-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, L8+ibYGFy5bWop1CTzqxwCk91c/aJl7PCe6sc/c8RByaQYAXE6cWK5BfIW8c/4kf kXAHXaLomBJojl43wLzc+g== 0000929624-98-001520.txt : 19980917 0000929624-98-001520.hdr.sgml : 19980917 ACCESSION NUMBER: 0000929624-98-001520 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980902 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 19980916 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: YES ENTERTAINMENT CORP CENTRAL INDEX KEY: 0000943747 STANDARD INDUSTRIAL CLASSIFICATION: GAMES, TOYS & CHILDREN'S VEHICLES (NO DOLLS & BICYCLES) [3944] IRS NUMBER: 943165290 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 000-25916 FILM NUMBER: 98709967 BUSINESS ADDRESS: STREET 1: 3875 HOPYARD RD STE 375 CITY: PLEASANTON STATE: CA ZIP: 94588 BUSINESS PHONE: 5108479444 MAIL ADDRESS: STREET 1: 3875 HOPYARD ROAD STREET 2: SUITE 375 CITY: PLEASANTON STATE: CA ZIP: 94588 8-K 1 FORM 8-K SECURITIES EXCHANGE AND COMMISSION Washington, D. C. 20549 ____________ FORM 8-K CURRENT REPORT ____________ Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Date of Report (Date of earliest event reported): September 2, 1998 YES! Entertainment Corporation --------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 0-25916 94-3165290 -------------- ------------------------------ ----------------- (State of (Commission File Number) (IRS Employer Incorporation) Identification No.) 3875 Hopyard Road, Suite 375, Pleasanton, California 94588 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (925) 847-9444 ---------------------------------------------------------- (Registrant's telephone number, including area code) Item 5. Other Events. ------------ On September 2, 1998, the Registrant entered into a Securities Exchange Agreement (the "Exchange Agreement") with certain of the Registrant's institutional investors (the "Investors") superseding an agreement entered into on July 25, 1997 (the "July Agreement") pursuant to which the Registrant had issued convertible subordinated debentures (the "July Debentures") and convertible preferred stock (the "July Shares"). The Registrant and the Investors agreed to supersede the July Agreement by entering into the Exchange Agreement and issuing new convertible subordinated debentures (the "Debentures") and convertible preferred stock ("Preferred Stock") in exchange for the Investors' remaining July Debentures and July Shares. The Exchange Agreement provides that the Investors will not convert the Debentures or Preferred Stock, or sell any shares of Preferred Stock, Common Stock or Debentures (subject to certain limited exceptions), in each case until the earlier of February 21, 1999 or the occurrence of an Event of Default (as defined in the Agreement). In addition, certain conversion and sale restrictions applicable to the July Shares and July Debentures do not apply to the Preferred Stock and the Debentures. The Exchange Agreement also requires the Registrant to call a meeting of the stockholders of the Registrant to (i) approve the issuance of all of the shares of Common Stock upon conversion of the Preferred Stock and Debentures (conversion is currently limited due to certain Nasdaq requirements which will no longer apply if such stockholder approval is obtained), and (ii) to increase the number of shares of Common Stock authorized for issuance. Failure of the Company to obtain such stockholder approval will constitute an Event of Default. The holders of the Preferred Stock are also entitled to elect two members to the Registrant's board of directors. These and other terms of the transactions referred to above are set forth in the Debentures, the Certificate of Designation relating to the Preferred Stock, and the Exchange Agreement, which are attached hereto as Exhibits 4.1, 4.2, and 4.3, respectively, and are incorporated by reference herein. The information set forth in the Registrant's Press Release dated September 3, 1998 relating to the above transactions is filed as Exhibit 99.1 hereto and is also incorporated by reference herein. Item 7. Exhibits -------- 4.1 Form of 5% Convertible Debenture due April 30, 2002. 4.2 Amended Certificate of Designation of Series C Preferred Shares. 4.3 Securities Exchange Agreement dated September 2, 1998. 99.1 Press release dated September 3, 1998. SIGNATURE Pursuant to the requirements 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. YES! ENTERTAINMENT CORPORATION Dated: September 15, 1998 By: /s/ Mark Shepherd ---------------------------- Mark Shepherd President and Chief Executive Officer INDEX TO EXHIBITS ----------------- Page number in sequentially numbered version ---------------- 4.1 Form of 5% Convertible Debenture due April 30, 2002. 5 4.2 Amended Certificate of Designation of Series C 23 Preferred Shares. 4.3 Securities Exchange Agreement dated September 2, 1998. 41 99.1 Press Release dated, September 3, 1998 63 EX-4.1 2 FORM OF 5% CONVERTIBLE DEBENETURE DUE 04/30/2002 EXHIBIT 4.1 NEITHER THIS DEBENTURE NOR THE SECURITIES INTO WHICH THIS DEBENTURE IS CONVERTIBLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER REGULATION D PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM THE REGISTRATION REQUIREMENTS THEREUNDER, AND IN COMPLIANCE WITH APPLICABLE STATE SECURITIES LAWS. THIS DEBENTURE IS SUBJECT TO CERTAIN RESTRICTIONS ON TRANSFER AND CONVERSION SET FORTH IN A SECURITIES EXCHANGE AGREEMENT, DATED AUGUST 28, 1998, BETWEEN YES! ENTERTAINMENT CORPORATION ("THE COMPANY") AND THE ORIGINAL HOLDER HEREOF. A COPY OF THAT AGREEMENT IS ON FILE AT THE PRINCIPAL OFFICE OF THE COMPANY. No. [_] $[ ] YES! ENTERTAINMENT CORPORATION 5% CONVERTIBLE DEBENTURE DUE APRIL 30, 2002 THIS DEBENTURE is one of a duly authorized issue of debentures of YES! Entertainment Corporation, a corporation organized and existing under the laws of Delaware and having a principal place of business at 3875 Hopyard Road, Suite 375, Pleasanton, California 94588 (the "Company"), designated as its 5% Convertible Debentures, due April 30, 2002 (the "Debentures"), in an aggregate principal amount of $[ ]. This Debenture supersedes in its entirety the Debentures of like tenor, issued by the Company to the Holder on or after July 25, 1997. FOR VALUE RECEIVED, the Company promises to pay to [ ], or its registered assigns (the "Holder"), the principal sum of [ ] ($[ ]) (together with all additional sums of deferred interest added to the principal balance of this Debenture as provided below) on April 30, 2002 or such earlier date as the Debentures are required to be repaid as provided hereunder (the "Maturity Date") with interest (calculated on the basis of a 360- day year and for the actual number of days elapsed) accruing on the unpaid balance thereof from the date hereof at the rate of 5% per annum, payable (i) on the last day of March, June, September and December of each year, commencing September 30, 1998; (ii) upon conversion; or (iii) upon the Maturity Date if not earlier converted. Accrued interest on this Debenture shall, at the Company's option, be (i) paid in cash or (ii) added to the outstanding principal balance of this Debenture with effect as of the day such interest is payable. Interest 1 hereunder will be paid to the person in whose name this Debenture (or one or more predecessor Debentures) is registered on the records of the Company regarding registration and transfers of the Debentures (the "Debenture Register"); provided, however, that the Company's obligation to a transferee of this Debenture arises only if such transfer, sale or other disposition is made in accordance with the terms and conditions hereof and of the Purchase Agreement (as hereafter defined). All overdue amounts hereunder shall bear interest at the rate of 15% per annum from the date such payment is due. Subject to the foregoing, the principal of, and interest on, this Debenture are payable in such coin or currency of the United States of America as at the time of payment is legal tender for payment of public and private debts, at the address of the Holder last appearing on the Debenture Register. A transfer of the right to receive principal and interest under this Debenture shall be transferable only through an appropriate entry in the Debenture Register as provided herein. This Debenture is subject to the following additional provisions: SECTION 1. The Debentures are exchangeable for an equal aggregate principal amount of Debentures of different authorized denominations, as requested by the Holder surrendering the same but shall not be issuable in denominations of less than integral multiplies of Fifty Thousand Dollars ($50,000). No service charge will be made for such registration of transfer or exchange. SECTION 2. This Debenture has been issued subject to certain investment representations of the original Holder set forth in the Purchase Agreement and may be transferred or exchanged only in compliance with the Securities Act, pursuant to an effective registration statement or pursuant to an available exemption from the registration requirements under the Securities Act. Prior to due presentment to the Company for transfer of this Debenture, the Company and any agent of the Company may treat the person in whose name this Debenture is duly registered on the Debenture Register as the owner hereof for the purpose of receiving payment as herein provided and for all other purposes, whether or not this Debenture is overdue, and neither the Company nor any such agent shall be affected by notice to the contrary. SECTION 3. EVENTS OF DEFAULT. "Event of Default," wherever used herein, means any one of the following events (whatever the reason and whether it shall be voluntary or involuntary or effected by operation of law or pursuant to any judgment, decree or order of any court, or any order, rule or regulation of any administrative or governmental body): (a) any default in the payment of the principal of or interest on this Debenture as and when the same shall become due and payable, either on the Conversion Date (as hereafter defined) or the Maturity Date, by acceleration or otherwise. (b) the Company shall fail to timely observe or perform any other covenant, agreement or warranty contained in, or otherwise commit any breach of, this Debenture, the Purchase Agreement, the Certificate of Designation of the Series C Preferred Stock of the Company (the "Certificate of Designation") or the Amended and Restated Registration Rights 2 Agreement, dated July 25, 1997 (the "Registration Rights Agreement"), and such failure or breach shall not have been remedied within five (5) Business Days thereafter or such other cure period as may specifically be provided herein or in such other agreements with respect to any particular covenant, agreement or warranty; (c) the Company or any of its subsidiaries shall commence a voluntary case under the United States Bankruptcy Code as now or hereafter in effect or any successor thereto (the "Bankruptcy Code"); or an involuntary case is commenced against the Company under the Bankruptcy Code and the petition is not controverted within thirty (30) days, or is not dismissed within sixty (60) days, after commencement of such involuntary case; or a "custodian" (as defined in the Bankruptcy Code) is appointed for, or takes charge of, all or any substantial part of the property of the Company or the Company commences any other proceeding under any reorganization, arrangement, adjustment of debt, relief of debtors, dissolution, insolvency or liquidation or similar law of any jurisdiction whether now or hereafter in effect relating to the Company or there is commenced against the Company any such proceeding which remains undismissed for a period of sixty (60) days; or the Company is adjudicated insolvent or bankrupt; or any order of relief or other order approving any such case or proceeding is entered; or the Company suffers any appointment of any custodian or the like for it or any substantial part of its property which continues undischarged or unstayed for a period of sixty (60) days; or the Company makes a general assignment for the benefit of creditors; or the Company shall call a meeting of its creditors with a view to arranging a composition or adjustment of its debts; or the Company shall by any act or failure to act indicate its consent to, approval of or acquiescence in any of the foregoing; or any corporate or other action is taken by the Company for the purpose of effecting any of the foregoing; (d) the Company shall fail to pay any amount of principal or interest on any mortgage, credit agreement or other facility, indenture or other instrument under which there may be issued, or by which there may be secured or evidenced, any indebtedness of the Company in an amount exceeding one hundred thousand dollars ($100,000) (collectively, "Indebtedness"), whether such Indebtedness now exists or shall hereafter be created, when and as the same shall become due and payable, or the Company shall fail to observe or perform any term, covenant or agreement contained in any agreement or instrument evidencing or governing any of such Indebtedness if the cure period for such term, covenant or agreement contained in such agreement or instrument has run and the holder or holders of such Indebtedness or a trustee on their behalf shall have the right to cause such Indebtedness to become due prior to its stated maturity; (e) the Company shall dispose of all or substantially all of its assets in one or more transactions or shall be a party to any business combination pursuant to which the Company shall not be the surviving entity, except if, upon the effectiveness of such a business combination, (i) the holders of the Common Stock immediately prior to such effectiveness beneficially own (as determined under Rule 13d-3 promulgated under the Exchange Act in the aggregate, 66 2/3% or more of the voting power of such surviving entity and (ii) no Person or group (as described in Rule 13d-5(b) promulgated under the Exchange Act) who was not a holder 3 of the Common Stock immediately prior to such business combination beneficially owns in excess of 16 2/3% of the voting power of such surviving entity; (f) the Company shall redeem or repurchase more than ten thousand (10,000) of its outstanding shares of Common Stock, other than a redemption or repurchase of an employee's Common Stock upon termination of such employee's employment with the Company for any reason and other than a redemption of shares of Series B Convertible Preferred Stock (the "Series B Preferred") issued pursuant to the Certificate of Designation; or (g) the entry of any judgments against the Company aggregating more than two hundred fifty thousand dollars ($250,000) (except in connection with litigation specifically scheduled in paragraph 3 of Schedule 3.1 (g) to the Purchase Agreement). If any Event of Default occurs and is continuing, and in every such case, then so long as such Event of Default shall then be continuing, Holders of a majority of the aggregate principal amount of Debentures then outstanding may, by notice to the Company, declare the full outstanding principal amount of this Debenture, together with all accrued but unpaid interest thereon and other amounts owing hereunder, through the date of acceleration to be, whereupon the same shall become, immediately due and payable without presentment, demand, protest or other notice of any kind, all of which are waived by the Company, notwithstanding anything herein contained to the contrary, and the Holder may immediately and without expiration of any grace period enforce any and all of its rights and remedies hereunder and all other remedies available to it under applicable law. Such declaration may be rescinded and annulled by Holder at any time prior to payment hereunder. No such rescission or annulment shall affect any subsequent Event of Default or impair any right consequent thereon. SECTION 4. CONVERSION. (a) CONVERSION AT HOLDER'S OPTION. This Debenture shall be convertible in whole or in part into shares of Common Stock (as hereafter defined) (subject to reduction pursuant to Section 4(b)) at the option of the Holder in whole or in part at any time and from time to time and prior to 7:30 p.m. (Eastern Standard Time) on the Maturity Date at the Conversion Ratio (as hereafter defined), as adjusted to give effect to any and all Adjustment Events (as hereafter defined) occurring prior to conversion. The Holder shall effect conversions by surrendering to the Transfer Agent (as hereafter defined) the Debentures (or such portions thereof) to be converted and to the Company and the Transfer Agent deliver a conversion notice in the form attached hereto as Exhibit A (the "Conversion Notice"). Each Conversion Notice shall specify the principal amount (and the amount of accrued but unpaid interest thereon) of Debentures to be converted and the date on which conversion is to be effected (the "Conversion Date"), which date may not be prior to the date the Holder delivers such Conversion Notice by facsimile. If no Conversion Date is specified in a Conversion Notice, the Conversion Date shall be the date that the Conversion Notice is deemed deliverable pursuant to Section 4(i). Subject to Section 4(b), each Conversion Notice, once given, shall be irrevocable unless the Company fails to deliver a certificate or certificates representing the underlying Common Stock pursuant to Section 4(d) within 3 Trading Days of the Conversion Date, at which time or any time thereafter 4 the holder of the Debentures may, at its option either (a) cancel the Conversion Notice or (b) elect to have the Common Stock issuable upon conversion of this Debenture deemed to be issued and outstanding and held as of record as of the Conversion Date by the holder of this Debenture which sent the Conversion Notice. If a Holder is converting less than all of the principal amount represented by the Debentures tendered by such Holder with the Conversion Notice, or if a conversion hereunder cannot be effected in full for any reason, the Company shall promptly deliver to such Holder (in the manner within the time set forth in Section 4(d)) a new Debenture for such principal amount as has not been converted. (b) CERTAIN REGULATORY APPROVAL. (i) The Company shall have until December 21, 1998 to obtain Stockholder Approval (as defined below) of the issuance of Common Stock upon conversion/exercise of the Series C Preferred, the Debentures and the Warrants (each as defined in the Purchase Agreement). In the event the Company has not obtained such Stockholder Approval by December 21, 1998, then, unless the holder of this Debenture on such date shall have delivered written notice to the Company that this Debenture shall not be redeemed pursuant to this subsection (b)(i), the Company shall within five business days thereafter repay all of the principal amount (and the amount of accrued but unpaid interest thereon) of Debentures then outstanding at a price equal to the Prepayment Price. If Company fails for any reason to pay the Prepayment Price on or prior to December 23, 1998, if required, the Company will pay interest on such Prepayment Price at a rate of 20% per annum to the Holder, accruing from December 21, 1998 until the Prepayment Price plus any accrued interest thereon is paid in full. The entire Prepayment Price, including interest thereon, shall be paid in cash. "Stockholder Approval" means the approval by a majority of the total votes cast on the proposal, in person or by proxy, at a meeting of the stockholders of the Company held in accordance with the Company's certificate of incorporation and by-laws, of (A) the issuance by the Company of shares of Common Stock pursuant to the conversion/exercise of Series C Preferred, the Debentures and the Warrants (each as defined in the Purchase Agreement) into Common Stock as and to the extent required pursuant to Rule 4460(i) of the Nasdaq Stock Market (or any successor or replacement provision thereof) and (B) an increase in the authorized number of shares of Common Stock sufficient to cause the number of authorized and unissued and unreserved shares of Common Stock on such date to exceed by at least 10 million shares the number of shares of Common Stock issuable upon the conversion and exercise of all of the outstanding shares of Series B Preferred and Series C Preferred, the July Debentures, the Debentures and the Warrants. (ii) If on a Conversion Date (A) the Common Stock is then listed for trading on the Nasdaq National Market or, if the rules of the Nasdaq Stock Market are hereafter amended to extend Rule 4460(i) promulgated thereby (or by a successor or replacement provision thereof) to the Nasdaq SmallCap Market, on the Nasdaq SmallCap Market, (B) the Conversion Ratio, as adjusted to give effect to any and all Adjustment Events occurring prior to conversion, is such that the aggregate number of shares of Common Stock that would then be issuable upon conversion of all outstanding shares of Series C Preferred and Debentures, would equal or exceed 20% of the number of shares of Common Stock outstanding on the Conversion Date (the "Issuable Maximum"), and (C) the Company has not previously obtained Stockholder 5 Approval, then the Company shall issue to the converting holder of this Debenture up to the Issuable Maximum (and no more). (c) AUTOMATIC CONVERSION. If the Company shall have obtained Stockholder Approval of the issuance of the Common Stock upon conversion of the Debentures on or prior to December 21, 1998, then the principal amount of (and accrued but unpaid interest thereon) any and all Debentures outstanding on April 30, 2002 (the "Automatic Conversion Date") shall be automatically converted into fully paid and nonassessable shares of Common Stock, at the Conversion Ratio, as adjusted to give effect to any and all prior Adjustment Events prior to conversion, in the manner provided herein. (d) DELIVERY OF CERTIFICATES. Not later than three (3) Trading Days after a Conversion Date or the Automatic Conversion Date, the Company shall cause the Transfer Agent (as hereafter defined) to deliver to the Holder (i) a certificate or certificates, representing the number of shares of Common Stock being acquired upon the conversion of Debentures (subject to reduction pursuant to Section 5(b)(ii)) and (ii) Debentures in a principal amount equal to the principal amount of Debentures tendered in connection with a conversion hereunder but not converted. Any certificates representing shares of Common Stock to be delivered upon a conversion hereunder shall be free of restrictive legends and trading restrictions, except those specified in Section 4.1(b) of the Purchase Agreement. The Company shall not be obligated to issue certificates evidencing the shares of Common Stock issuable upon conversion of any Debentures to be converted are either delivered to the Transfer Agent for conversion, or until the Holder notifies the Company that such Debentures have been lost, stolen or destroyed and provides a bond reasonably satisfactory to the Company (or other adequate security reasonably acceptable to the Company) to indemnify the Company from any loss incurred by it in connection therewith. The Company shall, upon request of the Holder, use its best efforts to deliver any Debentures required to be delivered by the Company under this Section electronically through the Depository Trust Corporation or another established clearing corporation performing similar functions. If such certificate or certificates are not delivered within ten (10) Trading Days after a Conversion Date, the holder shall be entitled to rescind such Conversion Notice upon written notice to the Company, in which event the Company shall immediately instruct the Transfer Agent to return the Debentures subject to such Conversion Notice that were tendered for conversion. The Company shall pay to the converting Holder, as liquidated damages and not as penalty, $3,000 for each day that the Company fails to deliver such certificate or certificates pursuant to this Section commencing after the fifth (5th) Trading Day after the applicable Conversion Date or Automatic Conversion Date. In addition, if the Company fails to deliver to the Holder such Debentures pursuant to this Section prior to a fifteenth (15th) day after the Conversion Date or Automatic Conversion Date, the Company shall, at the Holder's option, repay the principal amount of (and accrued but unpaid interest on) the Debentures then held by such Holder, as requested by such Holder, in an amount equal to the Prepayment Price calculated as of the Conversion Date or Automatic Conversion Date (which date may be referred to herein as a "Prepayment Date"). If the Holder has requested that the Company repay the Debentures pursuant to this Section and the Company fails for any reason to pay the Prepayment Price hereunder within five (5) Business Days after such notice, the Company will pay interest on such Prepayment Price at a rate of 17% per annum, in cash to such 6 Holder, accruing from such fifth (5th) Business Day until such Prepayment Price and any accrued but unpaid interest thereon is paid in full. (e) ADJUSTMENTS. (i) The following events shall be deemed to be "Adjustment Events:" A. If the Company, at any time while any Debentures are outstanding, (a) shall pay a stock dividend or otherwise make a distribution or distributions on shares of its Junior Securities payable in shares of either Common Stock or of capital stock of any class (whether payable in shares of its Common Stock or of capital stock of any class), (b) subdivide outstanding shares of Common Stock into a larger number of shares, or (c) combine outstanding shares of Common Stock into a smaller number of shares. B. If the Company, at any time while any Debentures are outstanding, shall issue rights or warrants to all Holders of Common Stock entitling them to subscribe for or purchase shares of Common Stock at a price per share less than the Per Share Market Price of Common Stock as calculated on the record date. C. If the Company, at any time while any Debentures are outstanding, shall distribute to all Holders of Common Stock (and not to the Holders) evidences of its indebtedness or assets or rights or warrants to subscribe for or purchase any security (excluding those referred to in Sections 4(e)(i)(A) and (i)(B) above). (ii) ADJUSTMENT FOR STOCK SPLITS, COMBINATIONS. If an Adjustment Event described in 4(e)(i)(A) occurs, then the Conversion Ratio, as adjusted to give effect to all prior Adjustment Events, shall be multiplied by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding before such event and the denominator of which shall be the number of shares of Common Stock outstanding after such event. Any adjustment computed pursuant to this Section 4(e)(ii) shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision or combination. (iii) ADJUSTMENT FOR ISSUANCES TO COMMON STOCKHOLDERS. If an Adjustment Event described in 4(e)(i)(B) occurs, then Conversion Ratio, as adjusted to give effect to all prior Adjustment Events, shall be multiplied by a fraction, the numerator of which shall be the number of shares of Common Stock (excluding treasury shares, if any, but including warrants or options that would be included for purposes of determining earnings per share in accordance with generally accepted accounting principles) outstanding on the date of issuance of such rights or warrants plus the number of shares which the aggregate offering price of the total number of shares so offered would purchase at such Per Share Market Price, and the denominator of which shall be the number of shares of Common Stock (excluding treasury shares, if any, but including warrants or options that would be included for purposes of determining earnings per share in accordance with generally accepted accounting principles) outstanding on the date of issuance of such rights or warrants plus the number of additional shares of Common Stock 7 offered for subscription or purchase. Such adjustment shall be calculated whenever such rights or warrants are issued, and shall become effective immediately after the record date for the determination of stockholders entitled to receive such rights or warrants. However, upon the expiration of any right or warrant to purchase Common Stock the issuance of which resulted in an adjustment pursuant to this Section 4(e)(iii), if any such right or warrant shall expire and shall not have been exercised, such adjustment shall immediately upon such expiration be recomputed as if the adjustment calculated upon the issuance of such rights or warrants been calculated on the basis of offering for subscription or purchase only that number of shares of Common Stock actually purchased upon the exercise of such rights or warrants actually exercised. (iv) ADJUSTMENT FOR DISTRIBUTION OF EVIDENCES OF INDEBTEDNESS OR ASSETS TO COMMON STOCKHOLDERS. If an Adjustment Event described in 4(e)(i)(C) occurs, then the Conversion Ratio, as adjusted to give effect to all prior Adjustment Events, shall be multiplied by a fraction the numerator of which shall be such Per Share Market Price on such record date less the then fair market value at such record date of the portion of such assets or evidence of indebtedness so distributed applicable to one outstanding share of Common Stock as determined by the Board of Directors in good faith, and the denominator of which shall be the Per Share Market Price determined as of such record date; provided, however, that in the event of a distribution exceeding ten percent (10%) of the net assets of the Company, such fair market value shall be determined by a nationally recognized or major regional investment banking firm or firm of independent certified public accountants of recognized standing (which may be the firm that regularly examines the financial statements of the Company) (an "Appraiser") selected in good faith by the Holders; and provided, further, that the Company, after receipt of the determination by such Appraiser shall have the right to select an additional Appraiser, in good faith, in which case the fair market value shall be equal to the average of the determinations by each such Appraiser. Such adjustment shall be calculated whenever any such distribution is made and shall become applicable immediately after the record date mentioned above. (v) Upon the occurrence of an Adjustment Event, the Company shall promptly to mail to each Holder a notice setting forth (a) the adjustment to the Conversion Ratio required by the Adjustment Event at issue, (b) the cumulative adjustment to which the Conversion Ratio shall be subject after the Adjustment Event, giving effect to any and all prior Adjustment Events, and (c) a brief statement of the facts requiring the adjustment at issue. (vi) ROUNDING. All calculations under this Section 4 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. (vii) RECLASSIFICATIONS OR SHARE EXCHANGE. In case of any reclassification of the Common Stock or any compulsory share exchange pursuant to which the Common Stock is converted into other securities, cash or property, the Holder shall have the right thereafter to, at their option, (A) convert the principal amount of (and accrued but unpaid interest on) this Debenture into the shares of stock and other securities, cash and property receivable upon or deemed to be held by holders of Common Stock following such reclassification or compulsory share exchange, and the Holder shall be entitled upon such event to receive such amount of securities or property as the shares of the Common Stock of the 8 Company into which the principal amount (and accrued and unpaid interest thereon) of the Debentures could have been converted immediately prior to such event or (B) require the Company to repay the principal amount (and all accrued and unpaid interest thereon) of the Debentures. (viii) CERTAIN EVENTS. The Company shall not effect any of the following actions prior to obtaining Stockholder Approval of the issuance of the Common Stock upon conversion of the Debentures: A. declare a dividend (or any other distribution) on its Common Stock (other than a subdivision of the outstanding shares of Common Stock); or B. declare a special nonrecurring cash dividend on or authorize a repurchase or redemption of more than ten thousand (10,000) shares of its then outstanding Common Stock, other than a repurchase or redemption of the Common Stock of an employee upon termination of employment with the Company for any reason; or C. authorize the granting to all Holders of the Common Stock rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights; or D. any reclassification of the Common Stock (other than a subdivision or combination of then outstanding shares of Common Stock), any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, or any compulsory share exchange whereby the Common Stock is converted into other securities, cash or property; or E. authorize the voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company. After obtaining such Stockholder Approval, in the event any of the foregoing actions occur, then the Company shall cause to be filed at each office or agency maintained for the purpose of conversion of Debentures and shall cause to be mailed to the Holders at its last addresses as shall appear on the Debenture Register, at least thirty (30) calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the Holders of Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer, share exchange, dissolution, liquidation or winding-up is expected to become effective, and the date as of which it is expected that Holders of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities, cash, or other property deliverable upon such reclassification, consolidation, merger, sale, transfer, share exchange, dissolution, liquidation or winding-up; provided, however, that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. 9 (f) RESERVATION OF COMMON STOCK. The Company covenants, from and after obtaining Stockholder Approval, that it shall at all times reserve and keep available out of its authorized and unissued Common Stock solely for the purpose of issuance upon conversion of Debentures, as herein provided, free from preemptive rights or any other actual contingent purchase rights of persons other than the Holder, such number of shares of Common Stock as shall be issuable upon the conversion of the aggregate principal amount of all outstanding Debentures. The Company covenants that all shares of Common Stock that shall be so issuable shall, upon issue, be duly and validly authorized, issued and fully paid and nonassessable. (g) FRACTIONAL SHARES. Upon a conversion hereunder the Company shall not be required to issue stock certificates representing fractions of shares of Common Stock, but may if otherwise permitted, make a cash payment in respect of any final fraction of a share based on the Per Share Market Price at such time. If the Company elects not to, or is unable to, make such a cash payment, the Holder shall be entitled to receive, in lieu of the final fraction of a share, one whole share of Common Stock. (h) CERTIFICATES. The issuance of certificates for shares of Common Stock on conversion of Debentures shall be made without charge to the Holders thereof for any documentary stamp or similar taxes that may be payable in respect of the issue or delivery of such certificate, provided that the Company shall not be required to pay any tax that may be payable in respect of any transfer involved in the issuance and delivery of any such certificate upon conversion in a name other than that of the Holder. (i) NOTICE. Any and all notices or other communications or deliveries to be provided by the Holder hereunder, including, without limitation, any Holder Conversion Notice, shall be in writing and delivered personally, by facsimile, sent by a nationally recognized overnight courier service or sent by certified or registered mail, postage prepaid, addressed to the attention of the Chief Financial Officer of the Company at the facsimile telephone number or address of the principal place of business of the Company, and if applicable, to the Transfer Agent. Any and all notices or other communications or deliveries to be provided by the Company hereunder shall be in writing and delivered personally, by facsimile, sent by a nationally recognized overnight courier service or sent by certified or registered mail, postage prepaid, addressed to the Holder at the facsimile telephone number or address of such Holder appearing on the books of the Company, or if no such facsimile telephone number or address appears, at the principal place of business of the Holder. Any notice or other communication or deliveries hereunder shall be deemed given and effective on the earliest of (i) the date of transmission, if delivered via facsimile at the facsimile telephone number specified in the Purchase Agreement prior to 4:30 p.m. (Eastern Standard Time) on a Trading Day, (ii) the Trading Day after the transmission, if delivered via facsimile at the facsimile telephone number specified in the Purchase Agreement later than 4:30 p.m. (Eastern Standard Time) on any date and earlier than 11:59 p.m. (Eastern Standard Time) on such date, (iii) the Trading Day following the date of mailing, if sent by nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. 10 SECTION 5. PREPAYMENT BY THE COMPANY. (a) OPTIONAL PREPAYMENT BY COMPANY. (i) The Company shall have the right, exercisable at any time after or concurrent with such time as all shares of Series B Preferred have been converted or redeemed upon fifteen (15) Trading Days notice to the Holders (the "Optional Prepayment Notice"), to prepay all of the principal amount of the Debentures then outstanding at the Prepayment Price calculated on the date of the Optional Prepayment Notice (which date may be referred to herein as a "Prepayment Date"); provided, however, that the Company shall not redeem the Debentures from a holder without simultaneously repaying any and all indebtedness owed to such holder of Debentures. The entire Prepayment Price shall be paid in cash. (ii) The holders of the Debentures shall have until the Redemption Date to convert any and all Debentures into shares of Common Stock by delivering a Conversion Notice on or prior to the date that is the business day before the Redemption Date. On or after the Prepayment Date, no Holder shall have the right to continue to convert Debentures which have been noticed for redemption. (iii) On or before the fifth Trading Day after the Optional Prepayment Date, the Holder shall deliver to the Company the Debentures subject to the Optional Prepayment Notice that have not been previously tendered for conversion and the Company shall deliver a sum equal to the Prepayment Price as calculated on the Prepayment Date. (iv) Notwithstanding the other provisions of this Section 5, in the event the Company effects a merger, redemption, consolidation, recapitalization, sale of all or substantially all of its assets or other business combination within 90 days of the Redemption Date and the Redemption Price is less than the consideration that the Holders of the Debentures would have received upon conversion of the Debentures into Common Stock pursuant to such subsequent Event (the "Subsequent Consideration") then, prior to or concurrently with such transaction the Company shall pay to the former holders of the Debentures that were redeemed on the Redemption Date the difference between the Subsequent Consideration and the Redemption Price. (b) LIQUIDATED DAMAGES. If the Optional Prepayment Price shall not be paid in full on or before the fifteenth Trading Day after the Prepayment Date, the Company shall pay to the holders of Debentures subject to Redemption as liquidated damages and not as a penalty the sum of seven thousand five hundred dollars ($7,500) per day in cash until such Optional Prepayment Price, together with all such liquidated damages, is paid in full. In addition, if the Company shall have failed to pay any portion of the Optional Prepayment Price on or before the eighteenth Trading Day after the Prepayment Date, then the Holder may demand that the Company (i) convert all or any portion of the principal amount of the Debentures for which the Optional Prepayment Price shall not have been paid (the "Unpaid Principal Portion") at a Conversion Price calculated as at the date of the Optional Prepayment Notice or the date of such conversion, whichever is lower, or (ii) promptly issue to the Holders new Debentures for a principal amount equal to the Unpaid Principal Portion. 11 (c) BNY CONSENTS. Notwithstanding anything to the contrary contained herein, so long as the BNY Bank Obligations are outstanding, the Company shall not deliver an Optional Prepayment Notice unless (i) there are no outstanding Debentures or all outstanding Debentures are subject to a delivered redemption notice and (ii) it has received (and furnished to the Holder evidence thereof reasonably satisfactory to it or) prior written consent of BNY to make such prepayment free from the subordination provisions of Section 8 hereof. SECTION 6. DEFINITIONS. For the purposes hereof, the following terms shall have the following meanings: "AUTOMATIC CONVERSION DATE" is as defined in Section 4(c). "BNY" means BNY Financial Corporation, 1290 Avenue of the Americas, New York, New York 10104. "BNY BANK OBLIGATIONS" means the borrowings and interest due thereon (including, without limitation, any interest accruing after the commencement of any case, proceeding or other action relating to the liquidation, dissolution, assignment for the benefit of creditors, receivership, arrangement, bankruptcy, insolvency or reorganization of the Company regardless of whether such interest is allowable, payable or accruable to BNY in such case, proceeding or other action) under the Receivables Agreement, as the same may from time to time be amended, supplemented, otherwise modified, replaced or refinanced. "BUSINESS DAY" means any day of the year on which commercial banks are not required or authorized to be closed in New York City. "CLOSING DATE" is as defined in the Purchase Agreement. "COMMON STOCK" means shares now or hereafter authorized of the class of Common Stock, par value $.001 per share, of the Company, stock of any other class into which such shares may hereafter be reclassified or changed and any other equity securities of the Company hereafter designated as Common Stock. "CONVERSION DATE" is as defined in Section 4(d). "CONVERSION NOTICE" is as defined in Section 4(d). "CONVERSION PRICE" shall mean, as of any date of determination, the product of (a) the Relevant Percentage as of the date of conversion and (b) the lowest Per Share Market Price during the Measurement Period immediately preceding the date of conversion; provided, however, that the Conversion Price shall not exceed the product of (x) 81.25% and (y) the average Per Share Market Price for the period from April 1, 1998 to and including April 30, 1998 (the "Maximum Conversion Price"). "CONVERSION RATIO" means a fraction of the numerator which is one (1) the denominator of which is the Conversion Price. 12 "DEBENTURE REGISTER" is as defined in paragraph two (2) of this Debenture. "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended. "ISSUABLE MAXIMUM" is as defined in Section 4(d). "JULY DEBENTURES" is as defined in the Purchase Agreement. "JUNIOR SECURITIES" means the Common Stock, all other equity securities of the Company and all other debt that is subordinated to the Debentures by its terms. "MAXIMUM CONVERSION PRICE" is as defined in the definition of "Conversion Price." "MEASUREMENT PERIOD" shall mean 30 Trading Days. "OPTIONAL PREPAYMENT NOTICE" is as defined in Section 5(a)(i). "MATURITY DATE" is as defined in paragraph two (2) of this Debenture. "PER SHARE MARKET PRICE" means on any date of determination (a) the lowest reported sales price per share of the Common Stock on such date on the Nasdaq National Market or other stock exchange on which the Common Stock is then listed, as reported on Bloomberg, L.P., or (b) if the Common Stock is not listed on the Nasdaq National Market or such other stock exchange, the lowest reported sales price for a share of Common Stock in the Nasdaq SmallCap Market, as reported on Bloomberg, L.P. (or similar organization or agency succeeding to its functions of reporting prices), or (c) if the Common Stock is no longer reported on Bloomberg, L.P. (or similar organization or agency succeeding to its functions of reporting prices), then the average of the "Pink Sheet" quotes for the relevant conversion period as determined by the Holder, or (d) if the Common Stock is no longer publicly traded, the fair market value of a share of Common Stock as determined by an Appraiser selected in good faith by the holders of a majority of principal amount of outstanding Debentures; provided, however, that the Company, after receipt of the determination by such Appraiser, shall have the right to select an additional Appraiser, in which case, the fair market value shall be equal to the average of the determinations by each such Appraiser. "PERSON" means an individual or a corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or political subdivision thereof) or other entity of any kind. "PREPAYMENT DATE" is as defined in Section 4(e) if in connection with a Conversion Notice and as defined in Section 5(a)(i) if in connection with an Optional Prepayment Notice. "PREPAYMENT PRICE" shall mean, as of any Prepayment Date a quotient equal to (i) the principal amount of (and accrued but unpaid interest thereon) the Debentures to be repaid, and (ii) the Relevant Percentage as of the Prepayment Date. 13 "PURCHASE AGREEMENT" means the Securities Exchange Agreement, dated August 28, 1998, as amended from time to time. "RECEIVABLES AGREEMENT" means the Accounts Receivable Management and Security Agreement, dated as of July 31, 1995, among the Company and BNY. "REGISTRATION RIGHTS AGREEMENT" is as defined in Section 3(b). "RELEVANT PERCENTAGE" shall mean 81.25%. "SECURITIES ACT" means the Securities Act of 1933, as amended. "SERIES C PREFERRED" means the Series C Preferred Stock designated in the Series C Certificate of Designation. "STOCKHOLDER APPROVAL" is as defined in Section 4(b). "TRADING DAY" means (a) a day on which the Common Stock is traded on the Nasdaq National Market or Nasdaq SmallCap Market or principal national securities exchange or market on which the Common Stock has been listed or quoted, or (b) if the Common Stock is not listed or quoted on the Nasdaq National Market or Nasdaq SmallCap Market or any principal national securities exchange or market, a day on which the Common Stock is traded in the over-the- counter market, as reported by the National Quotation Bureau Incorporated (or any similar organization or agency succeeding its functions of reporting prices). "TRANSFER AGENT" means Boston EquiServe. "UNDERLYING SECURITIES REGISTRATION STATEMENT" means the Registration Statement (as defined in the Registration Rights Agreement) to be amended within thirty (30) days of Closing (as defined in the Purchase Agreement). "UNPAID PRINCIPAL PORTION" is as defined in Section 5(b). "WARRANTS" is as defined in the Purchase Agreement. SECTION 7. Except as expressly provided herein, no provision of this Debenture shall alter or impair the obligation of the Company, which is absolute and unconditional, to pay the principal of, and interest on, this Debenture at the time, place, and rate, and in the coin or currency, herein prescribed. This Debenture is a direct obligation of the Company. This Debenture ranks pari passu with all other indebtedness, obligations or liabilities of the Company now or hereafter issued under the terms set forth herein. The Company may not prepay the outstanding principal amount on the Debentures except in accordance with the specific terms hereof. SECTION 8. (a) This Debenture is subordinated to full payment of all of the Company's obligations under the BNY Bank Obligations. Except to the extent otherwise specifically set forth in this Section, until such time as all BNY Bank Obligations are 14 indefeasibly paid to BNY, the Company shall not, directly or indirectly, make any cash or other payment (except for the issuance and delivery of shares of Common Stock in respect of conversions or payments of interest hereunder) that is due and owing under this Debenture. Cash payments contemplated by Sections 4(b) or 4(d) hereof, to the extent such payments do not exceed, in the aggregate, five hundred thousand $500,000, may be made by the Company to (and retained by) the Holders as long as (i) at the time any such payment is due under such Sections, the Bank has not given notice to the Company of acceleration of the Company's obligations under the Receivables Agreement or (ii) the making of such payment shall not cause (as determined at the time such payment shall become due to the Holders) the Company to exceed the borrowing limitations set forth in Section 2 of the Receivables Agreement, or cause an "Event of Default" (as defined under the Receivables Agreement) under Section 18(a) of the Receivables Agreement. Cash payments contemplated by Sections 4(b) or 4(d) hereof, to the extent that such payments, in the aggregate, exceed five hundred thousand ($500,000), may be made by the Company to (and retained by) the Holders as long as (i) at the time any such payment is due under such Sections, the Bank has not given notice to the Company of acceleration of the Company's obligations under the Receivables Agreement, or (ii) at the time such payment becomes due the Company shall not be in default of Sections 12(n), 12(o), 12(p), 12(q), 18(a), 18(i) or 18(j) of the Receivables Agreement, or (iii) the making of such payment shall not cause (as determined at the time such payment shall become due to the Holders) an Event of Default under such Receivables Agreement sections set forth in (ii) immediately above or cause the Company to exceed the borrowing limitations set forth in Section 2 of the Receivables Agreement. The subordination provided hereunder shall in no way limit the Holders' ability to convert Debentures into shares of Common Stock and to receive payment of interest hereunder in shares of Common Stock, including after such time as any Event of Default shall be declared hereunder. (b) Should any payment, other than payments contemplated in Section 8(a) above, be received by the Holders, such payment shall be held in trust by the Holders for the benefit of BNY and shall be delivered forthwith to BNY for application to BNY Bank Obligations, in the form received with any necessary endorsement or assignment. SECTION 9. This Debenture shall not entitle the Holder to any of the rights of a stockholder of the Company, including without limitation, the right to vote, to receive dividends and other distributions, or to receive any notice of, or to attend, meetings of stockholders or any other proceedings of the Company, unless and to the extent converted into shares of Common Stock in accordance with the terms hereof. SECTION 10. If this Debenture shall be mutilated, lost, stolen or destroyed, the Company shall execute and deliver, in exchange and substitution for and upon cancellation of a mutilated Debenture, or in lieu of or in substitution for a lost, stolen or destroyed debenture, a new Debenture for the principal amount of this Debenture so mutilated, lost, stolen or destroyed but only upon receipt of evidence of such loss, theft or destruction of such Debenture, and of the ownership hereof, and indemnity, if requested, all reasonably satisfactory to the Company. 15 SECTION 11. This Debenture shall be governed by and construed in accordance with the laws of the State of New York, without giving effect to conflicts of laws thereof. SECTION 12. Any waiver by the Company or the Holder of a breach of any provision of this Debenture shall not operate as or be construed to be a waiver of any other breach of such provision or of any breach of any other provision of this Debenture. The failure of the Company or the Holder to insist upon strict adherence to any term of this Debenture on one or more occasions shall not be considered a waiver or deprive that party of the right thereafter to insist upon strict adherence to that term or any other term of this Debenture. Any waiver must be in writing. SECTION 13. If any provision of this Debenture is invalid, illegal or unenforceable, the balance of this Debenture shall remain in effect, and if any provision is inapplicable to any person or circumstance, it shall nevertheless remain applicable to all other persons and circumstances. SECTION 14. Whenever any payment or other obligation hereunder shall be due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day (or, if such next succeeding Business Day falls in the next calendar month, the preceding Business Day in the appropriate calendar month). [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] [SIGNATURE PAGE FOLLOWS] 16 IN WITNESS WHEREOF, the Company has caused this instrument to be duly executed by an officer thereunto duly authorized as of September 2, 1998. YES! ENTERTAINMENT CORPORATION Attest: By: ------------------------- ----------------------------- Mark Shepherd Mark Shepherd Secretary Chief Executive Officer 17 EXHIBIT A NOTICE OF CONVERSION AT THE ELECTION OF HOLDER (To be Executed by the Registered Holder in order to Convert the Debenture) The undersigned hereby irrevocably elects to convert the above Debenture No. [ ] into shares of Common Stock, par value $.001 per share (the "Common Stock"), of YES! Entertainment Corporation (the "Company") according to the conditions hereof, as of the date written below. As of the date set forth below, the undersigned is in compliance with Section 4.18 of the Securities Exchange Agreement between the Company, Infinity Investors Limited, Infinity Emerging Opportunities Limited and Glacier Capital Limited dated August 28, 1998. If shares are to be issued in the name of a person other than undersigned, the undersigned will pay all transfer taxes payable with respect thereto and is delivering herewith such certificates and opinions as reasonably requested by the Company in accordance therewith. No fee will be charged to the Holder for any conversion, except for such transfer taxes, if any. Conversion calculations: ---------------------------------------------------- Date to Effect Conversion ---------------------------------------------------- Principal Amount of Debentures to be Converted ---------------------------------------------------- Applicable Conversion Ratio (as adjusted to give effect to all prior Adjustment Events) ---------------------------------------------------- Amount of Interest due on the Principal Amount of Debentures to be Converted ---------------------------------------------------- Signature ---------------------------------------------------- Name: ---------------------------------------------------- Address: 18 EX-4.2 3 AMENDED CERTIFICATE OF DESIGNATION EXHIBIT 4.2 AMENDED CERTIFICATE OF DESIGNATION OF SERIES C CONVERTIBLE PREFERRED STOCK OF YES! ENTERTAINMENT CORPORATION The undersigned, Mark Shepherd, hereby certifies that: I. He is the duly elected and acting Chief Executive Officer and Secretary, respectively, of YES! Entertainment Corporation, a Delaware corporation (the "Company"). II. The Certificate of Incorporation of the Company authorizes 2,000,000 shares of preferred stock, par value $.001 per share, of which 358,822 shares are issued and outstanding. III. No shares of Series C Convertible Preferred Stock are issued and outstanding. IV. The following is a true and correct copy of the consent dated September 1, 1998 (which amends and restates in their entirety the resolutions of the Board of Directors of the Company (the "Board of Directors") dated August 27, 1998 designating the rights, preferences, privileges and restrictions of the Series C Convertible Preferred Stock) duly adopted by the Board of Directors, which constituted all requisite action on the part of the Company for adoption of such consent. RESOLUTIONS WHEREAS, the Board of Directors is authorized to provide for the issuance of shares of preferred stock in series, and by filing a certificate pursuant to the applicable law of the State of Delaware, to establish from time to time the number of shares to be included in such series, and to fix the designations, powers, preferences and rights and the qualifications, limitations or restrictions thereof; WHEREAS, the Board of Directors desires, pursuant to its authority as aforesaid, to designate a new series of preferred stock, set the number of shares constituting such series and fix the rights, preferences, privileges and restrictions of such series; NOW, THEREFORE, BE IT RESOLVED, that the Board of Directors hereby designates a new series of preferred stock and the number of shares constituting such series and fixes the designations, powers, preferences, rights, qualifications, limitations, restrictions and privileges relating to such series as follows: SECTION 1. DESIGNATION, AMOUNT AND PAR VALUE. There are hereby provided one series of Preferred Stock designated and to be known as "Series C Convertible Preferred Stock" (the "Series C Preferred"). The number of shares constituting authorized Series C Preferred shall be five hundred forty thousand (540,000) (which shall not be subject to increase), with a par value of $.001. SECTION 2. DIVIDENDS. 1. (a) Holders of Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors out of funds legally available therefor, and the Company shall pay, cumulative dividends at the rate per share equal to $1.28 (as adjusted for any stock dividends, combinations, splits, recapitalizations and the like with respect to such shares) per annum, payable in shares of Series C Preferred Stock, on the last day of March, June, September and December commencing on September 30, 1998 or on the Conversion Date (each a "Dividend Payment Date"). Dividends on the Series C Preferred shall accrue daily commencing on September 2, 1998, and shall be deemed to accrue on the Dividend Payment Date whether or not earned or declared and whether or not there are profits, surplus or other funds of the Company legally available for the payment of dividends. The amount of dividends accrued on each share of Series C Preferred shall be calculated for each Dividend Payment Date on the basis of an annual dividend rate of $1.28 and a 360-day year of twelve 30-day months, and shall include any unpaid accrued dividends for prior periods or portions thereof. Within 15 Business Days of each Dividend Payment Date, dividends shall be paid by issuing and delivering to a holder of Series C Preferred that number of additional shares of Series C Preferred equal to the quotient of (a) the aggregate dollar amount of accrued and unpaid dividends for all shares of Series C Preferred held by such holder on the Dividend Payment Date divided by (b) Liquidation Preference (as hereafter defined). Should any dividend that is paid through the issuance and delivery of additional shares of Series C Preferred require the issuance and delivery of a fractional share or shares of Series C Preferred, no such fractional shares shall be so issued, but instead the Company shall pay the equivalent value of such fractional share in cash. The party that holds the Series C Preferred on an applicable record date for any dividend payment will be entitled to receive such dividend payment and any other accrued and unpaid dividends that accrued prior to such Dividend Payment Date, without regard to any sale or disposition of such Series C Preferred subsequent to the applicable record date but prior to the applicable Dividend Payment Date. Except as otherwise provided herein, if at any time the Company pays less than the total amount of dividends then accrued on account of the Series C Preferred, such payment shall be distributed ratably among the holders of the Series C Preferred based upon the number of shares held by each holder. SECTION 3A. NEW DIRECTORS. Within 10 days after the Closing Date, the Company shall cause a majority of its Board of Directors to elect each of Clark Hunt and Barrett Whissman to the Board. SECTION 3B. VOTING RIGHTS. The holders of the Series C Preferred shall have the right to elect two members of the Company's Board of Directors (the "Series C Directors") at each annual and special meeting of the Company's stockholders held for such purpose until such time as the number of shares of Series C Preferred outstanding is less 25% of the number of such shares outstanding on the date hereof (excluding the effects of reverse stock splits, recapitalizations and other such events). So long as the holders of the Series C Preferred shall have the right to elect two directors, the holders of a majority of the Series C Preferred shall have the right to nominate such two directors; provided that the holders of a majority of the Series C Preferred shall have provided the Company written notice at least fifteen (15) days prior to the date the Company files its proxy statement with respect to the election of directors with the Securities and Exchange Commission setting forth the nominees of the Series C Preferred in such notice; provided further, that this advance notice shall not apply to the first meeting of the stockholders of the Company, in which the nominees of the Series C Preferred shall be Clark 2. Hunt and Barrett Whissman. The Company shall give the holders of the Series C Preferred thirty (30) days advance written notice of its intention to file a proxy statement with the Securities and Exchange Commission relating to the election of directors. The two members shall be elected by the holders of a majority of the shares of Series C Preferred outstanding on the record date for the general election of directors. In addition, so long as any shares of Series C Preferred are outstanding, the Company shall not, without the affirmative vote of the holders of a majority of the shares of the Series C Preferred then outstanding, (a) alter or change adversely the powers, preferences or rights given to the Series C Preferred, (b) authorize or create any class of stock ranking as to dividends or distribution of assets upon a Liquidation (as defined in Section 4) senior to, prior to or pari passu with the Series C Preferred or (c) enter into any merger, recapitalization, consolidation or similar transaction that would result in the change in any of the terms of the Series C Preferred. SECTION 3C. CONSENT OF SERIES C DIRECTORS. Without the consent and approval of the Series C Directors, the Company shall not (i) incur more than $100,000 in additional indebtedness (excluding trade debt incurred in the ordinary course of business); (ii) permit to exist liens on its assets securing payment of claims or obligations in an aggregate amount of $500,000 other than existing liens or liens securing payment of (A) the BNY Bank Obligations, (B) the Bridge Loan, or (C) the New Facility; (iii) use any of the proceeds of the Bridge Loan or the New Facility for any purpose other than working capital in connection with the operation of the Company's present business operations; (iv) enter into any agreement to merge with or otherwise combine its assets or operations with any other entity or sell any material assets outside the ordinary course of business; (v) commence an action for relief under any provision of the United States Bankruptcy Code or any similar statutory scheme; (vi) pay any material additional or special compensation to any of its officers that is not currently required under any existing agreements with its officers; (vii) enter into any material transaction with any insider or affiliate; or (viii) issue any shares of stock in the Company other than in satisfaction of existing options, warrants, conversion rights, or existing obligations under the Company's employee benefit plans. Any of the foregoing actions taken by the Company without the consent and approval of the Series C Directors shall be null and void and shall have no legal effect. SECTION 4. LIQUIDATION. Upon any liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary (a "Liquidation"), the holders of Series C Preferred shall be entitled to receive out of the assets of the Company, whether such assets are capital or surplus, for each share of Series C Preferred, including any shares to be issued pursuant to Section 2 hereof whether declared or not, an amount equal to $25.00 (as adjusted for any stock dividends, combinations, splits, recapitalization and the like with respect to such shares) (the "Liquidation Preference"), before any distribution or payment shall be made to the holders of any Junior Securities (as hereafter defined), and if the assets of the Company shall be insufficient to pay in full such amounts, then the entire assets to be distributed shall be distributed among the holders of Series C Preferred ratably in accordance with the respective amounts that would be payable on such shares if all amounts payable thereon were paid in full. The Company shall mail written notice of any such Liquidation, not less than forty-five (45) days prior to the payment date stated therein, to each record holder of Series C Preferred. 3. SECTION 5. CONVERSION. (a) CONVERSION AT HOLDER'S OPTION. Each share of Series C Preferred shall be convertible into shares of Common Stock (as hereafter defined) (subject to reduction pursuant to Section 5(b)) at the option of the holder in whole or in part at any time and from time to time at the Conversion Ratio (as hereafter defined), as adjusted to give effect to any and all Adjustment Events (as hereafter defined) occurring prior to conversion. The holder shall effect conversions by surrendering the certificate or certificates representing the shares of Series C Preferred to be converted to the Company, together with the form of conversion notice attached hereto as Exhibit A (the "Conversion Notice"). Each Conversion Notice shall specify the number of shares of Series C Preferred to be converted and the date on which conversion is to be effected (the "Conversion Date"), which date may not be prior to the date the holder delivers such Conversion Notice by facsimile. If no Conversion Date is specified in a Conversion Notice, the Conversion Date shall be the date that the Conversion Notice is deemed deliverable pursuant to Section 5(d). Subject to Section 5(b), each Conversion Notice, once given, shall be irrevocable unless the Company fails to deliver a certificate or certificates representing the underlying Common Stock pursuant to Section 5(d) within 3 Trading Days of the Conversion Date, at which time or any time thereafter the holder of the Series C Preferred may, at its option, either (a) cancel the Conversion Notice or (b) elect to have the Common Stock issuable upon conversion of Series C Preferred deemed to be issued and outstanding and held of record as of the Conversion Date by the holder of Series C Preferred which sent the Conversion Notice. If a holder is converting less than all shares of Preferred Stock represented by the certificate or certificates tendered by such holder with the Conversion Notice, or if a conversion hereunder cannot be effected in full for any reason, the Company shall promptly deliver to such holder (in the manner within the time set forth in Section 5(d)) a certificate of such number of shares as have not been converted. (b) CERTAIN REGULATORY APPROVAL. (i) The Company shall have until December 21, 1998 to obtain Stockholder Approval (as defined below) of the issuance of Common Stock upon conversion/exercise of the Series C Preferred, the Debentures and the Warrants (each as defined in the Purchase Agreement). In the event the Company has not obtained such Stockholder Approval by December 21, 1998, then, unless the holders of a majority in interest of the outstanding Series C Preferred on such date shall have delivered written notice to the Company that the Series C Preferred shall not be redeemed pursuant to this subsection (b)(i), the Company shall within five business days thereafter redeem, from funds legally available therefor at the time of such redemption, all of the Series C Preferred then outstanding, including shares subject to a Conversion Notice, at a price per share equal to the Redemption Price (as hereafter defined). If the Company fails for any reason to pay the Redemption Price on or prior to December 23, 1998 if required, then the Company will pay interest on such Redemption Price at a rate of 17% per annum to the converting holder of Series C Preferred, accruing from December 21, 1998 until the Redemption Price plus any accrued interest thereon is paid in full. The entire Redemption Price, including interest thereon, shall be paid in cash. "Stockholder Approval" means the approval by a majority of the total votes cast on the proposal, in person or by proxy, at a meeting of the stockholders of the Company held in accordance with the Company's certificate of incorporation and by-laws, of (A) the issuance by the Company of shares of Common Stock pursuant to the conversion/exercise of Series B Preferred, Series C Preferred, the July Debentures, the Debentures and the Warrants (all as 4. defined in the Purchase Agreement) into Common Stock as and to the extent required pursuant to Rule 4460(i) of the Nasdaq Stock Market (or any successor or replacement provision thereof) and (B) an increase in the authorized number of shares of Common Stock sufficient to cause the number of authorized and unissued and unreserved shares of Common Stock on such date to exceed by at least 10 million shares the number of shares of Common Stock issuable upon the conversion and exercise of all of the outstanding shares of Series B Preferred and Series C Preferred, the July Debentures, the Debentures and the Warrants. (ii) If on a Conversion Date (A) the Common Stock is then listed for trading on the Nasdaq National Market or, if the rules of the Nasdaq Stock Market are hereafter amended to extend Rule 4460(i) promulgated thereby (or by a successor or replacement provision thereof) to the Nasdaq SmallCap Market, on the Nasdaq SmallCap Market, (B) the Conversion Ratio, as adjusted to give effect to any and all Adjustment Events occurring prior to conversion, is such that the aggregate number of shares of Common Stock that would then be issuable upon conversion of all outstanding shares of Series C Preferred and Debentures, would equal or exceed 20% of the number of shares of Common Stock outstanding on the Conversion Date (the "Issuable Maximum"), and (C) the Company has not previously obtained Stockholder Approval, then the Company shall issue to the converting holder of the Series C Preferred up to the Issuable Maximum (and no more). (c) AUTOMATIC CONVERSION. If the Company shall have obtained Stockholder Approval of the issuance of the Common Stock upon conversion of the Series C Preferred on or prior to December 21, 1998, then any and all shares of Series C Preferred outstanding on April 30, 2002 (the "Automatic Conversion Date") shall be automatically converted into fully paid and nonassessable shares of Common Stock, at the Conversion Ratio, as adjusted to give effect to any and all Adjustment Events occurring prior to conversion, in the manner provided herein. (d) DELIVERY OF CERTIFICATES. Not later than three (3) Trading Days after a Conversion Date or the Automatic Conversion Date, the Company shall cause the Transfer Agent to deliver to the holder (i) a certificate or certificates, representing the number of shares of Common Stock being acquired upon the conversion of Series C Preferred (subject to reduction pursuant to Section 5(b)(ii)) and (ii) a certificate representing the shares of Series C Preferred tendered in connection with a conversion hereunder but not converted. Any certificates representing shares of Common Stock to be delivered upon a conversion hereunder shall be free of restrictive legends and trading restrictions, except those specified in Section 4.1(b) of the Purchase Agreement. The Company shall not be obligated to issue certificates evidencing the shares of Common Stock issuable upon conversion of any Series C Preferred until certificates representing the shares of Series C Preferred to be converted are either delivered to the Transfer Agent for conversion or the holder notifies the Company that such shares of Series C Preferred have been lost, stolen or destroyed and provides a bond reasonably satisfactory to the Company (or other adequate security reasonably acceptable to the Company) to indemnify the Company from any loss incurred by it in connection therewith. The Company shall, upon request of the holder, use its best efforts to deliver any certificate or certificates required to be delivered by the Company under this Section electronically through the Depository Trust Corporation or another established clearing corporation performing similar functions. If such 5. certificate or certificates are not delivered within ten (10) Trading Days after a Conversion Date, the holder shall be entitled to rescind such Conversion Notice upon written notice to the Company and the Transfer Agent, in which event the Company shall immediately instruct the Transfer Agent to return the certificates representing shares of Series C Preferred subject to such Conversion Notice that were tendered for conversion. The Company shall pay to the converting holder, as liquidated damages and not as penalty, $3,000 for each day that the Company fails to deliver such certificate or certificates pursuant to this Section commencing after the fifth (5th) Trading Day after the applicable Conversion Date or Automatic Conversion Date. In addition, if the Company fails to deliver to the holder such certificate or certificates pursuant to this Section prior to the fifteenth (15th) day after a Conversion Date or Automatic Conversion Date, the Company shall, at the Holder's option, (i) redeem the shares of Series C Preferred then held by such holder, as requested by such holder, at the Redemption Price calculated as of the Conversion Date or Automatic Conversion Date (which date may be referred to herein as a "Redemption Date") and (ii) pay all accrued but unpaid dividends on account of the Series C Preferred for which the Company shall have failed to issue Series C Preferred certificates hereunder, in cash. If the holder has requested that the Company redeem shares of Series C Preferred pursuant to this Section and the Company fails for any reason to pay the Redemption Price hereunder within five (5) Business Days after such notice, the Company will pay interest on such Redemption Price at a rate of 17% per annum, in cash to such Holder, accruing from such fifth (5th) Business Day until such Redemption Price and any accrued but unpaid interest thereon is paid in full. (e) ADJUSTMENTS. (i) The following events shall be deemed to be "Adjustment Events": A. If the Company, at any time while any shares of Series C Preferred are outstanding, (a) shall pay a stock dividend or otherwise make a distribution or distributions on shares of its Junior Securities payable in shares of either Common Stock or of capital stock of any class, (b) subdivide outstanding shares of Common Stock into a larger number of shares, or (c) combine outstanding shares of Common Stock into a smaller number of shares. B. If the Company, at any time while any shares of Series C Preferred are outstanding, shall issue rights or warrants to all holders of Common Stock entitling them to subscribe for or purchase shares of Common Stock at a price per share less than the Per Share Market Price of Common Stock as calculated on the record date. C. If the Company, at any time while shares of Series C Preferred are outstanding, shall distribute to all holders of Common Stock (and not to holders of Series C Preferred) evidences of its indebtedness or assets or rights or warrants to subscribe for or purchase any security (excluding those referred to in Sections 5(e)(i)(A) and (B) above). (ii) ADJUSTMENT FOR STOCK SPLITS, COMBINATIONS. If an Adjustment Event described in 5(e)(i)(A) occurs, then the Conversion Ratio, as adjusted 6. to give effect to all prior Adjustment Events, shall be multiplied by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding before such event and the denominator of which shall be the number of shares of Common Stock outstanding after such event. Any adjustment completed pursuant to this Section 5(e)(ii) shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision or combination. (iii) ADJUSTMENT FOR ISSUANCES TO COMMON STOCKHOLDERS. If an Adjustment Event described in 5(e)(i)(B) occurs, then the Conversion Ratio, as adjusted to give effect to all prior Adjustment Events, shall be multiplied by a fraction, the numerator of which shall be the number of shares of Common Stock (excluding treasury shares, if any, but including warrants or options that would be included for purposes of determining earnings per share in accordance with generally accepted accounting principles) outstanding on the date of issuance of such rights or warrants plus the number of shares which the aggregate offering price of the total number of shares so offered would purchase at such Per Share Market Price, and the denominator of which shall be the number of shares of Common Stock (excluding treasury shares, if any, but including warrants or options that would be included for purposes of determining earnings per share in accordance with generally accepted accounting principles) outstanding on the date of issuance of such rights or warrants plus the number of additional shares of Common Stock offered for subscription or purchase. Such adjustment shall be calculated whenever such rights or warrants are issued and shall become effective immediately after the record date for the determination of stockholders entitled to receive such rights or warrants. However, upon the expiration of any right or warrant to purchase Common Stock the issuance of which resulted in an adjustment pursuant to this Section 5(e)(iii), if any such right or warrant shall expire and shall not have been exercised, such adjustment shall immediately upon such expiration be recomputed as if the adjustment computed upon the issuance of such rights or warrants been computed on the basis of offering for subscription or purchase only that number of shares of Common Stock actually purchased upon the exercise of such rights or warrants actually exercised. Such readjustment shall be effective immediately upon such expiration. (iv) ADJUSTMENT FOR DISTRIBUTION OF EVIDENCES OF INDEBTEDNESS OR ASSETS TO COMMON STOCKHOLDERS. If an Adjustment Event described in 5(e)(i)(C) occurs, then the Conversion Ratio, as adjusted to give effect to all prior Adjustment Events, shall be multiplied by a fraction the numerator of which shall be such Per Share Market Price on such record date less the then fair market value at such record date of the portion of such assets or evidence of indebtedness so distributed applicable to one outstanding share of Common Stock as determined by the Board of Directors in good faith, and the denominator of which shall be the Per Share Market Price determined as of such record date; provided, however, that in the event of a distribution exceeding ten percent (10%) of the net assets of the Company, such fair market value shall be determined by a nationally recognized or major regional investment banking firm or firm of independent certified public accountants of recognized standing (which may be the firm that regularly examines the financial statements of the Company) 7. (an "Appraiser") selected in good faith by the holders of a majority in interest of the shares of Preferred Stock then outstanding; and provided, further, that the Company, after receipt of the determination by such Appraiser shall have the right to select an additional Appraiser, in good faith, in which case the fair market value shall be equal to the average of the determinations by each such Appraiser. Such adjustment shall be calculated whenever any such distribution is made and shall become applicable immediately after the record date mentioned above. (v) Upon the occurrence of an Adjustment Event, the Company shall promptly mail or instruct the Transfer Agent to promptly mail to each holder of Series C Preferred a notice setting forth (a) the adjustment to the Conversion Ratio required by the Adjustment Event at issue, (b) the cumulative adjustment to which the Conversion Ratio shall be subject after the Adjustment Event, giving effect to any and all prior Adjustment Events, and (c) a brief statement of the facts requiring the adjustment at issue. (vi) ROUNDING. All calculations under this Section 5 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. (vii) RECLASSIFICATIONS, MERGERS, CONSOLIDATIONS OR SALES OF ASSETS. In case of any reclassification of the Common Stock, any consolidation or merger of the Company with or into another person pursuant to which the Company will not be the surviving entity, the sale or transfer of all or substantially all of the assets of the Company or any compulsory share exchange pursuant to which the Common Stock is converted into other securities, cash or property, the holders of the Series C Preferred then outstanding shall have the right thereafter to, at their option, (A) convert such shares only into the shares of stock and other securities, cash and property receivable upon or deemed to be held by holders of Common Stock following such reclassification, consolidation, merger, sale, transfer or share exchange, and the holders of the Series C Preferred shall be entitled upon such event to receive such amount of securities, cash or property as the shares of the Common Stock of the Company into which such shares of Series C Preferred could have been converted immediately prior to such reclassification, consolidation, merger, sale, transfer or share exchange would have been entitled or (B) require the Company to redeem, from funds legally available therefor at the time of such redemption, its shares of Series C Preferred at a price per share equal to the Redemption Price calculated on the date of the closing of the reclassification, consolidation, merger, sale, transfer or share exchange, as the case may be, triggering such redemption right. The entire Redemption Price shall be paid in cash, and the terms of payment of such Redemption Price shall be subject to the provisions set forth in Section 6(b). The terms of any such consolidation, merger, sale, transfer or share exchange shall include such terms so as to continue to give to the holder of Series C Preferred the right to receive the securities, cash or property in this Section 5(e)(vii) upon any conversion or redemption following such consolidation, merger, sale, transfer, or share exchange. This provision shall similarly apply to successive reclassifications, consolidations, mergers, sales, transfers or share exchanges. 8. (viii) CERTAIN EVENTS. The Company shall not effect any of the following actions prior to obtaining Stockholder Approval of the issuance of the Common Stock upon conversion of the Series C Preferred: A. declare a dividend (or any other distribution) on its Common Stock (other than a subdivision of the outstanding shares of Common Stock); or B. declare a special nonrecurring cash dividend on or authorize a repurchase or redemption of more than ten thousand (10,000) shares of its then outstanding Common Stock, other than a repurchase or redemption of the Common Stock of an employee upon termination of employment with the Company for any reason; or C. authorize the granting to all holders of the Common Stock rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights; or D. any reclassification of the Common Stock (other than a subdivision or combination of then outstanding shares of Common Stock), any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, or any compulsory share exchange whereby the Common Stock is converted into other securities, cash or property; or E. authorize the voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company; After obtaining such Stockholder Approval, in the event any of the foregoing actions occur, then the Company shall cause to be mailed to the holders of Series C Preferred at their last addresses as shall appear on the stock books of the Company, at least thirty (30) calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer, share exchange, dissolution, liquidation or winding-up is expected to become effective, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities, cash, or other property deliverable upon such reclassification, consolidation, merger, sale, transfer, share exchange, dissolution, liquidation or winding-up; provided, however, that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. (f) RESERVATION OF COMMON STOCK. The Company covenants, from and after obtaining Stockholder Approval, that it shall at all times reserve and keep available out of its authorized and unissued Common Stock solely for the purpose of issuance upon conversion 9. of Series C Preferred, as herein provided, free from preemptive rights or any other actual contingent purchase rights of persons other than the holders of Series C Preferred, such number of shares of Common Stock as shall be issuable upon the conversion of all outstanding shares of Series C Preferred. The Company covenants that all shares of Series C Preferred that shall be so issuable shall, upon issue, be duly and validly authorized, issued and fully paid and nonassessable. (g) RESERVATION OF SERIES C PREFERRED. The Company covenants that it will at all times reserve and keep available out of its authorized and unissued Series C Preferred solely for the purpose of payment of dividends on Series C Preferred, as herein provided, free from preemptive rights or any other actual contingent purchase rights of persons other than the holders of the Series C Preferred, such number of shares of Series C Preferred as shall be issuable upon payment of dividends hereunder. The Company covenants that all shares of Series C Preferred Stock that shall be so issuable shall, upon issue, be duly and validly authorized, issued and fully paid and nonassessable. (h) FRACTIONAL SHARES. Upon a conversion hereunder the Company shall not be required to issue stock certificates representing fractions of shares of Common Stock, but may if otherwise permitted, make a cash payment in respect of any final fraction of a share based on the Per Share Market Price at such time. If the Company elects not to, or is unable to, make such a cash payment, the holder of a share of Series C Preferred shall be entitled to receive, in lieu of the final fraction of a share, one whole share of Common Stock. (i) CERTIFICATES. The issuance of certificates for shares of Common Stock on conversion of Series C Preferred shall be made without charge to the holders thereof for any documentary stamp or similar taxes that may be payable in respect of the issue or delivery of such certificate, provided that the Company shall not be required to pay any tax that may be payable in respect of any transfer involved in the issuance and delivery of any such certificate upon conversion in a name other than that of the holder of such shares of Series C Preferred so converted. (j) CANCELLED SHARES. Shares of Series C Preferred converted into Common Stock shall be canceled and shall have the status of authorized but unissued shares of undesignated preferred stock. (k) NOTICE. Any and all notices or other communications or deliveries to be provided by a holder of Series C Preferred hereunder, including, without limitation, any Holder Conversion Notice, shall be in writing and delivered personally, by facsimile, sent by a nationally recognized overnight courier service or sent by certified or registered mail, postage prepaid, addressed to the attention of the Chief Financial Officer of the Company at the facsimile telephone number or address of the principal place of business of the Company, and, if applicable, to the Transfer Agent. Any and all notices or other communications or deliveries to be provided by the Company hereunder shall be in writing and delivered personally, by facsimile, sent by a nationally recognized overnight courier service or sent by certified or registered mail, postage prepaid, addressed to the holder of Series C Preferred at the facsimile telephone number or address of such holder appearing on the books of the Company, or if no such facsimile telephone number or address appears, at the principal place of business of the 10. holder. Any notice or other communication or deliveries hereunder shall be deemed given and effective on the earliest of (i) the date of transmission, if delivered via facsimile at the facsimile telephone number specified in the Purchase Agreement prior to 4:30 p.m. (Eastern Standard Time) on a Trading Day, (ii) the Trading Day after the transmission, if delivered via facsimile at the facsimile telephone number specified in the Purchase Agreement later than 4:30 p.m. (Eastern Standard Time) on any date and earlier than 11:59 p.m. (Eastern Standard Time) on such date, (iii) the Trading Day following the date of mailing, if sent by nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. SECTION 6. REDEMPTION. (a) OPTIONAL REDEMPTION BY COMPANY. (i) The Company shall have the right, exercisable at any time upon fifteen (15) Trading Days notice to the holders of the Series C Preferred (the "Optional Redemption Notice"), to redeem, from funds legally available therefor at the time of such redemption, all of the shares of Series C Preferred from a holder which have not been previously converted or redeemed at a price per share equal to the Redemption Price calculated on the date of the Optional Redemption Notice (which date may be referred to herein as a "Redemption Date"); provided, however, that the Company shall not redeem the Series C Preferred from a holder without simultaneously repaying any and all indebtedness owed to such holder of Series C Preferred. The entire Optional Redemption Price shall be paid in cash. (ii) The holders of the Series C Preferred shall have until the Redemption Date to convert any and all shares of Series C Preferred into shares of Common Stock by delivering a Conversion Notice on or prior to the date that is the business day prior to the Redemption Date. On or after the Redemption Date, no holder of Series C Preferred shall have the right to continue to convert shares of Series C Preferred which have been noticed for redemption. (iii) On or before the fifth Trading Day after the Redemption Date, each holder of Series C Preferred shall deliver to the Company the shares of Series C Preferred owned by it and subject to the Optional Redemption Notice that have not been previously tendered for conversion and the Company shall deliver a sum equal to the product of (i) the Redemption Price as calculated on the Redemption Date and (ii) the number of shares of Series C Preferred tendered by or on behalf of such holder for redemption in accordance with the provisions hereof. (iv) Notwithstanding the other provisions of this Section 6, in the event the Company effects a merger, redemption, consolidation, recapitalization, sale of all or substantially all of its assets or other business combination within 90 days of the Redemption Date and the Redemption Price is less than the consideration that the holders of the Series C Preferred would have received upon conversion of the Series C Preferred into Common Stock pursuant to such subsequent event (the "Subsequent Consideration") then, prior to or concurrently with such transaction the Company shall pay to the former 11. holders of the Series C Preferred that were redeemed on the Redemption Date the difference between the Subsequent Consideration and the Redemption Price. (b) LIQUIDATED DAMAGES. If the Redemption Price shall not be paid in full on or before the fifteenth Trading Day after the Redemption Date, the Company shall pay to the holders of the Series C Preferred subject to Redemption as liquidated damages and not as a penalty the sum of seven thousand five hundred dollars ($7,500) per day in cash until the Redemption Price, together with all such liquidated damages, is paid in full. In addition, if the Company shall have failed to pay any portion of the Redemption Price on or before the eighteenth Trading Day after the Redemption Date, then any holder of Series C Preferred that was subject to such redemption may demand that the Company (i) convert all or any portion of the shares of its Series C Preferred for which the Redemption Price, shall not have been paid (the "Unpaid Portion") at the Conversion Ratio, as adjusted to give effect to any and all Adjustment Events occurring prior to conversion, calculated as at the date of the Optional Redemption Notice, or the date of such conversion (a "Conversion Date"), whichever is higher, or (ii) promptly issue to such holder new certificates representing shares of Series C Preferred in a number equal to the Unpaid Portion. (c) BNY CONSENTS. Notwithstanding anything to the contrary contained herein, so long as the BNY Bank Obligations are outstanding, the Company may not deliver an Optional Redemption Notice unless it has received (and furnished to the each holder evidence thereof reasonably satisfactory to it of) prior written consent of BNY (as hereafter defined) to pay the redemption amounts contemplated by this Section free from the subordination provisions of Section 8 hereof. SECTION 7. DEFINITIONS. For the purposes hereof, the following terms shall have the following meanings: "Automatic Conversion Date" is as defined in Section 5(c). "BNY" means BNY Financial Corporation, 1290 Avenue of the Americas, New York, New York 10104. "BNY Bank Obligations" means the borrowings and interest due thereon (including, without limitation, any interest accruing after the commencement of any case, proceedings or other action relating to the liquidation, dissolution, assignment for the benefit of creditors, receivership, arrangement, bankruptcy, insolvency or reorganization of the Company regardless of whether such interest is allowable, payable or accruable to BNY in such case, proceeding or other action) under the Receivables Agreement, as the same may from time to time be amended, supplemented, otherwise modified, replaced or refinanced. "Bridge Loan" shall mean that certain $3 million loan from Infinity Investors Limited in favor of the Company and executed on the date hereof. "Business Day" means any day of the year on which commercial banks are not required or authorized to be closed in New York City. "Closing Date" is as defined in the Purchase Agreement. 12. "Common Stock" means shares now or hereafter authorized of the class of Common Stock, par value $.001 per share, of the Company, stock of any other class into which such shares may hereafter be reclassified or changed and any other equity securities of the Company hereafter designated as Common Stock. "Conversion Date" is as defined in Section 5(a). "Conversion Notice" is as defined in Section 5(a). "Conversion Price" shall mean, as of any date of determination, the product of (a) 0.8125 and (b) the lowest Per Share Market Price during the 30 Trading Days immediately preceding the Conversion Date; provided, however, that the Conversion Price shall not exceed the product of (x) 81.25% and (y) the average Per Share Market Price for the period from April 1, 1998 to and including April 30, 1998 (the "Maximum Conversion Price"). "Conversion Ratio" shall mean, as of any date of determination, a fraction the numerator of which is the Liquidation Preference and the denominator of which is the Conversion Price. "Debentures" means the 5% Convertible Debentures delivered by the Company pursuant to the Purchase Agreement. "Dividend Payment Date" is as defined in Section 2(a). "Issuable Maximum" is as defined in Section 5(b). "July Debentures" is as defined in the Purchase Agreement. "Junior Securities" means the Common Stock and all other equity securities of the Company other than the Series B Preferred and Series C Preferred. "Liquidation Preference" is as defined in Section 4. "Maximum Conversion Price" is as defined in the definition of "Conversion Price." "New Facility" shall mean the proposed $10 million loan facility which may be entered into between the Company and Infinity Investors Limited. "Optional Redemption Notice" is as defined in Section 6(a)(i). "Per Share Market Price" means on any date of determination (a) the lowest reported sales price per share of the Common Stock on such date on the Nasdaq National Market or other stock exchange on which the Common Stock is then listed, as reported on Bloomberg, L.P. or (b) if the Common Stock is not listed on the Nasdaq National Market or such other stock exchange, the lowest reported sales price for a share of Common Stock in the Nasdaq SmallCap Market, as reported on Bloomberg, L.P. (or similar organization or agency succeeding to its functions of reporting prices), or (c) if the Common Stock is no longer reported on Bloomberg, L.P. (or similar organization or agency succeeding to its functions of reporting prices), then the average of the "Pink Sheet" quotes for the relevant conversion period as determined by the holder, or (d) 13. if the Common Stock is no longer publicly traded, the fair market value of a share of Common Stock as determined by an Appraiser selected in good faith by the holders of a majority of shares of Series C Preferred; provided, however, that the Company, after receipt of the determination by such Appraiser, shall have the right to select an additional Appraiser, in which case, the fair market value shall be equal to the average of the determinations by each such Appraiser. "Person" means an individual or a corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or political subdivision thereof) or other entity of any kind. "Purchase Agreement" means the Securities Exchange Agreement, dated September 2, 1998. "Receivables Agreement" means the Accounts Receivable Management and Security Agreement, dated as of July 31, 1995, as amended, among the Company and BNY. "Redemption Date" is as defined in Section 5(d) if in connection with a Conversion Notice and as defined in Section 6(a)(i) if in connection with an Optional Redemption Notice. "Redemption Price" shall mean, as of any Redemption Date, a fraction, the numerator of which is the Liquidation Preference and the denominator of which is the Relevant Percentage as of the Redemption Date. "Stockholder Approval" is as defined in Section 5(b). "Trading Day" means (a) a day on which the Common Stock is traded on the Nasdaq National Market or Nasdaq SmallCap Market or principal national securities exchange or market on which the Common Stock has been listed or quoted, or (b) if the Common Stock is not listed or quoted on the Nasdaq National Market or Nasdaq SmallCap Market or any principal national securities exchange or market, a day on which the Common Stock is traded in the over-the- counter market as reported by the National Quotation Bureau Incorporated (or any similar organization or agency succeeding its functions of reporting prices). "Transfer Agent" means Boston EquiServe. "Underlying Securities Registration Statement" means the Registration Statement (as defined in the Registration Rights Agreement, to be amended within thirty (30) days of Closing (as defined in the Purchase Agreement). "Underlying Shares" means the number of shares of Common Stock into which the Series C Preferred are convertible in accordance with the terms hereof and the Purchase Agreement. "Unpaid Portion" is as defined in Section 6(a). "Warrants" is as defined in the Purchase Agreement. 14. SECTION 8. SUBORDINATION. (a) The Series C Preferred is subordinated to full payment of all of the Company's obligations under the BNY Bank Obligations. Except to the extent otherwise specifically set forth in this Section, until such time as all BNY Bank Obligations are indefeasibly paid to BNY, the Company shall not, directly or indirectly, make any cash or other payment (except for the issuance and delivery of shares of Common Stock in respect of conversions or payments of dividends hereunder) that is due and owing on account of the Series C Preferred. Cash payments contemplated by Sections 5(b) and 5(d) hereof, to the extent such payments do not exceed, in the aggregate, five hundred thousand dollars ($500,000), may be made by the Company to (and retained by) the holders of Series C Preferred as long as (i) at the time any such payment is due under such Sections, the Bank has not given notice to the Company of acceleration of the Company's obligations under the Receivables Agreement of (ii) the making of such payment shall not cause (as determined at the time such payment shall become due to the holders) the Company to exceed the borrowing limitations set forth in Section 2 of the Receivables Agreement, or cause an "Event of Default" (as defined under the Receivables Agreement) under Section 18(a) of the Receivables Agreement. Cash payments contemplated by Sections 5(b) and 5(d) hereof, to the extent that such payments, in the aggregate, exceed five hundred thousand dollars ($500,000), may be made by the Company to (and retained by) the holders of the Series C Preferred as long as (1) at the time any such payment is due under such Sections, the Bank has not given notice to the Company of acceleration of the Company's obligations under the Receivables Agreement, or (ii) at the time such payment becomes due the Company shall not be in default of Sections 12(n), 12(o), 12(p), 12(q), 18(a), 18(i) or 18(j) of the Receivables Agreement, or (iii) the making of such payment shall not cause (as determined at the time such payment shall become due to the holders) an Event of Default under such Receivables Agreement sections set forth in (ii) immediately above or cause the Company to exceed the borrowing limitations set forth in Section 2 of the Receivables Agreement. The subordination provided hereunder shall in no way limit the ability of the holders of the Series C Preferred to convert Debentures into shares of Common Stock and to receive payment of dividends hereunder in shares of Common Stock, including after such time as any Event of Default shall be declared under the Convertible Debentures. (b) Should any payment, other than payments contemplated in Section 8(a) above, held in trust by such holder for the benefit of BNY and shall be delivered forthwith to BNY for application to BNY Bank Obligations, in the form received with any necessary endorsements or assignment. SECTION 9. REDEMPTION OR PURCHASE OF JUNIOR SECURITY So long as any Preferred Stock shall remain outstanding, neither the Company nor any subsidiary thereof shall redeem, purchase or otherwise acquire directly or indirectly any Junior Securities (as defined in Section 7) except that the Company may (i) repurchase or redeem up to 10,000 shares of Common Stock and (ii) repurchase or redeem shares of Common Stock of any employee upon such employee's termination of employment with the Company), nor shall the Company directly or indirectly pay or declare any dividend or make any distribution (other than a dividend or distribution described in Section 5) upon, nor shall any distribution be made in respect of, any Junior Securities, nor shall any monies be set aside for or applied to the purchase 15. or redemption (through a sinking fund or otherwise) of any Junior Securities unless all dividends on the Preferred Stock for all post dividend period shall have been paid free of the subordination provisions of Section 8. RESOLVED FURTHER, that the Chief Executive Officer and Secretary of the Company be, and they hereby are, authorized and directed to prepare, execute, verify, and file with the Secretary of State of Delaware, a Certificate of Designation in accordance with these resolutions and as required by law. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] [SIGNATURE PAGE FOLLOWS] 16. IN WITNESS WHEREOF, Yes! Entertainment Corporation has caused its corporate seal to be hereunto affixed and this certificate to be signed by Mark Shepherd, its Chief Executive Officer and Secretary this 2nd day of September, 1998. YES! ENTERTAINMENT CORPORATION /s/ Mark Shepherd ------------------------------------ Name: Mark Shepherd Title: Chief Executive Officer Attest: /s/ Mark Shepherd - ------------------------------------ Name: Mark Shepherd Title: Secretary 17. EXHIBIT A --------- NOTICE OF CONVERSION AT THE ELECTION OF HOLDER (To be Executed by the Registration Holder in order to Convert shares of Preferred Stock) The undersigned hereby irrevocably elects to convert the number of shares of Series C Convertible Preferred Stock indicated below, into shares of Common Stock, par value $.001 per share (the "Common Stock"), of YES! Entertainment Corporation (the "Company") according to the conditions hereof, as of the date written below. As of the date set forth below, the undersigned is in compliance with Section 4.18 of the Securities Exchange Agreement between the Company, Infinity Investors Limited, Infinity Emerging Opportunities Limited and Glacier Capital Limited dated September 2, 1998. If shares are to be issued in the name of a person other than undersigned, the undersigned will pay all transfer taxes payable with respect thereto and is delivering herewith such certificates and opinions as reasonably requested by the Company in accordance therewith. No fee will be charged to the holder for any conversion, except for such transfer taxes, if any. Conversion calculations: ------------------------------------------------------- Date to Effect Conversion ------------------------------------------------------- Number of shares of Preferred Stock to be Converted ------------------------------------------------------- Number of shares of Common Stock to be Issued ------------------------------------------------------- Applicable Conversion Ratio (as adjusted to give effect to prior Adjustment Events) ------------------------------------------------------- Signature ------------------------------------------------------- Name: ------------------------------------------------------- Address: 18. EX-4.3 4 SECURITIES EXCHANGE AGREEMENT DATED 09/2/1998 EXHIBIT 4.3 SECURITIES EXCHANGE AGREEMENT AMONG YES! ENTERTAINMENT CORPORATION, INFINITY INVESTORS LIMITED, INFINITY EMERGING OPPORTUNITIES LIMITED AND GLACIER CAPITAL LIMITED ------------------------------------- Dated as of September 2, 1998 ------------------------------------- TABLE OF CONTENTS PAGE SECTION 1. CERTAIN DEFINITIONS........................................ 2 1.1 CERTAIN DEFINITIONS........................................ 2 SECTION 2. EXCHANGE OF SECURITIES..................................... 5 2.1 EXCHANGE OF SECURITIES; ISSUANCE OF SECURITIES............. 5 2.2 CLOSING.................................................... 5 SECTION 3. REPRESENTATIONS AND WARRANTIES............................. 6 3.1 REPRESENTATIONS AND WARRANTIES OF THE COMPANY.............. 6 3.2 REPRESENTATIONS AND WARRANTIES OF THE INVESTORS............ 10 SECTION 4. OTHER AGREEMENTS OF THE PARTIES............................ 11 4.1 TRANSFER RESTRICTIONS...................................... 11 4.2 STOP TRANSFER INSTRUCTION.................................. 12 4.3 FURNISHING OF INFORMATION.................................. 13 4.4 COPIES AND USE OF DISCLOSURE MATERIALS..................... 13 4.5 BLUE SKY LAWS.............................................. 13 4.6 INTEGRATION................................................ 13 4.7 CERTAIN AGREEMENTS......................................... 14 4.8 LISTING OF UNDERLYING SHARES............................... 14 4.9 INVESTOR'S RIGHTS IF TRADING IN COMMON STOCK IS SUSPENDED OR DELISTED................................................ 14 4.10 NO VIOLATION OF APPLICABLE LAW............................. 15 4.11 REPURCHASE RESTRICTIONS.................................... 15 4.12 LEGAL OPINION.............................................. 15 4.13 NOTICE OF BREACHES......................................... 15 4.14 CONVERSION PROCEDURES...................................... 15 4.15 TRANSFER AGENT............................................. 16 4.16 NEW DIRECTORS.............................................. 16 4.17 RESTRICTION ON DEBT........................................ 16 4.18 RESTRICTION ON SHORT SALES................................. 16 4.19 RESTRICTIONS ON CONVERSION AND SALE........................ 16 4.20 STOCKHOLDERS MEETING....................................... 17 i. TABLE OF CONTENTS (CONTINUED) PAGE SECTION 5. MISCELLANEOUS.............................................. 18 5.1 FEES AND EXPENSES.......................................... 18 5.2 ENTIRE AGREEMENT; AMENDMENTS............................... 18 5.3 NOTICES.................................................... 18 5.4 AMENDMENTS; WAIVERS........................................ 19 5.5 HEADINGS................................................... 20 5.6 SUCCESSORS AND ASSIGNS..................................... 20 5.7 NO THIRD-PARTY BENEFICIARIES............................... 20 5.8 GOVERNING LAW.............................................. 20 5.9 SURVIVAL................................................... 20 5.10 COUNTERPART SIGNATURES..................................... 20 5.11 PUBLICITY.................................................. 20 5.12 SEVERABILITY............................................... 21 5.13 REMEDIES................................................... 21 5.14 AMENDMENT TO REGISTRATION RIGHTS AGREEMENT................. 21 Exhibit A Form of Certificate of Designation Exhibit B Form of 5% Convertible Debenture Exhibit C [Intentionally Omitted] Exhibit D Form of Cooley Godward LLP Legal Opinion Exhibit F Conversion Procedures Schedule 2.2(b) Debentures, Preferred Stock, Warrants Schedule 3.1(a) Company Subsidiaries Schedule 3.1(c) Capitalization Schedule 3.1(f) Consents and Approvals Schedule 3.1(g) Litigation Schedule 4.20(b) Ownership Percentages ii. SECURITIES EXCHANGE AGREEMENT THIS SECURITIES EXCHANGE AGREEMENT, dated September 2, 1998 (this "Agreement"), by and among YES! ENTERTAINMENT CORPORATION, a Delaware corporation (the "Company"), INFINITY INVESTORS LIMITED, a corporation organized and existing under the laws of Nevis, West Indies ("Infinity"), GLACIER CAPITAL LIMITED, a corporation organized and existing under the laws of Nevis, West Indies ("Glacier") and INFINITY EMERGING OPPORTUNITIES LIMITED, a corporation organized and existing under the laws of Nevis, West Indies ("Emerging") (each of Infinity, Glacier and Emerging an "Investor," and collectively, the "Investors"). WHEREAS, the Company, Infinity and Fairway Capital Limited ("Fairway" and collectively with Infinity, the "Original Purchasers") are parties to that certain Amended and Restated Convertible Debenture and Convertible Preferred Stock Purchase Agreement, dated as of March 18, 1997 (the "March Purchase Agreement"), pursuant to which, among other things, (i) the Company issued and sold to the Original Purchasers an aggregate of $1,566,667 principal amount of the Company's 5% convertible debentures, due January 28, 2000 (collectively, the "March Debentures"), (ii) the Company issued 85,000 shares of its Series A Convertible Preferred Stock (the "Series A Preferred") to the Original Purchasers, and (iii) the Company delivered Common Stock Purchase Warrants exercisable into 300,000 shares of Common Stock (collectively, the "Warrants"); WHEREAS, the Company, the Original Purchasers and Cappello & Laffer Capital Corp. ("Cappello") are parties to that certain Amended and Restated Securities Purchase Agreement, dated July 25, 1997 (the "July Purchase Agreement"), which amended and restated the March Purchase Agreement on July 25, 1997 pursuant to which, among other things, (a) the Company issued and delivered to the Original Purchasers and Cappello in exchange for the March Debentures and the Series A Preferred they then held (i) an aggregate amount of 390,846 shares of the Company's Series B Preferred Stock (the "Series B Preferred") and (ii) an aggregate amount of $1,956,021.49 of the Company's 5% Convertible Debentures Due April 30, 2000 (the "July Debentures"); WHEREAS, (a) on December 31, 1997, Fairway transferred all of its Series B Preferred and July Debentures to Glacier, and (b) on May 15, 1998, Infinity sold $100,000 of its July Debentures to Emerging, in each case in a private transaction under Section 4(2) of the Securities Act of 1933, as amended; WHEREAS, subject to the terms of this Agreement the Company and the Investors desire to exchange the Investors' Series B Preferred for 348,670 shares of the Company's Series C Preferred Stock (the "Series C Preferred") and to exchange the Investors July Debentures for the Company's new 5% Convertible Debentures, due April 30, 2002 (the "Debentures); NOW, THEREFORE, in consideration of the mutual covenants and agreements set forth herein and for good and valuable consideration, the receipt of which is hereby acknowledged, the parties agree as follows: 1. SECTION 1. CERTAIN DEFINITIONS 1.1 CERTAIN DEFINITIONS. As used in this Agreement, and unless the context requires a different meaning, the following terms have the meanings indicated: "Affiliate" means, with respect to any Person, any Person that, directly or indirectly, controls, is controlled by or is under common control with such Person. For the purposes of this definition, "control" (including, with correlative meanings, the terms "controlled by" and "under common control with") shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities or by contract or otherwise. "Agreement Effective Date" shall mean September 2, 1998. "BNY" means BNY Financial Corporation, 1290 Avenue of the Americas, New York, New York 10104. "BNY Bank Obligations" means the borrowings and interest due thereon (including, without limitation, any interest accruing after the commencement of any case, proceeding or other action relating to the liquidation, dissolution, assignment for the benefit of creditors, receivership, arrangement, bankruptcy, insolvency or reorganization of the Company regardless of whether such interest is allowable, payable or accruable to BNY in such case, proceeding or other action) under the Receivables Agreement, as the same may from time to time be amended, supplemented, otherwise modified, replaced or refinanced. "Business Day" means any day except Saturday, Sunday and any day which shall be a legal holiday or a day on which banking institutions in the State of New York or the State of California are authorized or required by law or other government actions to close. "Certificate of Designation" means the Amended and Restated Certificate of Designation in the form of Exhibit A attached hereto, which is to be filed by the Company with the Secretary of State of the State of Delaware on or prior to the Closing Date. "Closing" and "Closing Date" are as defined in Section 2.2(a). "Commission" means the Securities and Exchange Commission. "Common Stock" means shares now or hereafter authorized of the class of Common Stock, par value $.001 per share, of the Company, stock of any other class into which such shares may hereafter be reclassified or changed and any other equity securities of the Company hereafter designated as Common Stock. "Conversion Date" when used in connection with the Debentures shall have the meaning set forth therein, and when used in connection with the Preferred Stock shall have the meaning set forth in the Certificate of Designation. 2. "Conversion Price" when used in connection with the Debentures shall have the meaning set forth therein, and when used in connection with the Preferred Stock shall have the meaning set forth in the Certificate of Designation. "Conversion Ratio" when used in connection with the Debentures shall have the meaning set forth therein, and when used in connection with the Preferred Stock shall have the meaning set forth in the Certificate of Designation. "Debentures" means the Company's 5% Convertible Debentures, due April 30, 2002, in the form attached hereto as Exhibit B, to be issued in accordance with and subject to the terms and conditions hereof and "Debenture" means any of them. "Disclosure Materials" means, collectively, the SEC Documents and the Schedules to this Agreement furnished by or on behalf of the Company. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Lien" means, with respect to any asset, any mortgage, lien, pledge, encumbrance, right of first refusal, charge or security interest of any kind in or on such asset or the revenues or income thereon or therefrom. "Liquidation Preference" is as set forth in the Certificate of Designation. "Material Adverse Effect" shall have the meaning set forth in Section 3.1(a). "Per Share Market Price," when used in connection with the Debentures shall have the meaning set forth therein, and when used in connection with the Preferred Stock or the Underlying Shares shall have the meaning set forth in the Certificate of Designation. "Person" means an individual or a corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or political subdivision thereof) or other entity of any kind. "Preferred Stock" means the shares of the Company's Series C Convertible Preferred Stock, par value $.001 per share, with the respective rights, preferences and privileges set forth in the Certificate of Designation. "Prepayment Date" is as defined in the Debenture. "Prepayment Price" is as defined in the Debenture. "Receivables Agreement" means the Accounts Receivable Management and Security Agreement, dated as of July 31, 1995, among the Company and BNY, as amended. "Redemption Date" shall have the meaning set forth in the Certificate of Designation. "Redemption Price" shall have the meaning set forth in the Certificate of Designation. 3. "Registration Rights Agreement" means the Amended and Restated Registration Rights Agreement dated July 25, 1998 among the Original Purchasers and Cappello, as the same may be amended, supplemented or otherwise modified in accordance with its terms, including pursuant to Section 5.14 hereof. "SEC Documents" shall have the meaning set forth in Section 3.1(k). "Securities Act" means the Securities Act of 1933, as amended. "Shares" shall have the meaning set forth in Section 2.1(d). "Short Sales" shall mean any sale of a security which the seller does not own (as defined below) or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller. A person shall be deemed to "own" a security if: (1) he or his agent is title to it; or (2) he has purchased, or has entered into an unconditional contract, binding on both parties thereto, to purchase it but has not yet received it; or (3) he owns a security convertible into or exchangeable for it and has tendered such security for conversion or exchange; or (4) he has an option to purchase or acquire it and has exercised such option; or (5) he has rights or warrants to subscribe to it and has exercised such rights or warrants, provided, however, that a person shall be deemed to own securities only to the extent that he has a net long position in such securities. "Subsidiaries" shall have the meaning set forth in Section 3.1(a). "Trading Day" means (a) a day on which the Common Stock is traded on the Nasdaq National Market or Nasdaq SmallCap Market or principal national securities exchange or market on which the Common Stock has been listed or quoted, or (b) if the Common Stock is not listed or quoted on the Nasdaq National Market or Nasdaq SmallCap Market or any principal national securities exchange or market, a day on which the Common Stock is traded in the over-the- counter market, as reported by the National Quotation Bureau Incorporated (or any similar organization or agency succeeding its functions of reporting prices). "Transaction Documents" shall have the meaning set forth in Section 3.1(b). "Transfer Agent" shall have the meaning set forth in Section 4.15. "Underlying Securities Registration Statement" means the registration statement contemplated by the Registration Rights Agreement and relating to the Underlying Shares and Warrant Shares. 4. "Underlying Shares" means the shares of Common Stock issuable upon the conversion of the Debentures and the Shares in accordance with their terms and the Certificate of Designation. "Warrants" shall be as defined in the preamble to this Agreement. "Warrant Shares" shall have the meaning set forth in Section 3.1(d). SECTION 2. EXCHANGE OF SECURITIES 2.1 EXCHANGE OF SECURITIES; ISSUANCE OF SECURITIES. (a) INFINITY. Subject to the terms and conditions set forth in this Agreement, Infinity shall receive and the Company shall issue and deliver upon surrender by Infinity of the July Debentures and Series B Preferred currently held by it: (i) Debentures in an aggregate principal amount of $1,545,787.50 (the "Infinity Debenture") and (ii) 313,454 shares of Series C Preferred Stock (the "Infinity Preferred Shares"). (b) EMERGING. Subject to the terms and conditions set forth in this Agreement, Emerging shall receive and the Company shall issue and deliver upon surrender by Emerging of the July Debentures currently held by it Debentures in an aggregate principal amount of $100,638.89 (the "Emerging Debenture"). (c) GLACIER. Subject to the terms and conditions set forth in this Agreement, Glacier shall receive and the Company shall issue and deliver upon surrender by Glacier of the July Debentures and Series B Preferred currently held by it: (i) Debentures in an aggregate principal amount of $189,494.20 (the "Glacier Debenture") and (ii) 35,216 shares of Series C Preferred Stock (the "Glacier Preferred Shares"). (d) DEFINITIONS. The Infinity Debenture, the Emerging Debenture and the Glacier Debenture are sometimes collectively referred to herein as the "Debentures." The Infinity Preferred Shares and the Glacier Preferred Shares are sometimes referred to collectively herein as the "Shares." The Shares, Debentures and Underlying Shares are sometimes collectively referred to as the "Securities." 2.2 CLOSING. (a) The closing of the exchange of the Debentures and the Shares (the "Closing") shall take place at the offices of Cooley Godward LLP, Five Palo Alto Square, 3000 El Camino Real, Palo Alto, California 94306, immediately following the execution hereof, or at such other time and/or place as the Investors and the Company may agree. The date of the Closing is hereinafter referred to as the "Closing Date." (b) At the Closing (A) the Company shall deliver (i) the Debentures and certificates representing the Shares to be issued and delivered to each Investor, as specified in Section 2.1 hereto, and (ii) to the Persons entitled thereto, all other documents, instruments and writings required to have been delivered at or prior to the Closing by the Company pursuant to this Agreement; (B) each Investor shall deliver to the Company (i) the July Debentures and Series B Preferred, as specified in Section 2.1 and (ii) all documents, instruments and writings 5. required to have been delivered at or prior to the Closing by such Investor pursuant to this Agreement. SECTION 3. REPRESENTATIONS AND WARRANTIES 3.1 REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company hereby represents and warrants to the Investors as follows: (a) ORGANIZATION AND QUALIFICATION. The Company is a corporation, duly incorporated, validly existing and in good standing under the laws of the State of Delaware, with the requisite corporate power and authority to own and use its properties and assets and to carry on its business as currently conducted. The Company has no subsidiaries other than as set forth in the SEC Documents (collectively, the "Subsidiaries"). Each of the Subsidiaries is a corporation, duly incorporated, validly existing and in good standing under the laws of the jurisdiction of its incorporation, with the full corporate power and authority to own and use its properties and assets and to carry on its business as currently conducted. Each of the Company and the Subsidiaries is duly qualified to do business and is in good standing as a foreign corporation in each jurisdiction in which the nature of the business conducted or property owned by it makes such qualification necessary, except where the failure to be so qualified or in good standing, as the case may be, could not individually or in the aggregate have a material adverse effect on the results of operations, assets, prospects or financial condition of the Company and the Subsidiaries, taken as a whole (a "Material Adverse Effect"). (b) AUTHORIZATION; ENFORCEMENT. The Company has the requisite corporate power and authority to enter into and to consummate the transactions contemplated hereby and by the Debentures and the Certificate of Designation and otherwise to carry out its obligations hereunder and thereunder. This Agreement, the Debentures, and the Certificate of Designation are collectively referred to as the "Transaction Documents." The execution and delivery of the Transaction Documents by the Company and the consummation by it of the transactions contemplated thereby have been duly authorized by all necessary action on the part of the Company. Each Transaction Document has been duly executed and delivered by the Company and constitutes the valid and binding obligation of the Company enforceable against the Company in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of, creditors' rights and remedies or by other equitable principles of general application. (c) CAPITALIZATION. The authorized, issued and outstanding capital stock of the Company and each of the Subsidiaries is set forth in the latest Form 10-Q filed by the Company with the Commission on August 14, 1998. No shares of Common Stock are entitled to preemptive or similar rights. Except as specifically disclosed in the Form 10-K filed by the Company for the year ended December 31, 1997 and options granted under the Company's stock option plans subsequent to December 31, 1997, there are no outstanding options, warrants, script rights to subscribe to, calls or commitments of any character whatsoever relating to, or, securities, rights or obligations convertible into or exchangeable for, or giving any Person any right to subscribe for or acquire any shares of Common Stock, or contracts, commitments, understandings, or arrangements by which the Company or any Subsidiary is or may become 6. bound to issue additional shares of Common Stock, or securities or rights convertible or exchangeable into shares of Common Stock except upon conversion of the July Debentures, the Debentures, Series B Preferred, the Shares and the Warrants. Neither the Company nor any Subsidiary is in violation of any of the provisions of its respective certificate of incorporation, bylaws or other charter documents. (d) ISSUANCE OF DEBENTURES AND SHARES. The Debentures have been duly and validly authorized for issuance, offer and sale pursuant to this Agreement and, when issued and delivered as provided hereunder against payment in accordance with the terms hereof, shall be valid and binding obligations of the Company enforceable in accordance with their terms free and clear of all Liens. The Shares are duly authorized and, when issued and paid for in accordance with the terms hereof, will be validly issued, fully paid and nonassessable. The Company has and at all times while the Debentures, Shares and Warrants are outstanding will maintain an adequate reserve of shares of Common Stock to enable it to perform its obligations under this Agreement, the Debentures, the Certificate of Designation and Warrants and in no circumstances shall such reserved and available shares of Common Stock be less than the sum of (i) 5 million shares prior to obtaining Stockholder Approval, and following the obtaining of Stockholder Approval, the number of Underlying Shares plus 10 million, assuming in each case such conversion occurred on the Agreement Effective Date, and assuming the payment of dividends and interest in additional Shares and Debentures, and (ii) the number of shares of Common Stock which would be issuable upon exercise in full of the Warrants (the "Warrant Shares"). When issued in accordance with the terms hereof, the Debentures and the Certificate of Designation, the Underlying Shares will be duly authorized, validly issued, fully paid nonassessable, free and clear of all Liens. (e) NO CONFLICTS. The execution, delivery and performance of the Transaction Documents by the Company and the consummation by the Company of the transactions contemplated hereby and thereby do not and will not (i) conflict with or violate any provision of its certificate of incorporation or bylaws (each as amended through the date hereof) or (ii) conflict with, or constitute a default (or an event which with notice or lapse of time or both would become a default) under, or give to others any rights of termination, amendment, acceleration or cancellation of, any agreement, indenture or instrument to which the Company is a party or by which any property or asset of the Company is bound or affected, or (iii) result in a violation of any law, rule, regulation, order, judgment, injunction, decree or other restriction of any court or governmental authority to which the Company is subject (including Federal and state securities laws and regulations), or by which any property or asset of the Company is bound or affected, except in the case of each of clauses (ii) or (iii), such conflicts, defaults, terminations, amendments, accelerations, cancellations and violations as could not, individually or in the aggregate, (x) adversely affect the legality, validity or enforceability of any Transaction Document, (y) have a Material Adverse Effect or (z) adversely impair the Company's ability to perform fully on a timely basis its obligations under any Transaction Document. The business of the Company is not being conducted in violation of any law, ordinance or regulation of any governmental authority, except for violations which, individually or in the aggregate, do not have a Material Adverse Effect. (f) CONSENTS AND APPROVALS. Except as obtained prior to the execution hereof, neither the Company nor any Subsidiary is required to obtain any consent, 7. waiver, authorization or order of, or make any filing or registration with, any court or other federal, state, local or other governmental authority or other Person in connection with the execution, delivery and performance by the Company of the Transaction Documents, other than (i) the filing of an amendment with the Commission of the Underlying Securities Registration Statement and the making of the applicable blue-sky filings under state securities laws, each as contemplated by the Registration Rights Agreement, which shall be filed in the time periods set forth in the Registration Rights Agreement, (ii) the filing of the Certificate of Designation with the Secretary of State of the State of Delaware, which shall occur prior to the Closing, and (iii) other than, in all other cases, where the failure to obtain such consent, waiver, authorization or order, or to give or make such notice or filing, could not, individually or in the aggregate, (x) adversely affect the legality, validity or enforceability of any of the Transaction Documents, (y) have a Material Adverse Effect or (z) adversely impair the Company's ability to perform fully on a timely basis its obligations under any of the Transaction Documents. (g) LITIGATION; PROCEEDINGS. There is no action, suit, notice of violation, proceeding or investigation pending or, to the knowledge of the Company, threatened against or affecting the Company or any of its Subsidiaries or any of their respective assets or properties before or by any court, governmental or administrative agency or regulatory authority (federal, state, county, local or foreign) which (i) relates to or challenges the legality, validity or enforceability of the Transaction Documents, Underlying Shares or Warrant Shares or (ii) could, individually or in the aggregate, adversely impair the Company's ability to perform fully on a timely basis its obligations under the Transaction Documents. (h) NO DEFAULT OR VIOLATION. Neither the Company nor any Subsidiary (i) is in default under or in violation of any indenture, loan or credit agreement or any other agreement or instrument to which it is a party or by which it or any of its properties is bound, (ii) is in violation of any order of any court, arbitrator or governmental body, or (iii) is in violation of any statute, rule or regulation of any governmental authority, except as could not, in any such case, individually or in the aggregate, (y) adversely affect the legality, validity or enforceability of any of the Transaction Documents, or (z) adversely impair the Company's ability to perform fully on a timely basis its obligations under the Transaction Documents. (i) CERTAIN FEES. No fees or commission will be payable by the Company to any broker, finder, investment banker or bank with respect to the consummation of the transactions contemplated hereby. (j) PRIVATE OFFERING. Assuming (without any independent investigation or verification by or on behalf of the Company) the accuracy of the representations and warranties of the Investors set forth in Section 3.2, the offer and sale of the Debentures, Shares, and the Underlying Shares are exempt from registration under Section 5 of the Securities Act. Neither the Company nor any person acting on its behalf has taken or will take any action (including, without limitation, any offering of any securities of the Company under circumstances which would require the integration of such offering with the offering of the Convertible Debentures or Shares under the Securities Act) which might subject the offering, issuance or sale of the Debentures, Shares, the Underlying Shares or the Warrant Shares to the registration requirements of Section 5 of the Securities Act. 8. (k) SEC DOCUMENTS. The Company has filed all forms, reports and documents required to be filed by it under the Exchange Act, including pursuant to Section 13(a) or 15(d) thereof, since March 18, 1995 (the foregoing reports being collectively referred to herein as the "SEC Documents") on a timely basis, or has received a valid extension of such time of filing. As of their respective dates, the SEC Documents complied in all material respects with the requirements of the Securities Act and the Exchange Act and the rules and regulations of the Commission promulgated thereunder and none of the SEC Documents, when filed, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. The audited and unaudited consolidated balance sheets of the Company and its Subsidiaries contained in the SEC Documents, and the related consolidated statements of income, changes in stockholders' equity and changes in cash flows for the periods then ended, including the footnotes thereto, except as indicated therein, have been prepared in accordance with generally accepted accounting principles consistently followed throughout the periods indicated, except that unaudited financial statements contained therein do not contain notes and may be subject to normal audit adjustments and normal annual adjustments and fairly present the financial condition of the Company and its consolidated Subsidiaries as of and for the dates thereof and, except as indicated therein, reflects all claims against and all material debts and liabilities of the Company and its consolidated Subsidiaries, fixed or contingent, as at and for the dates thereof; and the related statements of income, stockholders' equity and changes in cash flows fairly present the results of the operations of the Company and its consolidated Subsidiaries and the changes in financial position for the period indicated. Since the date of the financial statements included in the Company's last filed Quarterly Report on Form 10-Q, there has been no event, occurrence or development that has had a Material Adverse Effect which is not specifically disclosed in any of the Disclosure Materials. (l) FORM S-3 ELIGIBILITY. The Company meets the registrant requirements set forth in connection with offerings by persons other than the issuer set forth in the General Instructions of Form S-3 promulgated under the Securities Act. (m) INVESTMENT COMPANY. The Company is not, and following the Closing will not be, an Affiliate of an "investment company" within the meaning of the Investment Company Act of 1940, as amended. (n) SOLICITATION MATERIALS. The Company did not solicit any offer to buy or sell the Debentures, the Shares, or the Underlying Shares by means of any form of general solicitation or advertising. (o) MARGIN REQUIREMENTS. The Company will not use the proceeds of the offer and sale of the Debentures and Shares hereunder, directly or indirectly, immediately, incidentally or ultimately, (i) to purchase or carry Margin Stock (as such term is defined under Regulation U of the Board of Governors of the Federal Reserve System, as in effect from time to time) or to extend credit to others for the purpose of purchasing or carrying Margin Stock or to refund indebtedness originally incurred for such purpose, or (ii) for any purpose which entails a violation of, or which is inconsistent with, the provisions of Regulations T, U or X of the Board of Governors of the Federal Reserve System. 9. 3.2 REPRESENTATIONS AND WARRANTIES OF THE INVESTORS. Each of the Investors, severally and not jointly, hereby represents and warrants to the Company as follows: (a) ORGANIZATION; AUTHORITY. Such Investor is a corporation duly incorporated, validly existing and in good standing under the laws of the jurisdiction of its incorporation with the requisite corporate power and authority to enter into and to consummate the transactions contemplated hereby and otherwise to carry out its obligations hereunder and thereunder. The acquisition of the Debentures and Shares purchased by such Investor hereunder has been duly authorized by all necessary action on the part of such Investor. This Agreement has been duly executed and delivered by such Investor and constitutes the valid and legally binding obligation of such Investor, enforceable against it in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws relating to, or affecting generally the enforcement of, creditors' rights and remedies or by other general principles of equity. (b) INVESTMENT INTENT. Such Investor is acquiring the Debentures and Shares to be purchased by it hereunder, and the Underlying Shares relating to such Debentures and Shares, for its own account for investment purposes only and not with a view to or for distributing or reselling such Debentures, Shares or Underlying Shares or any part thereof or interest therein, without prejudice, however, to such Investor's right, subject to the provisions of this Agreement and the Registration Rights Agreement, at all times to sell or otherwise dispose of all or any part of such Debentures, Shares or Underlying Shares, pursuant to under an effective registration statement under the Securities Act or pursuant to an available exemption from the registration requirements thereunder and in compliance with applicable state securities laws. (c) INVESTOR STATUS. At the time such Investor was offered the Debentures and Shares to be acquired by it hereunder, it was and at the date hereof, it is, an "accredited investor" as defined in Rule 501(a) under the Securities Act. (d) INVESTMENT COMPANY. The Investor is not, and following the Closing and issuance of the Debentures and Shares will not be, nor is it an Affiliate of an "investment company" within the meaning of the Investment Company Act of 1940, as amended. (e) EXPERIENCE OF INVESTOR. Such Investor, either alone or together with its representatives, has such knowledge, sophistication and experience in business and financial matters so as to be capable of evaluating the merits and risks of an investment in the securities to be acquired by it hereunder, and has so evaluated the merits and risks of such investment. (f) ABILITY OF INVESTOR TO BEAR RISK OF INVESTMENT. Such Investor is able to bear the economic risk of an investment in the securities to be acquired by it hereunder and, at the present time, is able to afford a complete loss of such investment. 10. (g) PROHIBITED TRANSACTIONS. The securities to be acquired by such Investor hereunder are not being acquired, directly or indirectly, with the assets of any "employee benefit plan," within the meaning of Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended. (h) ACCESS TO INFORMATION. Such Investor acknowledges receipt of the Disclosure Materials and further acknowledges that it has been afforded (i) the opportunity to ask such questions as it has deemed necessary of, and to receive answers from, representatives of the Company concerning the terms and conditions of the securities offered hereunder and the merits and risks of investing in such securities; (ii) access to information about the Company and the Company's financial condition, results of operations, business, properties, management and prospects sufficient to enable it to evaluate its investment in such securities; and (iii) the opportunity to obtain such additional information which the Company possesses or can acquire without unreasonable effort or expense that is necessary to make an informed investment decision with respect to the investment and to verify the accuracy and completeness of the information contained in the Disclosure Materials. (i) RELIANCE. Such Investor understands and acknowledges that (i) the Debentures and the Shares being offered and sold to it hereunder are being offered and sold without registration under the Securities Act in a private placement that is exempt from the registration provisions of the Securities Act under Regulation D promulgated thereunder and (ii) the availability of such exemption, depends in part on, and that the Company will rely upon the accuracy and truthfulness of, the foregoing representations and such Investor hereby consents to such reliance. The Company acknowledges and agrees that the Investors make no representations or warranties with respect to the transactions contemplated hereby other than those specifically set forth in this Section 3.2. SECTION 4. OTHER AGREEMENTS OF THE PARTIES 4.1 TRANSFER RESTRICTIONS. (a) If any Investor should decide to dispose of any portion of the principal amount of the Debentures, or any of the Shares to be purchased by it hereunder (and upon conversion thereof, any Underlying Shares), such Investor understands and agrees that it may do so only (i) pursuant to an effective registration statement under the Securities Act, (ii) to the Company or (iii) pursuant to an available exemption from registration under the Securities Act. As a condition to any transfer of any Debentures, Shares or Underlying Shares other than pursuant to an effective registration statement or to the Company, the Company may require that the transferor provide to the Company an opinion of counsel experienced in the area of United States securities laws selected by the transferor, the form and substance of which opinion shall be reasonably satisfactory to the Company, to the effect that such transfer of such Debentures, Shares, or Underlying Shares, as the case may be, is being made pursuant to an exemption under the Securities Act. Any transfer of the Underlying Shares shall be subject to the transfer and sales restrictions set forth in Section 4.19(b) of this Agreement. 11. (b) The Investors agree to the imprinting, so long as required by the terms of this Section 4.1(b), of the following legend on certificates representing the Debentures, the Shares, and the Underlying Shares, to be modified as applicable: NEITHER THESE SECURITIES NOR THE SECURITIES INTO WHICH THESE SECURITIES ARE CONVERTIBLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM THE REGISTRATION REQUIREMENTS THEREUNDER, AND IN COMPLIANCE WITH APPLICABLE STATE SECURITIES LAWS. THIS [ ] IS SUBJECT TO CERTAIN RESTRICTIONS ON TRANSFER AND CONVERSION SET FORTH IN A SECURITIES EXCHANGE AGREEMENT, DATED AS OF SEPTEMBER 2, 1998, BETWEEN YES! ENTERTAINMENT CORPORATION ("THE COMPANY") AND THE ORIGINAL HOLDER HEREOF. A COPY OF SUCH AGREEMENT IS ON FILE AT THE PRINCIPAL OFFICE OF THE COMPANY. The legend set forth above shall be removed upon the conversion of Debentures or Shares represented by such certificate at any time after an Underlying Securities Registration Statement has been declared, and so long as such Underlying Securities Registration Statement remains effective under the Securities Act or, if not converted during such time, at such other time as in the opinion of counsel to the Company experienced in the area of United States securities laws such legend is no longer required under applicable requirements of the Securities Act (including judicial interpretations and pronouncements issued by the staff of the Commission). The certificates representing the Debentures, Shares, and Underlying Shares shall also bear any other legends required by applicable Federal or state securities laws, which legends may be removed as set forth above in the immediately preceding sentence, or, with respect to legends required pursuant to state securities laws, when such legends are no longer required under the applicable requirements of such securities laws. The Company agrees that it will provide each Investor, upon request, with a substitute certificate or certificates, free from such legend at such time as such legend is no longer applicable at no charge. Each Investor agrees that, in connection with any transfer of Underlying Shares by it pursuant to an effective registration statement under the Securities Act, such Investor will comply with all applicable prospectus delivery requirements of the Securities Act. The Company makes no representation, warranty or agreement as to the availability of any exemption from registration under the Securities Act with respect to any resale of the Debentures, Shares, or Underlying Shares. 4.2 STOP TRANSFER INSTRUCTION. For so long as an Underlying Securities Registration Statement is effective or the Investor complies with Section 4.1, the Company shall 12. not issue any stop transfer instruction or make any notation on its records with respect thereto to any transfer agent (including the Transfer Agent) of the Company and shall issue shares of Common Stock upon a conversion of Debentures or Shares or exercise of Warrants in accordance with Section 4.1. 4.3 FURNISHING OF INFORMATION. (a) As long as any Investor owns Debentures, Shares or Underlying Shares, the Company covenants to timely file (or obtain extensions in respect thereof) all reports required to be filed by the Company after the date hereof pursuant to Section 13(a) or 15(d) of the Exchange Act and to furnish to each Investor within ten days of each such filing true and complete copies of all such filings. If the Company is not at the time required to file reports pursuant to such sections, it will prepare and furnish to each Investor annual and quarterly financial statements, together with a management discussion and analysis of such financial statements in form and substance substantially similar to those that would otherwise be required to be included in reports required by Section 13(a) or 15(d) of the Exchange Act in the time period that such filings would have been required to have been made under the Exchange Act. (b) The Company shall deliver copies to the Investors of any documents or financial statements it delivers to BNY pursuant to Sections 11(a), 11(b), 11(c) or 11(d) of the Receivables Agreement concurrently with such delivery to BNY, provided that the Company shall not be obligated to deliver the accountant's consent required under Section 11 of the Receivables Agreement and shall not deliver to the Investors the other materials it is required to deliver to BNY under such Section 11. 4.4 COPIES AND USE OF DISCLOSURE MATERIALS. The Company consents to the use of the SEC Documents, and any amendments and supplements thereto, by the Investors in connection with resales of the Underlying Shares to the extent such resales are not pursuant to an effective registration statement. 4.5 BLUE SKY LAWS. The Company shall qualify the Underlying Shares under the securities or Blue Sky laws of such jurisdictions as each Investor may request and shall continue such qualification at all times through the third anniversary of the Closing Date; provided, however, that the Company shall not be required in connection therewith to qualify as a foreign corporation where it is not now so qualified, or take any action that would subject the Company to general service of process in any such jurisdiction where it is not then so subject or subject the Company to any material tax in any such jurisdiction where it is not then so subject. 4.6 INTEGRATION. The Company shall not and shall use its best efforts to ensure that no Affiliate shall sell, offer for sale or solicit offers to buy or otherwise negotiate in respect of any security (as defined in Section 2 of the Securities Act) that would be integrated with the offer or sale of the Debentures, the Shares or the Underlying Shares in a manner that would require the registration under the Securities Act of the sale of the Debentures, the Shares or the Underlying Shares to the Investors. 13. 4.7 CERTAIN AGREEMENTS. (a) The Company shall not and shall cause the Subsidiaries not to, without the consent of the Investors, (i) amend its certificate of incorporation, bylaws or other charter documents so as to adversely affect any rights of the Investors under the Transaction Documents; (ii) repay, repurchase or offer to repay, repurchase or otherwise acquire in excess of 10,000 shares of its Common Stock (counting since March 17, 1997), other than shares which may be repurchased from employees of the Company in connection with the termination of their employment with the Company; or (iii) enter into any agreement with respect to any of the foregoing. (b) The Company may not force any conversion or call a redemption of any portion of the principal amount of the Debentures until such time as all of the Shares have been converted or redeemed in accordance with the terms hereof and the Certificate of Designation. 4.8 LISTING OF UNDERLYING SHARES. The Company shall, within seven (7) Business Days of the Closing Date, file with the Nasdaq National Market an additional shares listing application covering such Underlying Shares and Warrant Shares that shall not have been previously covered by a Nasdaq additional shares listing and shall take all steps necessary to cause such application to be approved as soon as possible thereafter. The Company shall also take all steps necessary to cause such shares to be listed on any other national securities exchange or market on which the Common Stock is then listed as soon as possible after the Closing Date. The Company shall provide to each Investor evidence of such filings and listings, and shall maintain such listings as long as any Investor holds Debentures, Shares, Warrants, Underlying Shares or Warrant Shares. In the event the aggregate number of Underlying Shares and Warrant Shares exceeds the number covered by the additional shares listing application filed with the Nasdaq National Market, the Company shall promptly file one or more appropriate listing applications to continually list for trading a number of such additional shares, as the Company and the Investors shall reasonably agree. 4.9 INVESTOR'S RIGHTS IF TRADING IN COMMON STOCK IS SUSPENDED OR DELISTED. In the event that at any time within the three-year period after the date hereof, trading in the shares of the Common Stock is suspended on or delisted from the Nasdaq National Market (other than as a result of the suspension of trading in securities on such market generally or temporary suspensions pending the release of material information and other than a suspension of trading if the Common Stock is quoted on the Nasdaq SmallCap Market within one Business Day after such suspension), at each Investor's option exercisable by five Business Days prior written notice to the Company, the Company shall repay, redeem, or repurchase as applicable, all of the Debentures owned by each Investor at the Prepayment Price as calculated on the date of such notice, all of the Shares owned by each Investor at the Redemption Price as calculated on the date of such notice, all of the Warrants at the Warrant Repurchase Price as calculated on the date of such notice as provided in the July Purchase Agreement, and all of the Underlying Shares at the Per Share Market Price as calculated on the date of such notice and interest on such amounts at the rate of 15% per annum accruing from the fifth (5th) Business Day after such notice until the repurchase price under this Section 4.9 is paid in full. 14. 4.10 NO VIOLATION OF APPLICABLE LAW. Notwithstanding any provision of this Agreement to the contrary, if any repurchase or redemption otherwise required under this Agreement or the Registration Rights Agreement would be prohibited by the relevant provisions of Delaware General Corporation Law, such repurchase shall not be effected unless and until it is permitted under such law; provided, however, that interest payable by the Company with respect to any such repurchase or redemption shall continue to accrue in accordance with Section 4.9. 4.11 REPURCHASE RESTRICTIONS. Notwithstanding any provision of this Agreement to the contrary, if any repurchase or redemption otherwise required under this Agreement or the Registration Rights Agreement would be prohibited in the absence of consent from any institutional lender of the Company or any of the Subsidiaries which has an outstanding loan balance in excess of $1 million, the Company shall use its best efforts to obtain such consent as promptly as practicable after the repurchase or redemption is required and such repurchase or redemption shall not be effected unless and until such consent is obtained. Interest payable by the Company with respect to any such repurchase or redemption shall continue to accrue until such consent is obtained and the repurchase price therefor paid. Nothing contained in this Section 4.11 shall be construed as a waiver by the Investor of any rights it may have by virtue of any breach of any representation or warranty of the Company herein as to the absence of any requirement to obtain any such consent. 4.12 LEGAL OPINION. The Company shall cause the legal opinion of Cooley Godward LLP in the form of Exhibit D, to be delivered at the Closing. 4.13 NOTICE OF BREACHES. Each party shall give prompt written notice to the other party of any breach by it of any representation, warranty or other agreement contained in this Agreement or in the Registration Rights Agreement, as well as any events or occurrences arising after the date hereof and prior to the Closing, which would reasonably be likely to cause any representation or warranty or other agreement of such party, as the case may be, contained herein to be incorrect or breached as of such Closing Date. However, no disclosure by either party pursuant to this Section 4.13 shall be deemed to cure any breach of any representation, warranty or other agreement contained herein or in the Registration Rights Agreement. Notwithstanding the generality of the foregoing, the Company shall promptly notify each Investor of any notice or claim (written or oral) that it receives from any lender of the Company to the effect that the consummation of the transactions contemplated hereby and by the Registration Rights Agreement violates or would violate any written agreement or understanding between such lender and the Company, and the Company shall promptly furnish by facsimile to the holders of the Debentures and Shares a copy of any written statement in support of or relating to such claim or notice. 4.14 CONVERSION PROCEDURES. Exhibit F sets forth the procedures that are to followed in addition to the tendering of a Conversion Notice hereunder with respect to the conversion of the Debentures or Shares including the form of legal opinion, if necessary, that shall be rendered to the Transfer Agent and such other information and instructions as may be reasonably necessary to enable the Investors to exercise its right of conversion smoothly and expeditiously. 15. 4.15 TRANSFER AGENT. Boston EquiServe shall act as transfer agent (the "Transfer Agent") of the Company. The Company may not remove or replace the Transfer Agent as its transfer agent without the written consent of the Investors. 4.16 NEW DIRECTORS. Within 10 days after the Closing Date, the Company shall cause a majority of its Board of Directors to elect each of Stuart Chasanoff and Barrett Whissman to the Board. 4.17 RESTRICTION ON DEBT. The Company covenants and agrees that from and after the date hereof and so long as any of the Debentures remain outstanding, or the Company shall have any obligation to the Investors hereunder or pursuant hereto, the Company shall not, and shall not permit any Subsidiary to, without the prior written consent of the Investors in each instance incur, create, assume, guarantee or suffer to exist, or become or remain liable directly or indirectly, for or on account of any indebtedness, obligations or liabilities that rank pari passu with or senior to the indebtedness, obligations and liabilities represented by the Debentures, except under the BNY Bank Obligations or any obligations to any of the Investors or their respective successors and permitted assigns. 4.18 RESTRICTION ON SHORT SALES. Each Investor covenants and agrees not to engage in any Short Sales of Common Stock so long as the Investors or any of their affiliates, as defined in the Exchange Act, hold any Shares or Debentures; provided, however, that each Investor may engage in sales of Common Stock issuable to an Investor upon conversion or upon exercise of a Warrant, made within 72 hours prior to the time notice of conversion is given, or such Warrant is exercised, as applicable. 4.19 RESTRICTIONS ON CONVERSION AND SALE. (a) The Investors agree not to convert the Series C Preferred and Debentures into or exercise the Warrants for Common Stock until the earlier of (i) February 21, 1999 or (ii) the date an Event of Default (as defined below) occurs. For purposes of this Agreement, the following shall constitute an Event of Default: (i) the Company incurs more than $100,000 in additional indebtedness (excluding trade debt incurred in the ordinary course of business); (ii) the Company permits to exist liens on its assets securing payment of claims or obligations in an aggregate amount of $500,000 other than existing liens or liens securing payment of (A) the BNY Bank Obligations, (B) the Bridge Loan (as defined below), or (C) the New Facility (as defined below); (iii) the Company uses any of the proceeds of the Bridge Loan or the New Facility for any purpose other than working capital in connection with the operation of the Company's present business operations; (iv) the Company enters into any agreement to merge with or otherwise combine its assets or operations with any other entity or sells any material assets outside the ordinary course of business; (v) the Company commences an action for relief under any provision of the United States Bankruptcy Code or any similar statutory scheme (or is made the subject of such an action and such action is not dismissed within 30 days of commencement); (vi) the Company pays any material additional or special compensation to any of its officers that is not currently required under any existing agreements with its officers; (vii) the Company enters into any material transaction with any insider or affiliate; (viii) the Company issues any shares of stock in the Company other than in satisfaction of existing options, warrants, conversion rights, or existing obligations under the Company's employee benefit plans; or (ix) the Company's stockholders fail to approve (A) the Company's issuance of more than 20% of the Company's Common Stock upon conversion of 16. the Debentures and Series C Preferred to the Investors pursuant to Rule 4460 of the Nasdaq National market rules or (B) an increase in the authorized number of shares of Common Stock sufficient to cause the number of authorized and unissued and unreserved shares of Common Stock on such date to exceed (by not less than 10 million shares) the number of shares of Common Stock issuable upon the conversion and exercise of all of the outstanding shares of Series B Preferred and Series C Preferred, the July Debentures, the Debentures and the Warrants, in each case, on or prior to December 21, 1998. The Bridge Loan shall mean that certain $3 million loan from Infinity Investors Limited in favor of the Company and executed on the date hereof. The New Facility shall mean the proposed $10 million loan facility which may be entered into between the Company and Infinity Investors Limited. (b) The Investors agree not to sell, assign or otherwise transfer their shares of the Series C Preferred and Debentures or the Underlying Shares or Warrants until the earlier of (i) February 21, 1999 or (ii) the date an Event of Default occurs, except (X) in a private placement to a bona fide, independent third-party which is not an affiliate of any of the Investors in a transaction not entered into for the purpose of avoiding the provisions of this Section 4.19, which private placement is exempt from the registration requirements of Section 5 of the Securities Act, (Y) pursuant to an underwritten public offering of such securities, and (Z) the Investors may collectively sell, in any calendar quarter, Securities that convert into Underlying Shares or Underlying Shares in amounts up to 5% of the outstanding Common Stock on a fully diluted basis. On or after the first to occur of (i) February 21, 1999 or (ii) the date an Event of Default occurs, the Investors may (1) sell, assign or otherwise transfer their shares of the Series C Preferred and Debentures or the Underlying Shares or Warrants (A) in a private placement to a bona fide, independent third party which is not an affiliate of any of the Investors in a transaction not entered into for the purpose of avoiding the provisions of this Section 4.19, which private placement is exempt from the registration requirements of Section 5 of the Securities Act, (B) pursuant to an underwritten public offering of such securities or (2) collectively sell, in any calendar quarter, Securities that convert into Underlying Shares or Underlying Shares in amounts up to (but not exceeding) 10% of the outstanding Common Stock on a fully diluted basis. 4.20 STOCKHOLDERS MEETING. As soon as practicable, the Company shall file proxy materials with the Commission relating to a special or annual meeting of the stockholders of the Company called for the purpose of approving (A) the issuance (the "Issuance") of such Common Stock upon conversion of the Debentures, Warrants and Series C Preferred pursuant to Rule 4460 of Nasdaq National Market and (B) an increase in the authorized number of shares of Common Stock sufficient to cause the number of authorized and unissued and unreserved shares of Common Stock on such date to exceed (by not less than 10 million shares) the number of shares of Common Stock issuable upon the conversion and exercise of all of the outstanding shares of Series B Preferred and Series C Preferred, the July Debentures, the Debentures and the Warrants (the "Special Meeting"). The Company shall use its best efforts to clear the proxy statement relating to the Special Meeting with the Commission as soon as practicable and to mail the same to its stockholders as soon as practicable. The Company covenants to hold the Special Meeting on the earliest practicable date in compliance with Delaware law and the Company's certificate of incorporation and bylaws as in effect on the date hereof. The Board of Directors of the Company shall recommend to its stockholders that they vote in favor of a proposal to approve the Issuance and against any proposal that would prevent or discourage the Issuance. Simultaneous with the execution of this Agreement, Messrs. Donald Kingsborough and Gary 17. Nemetz have provided irrevocable proxies to the Investors allowing the Investors to vote all of their shares of Common Stock at the Special Meeting in favor of the Issuance. SECTION 5. MISCELLANEOUS 5.1 FEES AND EXPENSES. The Company shall pay the fees and expenses of its advisers, counsel, accountants and other experts, if any, and all other expenses incurred incident to the negotiation, preparation, execution, delivery and performance of this Agreement and the Registration Rights Agreement. The Company shall also pay the legal fees and expenses of the Investors incurred by them in connection with the negotiation, preparation, execution and delivery of this Agreement and the other documents delivered at the Closing. The Company shall pay all stamp and other taxes and duties levied in connection with the issuance of the Debentures and Shares pursuant hereto. Each Investor shall be responsible for such Investor's own tax liability that may arise as a result of the investment hereunder or the transactions contemplated by this Agreement. 5.2 ENTIRE AGREEMENT; AMENDMENTS. This Agreement, together with the Exhibits and Schedules hereto, the Debentures, the Certificate of Designation, the Registration Rights Agreement, the July Purchase Agreement solely as it relates to the Warrants (except that Sections 4.8 and 4.20 with respect to the Warrants are hereby deleted and of no further force and effect), and the Warrants contain the entire understanding of the parties with respect to the subject matter hereof and supersede all prior agreements and understandings, oral or written, with respect to such matters. 5.3 NOTICES. Any and all notices or other communications or deliveries required or permitted to be provided hereunder shall be in writing and shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section prior to 4:30 p.m. (Eastern Standard Time) on a Business Day, (ii) the Business Day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in the Purchase Agreement later than 4:30 p.m. (Eastern Standard Time) on any date and earlier than 11:59 p.m. (Eastern Standard time) on such date, (iii) the Business Day following the date of mailing, if sent by nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. The addresses for such communications shall be: If to the Company: YES! Entertainment Corporation 3875 Hopyard Road Pleasanton, CA 94588 Attn: Donald Kingsborough Facsimile No.: (510) 734-0997 18. With copies to: Cooley Godward LLP Five Palo Alto Square 3000 El Camino Real Palo Alto, CA 94306-2155 Attn: Patrick Pohlen Facsimile No.: (415) 857-0663 If to Infinity: Infinity Investors Limited Hunkins Waterfront Plaza Main Street P.O. Box 556 Charlestown, Nevis, West Indies Attn: _________ Facsimile No.: (__) __________ If to Glacier: Glacier Capital Limited Main Street P.O. Box 556 Charlestown, Nevis, West Indies Attn: _________ Facsimile No.: (__) __________ If to Emerging: Infinity Emerging Opportunities Limited Main Street P.O. Box 556 Charlestown, Nevis, West Indies Attn: _________ Facsimile No.: (__) __________ With copies to: White & Case LLP 4900 First Union Financial Center 200 South Biscayne Boulevard Miami, Florida 33131 Attn: Thomas E Lauria Facsimile No.: (305) 358-5744 and Mr. Stuart Chasanoff c/o HW Finance 160 Elm Street, Suite 4000 Dallas, Texas 75201 Facsimile No.: (214) 720-1662 or such other address as may be designated in writing hereafter, in the same manner, by such person. 5.4 AMENDMENTS; WAIVERS. No provision of this Agreement may be waived or amended except in a written instrument signed, in the case of an amendment, by both the 19. Company and the Investors, or, in the case of a waiver, by the party against whom enforcement of any such waiver is sought. No waiver of any default with respect to any provision, condition or requirement of this Agreement shall be deemed to be a continuing waiver in the future or a waiver of any other provision, condition or requirement hereof, nor shall any delay or omission of either party to exercise any right hereunder in any manner impair the exercise of any such right accruing to it thereafter. 5.5 HEADINGS. The headings herein are for convenience only, do not constitute a part of this Agreement and shall not be deemed to limit or affect any of the provisions hereof. 5.6 SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon and inure to the benefit of the parties and their successors and permitted assigns. Neither the Company nor the Investors may assign this Agreement or any rights or obligations hereunder without the prior written consent of the other, except that each Investor may assign its rights hereunder and under the Registration Rights Agreement to an Affiliate thereof, provided, that such assignee demonstrates to the reasonable satisfaction of the Company its satisfaction of the representations and warranties set forth in Section 3.2 herein. The assignment by a party of this Agreement or any rights hereunder shall not affect the obligations of such party under this Agreement. 5.7 NO THIRD-PARTY BENEFICIARIES. This Agreement is intended for the benefit of the parties hereto and their respective permitted successors and assigns and is not for the benefit of, nor may any provision hereof be enforced by, any other person. 5.8 GOVERNING LAW. This Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of New York without regard to the principles of conflicts of law thereof. 5.9 SURVIVAL. Each of the representations and warranties of the Company and the Investor contained in Article III and the agreements and covenants of the parties contained in Article IV and this Article V shall survive until a date that is three years after the last Closing date. 5.10 COUNTERPART SIGNATURES. This Agreement may be executed in two or more counterparts, all of which when taken together shall be considered one and the same agreement and shall become effective when counterparts have been signed by each party and delivered to the other party, it being understood that both parties need not sign the same counterpart. In the event that any signature is delivered by facsimile transmission, such signature shall create a valid and binding obligation of the party executing (or on whose behalf such signature is executed) the same with the same force and effect as if such facsimile signature page were an original thereof. 5.11 PUBLICITY. Prior to, or concurrently with, the filing of an amended registration statement contemplated by this transaction the Company and the Investors shall consult with each other in issuing any press releases or otherwise making public statements with respect to the transactions contemplated hereby and neither party shall issue any such press release or otherwise make any such public statement without the prior written consent of the 20. other, which consent shall not be unreasonably withheld or delayed, except for such releases, filings or public statements that are required by law. Any press release or public statement made subsequent to the filing of the amended registration statement contemplated by this transaction shall not contain any statement regarding the trading on investment of the Investors in connection with this Agreement, the March Agreement or the predecessor thereto, without first obtaining the consent of such Investors, which consent shall not be unreasonably withheld. 5.12 SEVERABILITY. In case any one or more of the provisions of this Agreement shall be invalid or unenforceable in any respect, the validity and enforceability of the remaining terms and provisions of this Agreement shall not in any way be affected or impaired thereby and the parties will attempt to agree upon a valid and enforceable provision which shall be a reasonable substitute therefor, and upon so agreeing, shall incorporate such substitute provision in this Agreement. 5.13 REMEDIES. In addition to being entitled to exercise all rights provided herein or granted by law, including recovery of damages, the Investors will be entitled to specific performance of the obligations of the Company under this Agreement and the Company will be entitled to specific performance of the obligations of the Investors hereunder with respect to the subsequent transfer of Debentures, Shares and the Underlying Shares. Each of the Company and the Investors agrees that monetary damages would not be adequate compensation for any loss incurred by reason of any breach of its obligations described in the foregoing sentence and hereby agrees to waive in any action for specific performance of any such obligation the defense that a remedy at law would be adequate. 5.14 AMENDMENT TO REGISTRATION RIGHTS AGREEMENT. The Investors, being the holders of at least a majority of the Registrable Securities (as defined in the Registration Agreement), and the Company hereby agree to amend the Registration Rights Agreement to provide the holders of the Series C Preferred and Debentures the same rights as the holders of the Series B Preferred and the July Debentures and such holders are hereby deemed to be parties to, and have the rights and benefits of, the Registration Rights Agreement as though they were original signatories thereto. The Company represents to the Investors that the Registration Rights Agreement is in full force and effect, is an enforceable obligation of the Company in accordance with its terms and the Company has no claims or defenses with respect thereto, except that the enforceability of the Registration Rights Agreement may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of, creditors' rights and remedies or by other equitable principles of general application. The Company covenants that within thirty (30) days of the date hereof the Company shall file an amendment to the Underlying Securities Registration Statement to include the Series C Preferred and Debentures or file a new registration statement as would have been required under the Registration Rights Agreement had the Series C Preferred and Debentures been issued with the Series B Preferred and July Debentures. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] [SIGNATURE PAGE FOLLOWS] 21. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first indicated above. YES! ENTERTAINMENT CORPORATION By: /s/ Mark Shepherd ------------------------------------ Name: Mark Shepherd ---------------------------------- Title: CEO and President --------------------------------- INFINITY INVESTORS LIMITED By: /s/ James E. Martin ------------------------------------ Name: James E. Martin ---------------------------------- Title: Director --------------------------------- GLACIER CAPITAL LIMITED By: /s/ James E. Martin ------------------------------------ Name: James E. Martin ---------------------------------- Title: Director --------------------------------- INFINITY EMERGING OPPORTUNITIES LIMITED By: /s/ James E. Martin ------------------------------------ Name: James E. Martin ---------------------------------- Title: Director --------------------------------- 22. EX-99.1 5 PRESS RELEASE DATED, 09/03/1998 EXHIBIT 99.1 YES! ENTERTAINMENT APPOINTS MARK SHEPHERD CEO PLEASANTON, Calif.--(BUSINESS WIRE)--Sept. 3, 1998--YES! Entertainment (NASDAQ: YESS - news) today announced that the Board of Directors has appointed Mark C. Shepherd as Chief Executive Officer of the Company. In addition, Mr. Shepherd will serve as a Director of the Company. Concurrent with this announcement, Donald D. Kingsborough has resigned as Chief Executive Officer and Chairman of the Board. He is replaced as Chairman by current Board member Gary L. Nemetz, who is a General Partner with DCC Growth Fund, L.P. With his new position, Mr. Shepherd will continue to perform the duties of Chief Operating Officer and will appoint a Chief Financial Officer at a later date. Mr. Kingsborough will remain on the Board of Directors and will continue to provide the Company with the benefit of his industry experience. Mark Shepherd commented, "We recently completed a capital infusion of $3 million and an agreement that ends all outstanding disputes with the holders of the Company's Preferred Stock and 5% Convertible Debentures. This resolution allows us to focus on the core business and to continue exploring options to increase shareholder value. We also expect to complete, on or before September 15, 1998, a working capital line with the majority holder of the Company's Preferred Stock." All terms of the transaction will be detailed in an 8K filing with the Securities and Exchange Commission. Shepherd continued, "Since I have been with YES!, we have made great progress in lowering our break-even to match our expected revenue level. This new working capital line will give us the flexibility to focus on the business and leverage our strong core brand names such as Yak Bak(R), Power Penz(R), and Air Vectors(TM). During the year, we introduced W-3 Wild Water Weapons(TM) and Fistful of Aliens(TM), a collectible action figures/game combination. We see an opportunity to balance the cyclicality of our business as Water Weapons are counter seasonal. We are encouraged about the positive reception of Fistful of Aliens, specifically on the international front." "Late in the third quarter we will begin shipping The New World of Teddy Ruxpin. We believe this product gives us a tremendous opportunity to break into the Interactive Feature Plush category, which is one of the fastest growing segments in the Feature Plush category," Shepherd added. The Company also announced the appointment of Stuart J. Chasanoff and Barrett N. Wissman, of HW Partners, L.P., to the Board of Directors as representatives of the Preferred shareholders. 1. In addition, David C. Costine has resigned from the Company's Board. The addition of Messrs. Shepherd, Chasanoff and Wissman, brings YES!'s Board membership to six. "We welcome Stuart and Barrett to the Board. Their expertise will provide the Company with valuable insight and direction," Shepherd concluded. Mr. Shepherd joined YES! in October of 1997 as Chief Operating Officer and was named Chief Financial Officer in April 1998. Prior to joining YES!, Mr. Shepherd was Senior Vice President - Finance for Einstein/Noah Bagel Corp. (Nasdaq:ENBX - news) where he was responsible for operations finance, procurement, distribution and manufacturing operations for this multi-unit bagel retailer. Prior to that, he was Vice President/Chief Financial Officer for Noah's Pacific L.L.C./Noah's Bay Area L.L.C. From 1992 to 1995, Mr. Shepherd was Senior Vice President and Chief Financial Officer for Lewis Galoob Toys, Inc. (NYSE:GAL - news). YES! Entertainment Corporation develops, manufactures and markets toys and other children's products, including a variety of interactive products. YES! uses innovative technology to design products that are fun for children and build on their natural creativity. This press release includes certain forward looking statements about the Company that are based on management's current expectations. Actual results may differ materially as a result of any one or more of the risks including that the Company will not successfully complete negotiations of the working capital facility and those risks identified in the Company's filings under the Securities and Exchange Act of 1934, in particular in the section captioned "Business Factors" of the Company's Form 10- K as amended filed with the Securities Exchange Commission for the year ended December 31, 1997 and subsequent filings. 2. -----END PRIVACY-ENHANCED MESSAGE-----