In the underworld, the demon lord Sutekh sends forth a trio of diminutive servants called Totems, magically controlled by his netherworld minions, to kill those who possess the secret of animation, including the magic Andre Toulon used to give his puppets life. It transpires also that a team of researchers working on the development of artificial intelligence are close to discovering Toulon's secret. Sutekh sends one of the Totems as a package to two of the researchers involved, Dr. Piper and Dr. Baker of the Phoenix Division, who are taken by surprise, killed and stripped off their souls by the foul creature.
One of the researchers, a talented young man named Rick Myers, is working as a caretaker at the Bodega Bay Inn and has also been using it for a place to conduct his experiments on the A.I. project. The same night Drs. Piper and Baker are murdered, Rick's friends Suzie, Lauren, and Cameron come to visit him. At dinner, Lauren, who is a psychic, finds Blade (who had been discovered earlier by Rick inside the house and is still animate) and then Toulon's old trunk, with the puppets, Toulons diary and some phials with the life-giving formula inside. Out of curiosity, Rick and his friends use the fluid on the puppets, and one by one they awaken; next to Blade, they find Pinhead, Six Shooter, Tunneler and Jester. (Torch, who joins the puppet cast in the sequel, makes no appearance here.)
Fascinated by the puppets' spontaneous reactions, and believing that the formula is the answer to the running AI projects, Rick wants to see how smart they are by playing a laser tag game with Pinhead and Tunneler. Cameron, who is competing with Rick for success, tries to use the formula's secret for his personal gain, and he and Lauren decide to use a strange gameboard found in the trunk to try and contact Toulon for its exact composition (the recipe of which was not recorded in the diary). But the glowing pyramid icon which goes with the board is a conduit between the mortal world and the underworld; Sutekh uses the link to send two of his Totems to attack. Cameron and Lauren attempt to flee by car, but Cameron is ambushed by one of the Totems inside his car and killed, while Lauren manages to get back into the hotel. When Rick looks after Cameron, the Totem attacks him as well, but he manages to escape.
But inside the inn, the third Totem, sent in earlier by package, is also on the prowl. The puppets, intend on protecting Rick, search the hotel and soon manage to kill one of the Totems in the kitchen and, through its supervision link, its controller in the underworld. Then Toulon's spirit, who has been appearing around the hotel all night, tells the puppets to animate the new puppet, Decapitron. Under Rick and Suzie's astonished eyes, the puppets move up to Rick's room, retrieve a box which contains yet another puppet with a soft plastic head, and revive it with the formula and a lightning strike. The two remaining Totems attack to disrupt the process, but one is electrocuted when Six Shooter uses a wire as a lariat to divert some of the lightning's power into the Totem. Decapitron briefly awakens, and his head morphs into the likeness of Toulon, who explains to Rick the origin and the secret of the life-giving formula. The phial, however, turns out to be missing; immediately suspecting Cameron, Rick goes back to search his body, where he does find the phial.
Meanwhile, the last Totem corners the panicked Lauren and prepares to drain her life away when Suzie interferes and douses it with acid. Toulon speaks through Lauren, urging Rick to animate Decapitron to destroy the Totem, and Rick uses his computer to divert power from his generator into Decapitron, bringing him to life. As the Totem attacks, Decapitron exchanges his plastic head for an electron-bolt launching system and destroys the creature. Afterwards, Toulon speaks to Rick yet again, surrendering custody of his puppets and the formula to him and promising his help in times of need.