Inc., a Delaware corporation ("TFY-Delaware"), to consolidate and more
efficiently handle the Company's sales and distribution operations in the
western part of the United States. TFY-Delaware has sales offices in Missouri
and California, and is the Company's exclusive sales agent for certain states in
the western part of the United States.
 
     In Europe and the Middle East, the Company's products are sold by the
Company's internal staff at its sales office in Cirencester, England, which is
headed by the Vice President -- International Sales/Europe. This staff manages a
network of foreign distributors and independent sales representatives. In
Central and South America and the Pacific Rim, the Company's products are sold
by its internal sales staff which manages a network of foreign distributors and
independent sales representatives in such areas.
 
     The Company's international sales in 1998, 1997 and 1996 were approximately
$16.7, $16.2 and $11.6 million, respectively, and accounted for approximately
12.6%, 13.5% and 12.5% of the Company's total net sales in 1998, 1997 and 1996,
respectively. (See "Notes to Financial Statements, Number 8.")
 
     During 1998, Wal*Mart, Toys "R" Us, and Target accounted for approximately
29%, 17%, and 11% of the Company's net sales, respectively. A significant
reduction in purchases by any of these customers could have a material adverse
effect on the Company's business.
 
     Backlog is not a significant and material aspect of the Company's business.
Customers place orders on an as needed basis. As the Company's sales have
increased, the amount of unfilled orders at any time has not been indicative of
future results.
 
LICENSED CHARACTER PRODUCTS
 
     Since 1996, the Company has entered into and renewed various agreements
which provide for the payment of royalties on certain of the Company's products
featuring licensed cartoon characters. The agreements have various terms and
require minimum royalty payments of $5,380,000 during the terms of these
agreements. A major licensing agreement which was to expire at the end of 1998
has been extended through March 31, 1999. Sales of products licensed under the
agreement amounted to 42% of the Company's total net sales for the year ended
December 31, 1998. Management is in the process of negotiating a renewal of this
agreement. While management expects the licensing agreement to be renewed,
non-renewal of this
                                       I-2
<PAGE>   5
 
licensing agreement or, renewal on terms not favorable to the Company could have
a material adverse affect on the Company's business (see Exhibit 99 to this
Report, "Important Factors Regarding Forward-Looking Statements" and "Notes to
the Financial Statements," Numbers 6 and 8).
 
MANUFACTURING AND SOURCES OF SUPPLY
 
     The Company does not own or operate its own manufacturing facilities. In
1998, all of the Company's products were manufactured either using the Company's
custom tools (molds and dies) or to the Company's specifications by
approximately 25 manufacturers located in the United States, Canada, China,
Taiwan, Thailand, and Mexico. Approximately 65% of all of its products sold in
1998 were manufactured in Asia, primarily in China. A large percentage of the
Company's furnishings and other large products were manufactured in 1998 by
suppliers in the United States and Canada because of the significantly higher
shipping costs from the Far East.
 
     Generally the Company uses one manufacturer to make each product from its
supplier base in Asia, Canada, and the United States. Due to the high cost of
developing duplicate tooling (predominantly molds and dies), most of the
Company's products are made using one set of tools; however, the Company has
developed duplicate tools for several of its key and high-volume products. In
December, 1996, the Company entered into an agreement with Exergen Corporation
to jointly design and develop the Company's ComforTemp thermometer. The
ComforTemp is an instant underarm thermometer which uses an infrared
temperature-taking technology developed and patented by Exergen. The Company is
dependent on Exergen for Exergen's technology and proprietary components. The
Company introduced the Comfortemp to the market in 1997. There can be no
assurance that the Company will continue to obtain such proprietary components
from Exergen or that the ComforTemp thermometer, will result in substantial
sales. The Company believes it has alternative manufacturing sources available
for all of its other products. Because it owns its tools, it could shift its
sources of manufacturing for such other products to an alternative supplier.
 
     In 1998, the Company's largest supplier, which is based in the United
States, accounted for products that represented approximately 13% of its net
sales in 1998. Other than as described above, the Company has not entered into
long-term contractual arrangements with any of its suppliers.
 
     The principal raw materials used in the production and sale of the
Company's products are plastic, paperboard and cloth. Raw materials are
purchased by the manufacturers who deliver completed products to the Company.
Because the primary source used in manufactured plastic is petroleum, the cost
and availability of plastic for use in the Company's products varies to a great
extent with the price of petroleum. The inability of the Company's suppliers to
acquire sufficient plastic and paperboard at a reasonable price could have a
material adverse effect on the Company's profitability. The Company did not
experience any difficulties in obtaining materials in 1998.
 
     The Company purchases its products from its suppliers primarily in the U.S.
dollar and the Hong Kong dollar which is currently pegged to the U.S. dollar.
Generally, the Company's suppliers ship the products on the basis of open credit
terms or upon the acceptance of products by the Company.
 
     Foreign manufacturing is subject to a number of risks including
transportation delays and interruptions, the imposition of tariffs, quotas, and
other import or export controls, currency fluctuations, misappropriation of
intellectual property, political and economic disruptions, and changes in
governmental policies. From time to time, the United States Congress has
attempted to impose additional restrictions on trade with China. Enactment of
legislation or the imposition of restrictive regulations conditioning or
revoking China's Normal Trade Relations ("NTR") trading status could have a
material adverse effect upon the Company's business because products originating
from China could be subjected to substantially higher rates of duty. China's NTR
trading status has been extended through July 3, 1999. Unless Congress takes
action to override this decision, China will continue to enjoy NTR treatment
during this period. The European Community (the "EC") has enacted a quota and
tariff system with respect to the importation into the EC of certain toy
products originating in China. The Company, therefore, continues to evaluate
alternative sources of supply outside of China.
 
                                       I-3
<PAGE>   6
 
     The Company, because of its substantial reliance on suppliers in foreign
countries, is required to order products further in advance of customer orders
than would generally be the case if such products were produced in the United
States. As a result, the Company is required to carry significant amounts of
inventory to meet rapid delivery requirements of customers and to assure itself
of continuous allotment of goods from suppliers.
 
WORKING CAPITAL ITEMS
 
     See Item 7, "Management Discussion and Analysis of Financial Condition and
Results of Operation."
 
COMPETITION
 
     The juvenile products industry is highly competitive and includes numerous
domestic and foreign competitors, some of which are substantially larger and
have greater financial and other resources than the Company. The Company
competes with a number of different competitors, depending on the product
category, and it competes against no single company across all product
categories. Its competition includes large, diversified health care product
companies, specialty infant products makers, toy makers and specialty health
care products companies. The Company competes principally on the basis of brand
name recognition and price/value relationship. In addition, the Company believes
that it competes favorably with respect to product quality, customer service and
breadth of product line.
 
DISTRIBUTION
 
     The Company distributes its products in the United States from its 103,500
square foot warehouse facility in Avon, Massachusetts and from a public
warehouse in Fontana, California. The Company distributes its products in Canada
from a public warehouse in Toronto, Ontario. In Europe, the Company distributes
its products from a public warehouse in Ghent, Belgium. Warehouse services at
the various public warehouses are performed by warehouse operators unaffiliated
with the Company.
 
TRADEMARKS, PATENTS AND COPYRIGHTS
 
     The Company's principal trademark THE FIRST YEARS and design, is registered
in the United States and in a number of foreign countries. The Company also uses
other trademarks for certain of its products and product categories, some of
which are registered in the United States and in various foreign countries.
 
     The Company, also owns patents, design patents and design registrations, as
well as pending applications in the United States and certain foreign countries.
Although the Company believes such are important to its business, it does not
believe that any single patent, design patent, or design registration, including
any which may be issued on a pending application, is material to its business.
There can be no assurance that such patents, design patents, or design
registrations, including those that may be issued on pending applications, will
offer any significant competitive advantage for the Company's products.
 
     The Company, also owns copyrights, some of which are registered in the
United States. The Company does not believe that any single copyright is
material to its business. There can be no assurance that such copyrights will
offer any significant competitive advantage for the Company's products.
 
EMPLOYEES
 
     As of December 31, 1998, the Company employed 148 full-time and 7 part-time
employees, of whom 6 are senior executive officers and all of the other
employees of the Company are in sales, marketing and product development, in
materials, purchasing, quality control, data processing, finance, administration
and clerical, and warehousing positions. None of the Company's employees is
represented by a union, and the Company has not experienced any work stoppages.
The Company believes that relations with employees are good.
 
GOVERNMENT REGULATIONS
 
     The Company's products are subject to the provisions of the Federal
Consumer Product Safety Act, the Federal Hazardous Substances Act, as amended,
the Federal Flammable Fabrics Act, and the Child Safety
 
                                       I-4
<PAGE>   7
 
Protection Act, and the regulations promulgated thereunder (the "Acts"). The
Company's nursery monitors are subject to regulations of the Federal
Communications Commission. The Company's medical devices and drug products are
subject to the regulations of the Food and Drug Administration. The Acts enable
the Consumer Product Safety Commission (the "CPSC") to protect children from
hazardous toys and other articles. The CPSC has the authority to exclude from
the market certain consumer products which are found to be hazardous. The CPSC's
determination is subject to court review. The CPSC can require the repurchase by
the manufacturer of articles which are banned. The Federal Flammable Fabrics Act
enables the CPSC to regulate and enforce flammability standards for fabrics used
in consumer products. Similar laws exist in some states and cities and in
various international markets. The Company designs and tests its products to
ensure compliance with the various federal, state and international
requirements. Any recall of a product could have a material adverse effect on
the Company, depending on the particular product.
 
EXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY
 
     The names of the Company's Executive Officers and Directors and certain
information about them are set forth below. Officers have served in the capacity
indicated in the table below for at least five years, unless otherwise indicated
in the notes.
 
<TABLE>
<CAPTION>
                                                                                               OFFICER OR
                                                                                                DIRECTOR
                   NAME                     AGE                    POSITION                      SINCE
                   ----                     ---                    --------                    ----------
<S>                                         <C>   <C>                                          <C>
Ronald J. Sidman..........................  52    President, Chairman of the Board of
                                                  Directors, and Chief Executive Officer          1975
Jerome M. Karp............................  71    Vice Chairman of the Board of Directors         1969
Benjamin Peltz............................  59    Director                                        1975
Evelyn Sidman.............................  85    Clerk and Director                              1979
Fred T. Page..............................  52    Director                                        1988
Kenneth R. Sidman.........................  53    Director                                        1998
Lewis M. Weston...........................  72    Director                                        1998
Walker J. Wallace.........................  54    Director                                        1999
John R. Beals.............................  44    Treasurer, Senior Vice President -- Finance
                                                  and Chief Financial Officer                     1990
Wayne Shea................................  44    Senior Vice President -- Worldwide Sales
                                                  and Merchandising                               1991
Bruce Baron...............................  38    Senior Vice President -- Operations             1997
James N. Turner...........................  41    Senior Vice President -- Marketing and New
                                                  Product Development                             1998
</TABLE>
 
---------------
 
     Mr. Sidman has been the President of the Company since January 1989 and
Chairman of the Board of Directors and Chief Executive Officer since March 1995.
 
     Mr. Page has been the President -- Network Services of Southern New England
Telecommunications Corporation ("SNET"), a subsidiary of Southwestern Bell,
since January, 1994 and has been with SNET for over 5 years.
 
     Kenneth R. Sidman has been Vice President, Business & Technology
Development, at Norton Performance Plastics Corp., Wayne, NJ, a subsidiary of
Compagnie de Saint-Gobain, since 1997. Mr. Sidman joined Norton Performance
Plastics Corp. in 1984 as Director, New Business Development, and from 1992 to
1997, was Vice President, Marketing & New Business Development.
 
     Mr. Lewis M. Weston has been a Limited Partner of Goldman, Sachs & Co.,
since 1978. He has been with Goldman Sachs since 1951 and was made a General
Partner in 1967. He was Partner in charge of the Syndicate Department from 1969
to 1978, a period during which he was also active with the National Association
of Securities Dealers (NASD), serving three years as a member of the NASD's
Board of Governors. Currently, Mr. Weston is a board member of South East Asia
Venture Investment Company (SEAVIC) and SEAVIC, III, Singapore, and the Thai
Prime Fund, Singapore, as well as a member of the
 
                                       I-5
<PAGE>   8
 
International Advisory Board of Banco Finantia, Lisbon, Portugal. He also serves
on the Investors Representative Committee of the China Dynamic Investment Fund.
 
     Walker J. Wallace was with Proctor & Gamble for 30 years, from 1967 to
1997. He was made a Vice President of Proctor & Gamble in 1991 and served as
Vice President -- Worldwide Strategic Planning for various core product
categories (laundry and cleaning products, paper products, diapers) from 1993 to
1997. Mr. Wallace is on the Board of the Student Loan Funding Resources in
Cincinnati, Ohio.
 
     Mr. Beals has been Senior Vice President -- Finance since March, 1998 and
Treasurer of the Company since January, 1998. He has been Chief Financial
Officer of the Company since July, 1997. From July, 1997 to March, 1998 he was
Vice President -- Finance of the Company and from January, 1990 to June, 1997,
he was the Assistant Treasurer and Controller of the Company.
 
     Mr. Shea has been Senior Vice President of Worldwide Sales & Merchandising
since July, 1997. From January, 1995 to June, 1997, Mr. Shea was Vice President
Worldwide Sales & Merchandising and from July, 1991 to December, 1994, Mr. Shea
was Vice President of Service and Merchandising of the Company.
 
     Mr. Baron has been Senior Vice President -- Operations since August, 1997.
Prior to that time, Mr. Baron was Vice President of Operations at Crabtree &
Evelyn from 1988 to July, 1997.
 
     Mr. Turner has been Senior Vice President -- Marketing and New Product
Development since July, 1998. Prior to that time, from July, 1995 to June, 1998,
he was the Vice President -- Product Development of Tupperware Services and from
November, 1992 to June, 1995 he was Vice President -- Marketing of Tupperware
Asia Pacific.
 
ITEM 2.  PROPERTIES
 
     The Company owns its executive and administrative offices and principal
warehouse which are located in a building at One Kiddie Drive, Avon,
Massachusetts. The building contains approximately 124,000 square feet of space,
of which approximately 20,500 square feet are used for executive and
administrative offices and the balance, approximately 103,500 square feet is
utilized for warehousing. The Company also has sales offices in leased premises
in Cirencester, England. The Company's subsidiary, TFY-Delaware has sales
offices in leased premises in Missouri and California.
 
     The Company also uses public warehouses located in Toronto, Canada;
Fontana, California; and in Ghent, Belgium.
 
     The Company believes that its properties (owned and leased) are in good
condition and adequate for its current needs.
 
ITEM 3.  LEGAL PROCEEDINGS
 
     The Company is involved in legal proceedings which have arisen in the
ordinary course of business. The Company believes that there are no claims or
litigation pending, the outcome of which could have a material adverse effect on
the Company's financial condition or operating results.
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     No matter was submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders of the Company.
 
                                       I-6
<PAGE>   9
 
                                    PART II
 
ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
(a)  MARKET INFORMATION
 
     The Company's Common Stock is traded on the Nasdaq National Market. Below
is a summary of the actual high and low sales prices of the Company's Common
Stock for each quarter of 1998 and 1997 as reported by Nasdaq and retroactively
adjusted to reflect the Company's 2-for-1 stock split effected on June 29, 1998.
 
                                      1998
 
<TABLE>
<CAPTION>
                          QUARTER                              LOW         HIGH
                          -------                              ---         ----
<S>                                                           <C>         <C>
First.......................................................  $10 1/2     $18 1/8
Second......................................................   15 1/4      20
Third.......................................................   12          19 1/2
Fourth......................................................    9          18 1/4
</TABLE>
 
                                      1997
 
<TABLE>
<CAPTION>
                          QUARTER                              LOW         HIGH
                          -------                              ---         ----
<S>                                                           <C>         <C>
First.......................................................  $ 7 3/4     $ 8 15/16
Second......................................................    7 1/2      10 7/8
Third.......................................................    9 3/4      14 1/2
Fourth......................................................   10 1/4      14 3/8
</TABLE>
 
(b)  APPROXIMATE NUMBER OF EQUITY SECURITY HOLDERS
 
<TABLE>
<CAPTION>
                                                                APPROXIMATE NUMBER
                                                                 OF RECORD HOLDERS
                       TITLE OF CLASS                        (AS OF DECEMBER 31, 1998)
                       --------------                        -------------------------
<S>                                                          <C>
Common Stock, $.10 Par Value                                            155
</TABLE>
 
(c)  DIVIDEND POLICY
 
     In 1997 and 1998, the Company paid a cash dividend on its Common Stock of
$0.05 and $0.06 per share, respectively, which were paid on June 2, 1997 and
June 29, 1998, respectively. The Company currently expects that comparable cash
dividends will continue to be paid in the future. However, the declaration and
payment of any such cash dividends in the future will depend upon the Company's
earnings, financial condition, capital needs, and other factors deemed relevant
by the Board of Directors. There can be no assurance that the Company will
continue to pay dividends in the future.
 
     The Company's Board of Directors declared on May 8, 1998, a 2-for-1 stock
split effected in the form of a 100% stock dividend payable on June 29, 1998 to
holders of record on May 29, 1998.
 
                                      II-1
<PAGE>   10
 
ITEM 6.  SELECTED FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                 1998           1997          1996          1995          1994
                                 ----           ----          ----          ----          ----
<S>                          <C>            <C>            <C>           <C>           <C>
SELECTED INCOME STATEMENT DATA:
Net sales.................   $132,716,379   $120,695,988   $93,110,361   $75,757,322   $53,233,109
Cost of products sold.....     80,737,193     71,185,634    55,463,255    45,108,546    29,498,457
Selling, general and
  administrative
  expenses................     39,011,893     37,165,878    28,580,039    23,961,206    18,915,908
Interest expense..........             --         27,709       358,637       186,338        24,575
Interest income...........        590,822        168,922        27,349        16,718        66,605
Offering expenses.........             --             --            --       310,457            --
Income before income
  taxes...................     13,558,115     12,485,689     8,735,779     6,207,493     4,860,774
Provision for income
  taxes...................      5,545,300      5,040,900     3,494,300     2,483,000     1,871,400
Net income................      8,012,815      7,444,789     5,241,479     3,724,493     2,989,374
Basic earnings per
  share**.................          $0.78          $0.75         $0.55         $0.41         $0.33
Diluted earnings per
  share**.................          $0.75          $0.71         $0.53         $0.40         $0.33
Dividends paid per
  share*..................          $0.06          $0.05         $0.05         $0.05         $0.05
Basic weighted average
  number of shares
  outstanding**...........     10,338,857     10,003,774     9,466,356     9,014,116     8,994,488
Diluted weighted average
  number of shares
  outstanding**...........     10,669,503     10,453,062     9,891,982     9,326,982     8,994,488
SELECTED BALANCE SHEET
  DATA:
Total assets..............   $ 69,275,895   $ 60,571,561   $47,049,537   $41,712,080   $28,852,785
Long-term debt............             --             --            --       100,001       233,334
Stockholders' equity......     52,647,404     44,009,004    35,866,440    25,763,259    22,349,947
Stockholders' equity per
  share**.................          $4.93          $4.21         $3.63         $2.76         $2.49
</TABLE>
 
---------------
 
 * Adjusted to reflect the two-for-one stock split effected on June 29, 1998 and
   December 29, 1995, respectively.
 
** Adjusted to reflect the two-for-one stock split effected on June 29, 1998 and
   December 29, 1995, respectively and restated to reflect adoption of Statement
   of Financial Accounting Standard No. 128 in the fourth quarter of 1997.
 
                                      II-2
<PAGE>   11
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
STATEMENT OF FORWARD LOOKING INFORMATION:
 
     Statements in this Report on Form 10-K that are not strictly historical are
"forward looking" statements, as defined in the Private Securities Litigation
Reform Act of 1995. Forward-looking statements involve risks, uncertainties or
other factors which may cause material differences in actual results or
performance. These factors include, but are not limited to, the ability to
introduce new products, dependence on licensed products, and the renewal of a
major license, reliance upon major customers and foreign suppliers, competitive
market pressures, changes in consumer preferences and in the retail industry,
risks related to year 2000 compliance and other factors, described more fully in
Exhibit 99 of this Annual Report for the year ended December 31, 1998.
 
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
 
     Net sales in 1998 were $132.8 million, an increase of $12.1 million, or
10.0%, as compared to $120.7 million in 1997. The increase was due to new
product introductions and expanded retail distribution in domestic and foreign
markets. An additional factor affecting sales was a charge of $3.0 million
relating to sales returns of certain products containing diisononyl phthalate
("DINP"), a plastic softener. As a percent of sales, net sales to foreign
markets decreased to 12.6% in 1998 from 13.5% in 1997 as sales increases in
Europe were partially offset by reduced sales in Latin America and the Pacific
Rim due to poor economic conditions. The Company currently believes economic
conditions in Latin America and the Pacific Rim may negatively affect sales
potential during the short to medium term but that in the long term substantial
opportunity exists. As a percentage of net sales, sales of licensed products
increased to 48.4% in 1998 from 43.1% in 1997. The Company derives a significant
portion of its sales from products under license. A major licensing agreement,
which was to expire at the end of 1998, has been extended through March 31,
1999. Sales of products licensed under the agreement amounted to 42% of the
Company's total net sales for the year ended December 31, 1998. Management is in
the process of negotiating a renewal of this agreement. While management expects
the licensing agreement to be renewed, non-renewal of this licensing agreement
or, renewal on terms not favorable to the Company could have a material adverse
affect on the Company's business. The Company also currently believes that the
growth in licensed products as a percent of total sales may begin to lessen as
demand for licensed products matures.
 
     Cost of products sold in 1998 was $80.7 million, an increase of $9.5
million or 13.4%, as compared to $71.2 million in 1997. As a percentage of net
sales, cost of products sold in 1998 increased to 60.8% from 59.0% in the
comparable period of 1997. The increase was primarily due to a charge of $1.1
million relating to write-off of inventory of certain products containing DINP.
Without the charge related to DINP, cost of products sold would have remained
consistent at 58.9% in 1998 and 59.0% in 1997, respectively.
 
     Selling general and administrative expenses in 1998 were $39.0 million, an
increase of $1.8 million, or 5.0%, as compared to $37.2 million of such expenses
in 1997. The increase was primarily due to costs related to increased sales
volume and payroll and payroll related costs. As a percentage of net sales,
selling, general, and administrative expenses decreased to 29.4% in 1998 from
30.8% in the comparable period of 1997. The decrease reflects a reduction in
advertising expenses in 1998 as well as the continued effective management of
selling, general, and administrative expenses.
 
     Income tax expense as a percentage of pretax income increased to 40.9% in
1998 from 40.4% in 1997 as a portion of the Company's taxable income was taxed
at a higher statutory rate.
 
YEAR 2000 ISSUE
 
     The "Year 2000 Issue" (Y2K) relates to problems that may result from the
incorrect processing of information using dates or date sensitive data by
computers and other machines utilizing embedded microprocessors. The problem is
attributable to the computer or software recognizing the year as a two digit
number "00" as opposed to the Year "2000". As year 2000 approaches, uncertainty
relating to these Y2K issues must be addressed in order to correct the problem
or properly plan for possible contingencies to handle anticipated issues, if
any.
 
                                      II-3
<PAGE>   12
 
     The Company started addressing the Y2K issue in 1996 and has been following
a plan, in phases, to identify, inventory, prioritize and correct all known Y2K
issues. The project plan incorporates the various phases and will evaluate both
information technology (IT) related hardware and software as well as non-IT
issues such as facilities operations and product related technology. The project
will also attempt to obtain assurance from mission critical vendors (banks,
transfer agents, manufacturing suppliers, utilities and other suppliers of
critical services to the Company) about their Y2K readiness and develop
contingency plans for issues that may arise from the failure of those vendors as
well as customers to achieve Y2K compliance. The Company has substantially
completed its review of all IT related systems and currently believes it will be
Y2K compliant by the end of the third quarter of 1999. The Company is currently
in the identification and inventory phase of the review of non-IT systems and
mission critical third party relationships which is currently expected to be
completed during the second quarter of 1999. Based on the review of responses
from third-party vendors, which has been substantially completed, the Company
currently expects to prioritize the corrective actions required, if any, and
commence the corrections phase of the project during the third quarter of 1999.
 
     The Company has initiated the contingency planning phase of the Y2K
project. A committee, including members of senior management, has been formed to
evaluate the response from mission critical third parties regarding assurance of
their Y2K readiness. Additionally, the committee is evaluating general
operational issues that may be affected by Y2K problems not limited to direct
third party relationships and is in the process of incorporating all issues into
a formal contingency plan. The contingency plan development is progressing
according to the overall Y2K plan and is expected to be substantially complete
by the end of the second quarter of 1999.
 
     The cost to address the Y2K Issue has not been and is not expected to be
material to the Company's financial position or have a material impact on
operating results. Since 1996 the Company has incurred expenses of approximately
$100,000 to address the Y2K issue and anticipates incurring an additional
$100,000 related to the Y2K issue. Anticipated additional costs do not consider
costs, if any, related to the failure of third party relationships to become
"Year 2000" compliant. All expenses incurred to date have been recognized as
expense in the Company's consolidated financial statements in the period
incurred. Costs, if any, related to the correction of Y2K issues caused by a
third party's failure to be Y2K compliant would be expensed as incurred.
 
     Based on the Y2K assessment information obtained and corrections
implemented to date, the Company currently believes that the Year 2000 Issue
will not have a material adverse effect on its financial position or results of
operations. The Company believes that its most reasonably likely, worst case
scenario may involve non-compliant third parties, including failure of
suppliers, distributors, shipping carriers, utility companies and other similar
third parties to provide their services to the Company. The Company is currently
inventorying results of a vendor compliance survey which will facilitate the
risk assessment and contingency planning phase of non-IT related issues which
will include planning for worst case scenarios, however, there can be no
assurance that the failure to ensure Year 2000 capability by a supplier,
customer, or another third party would not have a material adverse effect on the
Company.
 
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
 
     Net sales in 1997 were $120.7 million, an increase of $27.6 million, or
29.6%, as compared to $93.1 million in 1996. The increase was due to new product
introductions, including the Sesame Street brand licensed from the Children's
Television Workshop, and expanded retail distribution in domestic and foreign
markets. As a percentage of net sales, net sales to foreign markets increased to
13.5% in 1997 from 12.5% in 1996 resulting primarily from increases in Europe,
the Pacific Rim and Canada. As a percentage of net sales, licensed products
increased to 43.1% in 1997 from 31.8% in 1996.
 
     Cost of products sold in 1997 was $71.2 million, an increase of $15.7
million or 28.3%, as compared to $55.5 million in 1996. As a percentage of net
sales, cost of products sold in 1997 decreased to 59.0% from 59.6% in the
comparable period of 1996. The decrease was primarily due to reduced cost of
products resulting from manufacturing efficiencies and increased sales of higher
margin products.
 
                                      II-4
<PAGE>   13
 
     Selling, general, and administrative expenses in 1997 were $37.2 million,
an increase of $8.6 million, or 30.0%, as compared to $28.6 million over such
expenses in 1996. The increase resulted primarily from costs related to
increased sales volume; payroll and payroll related costs, and integrated
marketing communication program expenses. As a percentage of net sales, selling,
general, and administrative expenses in 1997 and 1996 remained consistent at
30.8% and 30.7%, respectively.
 
     Income tax expense as a percentage of pretax income increased to 40.4% in
1997 from 40.0% in 1996.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Net working capital increased by $7.5 million to $45.5 million at December
31, 1998 from $38.0 million at December 31, 1997 primarily due to funds
generated from profitable operations and reductions in inventory. Cash increased
by $12.1 million primarily as a result of profitable operations.
 
     In 1996, the Company consummated a public offering of common stock. The
closing of the sale, consisting of 800,000 (post 1998 stock split) newly issued
shares and 2,400,000 (post 1998 stock split) shares of certain selling
stockholders was held on July 1, 1996 at which time the Company issued the new
shares and received the net proceeds of $5,121,750. The proceeds of the newly
issued shares were used to pay certain indebtedness of the Company.
 
     An unsecured line of credit of $10 million which is subject to annual
renewal, is available from a bank. Amounts outstanding under the line are
payable upon demand by the bank. During 1998, the Company had no borrowings
under the line of credit. As of December 31, 1998 no balance was outstanding.
 
     The Company paid a cash dividend of $0.06 and $0.05 per share of Common
Stock in June of 1998 and 1997, respectively.
 
     The Company expects cash flow from operations and availability under the
Company's lines of credit to be sufficient to meet cash needs for working
capital expenditures for the next two years.
 
INFLATION AND FOREIGN CURRENCY FLUCTUATIONS
 
     Inflation has not had a material effect on the Company's operating results
over the past three years.
 
     The Company enters into forward exchange contracts to minimize the impact
of fluctuations in currency exchange rates on future cash flows emanating from
sales denominated in foreign currencies. The Company does not purchase such
contracts for trading purposes. During 1998, the Company entered into forward
exchange contracts with a bank whereby the Company is committed to deliver
foreign currency at predetermined rates. The contracts expire within one year.
The Company's commitment under these contracts approximated $500,000 as of
December 31, 1998. At December 31, 1998, the exchange rates for such currencies
covered by the contracts approximated the predetermined rates included therein.
The Company routinely assesses the financial strength of the bank which is
counterparty to the forward exchange contracts. As of December 31, 1998,
management believes it had no significant exposure to credit risk relative to
such contracts.
 
RECENT ACCOUNTING PRONOUNCEMENTS
 
     In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 130, "Reporting Comprehensive Income." The adoption of SFAS No. 130 resulted
in no changes to the consolidated financial statements.
 
     In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of
an Enterprise and Related Information." As required, the company adopted SFAS
No. 131 in the fourth quarter of 1998.
 
     In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which will require recognition of all
derivatives as either assets or liabilities on the balance sheet at fair value.
The Company is currently evaluating the effect of implementing SFAS No. 133,
which will be effective for the year beginning January 1, 2000.
 
                                      II-5
<PAGE>   14
 
ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
 
     See discussion in second paragraph of Item 7, "Inflation and Foreign
Currency Fluctuations", for required quantitative and qualitative disclosure
about primary exposure to market risk.
 
     The foreign currencies to which the Company has the most significant
exchange rate exposure is the British pound. Based on a hypothetical ten percent
adverse movement in foreign currency exchange rates, the potential losses in
future earnings, fair value of risk-sensitive instruments, and cash flows are
immaterial, although the actual effects may differ materially from the
hypothetical analysis.
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
     Financial Statements listed under Item 14.(a) 1. are included in Part IV.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE
 
     There is nothing to report relating to this Item.
 
                                      II-6
<PAGE>   15
 
                                    PART III
 
ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
     The information required by this item is included in the Registrant's
definitive proxy statement for the 1999 Annual Meeting of Stockholders and is
incorporated herein by reference.
 
ITEM 11.  EXECUTIVE COMPENSATION
 
     The information required by this item is included in the Registrant's
definitive proxy statement for the 1999 Annual Meeting of Stockholders, except
that the sections in said definitive proxy statement entitled "Board
Compensation Committee Report on Executive Compensation" and the "Stock
Performance Chart" shall not be deemed incorporated herein by reference to this
10-K Report.
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     The information required by this item is included in the Registrant's
definitive proxy statement for the 1999 Annual Meeting of Stockholders.
 
                                      III-1
<PAGE>   16
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
14.(a) 1.  FINANCIAL STATEMENTS
 
         Independent Auditors' Report
 
         Consolidated Balance Sheets as of December 31, 1998 and 1997
 
         Consolidated Statements of Income for the Years Ended December 31,
           1998, 1997 and 1996
 
         Consolidated Statements of Stockholders' Equity for the Years Ended
           December 31, 1998, 1997 and 1996
 
         Consolidated Statements of Cash Flows for the Years Ended December 31,
           1998, 1997 and 1996
 
   (a) 2.  SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED
           DECEMBER 31, 1998, 1997 AND 1996
 
           Other schedules are omitted because of the absence of conditions
           under which they are required or because the required information is
           given in the financial statements or notes thereto.
 
14.(a) 3.  EXHIBITS
 
     The following are either (i) filed herewith as exhibits to this 10-K Report
or (ii) have been filed as exhibits to filings under the Securities Act of 1933
or the Securities Exchange Act of 1934 and are incorporated herein by reference
as exhibits to this 10-K Report.
 
<TABLE>
<CAPTION>
                                                                          PAGE
                                                                          ----
<S>       <C>                                                            <C>
(3)(i)    Restated Articles of Organization as currently in effect
          (filed as Exhibit (3.1) to Amendment No. 1 to Form S-1
          Registration Statement filed with the Commission on October
          5, 1995 and incorporated herein by reference).
(3)(ii)   By-laws of the Company and any amendments thereto, as
          currently in effect (filed as Exhibit 3(ii) on Form 10-K for
          the year ended December 31, 1994 and incorporated herein by
          reference.)
(10)(a)   Security and Trust Agreement among Town of Avon, acting by
          and through its Industrial Development Financing Authority,
          Kiddie Products, Inc., and State Street Bank and Trust
          Company relating to issuance of industrial revenue bonds,
          dated as of October 1, 1982 (filed as Exhibit 10 (c) on Form
          10-K for the year ended December 31, 1994 and incorporated
          herein by reference).
(10)(b)   Bond Purchase Agreement among Town of Avon, acting by and
          through its Industrial Development Financing Authority,
          Kiddie Products, Inc., and State Street Bank and Trust
          Company, dated as of October 1, 1982 (filed as Exhibit 10
          (d) on Form 10-K for the year ended December 31, 1994 and
          incorporated herein by reference).
(10)(c)   Loan Agreement between Town of Avon, acting by and through
          its Industrial Development Financing Authority, and Kiddie
          Products, Inc., dated as of October 1, 1982 (filed as
          Exhibit 10 (e) on Form 10-K for the year ended December 31,
          1994 and incorporated herein by reference).
(10)(d)   Put Agreement between State Street Bank and Trust Company
          and Kiddie Products, Inc., dated as of October 1, 1982
          (filed as Exhibit 10 (f) on Form 10-K for the year ended
          December 31, 1994 and incorporated herein by reference).
(10)(e)   Agreement with Disney Enterprises, Inc. dated December 3,
          1996 (filed as Exhibit (10)(f) on Form 10-K for the year
          ended December 31, 1996 and incorporated herein by
          reference; certain portions of such Agreement are subject to
          confidential treatment).
(10)(f)   Agreement with the Children's Television Workshop dated July
          1, 1996 (filed as Exhibit (10)(g) on Form 10-K for the year
          ended December 31, 1996 and incorporated herein by
          reference; certain portions of such Agreement are subject to
          confidential treatment).
</TABLE>
 
                                      IV-1
<PAGE>   17
 
<TABLE>
<CAPTION>
                                                                          PAGE
                                                                          ----
<S>       <C>                                                            <C>
  Management Contracts and Compensatory Plans
 
(10)(g)   The First Years Inc. 1993 Equity Incentive Plan, as amended
          through March 19, 1998 (filed as Exhibit (10)(g) on Form
          10-K for the year ended December 31, 1997 and incorporated
          herein by reference).
(10)(h)   The First Years Inc. 1993 Stock Option Plan for Directors,
          as amended through March 19, 1998 (filed as Exhibit (10)(h)
          on Form 10-K for the year ended December 31, 1997 and
          incorporated herein by reference).
(10)(i)   Agreement between The First Years Inc. and Jerome M. Karp
          dated August 8, 1994 (filed as Exhibit 10(c) to the Form
          10-Q Report for the quarter ended June 30, 1994, and
          incorporated herein by reference).
(10)(j)   Employment Agreement between The First Years Inc. and
          Benjamin Peltz, dated March 23, 1995 (filed as Exhibit 10(j)
          on Form 10-K for the year ended December 31, 1994 and
          incorporated herein by reference).
(10)(k)   Employment Agreement between The First Years Inc. and Ronald
          J. Sidman, dated March 23, 1995 (filed as Exhibit 10(k) on
          Form 10-K for the year ended December 31, 1994 and
          incorporated herein by reference).
(10)(l)   First Amendment to Employment Agreement between The First
          Years Inc. and Ronald J. Sidman dated January 16, 1997
          (filed as Exhibit (10)(l) on Form 10-K for the year ended
          December 31, 1997 and incorporated herein by reference).
(10)(m)   First Amendment to Employment Agreement between The First
          Years Inc. and Benjamin Peltz dated January 16, 1997 (filed
          as Exhibit (10)(m) on Form 10-K for the year ended December
          31, 1997 and incorporated herein by reference).
(10)(n)   The First Years Inc., a Massachusetts Corporation, and
          Affiliates -- 1998 Annual Incentive Plan, effective as of
          January 1, 1998.                                               IV-19
(10)(o)   Agreement between The First Years Inc. and Wayne Shea dated
          August 12, 1997 (filed as Exhibit (10)(o) on Form 10-K for
          the year ended December 31, 1997 and incorporated herein by
          reference).
(10)(p)   Agreement between The First Years Inc. and Bruce Baron dated
          July 10, 1997.                                                 IV-19
(10)(q)   Agreement between The First Years Inc. and James N. Turner
          dated June 15, 1998.                                           IV-19
-------------------------------------------------------------------------------
 
(21)      List of Subsidiaries of the Registrant.                        IV-19
(23)      Consent of Deloitte & Touche LLP dated March 31, 1999.         IV-19
(27)      Financial Data Schedule -- 12/31/98                            IV-19
(99)      Important Factors Regarding Forward-Looking Statements.        IV-19
</TABLE>
 
14.(b)  REPORT ON FORM 8-K
 
     The Company did not file any reports on Form 8-K with the Securities and
Exchange Commission during the quarter ended December 31, 1998.
 
                                      IV-2
<PAGE>   18
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
 
                                                    THE FIRST YEARS INC.
                                            ....................................
                                                        (Registrant)
 
                                            By:    /s/ RONALD J. SIDMAN
                                              ..................................
                                              RONALD J. SIDMAN, CHIEF EXECUTIVE
                                                            OFFICER,
                                                   CHAIRMAN OF THE BOARD OF
                                                    DIRECTORS, AND PRESIDENT

                                            Date:  March 18, 1999

                                            By:      /s/ JOHN R. BEALS
                                              ..................................
                                                 JOHN R. BEALS, TREASURER AND
                                                    SENIOR VICE PRESIDENT --
                                               FINANCE(CHIEF FINANCIAL OFFICER
                                                           AND CHIEF
                                                     ACCOUNTING OFFICER)

                                            Date:  March 18, 1999
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 18, 1999.
 
<TABLE>
<CAPTION>
                     SIGNATURE                                       TITLE                       DATE
                     ---------                                       -----                       ----
<C>                                                  <S>                                    <C>
               /s/ RONALD J. SIDMAN                  Chief Executive Officer Chairman of    March 18, 1999
     ........................................        the Board of Directors and President
                 RONALD J. SIDMAN
 
                /s/ JEROME M. KARP                   Vice Chairman of the Board of          March 18, 1999
     ........................................        Directors
                  JEROME M. KARP
 
                 /s/ EVELYN SIDMAN                   Director                               March 18, 1999
     ........................................
                   EVELYN SIDMAN
 
                /s/ BENJAMIN PELTZ                   Director                               March 18, 1999
     ........................................
                  BENJAMIN PELTZ
 
                 /s/ FRED T. PAGE                    Director                               March 18, 1999
     ........................................
                   FRED T. PAGE
</TABLE>
 
                                      IV-3
<PAGE>   19
 
                              THE FIRST YEARS INC.
 
                 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
                          FINANCIAL STATEMENT SCHEDULE
 
<TABLE>
<CAPTION>
                                                                PAGE
                                                                ----
<S>                                                           <C>
Independent Auditors' Report................................  IV-5
Consolidated Financial Statements:
     Consolidated Balance Sheets as of December 31, 1998 and
      1997..................................................  IV-6
     Consolidated Statements of Income for the Years Ended
      December 31, 1998, 1997, and 1996.....................  IV-7
     Consolidated Statements of Stockholders' Equity for the
      Years Ended December 31, 1998, 1997, and 1996.........  IV-8
     Consolidated Statements of Cash Flows for the Years
      Ended December 31, 1998, 1997, and 1996...............  IV-9
     Notes to Consolidated Financial Statements.............  IV-10-17
Financial Statement Schedule II -- Valuation and Qualifying
  Accounts for the Years Ended December 31, 1998, 1997, and
  1996......................................................  IV-18
</TABLE>
 
                                      IV-4
<PAGE>   20
 
                          INDEPENDENT AUDITORS' REPORT
 
To the Board of Directors and Stockholders of
The First Years Inc.
Avon, Massachusetts
 
     We have audited the accompanying consolidated balance sheets of The First
Years Inc. as of December 31, 1998 and 1997, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 1998. Our audits also included the
financial statement schedule listed in the accompanying index. These financial
statements and the financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on the
financial statements and the financial statement schedule based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, such financial statements present fairly, in all material
respects, the financial position of The First Years Inc. as of December 31, 1998
and 1997, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly, in all material respects, the information set forth
therein.
 
DELOITTE & TOUCHE LLP
Boston, Massachusetts
March 4, 1999 (March 29, 1999 as
to paragraph 3 of footnote 8)
 
                                      IV-5
<PAGE>   21
 
                              THE FIRST YEARS INC.
 
                          CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 1998 AND 1997
 
<TABLE>
<CAPTION>
                                                                 1998           1997
                                                                 ----           ----
<S>                                                           <C>            <C>
                                         ASSETS
 
Current Assets:
     Cash and cash equivalents (Notes 1 and 8)..............  $19,776,897    $ 7,697,040
     Accounts receivable (less allowance for doubtful
      accounts of $270,000 and $185,000 in 1998 and 1997,
      respectively) (Note 8)................................   19,013,127     19,962,226
     Inventories (Note 1)...................................   18,520,023     24,372,881
     Prepaid expenses and other assets......................    2,638,634        414,764
     Deferred tax asset (Notes 1 and 3).....................    1,424,500      1,279,000
                                                              -----------    -----------
          Total current assets..............................   61,373,181     53,725,911
                                                              -----------    -----------
 
Property, Plant, and Equipment (Note 1):
     Land...................................................      167,266        167,266
     Building...............................................    4,199,790      4,022,095
     Machinery and molds....................................    7,878,103      7,151,019
     Furniture and equipment................................    4,571,636      3,947,144
                                                              -----------    -----------
          Total.............................................   16,816,795     15,287,524
     Less accumulated depreciation..........................    8,914,081      8,441,874
                                                              -----------    -----------
          Property, plant, and equipment -- net.............    7,902,714      6,845,650
                                                              -----------    -----------
          Total Assets......................................  $69,275,895    $60,571,561
                                                              ===========    ===========
 
                          LIABILITIES AND STOCKHOLDERS' EQUITY
 
Current Liabilities:
     Accounts payable.......................................  $ 9,400,966    $10,163,844
     Accrued royalty expense (Note 6).......................    2,130,027      2,051,721
     Accrued payroll expenses...............................    1,200,966      1,143,063
     Accrued selling expenses...............................    3,098,232      2,387,029
                                                              -----------    -----------
          Total current liabilities.........................   15,830,191     15,745,657
                                                              -----------    -----------
 
Deferred Tax Liability (Notes 1 and 3)......................      798,300        816,900
Commitments and Contingencies (Notes 5, 6 and 8)
Stockholders' Equity (Notes 4, 7, 9 and 10):
Common stock -- authorized, 15,000,000 shares; issued
  10,461,408 and 10,176,000; outstanding, 10,440,014 and
  10,169,182 as of December 31, 1998 and 1997,
  respectively..............................................    1,046,141        508,800
Paid-in-capital.............................................    7,472,398      6,534,308
Retained earnings...........................................   44,438,589     37,047,709
Less treasury stock at cost, 21,394 and 6,818 shares as of
  December 31, 1998 and 1997, respectively..................     (309,724)       (81,813)
                                                              -----------    -----------
          Total stockholders' equity........................   52,647,404     44,009,004
                                                              -----------    -----------
          Total Liabilities and Stockholders' Equity........  $69,275,895    $60,571,561
                                                              ===========    ===========
</TABLE>
 
                See notes to consolidated financial statements.

                                      IV-6
<PAGE>   22
 
                              THE FIRST YEARS INC.
 
                       CONSOLIDATED STATEMENTS OF INCOME
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
<TABLE>
<CAPTION>
                                                        1998            1997           1996
                                                        ----            ----           ----
<S>                                                 <C>             <C>             <C>
Net Sales (Notes 1, 6, 8 and 11)..................  $132,716,379    $120,695,988    $93,110,361
Cost of Products Sold (Notes 1 and 11)............    80,737,193      71,185,634     55,463,255
                                                    ------------    ------------    -----------
Gross Profit......................................    51,979,186      49,510,354     37,647,106
Selling, General, and Administrative Expenses
  (Notes 1 and 7).................................    39,011,893      37,165,878     28,580,039
                                                    ------------    ------------    -----------
Operating Income..................................    12,967,293      12,344,476      9,067,067
 
Other Income (Expense):
     Interest expense.............................            --         (27,709)      (358,637)
     Interest income..............................       590,822         168,922         27,349
                                                    ------------    ------------    -----------
Income Before Income Taxes........................    13,558,115      12,485,689      8,735,779
Provision for Income Taxes (Notes 1 and 3)........     5,545,300       5,040,900      3,494,300
                                                    ------------    ------------    -----------
Net Income (Note 11)..............................  $  8,012,815    $  7,444,789    $ 5,241,479
                                                    ============    ============    ===========
Basic Earnings Per Share (Notes 1 and 9)..........  $       0.78    $       0.75    $      0.55
                                                    ============    ============    ===========
Diluted Earnings Per Share (Notes 1 and 9)........  $       0.75    $       0.71    $      0.53
                                                    ============    ============    ===========
</TABLE>
 
                See notes to consolidated financial statements.

                                      IV-7
<PAGE>   23
 
                              THE FIRST YEARS INC.
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
<TABLE>
<CAPTION>
                                        COMMON STOCK
                                     --------------------     PAID-IN      RETAINED     TREASURY
                                     SHARES     PAR VALUE     CAPITAL      EARNINGS       STOCK
                                     ------     ---------     -------      --------     --------
<S>                                <C>          <C>          <C>          <C>           <C>
Balance, January 1, 1996.........   4,515,142   $  451,514   $       --   $25,311,745   $      --
     Stock issued under stock
       option plans (Note 7).....      33,838        3,384      190,125            --          --
     Dividends paid..............          --           --           --      (453,557)         --
     Stock issued through public
       offering (Note 10)........     400,000       40,000    5,081,750            --          --
     Net income..................          --           --           --     5,241,479          --
                                   ----------   ----------   ----------   -----------   ---------
Balance, December 31, 1996.......   4,948,980      494,898    5,271,875    30,099,667          --
     Stock issued under stock
       option plans (Note 7).....     139,020       13,902      804,433            --          --
     Tax benefit derived from
       option compensation
       deduction.................          --           --      458,000            --          --
     Dividends paid..............          --           --           --      (496,747)
     Repurchase of 3,409 shares
       for treasury..............      (3,409)          --           --            --     (81,813)
     Net income..................          --           --           --     7,444,789          --
                                   ----------   ----------   ----------   -----------   ---------
Balance, December 31, 1997.......   5,084,591      508,800    6,534,308    37,047,709     (81,813)
     Stock issued under stock
       option plans (Note 7).....     183,205       18,321      916,510            --          --
     Tax benefit derived from
       option compensation
       deduction.................          --           --      540,600            --          --
     Dividends paid..............          --           --           --      (621,935)         --
     Repurchase of 10,576 shares
       for treasury..............     (10,576)          --           --            --    (227,911)
     Stock split, two-for-one
       (Note 4)..................   5,182,794      519,020     (519,020)           --          --
     Net income..................          --           --           --     8,012,815          --
                                   ----------   ----------   ----------   -----------   ---------
Balance, December 31, 1998.......  10,440,014   $1,046,141   $7,472,398   $44,438,589   $(309,724)
                                   ==========   ==========   ==========   ===========   =========
</TABLE>
 
                See notes to consolidated financial statements.

                                      IV-8
<PAGE>   24
 
                              THE FIRST YEARS INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
<TABLE>
<CAPTION>
                                                             1998          1997          1996
                                                          -----------   -----------   -----------
<S>                                                       <C>           <C>           <C>
Cash Flows from Operating Activities:
  Net income............................................  $ 8,012,815   $ 7,444,789   $ 5,241,479
  Adjustments to reconcile net income to net cash
     provided by (used for) operating activities:
     Depreciation.......................................    1,415,525     1,397,078     1,228,790
     Provision for doubtful accounts....................      176,034       147,541       152,582
     Loss on disposal of equipment......................      548,469       617,693        37,699
     Increase (decrease) arising from working capital
       items:
       Accounts receivable..............................      773,065    (4,180,302)   (1,890,417)
       Inventories......................................    5,852,858    (5,784,837)      421,740
       Prepaid expenses and other assets................   (1,683,270)      (39,447)      402,757
       Accounts payable.................................     (762,878)    3,652,730       344,167
       Accrued royalty expense..........................       78,306     1,203,050       314,870
       Accrued payroll expenses.........................       57,903        55,761       (17,702)
       Accrued selling expenses.........................      711,203       981,020       801,575
     Change in deferred income taxes....................     (164,100)     (287,700)       50,600
                                                          -----------   -----------   -----------
          Net cash provided by operating activities.....   15,015,930     5,207,376     7,088,140
                                                          -----------   -----------   -----------
Cash Flows from Investing Activities
Purchase of property, plant, and equipment..............   (3,021,058)   (1,814,698)   (2,004,489)
                                                          -----------   -----------   -----------
Cash Flows from Financing Activities:
  Repayment of industrial revenue bonds.................           --      (100,000)     (133,334)
  Net repayment from short-term borrowings..............           --            --    (6,200,000)
  Dividends paid........................................     (621,935)     (496,747)     (453,557)
  Net proceeds from public offering.....................           --            --     5,121,750
  Purchase of treasury stock............................     (227,911)      (81,813)           --
  Common stock issued under stock option plans..........      934,831       818,335       193,509
                                                          -----------   -----------   -----------
          Net cash provided by (used for) financing
            activities..................................       84,985       139,775    (1,471,632)
                                                          -----------   -----------   -----------
Increase in Cash and Cash Equivalents...................   12,079,857     3,532,453     3,612,019
Cash and Cash Equivalents, Beginning of Year............    7,697,040     4,164,587       552,568
                                                          -----------   -----------   -----------
Cash and Cash Equivalents, End of Year..................  $19,776,897   $ 7,697,040   $ 4,164,587
                                                          ===========   ===========   ===========
Supplemental Disclosures of Cash Flow Information
       Cash paid during the year for:
       Interest.........................................  $         0   $    27,709   $   358,637
                                                          ===========   ===========   ===========
       Income taxes.....................................  $ 7,584,400   $ 4,684,690   $ 3,087,700
                                                          ===========   ===========   ===========
  Non-cash transactions:
       Tax benefit of stock option exercises............  $   540,600   $   458,000   $         0
                                                          ===========   ===========   ===========
</TABLE>
 
                See notes to consolidated financial statements.

                                      IV-9
<PAGE>   25
 
                              THE FIRST YEARS INC.
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
     Business -- The First Years Inc. (the "Company") is a developer, marketer,
and distributor of certain basic accessory and related products for infants and
toddlers. The Company was founded and incorporated in 1952. Since its inception,
the Company has engaged in this single line of business, with one class of
similar products. The following is a summary of the Company's significant
accounting policies.
 
     Basis of Reporting -- The consolidated financial statements include the
accounts of all the Company's wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated.
 
     Revenue Recognition -- Revenue is recognized when products are shipped.
 
     Cash Equivalents -- Highly liquid investments with a maturity of three
months or less when purchased have been classified as cash equivalents in the
accompanying financial statements. Such investments are carried at cost, which
approximates market value.
 
     Inventories -- Inventories are stated at the lower of cost (first-in,
first-out) or market. Inventories consist principally of finished goods,
unpackaged components, and supplies.
 
     Property, Plant, and Equipment -- Property, plant, and equipment is stated
at cost. Depreciation is provided based on the estimated useful lives of the
various classes of assets (building, 15 to 40 years; machinery and molds, 5 to
10 years; furniture and equipment, 5 to 10 years) using the straight-line
method.
 
     Income Taxes -- Deferred tax assets and liabilities are determined based on
the differences between the financial statement and tax bases of assets and
liabilities using enacted tax rates.
 
     Employee Stock-Based Compensation -- The Company uses the intrinsic
value-based method of Accounting Principles Board Opinion ("APB") No. 25 to
account for employee stock-based compensation plans.
 
     Earnings Per Share -- In 1997, the Company adopted SFAS No. 128 "Earnings
Per Share." All earnings per share amounts for all periods presented have been
restated to conform to the requirements of SFAS No. 128.
 
     Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. The primary estimates underlying the Company's
consolidated financial statements include allowances for doubtful accounts and
obsolete inventories and estimates related to the DINP charges (See footnote
11). Actual results could differ from those estimates.
 
     Research and Development Costs -- Research and development costs are
expensed as incurred. During 1998, 1997, and 1996, research and development
costs approximated $3,320,000, $2,584,000, and $2,209,000, respectively.
 
     Foreign Currency Translation -- The Company's functional currency is the
U.S. dollar. Accordingly, monetary assets and liabilities of the Company's
foreign operations are translated from the respective local currency to the U.S.
dollar using year-end exchange rates while nonmonetary items are translated at
historical rates. Income and expense accounts are translated at the average
rates in effect during the year. Accordingly, translation adjustments and
transaction gains and losses are recognized as income in the year of occurrence
and are recorded as a component of cost of sales.
 
     Foreign Exchange Contracts -- The Company enters into forward exchange
contracts to minimize the impact of fluctuations in currency exchange rates on
future cash flows emanating from sales denominated in
 
                                      IV-10
<PAGE>   26
                              THE FIRST YEARS INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
foreign currencies. The Company does not purchase such contracts for trading
purposes. Gains and losses related to foreign exchange contracts which qualify
as accounting hedges of firm commitments are deferred and recognized in income
when the hedged transaction occurs. Gains and losses related to foreign exchange
contracts which do not qualify for hedge accounting are marked to market
currently and recognized as a foreign currency transaction gain or loss.
 
     Fair Value of Financial Instruments -- The fair value of the Company's
assets and liabilities which constitute financial instruments as defined in SFAS
No. 107 approximate their recorded value.
 
     Reclassifications -- Certain reclassifications were made to prior year
amounts in order to conform with the current year presentation.
 
     New Accounting Pronouncements -- In June 1997, the Financial Accounting
Standards Board (FASB) issued SFAS No. 130, "Reporting Comprehensive Income."
The adoption of SFAS No. 130 resulted in no changes to the consolidated
financial statements.
 
     In June 1997, the FSAB issued SFAS No. 131, "Disclosure about Segments of
an Enterprise and Related Information." As required, the Company adopted SFAS
No. 131 in the fourth quarter of 1998 (See footnote 12).
 
     In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which will require recognition of all
derivatives as either assets or liabilities on the balance sheet at fair value.
The Company is currently evaluating the effect of implementing SFAS No. 133,
which will be effective for the year beginning January 1, 2000.
 
2.  DEBT
 
     During 1998 and 1997, the Company had available an unsecured line of credit
totaling $10,000,000 with one bank. The line is subject to annual renewal and
requires no compensating balances. The line bears interest at the prime rate or
the LIBOR rate plus 1.75%. During 1997 the Company borrowed various amounts up
to $2,500,000 under the line. No short-term borrowings were incurred by the
Company during 1998. As of December 31, 1998 and 1997 no balance was
outstanding. The line of credit will expire on June 30, 1999.
 
3.  INCOME TAXES
 
     Components of the Company's net deferred tax asset at December 31 are as
follows:
 
<TABLE>
<CAPTION>
                                                       1998         1997
                                                    ----------   ----------
<S>                                                 <C>          <C>
 
Deferred tax assets:
     Reserves not currently deductible............  $  411,400   $  266,900
     Capitalized packaging costs not currently 
       deductible.................................     586,500      528,900
     Capitalized inventory costs not currently
       deductible.................................     393,700      432,800
     Other........................................      32,900       50,400
                                                    ----------   ----------
                                                     1,424,500    1,279,000
                                                    ----------   ----------
 
Deferred tax liabilities:
     Excess tax depreciation over financial
       reporting depreciation.....................     793,800      812,400
     Other........................................       4,500        4,500
                                                    ----------   ----------
                                                       798,300      816,900
                                                    ----------   ----------
Net deferred tax asset............................  $  626,200   $  462,100
                                                    ==========   ==========
</TABLE>
 
                                      IV-11
<PAGE>   27
                              THE FIRST YEARS INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     There was no valuation allowance for the years ended December 31, 1998 and
1997.
 
     The provision for income taxes consists of the following:
 
<TABLE>
<CAPTION>
                                          1998         1997         1996
                                       ----------   ----------   ----------
<S>                                    <C>          <C>          <C>
Federal:
     Current.........................  $4,318,600   $4,157,200   $2,649,600
     Deferred........................    (164,100)    (287,700)      50,600
                                       ----------   ----------   ----------
          Total federal..............   4,154,500    3,869,500    2,700,200
State................................   1,390,800    1,171,400      794,100
                                       ----------   ----------   ----------
Provision for income taxes...........  $5,545,300   $5,040,900   $3,494,300
                                       ==========   ==========   ==========
</TABLE>
 
     A reconciliation of the statutory federal income tax rate and the effective
tax rate as a percentage of pretax income is as follows:
 
<TABLE>
<CAPTION>
                                                    1998     1997     1996
                                                    ----     ----     ----
<S>                                                 <C>      <C>      <C>
Statutory rate....................................  35.0%    34.0%    34.0%
State income taxes, net of federal income tax
  benefit.........................................   6.5      6.4      6.0
Other.............................................  (0.6)      --       --
                                                    ----     ----     ----
Effective tax rate................................  40.9%    40.4%    40.0%
                                                    ====     ====     ====
</TABLE>
 
4.  COMMON STOCK
 
     In May 1998, the Company's Board of Directors (the Board) declared a
two-for-one split of the Company's common stock. The 1998 stock split, effected
in the form of a stock dividend, was distributed on June 29, 1998 (to
stockholders of record on May 29, 1998). Earnings per share amounts shown in the
accompanying financial statements have been retroactively adjusted to reflect
the 1998 stock split.
 
5.  COMMITMENTS AND CONTINGENCIES
 
     Forward Exchange Contracts -- During 1998 and 1997, the Company entered
into forward exchange contracts with a bank whereby the Company is committed to
deliver foreign currency at predetermined rates. The contracts expire within one
year. The Company's future commitment under these contracts approximated
$494,000 and $2,500,000 as of December 31, 1998 and 1997, respectively. At
December 31, 1998 and 1997, the fair market value of the contracts approximated
their carrying amount.
 
     Other Commitments -- At December 31, 1998 and 1997, letters of credit
outstanding aggregated approximately $33,000 and $125,000, respectively.
 
     During 1994, the Company entered into an employment agreement with an
executive officer which provides for an annual salary of $100,000 through August
1999. On March 23, 1995, the Company entered into employment agreements (as
amended on January 16, 1997) with two key senior executive officers which
provide for aggregate annual base salaries through March 2000 of $391,000,
subject to any increases or decreases established from time to time at the
discretion of the Compensation Committee of the Board and, in the event of
termination, provide for noncompetition payments for two years equal to their
annual base salaries.
 
     As of July 1997, one of the above mentioned officers terminated employment
with the Company and pursuant to the terms of the employment agreement, the
Company is currently making noncompetition payments to him. Such payments under
the contract will be completed as of June 30, 1999.
 
                                      IV-12
<PAGE>   28
                              THE FIRST YEARS INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Contingencies -- The Company is involved in legal proceedings which have
arisen in the ordinary course of business. Management believes the outcome of
these proceedings will not have a material adverse impact on the Company's
financial condition or operating results.
 
6.  ROYALTIES
 
     During 1998 and 1997, the Company entered into various agreements which
provide for the payment of royalties on sales of certain character and patent
licensed products. The agreements have terms ranging from one to fifteen years
and require minimum royalty payments of $1,363,000 and $1,398,000 for agreements
signed during 1998 and 1997, respectively. Future outstanding minimum royalty
commitments under all agreements amounted to $289,000 and $650,000 at December
31, 1998 and 1997, respectively. Royalty expense aggregated $8,311,000,
$6,356,000 and $3,197,000 in 1998, 1997 and 1996, respectively.
 
7.  BENEFIT PLANS
 
     Defined Contribution Plans -- The Company has a defined contribution
trusteed benefit plan covering eligible employees, requiring annual
contributions based upon certain percentages of salaries of employees. The
Company's policy is to fund pension expense as accrued. Pension expense
aggregated $566,000, $545,000, and $472,000 in 1998, 1997, and 1996,
respectively. The Company sponsors a 401(k) defined contribution plan covering
substantially all Company employees pursuant to which the Company is obligated
to match, up to specified amounts, employee contributions. Company contributions
to this plan were not material for the periods presented.
 
     Stock Option Plans -- In May 1993, the Company's stockholders approved the
adoption of The First Years Inc. 1993 Equity Incentive Plan and The First Years
Inc. 1993 Stock Option Plan for Non-employee Directors (the "plans") which cover
employees and directors of the Company. The Board has reserved 2,680,000 shares
for issuance under the plans and 40,000 shares for another stock option plan
(all share amounts adjusted to reflect the two-for-one stock split effected on
June 29, 1998.) The exercise price for the options granted may not be less than
the fair market value of the optioned stock at the date of grant, 110% of fair
market value in the case of options granted to a 10% stockholder.
 
     Under the plans, employees of the Company may purchase stock on the
exercise of their options through the delivery of existing shares of the
Company's common stock. The shares delivered to the Company by the employee must
have been outstanding for at least six months. The Company acquired 14,576 and
6,818 shares of its common stock for the years ended December 3, 1998 and 1997,
respectively, through the exercise of employee stock options.
 
     Options granted must be exercised within the period prescribed by the
Committee; the options vest in accordance with the vesting provisions prescribed
at the time of grant.
 
                                      IV-13
<PAGE>   29
                              THE FIRST YEARS INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     A summary of activity (all years adjusted to reflect the two-for-one stock
split effected on June 29, 1998) of stock options granted under the plans is as
follows:
 
<TABLE>
<CAPTION>
                                                                WEIGHTED
                                                                AVERAGE
                                                                EXERCISE                  NUMBER OF
                                                                 PRICE       NUMBER OF     OPTIONS
                                                                  PER         OPTIONS     AVAILABLE
                                                                 SHARE      OUTSTANDING   FOR GRANT
                                                                --------    -----------   ---------
<S>                                                             <C>         <C>           <C>
January 1, 1996.............................................     $3.20        823,156       519,600
 
     Granted................................................      6.23        137,210      (137,210)
     Canceled...............................................      4.10        (17,114)       17,114
     Exercised..............................................      2.86        (67,676)           --
                                                                             --------     ---------
December 31, 1996...........................................      3.69        875,576       399,504
 
     Granted................................................      9.16        194,140      (194,140)
     Canceled...............................................      7.11        (56,610)       56,610
     Exercised..............................................      2.96       (278,040)           --
                                                                             --------     ---------
December 31, 1997...........................................      5.16        735,066       261,974
 
     Authorized.............................................                       --     1,340,000
     Granted................................................     14.51        258,029      (258,029)
     Canceled...............................................      9.96        (13,131)       13,131
     Exercised..............................................      3.27       (285,408)           --
                                                                             --------     ---------
December 31, 1998...........................................     $9.30        694,556     1,357,075
                                                                             ========     =========
 
     Exercisable at December 31, 1996.......................     $3.00        557,870
     Exercisable at December 31, 1997.......................     $3.66        465,712
     Exercisable at December 31, 1998.......................     $5.88        341,902
</TABLE>
 
     The grant date fair value for options granted in 1998, 1997 and 1996 was
$7.43, $4.80 and $2.09, respectively.
 
     The following table sets forth information regarding stock options
outstanding at December 31, 1998 under the Stock Option Plans as described
above:
 
<TABLE>
<CAPTION>
                                                                                  NUMBER        AVERAGE
              NUMBER                                   WEIGHTED    WEIGHTED      CURRENTLY     EXERCISE
            OF OPTIONS                 RANGE OF        AVERAGE      AVERAGE     EXERCISABLE    PRICE FOR
           OUTSTANDING                 EXERCISE        EXERCISE    REMAINING        AT          OPTIONS
           AT 12/31/98                  PRICES          PRICE        LIFE        12/31/98     EXERCISABLE
           -----------              ---------------    --------    ---------    -----------   -----------
<S>                                 <C>                <C>         <C>          <C>           <C>
 51,612...........................  $ 2.28 - $ 3.42     $ 2.49       1.32          51,612       $ 2.59
155,636...........................    3.42 -   5.13       4.64       2.96         155,636         4.67
 85,515...........................    5.13 -   7.70       6.07       3.04          57,010         6.17
116,931...........................    7.70 -  11.55       8.47       8.23          54,977         8.77
264,862...........................   11.55 -  17.32      14.15       9.34          22,667        14.23
 20,000...........................   17.32 -  25.99      17.75       9.58              --           --
--------                                                ------       ----         -------       ------
694,556...........................                      $ 9.30       6.08         341,902       $ 7.25
--------                                                ======       ====         =======       ======
--------
</TABLE>
 
                                      IV-14
<PAGE>   30
                              THE FIRST YEARS INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
PRO FORMA DISCLOSURES
 
     As described in Note 1, the Company applies the intrinsic value method of
APB No. 25 and related Interpretations in accounting for its stock option plans.
Accordingly, no compensation cost has been recognized for its stock option
plans. Had compensation cost been determined based on the fair value at the
grant dates for awards under those plans consistent with the method of FASB
Statement 123, the Company's net income and earnings per share for the years
ended December 31, 1998, 1997 and 1996 would have been as follows:
 
<TABLE>
<CAPTION>
                                           1998          1997         1996
                                           ----          ----         ----
<S>                                     <C>           <C>          <C>
Net income............................  $7,233,876    $7,023,195   $5,038,337
Basic earnings per share..............  $     0.70    $     0.70   $     0.53
Diluted earnings per share............  $     0.68    $     0.67   $     0.51
</TABLE>
 
     For purposes of the pro forma disclosures, the fair value of the options
granted under the Company's stock option plans during 1998, 1997 and 1996 was
estimated on the date of grant using the Binomial option pricing model. Key
assumptions used to apply this pricing model are as follows:
 
<TABLE>
<CAPTION>
                                            1998          1997         1996
                                            ----          ----         ----
<S>                                      <C>           <C>           <C>
Risk free interest rate................    5.49%         6.41%         6.08%
Expected life of option grants.........  7.85 years    9.5 years     4.5 years
Expected volatility of underlying
  stock................................    38.40%        35.27%       32.87%
Expected dividend payment rate.........    0.85%         0.85%         0.85%
</TABLE>
 
     The pro forma disclosures include the effects of options granted in 1998,
1997, 1996 and 1995.
 
8.  CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS
 
     Concentrations of Credit Risk -- Financial instruments which potentially
subject the Company to concentrations of credit risk consist principally of cash
equivalents, trade receivables and forward exchange contracts (see Note 5). The
Company's cash equivalents consist of money market funds placed with major banks
and financial institutions. The Company's trade receivables principally include
amounts due from retailers who are geographically dispersed. The Company's three
largest customers accounted for 57% and 54% of the trade receivables outstanding
at December 31, 1998 and 1997, respectively. The Company routinely assesses the
financial strength of its customers and purchases credit insurance to limit its
potential exposure to trade receivable credit risks. The Company routinely
assesses the financial strength of the bank which is the counterparty to the
forward exchange contracts. As of December 31, 1998, management believes it had
no significant exposure to credit risks.
 
     Major Customers and Export Sales -- The Company derived 10% or more of its
sales from its three largest customers. The Company's largest customer accounted
for sales of $42,622,000, $33,643,000, and $25,722,000 in 1998, 1997, and 1996,
respectively. The Company's second largest customer accounted for sales of
$24,413,000, $23,075,000, and $18,257,000 in 1998, 1997, and 1996, respectively.
The Company's third largest customer accounted for sales of $15,706,000,
$13,315,000 and 9,908,000 in 1998, 1997, and 1996. No other customer accounted
for 10% or more of the Company's sales. Export sales, primarily to Europe,
Canada, South America and the Pacific Rim, were approximately $16,735,000,
$16,250,000 and $11,564,000 in 1998, 1997, and 1996, respectively.
 
     Reliance on Licensed Products -- The Company derives a significant portion
of its sales from products under license. A major licensing agreement (see Note
6), which was to expire at the end of 1998, has been extended through March 31,
1999. Sales of products licensed under the agreement amounted to 42% of the
Company's total net sales for year ended December 31, 1998. Management is in the
process of negotiating a renewal of this agreement. While management expects the
licensing agreement to be renewed, non-renewal of
 
                                      IV-15
<PAGE>   31
                              THE FIRST YEARS INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
this licensing agreement or, renewal on terms not favorable to the Company could
have a material adverse affect on the Company's business.
 
     Reliance on Foreign Manufacturers -- The Company does not own or operate
its own manufacturing facilities. In 1998 and 1997, the Company derived
approximately 65% and 60%, respectively, of its net sales from products
manufactured by others in the Far East, mainly in the Peoples Republic of China.
A change in suppliers or disruptions in the normal supply channels resulting
form the Year 2000 Issue could cause a delay in manufacturing and a possible
loss of sales, which could affect operating results adversely, depending on the
particular product.
 
9.  COMPUTATION OF EARNINGS PER SHARE
 
     Computation of the earnings per share ("EPS") in accordance with SFAS No.
128 are as follows:
 
<TABLE>
<CAPTION>
                                                         1998            1997            1996
                                                         ----            ----            ----
<S>                                                   <C>             <C>             <C>
Average shares outstanding..........................  10,338,857      10,003,774       9,466,356
Effect of dilutive shares...........................     330,646         449,288         425,626
                                                      ----------      ----------      ----------
Average diluted shares outstanding..................  10,669,503      10,453,062       9,891,982
                                                      ==========      ==========      ==========
Net Income..........................................  $8,012,815      $7,444,789      $5,241,479
                                                      ==========      ==========      ==========
Basic earnings per share............................       $0.78           $0.75           $0.55
                                                           -----           -----           -----
                                                           -----           -----           -----
Diluted earnings per share..........................       $0.75           $0.71           $0.53
                                                           -----           -----           -----
                                                           -----           -----           -----
</TABLE>
 
     As of December 31, 1998, options to purchase 1,964, 20,000, 56,290, 12,000,
and 40,000 shares of common stock at $15 15/16, $17 3/4, $15, $17 and $15 per
share, respectively were not included in the computation of diluted EPS because
the options' exercise price was greater than the average price of the common
shares. The options, which expire in 2008, were still outstanding at the end of
1998.
 
     As of December 31, 1997, options to purchase 30,000 shares of common stock
at $13 1/2 per share were not included in the computation of diluted EPS because
the options' exercise price was greater than the average price of the common
shares. The options, which expire in 2007, were still outstanding at the end of
1997.
 
     As of December 31, 1996, options to purchase 12,000 shares of common stock
at $8 9/16 per share were not included in the computation of diluted EPS because
the options' exercise price was greater than the average price of the common
shares. The options, which expire in 2001, were still outstanding at the end of
1996.
 
10.  OFFERING OF COMMON STOCK
 
     During 1996, the Company entered into an agreement with a group of
underwriters to sell 3.2 million shares of common stock (the "shares"),
consisting of 800,000 newly issued shares and 2,400,000 shares of certain
selling stockholders. The closing of the sale was held on July 1, 1996 at which
time the Company issued 800,000 new shares and received the net proceeds of
$5,121,750. All shares have been adjusted to reflect the two-for-one stock split
effected on May 29, 1998.
 
11.  DIISONONYL PHTHALATE ISSUE
 
     During the fourth quarter of 1998, the Company incurred a charge relating
to sales returns and the write-off of inventory of certain products containing
diisononyl phthalate ("DINP"), a plastic softener. Although the results of a
study on DINP conducted by the U.S. Consumer Product Safety Commission resulted
in the Commission not recommending a ban on products containing DINP, some
retailers decided to return certain products containing this material.
 
                                      IV-16
<PAGE>   32
                              THE FIRST YEARS INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Net sales reflect a charge of $3,000,000 related to the sales returns of
certain DINP products. Accounts receivable have been reported net of the
$3,000,000 charge as customers are expected to take credits against outstanding
balances as of December 31, 1998. Cost of sales reflect a charge of $1,100,000
related to the write-off of inventory of certain products containing DINP.
Inventory has been reported net of the $1,100,000 charge. Net income for the
year ended December 31, 1998 reflects a total after-tax charge of $2,400,000
related to the DINP issue.
 
12.  SEGMENT INFORMATION
 
     During 1998, the Company adopted SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information." This statement establishes new
standards for the definition and disclosure of information pertaining to the
Company's business segments. SFAS No. 131 requires identification of segments
based upon a company's internal structure and reporting methodology.
 
     The Company has identified one operating segment as it engages in a single
line of business developing and marketing one class of similar products for
infants and toddlers distributed through the same channels.
 
     See footnote 8 for discussion of major customers and export sales.
 
                                  * * * * * *
 
                                      IV-17
<PAGE>   33
 
                                                                     SCHEDULE II
 
                              THE FIRST YEARS INC.
                       VALUATION AND QUALIFYING ACCOUNTS
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
<TABLE>
<CAPTION>
                                                               ADDITIONS
                                                  BALANCE,      CHARGED
                                                  BEGINNING   TO COSTS AND                    BALANCE
                  DESCRIPTION                      OF YEAR      EXPENSES      DEDUCTIONS    END OF YEAR
                  -----------                     ---------   ------------    ----------    -----------
<S>                                               <C>         <C>             <C>           <C>
Valuations Accounts Deducted from Assets to
  which they Apply --
     Allowance for doubtful accounts:
          1998..................................  $185,000     $  261,034      $176,034(1)  $  270,000
                                                  ========     ==========      ========     ==========
          1997..................................  $185,000     $  147,541      $147,541(1)  $  185,000
                                                  ========     ==========      ========     ==========
          1996..................................  $185,000     $  152,582      $152,582(1)  $  185,000
                                                  ========     ==========      ========     ==========
     Allowance for obsolete inventory:
          1998..................................  $250,000     $        0      $      0     $  250,000
                                                  ========     ==========      ========     ==========
          1997..................................  $      0     $  250,000      $      0     $  250,000
                                                  ========     ==========      ========     ==========
     Allowance for Diisononyl Phthalate product
       returns:
          1998..................................  $      0     $3,000,000      $126,000     $2,874,000
                                                  ========     ==========      ========     ==========
</TABLE>
 
---------------
(1) Net accounts written off.
 
                                      IV-18
<PAGE>   34
 
                              THE FIRST YEARS INC.
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
EXHIBIT                            DESCRIPTION
-------                            -----------
<C>        <S>
  10(n)    The First Years, a Massachusetts Corporation and Affiliates,
           1998 Annual Incentive Plan effective as of January 1, 1998.
  10(p)    Agreement between The First Years Inc. and Bruce Baron dated
           July 10, 1997.
  10(q)    Agreement between The First Years Inc. and James N. Turner
           dated June 15, 1998.
  21       List of Subsidiaries of the Registrant.
  23       Consent of Deloitte & Touche LLP dated March 31, 1999.
  27       Financial Data Schedule -- 12/31/98
  99       Important Factors Regarding Forward-Looking Statements
</TABLE>