**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

** **

**FORM 10-Q**

** **

**(MARK ONE)**

 

| **ý** |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                   |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   | **For the quarterly period ended June 30, 2002**                                                                                                                                                                               |
|       |   |                                                                                                                                                                                                                           |
|       |   | **or**                                                                                                                                                                                                                         |
|       |   |                                                                                                                                                                                                                           |
| **o**      |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                  |
|       |   | **For the transition period from                   to                 ** |

 

**Commission File No. 0-22545**

 

**DSI Toys, Inc.**

(Exactname of Registrant as specified in its charter)

** **

| **Texas**                                                                  |   | **74-1673513**                         |
|----------------------------------------------------------------------------|--------|----------------------------------------|
| (State  or other jurisdiction of  incorporation or organization)           |   | (I.R.S.  Employer  Identification No.) |
|                                                                       |   |                                   |
| **10110 West Sam  Houston Parkway South, #150**                            |   |                                   |
| **Houston, Texas**                                                         |   | **77099**                              |
| (Address  of principal executive offices)                                  |   | (Zip  Code)                            |
|                                                                       |   |                                   |
| Registrant’s  telephone number including area code:**(713) 365-9900** |

** **

Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.   Yes o   No  o

 

As of August 9, 2002, 9,066,365 shares of commonstock, par value $.01 per share, of DSI Toys, Inc. were outstanding.

 

 

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**TABLE OFCONTENTS**

 
| **PART I - FINANCIAL  INFORMATION** |
|-------------------------------------|
|                                |   |
| Item 1.                             | Financial Statements |
|                                |   |
|                                | Consolidated Balance Sheet  as of June 30, 2002 and December 31, 2001 |
|                                |   |
|                                | Consolidated  Statement of Operations for the Three Months and Six Months Ended June 30,  2002 and 2001 |
|                                |   |
|                                | Consolidated  Statement of Cash Flows for the Six Months Ended June 30, 2002 and 2001 |
|                                |   |
|                                | Consolidated  Statement of Shareholders’ Equity |
|                                |   |
|                                | Notes to  Consolidated Financial Statements |
|                                |   |
| Item  2.                            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                                |   |
| Item  3.                            | Quantitative  and Qualitative Disclosure About Market Risk |
|                                |   |
|                                | **PART II - OTHER INFORMATION** |
|                                |   |
| Item 1.                             | Legal Proceedings |
|                                |   |
| Item  2.                            | Change  in Securities and Use of Proceeds |
|                                |   |
| Item  4.                            | Submission  of Matters to a Vote of Security Holders |
|                                |   |
| Item 5.                             | Other Information |
|                                |   |
| Item 6.                             | Exhibits and  Reports on Form 8-K |
|                                |   |
| Signatures                          |   |

 

i

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**PART I -FINANCIAL INFORMATION**

 

**Item 1.    Financial Statements**

 

**DSI Toys, Inc.**

**ConsolidatedBalance Sheet**

 
|                                                                                                |   | **June 30,  2002** |       | **December  31,  2001** |       |
|-----------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------------|------------|
|                                                                                                |   | **(Unaudited)**    | ** ** |                    | ** ** |
| **ASSETS**                                                                                          |   |               | ** ** |                    | ** ** |
| Current assets:                                                                                     |   |               |       |                    |       |
| Cash                                                                                                |   | $                  | 662,203    |                    | $          | 284,637 |   |
| Accounts receivable, net                                                                            |   | 5,069,000          |       | 8,767,550               |       |
| Inventories                                                                                         |   | 6,345,367          |       | 6,739,920               |       |
| Prepaid expenses                                                                                    |   | 2,983,625          |       | 1,981,592               |       |
| Deferred income taxes                                                                               |   | 1,820,527          |       | 893,000                 |       |
| Total current assets                                                                                |   | 16,880,722         |       | 18,666,699              |       |
|                                                                                                |   |               |       |                    |       |
| Property and equipment, net                                                                         |   | 2,130,191          |       | 1,769,284               |       |
| Deferred income taxes                                                                               |   | 1,312,000          |       | 1,312,000               |       |
| Goodwill, net                                                                                       |   | 9,241,128          |       | 9,241,128               |       |
| Other assets                                                                                        |   | 220,119            |       | 323,624                 |       |
| Total assets                                                                                        |   | $                  | 29,784,160 |                    | $          | 31,312,735 |   |
|                                                                                                |   |               |       |                    |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                      |   |               | ** ** |                    | ** ** |
|                                                                                                |   |               |       |                    |       |
| Current liabilities:                                                                                |   |               |       |                    |       |
| Accounts payable and accrued liabilities                                                            |   | $                  | 9,264,968  |                    | $          | 6,580,780 |   |
| Current portion of long-term debt                                                                   |   | 2,139,804          |       | 1,120,650               |       |
| Current portion of long-term debt due to a related party                                            |   | 943,076            |       | 1,751,485               |       |
| Income taxes payable                                                                                |   | 168,760            |       | 69,638                  |       |
| Total current liabilities                                                                           |   | 12,516,608         |       | 9,522,553               |       |
|                                                                                                |   |               |       |                    |       |
| Long-term debt                                                                                      |   | 4,837,800          |       | 9,210,390               |       |
| Long-term debt due to a related party                                                               |   | 4,938,764          |       | 3,289,552               |       |
| Deferred income taxes                                                                               |   | 156,642            |       | 156,642                 |       |
| Total liabilities                                                                                   |   | 22,449,814         |       | 22,179,137              |       |
|                                                                                                |   |               |       |                    |       |
| Shareholders’ equity:                                                                          |   |               |       |                    |       |
| Preferred stock, $.01 par value, 5,000,000 shares authorized,  none issued or outstanding           |   |               |       |                    |       |
| Common stock, $.01 par value, 35,000,000 shares authorized  9,066,365 shares issued and outstanding |   | 90,664             |       | 90,664                  |       |
| Additional paid-in capital                                                                          |   | 5,173,465          |       | 5,173,465               |       |
| Common stock warrants                                                                               |   | 2,802,500          |       | 2,802,500               |       |
| Accumulated other comprehensive loss                                                                |   | (69,686            | )          | (70,928                 | )          |
| Retained earnings (deficit)                                                                         |   | (662,597           | )          | 1,137,897               |       |
| Total shareholders’ equity                                                                     |   | 7,334,346          |       | 9,133,598               |       |
| Total liabilities and shareholders’ equity                                                     |   | $                  | 29,784,160 |                    | $          | 31,312,735 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

1

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**DSIToys, Inc.**

**ConsolidatedStatement of Operations**

**(Unaudited)**

** **
|                                         |   | **Three Months Ended June 30,** |      | **Six Months Ended June 30,** |   |
|----------------------------------------------|--------|---------------------------------|-----------|-------------------------------|--------|
|                                         |   | **2002**                        |      | **2001**                      |   | **2002** |   | **2001** |   |
|                                         |   |                            |      |                          |   |   |   |   |   |
| Net sales                                    |   | $                               | 8,951,657 |                          | $      | 9,416,184 |   | $ | 14,140,517 |   | $ | 16,137,407 |   |
| Costs of goods sold                          |   | 6,448,409                       |      | 7,489,073                     |   | 10,534,117 |   | 12,419,030 |   |
| Gross profit                                 |   | 2,503,248                       |      | 1,927,111                     |   | 3,606,400 |   | 3,718,377 |   |
| Selling, general and administrative expenses |   | 2,926,764                       |      | 3,997,393                     |   | 5,966,822 |   | 7,976,847 |   |
| Operating loss                               |   | (423,516                        | )         | (2,070,282                    | )      | (2,360,422 | ) | (4,258,470 | ) |
| Interest expense                             |   | (252,397                        | )         | (269,711                      | )      | (450,264 | ) | (537,690 | ) |
| Other income (expense)                       |   | (62,087                         | )         | 25,415                        |   | 82,665 |   | 59,790 |   |
| Loss before income taxes                     |   | (738,000                        | )         | (2,314,578                    | )      | (2,728,021 | ) | (4,736,370 | ) |
| Benefit from income taxes                    |   | 250,920                         |      | 833,248                       |   | 927,527 |   | 1,705,093 |   |
| Net loss                                     |   | $                               | (487,080  | )                             | $      | (1,481,330 | ) | $ | (1,800,494 | ) | $ | (3,031,277 | ) |
|                                         |   |                            |      |                          |   |   |   |   |   |
| Basic earnings per share                     |   |                            |      |                          |   |   |   |   |   |
| Loss per share                               |   | $                               | (0.05     | )                             | $      | (0.16 | ) | $ | (0.20 | ) | $ | (0.33 | ) |
| Weighted average shares outstanding          |   | 9,066,365                       |      | 9,066,365                     |   | 9,066,365 |   | 9,066,365 |   |
|                                         |   |                            |      |                          |   |   |   |   |   |
| Diluted Earnings per share                   |   |                            |      |                          |   |   |   |   |   |
| Loss per share                               |   | $                               | (0.05     | )                             | $      | (0.16 | ) | $ | (0.20 | ) | $ | (0.33 | ) |
| Weighted average shares outstanding          |   | 9,066,365                       |      | 9,066,365                     |   | 9,066,365 |   | 9,066,365 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

2

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**DSIToys, Inc**

**Consolidated Statement of Cash Flows**

**(Unaudited)**

 
|                                                                                                       |   | **Six months ended June 30,** |       |
|------------------------------------------------------------------------------------------------------------|--------|-------------------------------|------------|
|                                                                                                       |   | **2002**                      |       | **2001** |   |
| Cash flows from operating activities:                                                                      |   |                          |       |   |   |
| Net loss                                                                                                   |   | $                             | (1,800,494 | ) | $ | (3,031,277 | ) |
| Adjustments to reconcile net loss to net cash used by       operating activities:      |   |                          |       |   |   |
| Depreciation and amortization                                                                              |   | 480,500                       |       | 682,283 |   |
| Amortization and write-off of          debt discount and issuance costs |   | 28,505                        |       | 19,297 |   |
| Amortization of goodwill                                                                                   |   |                          |       | 256,698 |   |
| Provision for inventory obsolescence                                                                       |   |                          |       | 300,000 |   |
| Provision for doubtful accounts                                                                            |   | 1,738                         |       | 37,623 |   |
| Loss on abandonment or sale of equipment                                                                   |   | 2,755                         |       | 4,107 |   |
| Deferred income taxes                                                                                      |   | (927,527                      | )          | (1,693,489 | ) |
| Changes in assets and liabilities:                                                                         |   |                          |       |   |   |
| Accounts receivable                                                                                        |   | 3,696,812                     |       | 1,924,304 |   |
| Inventories                                                                                                |   | 394,553                       |       | (2,689,515 | ) |
| Income taxes payable                                                                                       |   | 99,122                        |       | (30,852 | ) |
| Prepaid expenses                                                                                           |   | (1,002,033                    | )          | (1,515,164 | ) |
| Accounts payable and accrued liabilities                                                                   |   | 2,684,188                     |       | 3,360,213 |   |
| Net cash provided  (used) by  operating activities                                                    |   | 3,658,119                     |       | (2,375,772 | ) |
|                                                                                                       |   |                          |       |   |   |
| Cash flows from investing activities:                                                                      |   |                          |       |   |   |
| Capital expenditures                                                                                       |   | (844,162                      | )          | (266,491 | ) |
| Proceeds from sale of equipment                                                                            |   |                          |       | 10,076 |   |
| Decrease (increase) in other assets                                                                        |   | 75,000                        |       | (463,813 | ) |
| Net cash used in investing activities                                                                      |   | (769,162                      | )          | (720,228 | ) |
|                                                                                                       |   |                          |       |   |   |
| Cash flows from financing activities:                                                                      |   |                          |       |   |   |
| Net borrowings under revolving lines of credit                                                             |   | 1,019,154                     |       | 1,306,441 |   |
| Net payments on long-term debt                                                                             |   | (4,372,590                    | )          | (777,088 | ) |
| Borrowings (payments) of long-term debt due to related party                                               |   | 840,803                       |       | (147,979 | ) |
| Net proceeds from issuance of warrants                                                                     |   |                          |       | 2,700,000 |   |
| Debt and stock issue costs                                                                                 |   |                          |       | (85,000 | ) |
| Net cash provided (used) by financing activities                                                           |   | (2,512,633                    | )          | 2,996,374 |   |
|                                                                                                       |   |                          |       |   |   |
| Effect of exchange rate changes on cash                                                                    |   | 1,242                         |       | 12,101 |   |
| Net increase (decrease) in cash                                                                            |   | 377,566                       |       | (87,525 | ) |
| Cash and cash equivalents, beginning of period                                                             |   | 284,637                       |       | 177,682 |   |
| Cash and cash equivalents,  end  of period                                                            |   | $                             | 662,203    |   | $ | 90,157 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

3

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**DSI Toys, Inc.**

**Consolidated Statement of Shareholders’ Equity**

**(Unaudited)**

 
|                                           |   |             |   |       |   |                                         |         |      |   | **Accumulated********Other  Comprehensive********Loss** |                              |       |   |          |   |
|------------------------------------------------|--------|------------------|--------|------------|--------|----------------------------------------------|--------------|-----------|--------|---------------------------------------------------------|-----------------------------------|------------|--------|---------------|--------|
|                                           |   |             |   |       |   | **Additional********Paid-in********Capital** |         |      |   |                                                    | **Retained  Earnings  (Deficit)** |       |   |          |
|                                           |   | **Common Stock** |   |       |   |                                         |         |      |   |                                                    |
|                                           |   | **Shares**       |   | **Amount** |   |                                         | **Warrants** |      |   |                                                    | **Totals**                        |       |
| Balance, December 31, 2000                     |   | 9,066,365        |   | $          | 90,664 |                                         | $            | 5,173,465 |   | $                                                       | 102,500                           |       | $      | (27,062       | )      | $ | 2,587,415 |   | $ | 7,926,982 |   |
| Comprehensive loss:                            |   |             |   |       |   |                                         |         |      |   |                                                    |                              |       |   |          |   |
| Net loss                                       |   |             |   |       |   |                                         |         |      |   |                                                    |                              | (1,449,518 | )      | (1,449,518    | )      |
| Foreign currency translation adj.   net of tax |   |             |   |       |   |                                         |         |      |   | (43,866                                                 | )                                 |       |   | (43,866       | )      |
| Comprehensive loss                             |   |             |   |       |   |                                         |         |      |   |                                                    |                              |       |   | (1,493,384    | )      |
| Warrants issued                                |   |             |   |       |   |                                         |         | 2,700,000 |   |                                                    |                              |       |   | 2,700,000     |   |
| Balance, December 31, 2001                     |   | 9,066,365        |   | 90,664     |   | 5,173,465                                    |         | 2,802,500 |   | (70,928                                                 | )                                 | 1,137,897  |   | 9,133,598     |   |
|                                           |   |             |   |       |   |                                         |         |      |   |                                                    |                              |       |   |          |   |
| Comprehensive loss:                            |   |             |   |       |   |                                         |         |      |   |                                                    |                              |       |   |          |   |
| Net loss                                       |   |             |   |       |   |                                         |         |      |   |                                                    |                              | (1,313,414 | )      | (1,313,414    | )      |
| Foreign currency translation adj.   net of tax |   |             |   |       |   |                                         |         |      |   | (1,611                                                  | )                                 |       |   | (1,611        | )      |
| Comprehensive loss                             |   |             |   |       |   |                                         |         |      |   |                                                    |                              |       |   | (1,315,025    | )      |
| Balance, March 31, 2002                        |   | 9,066,365        |   | 90,664     |   | 5,173,465                                    |         | 2,802,500 |   | (72,539                                                 | )                                 | (175,517   | )      | 7,818,573     |   |
|                                           |   |             |   |       |   |                                         |         |      |   |                                                    |                              |       |   |          |   |
| Comprehensive loss:                            |   |             |   |       |   |                                         |         |      |   |                                                    |                              |       |   |          |   |
| Net loss                                       |   |             |   |       |   |                                         |         |      |   |                                                    |                              | (487,080   | )      | (487,080      | )      |
| Foreign currency translation adj.   net of tax |   |             |   |       |   |                                         |         |      |   | 2,853                                                   |                              |       |   | 2,853         |   |
| Comprehensive loss                             |   |             |   |       |   |                                         |         |      |   |                                                    |                              |       |   | (484,227      | )      |
| Balance, June 30, 2002                         |   | 9,066,365        |   | $          | 90,664 |                                         | $            | 5,173,465 |   | $                                                       | 2,802,500                         |       | $      |  (69,686 | )      | $ |  (662,597 | ) | $ |  7,334,346 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

4

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**DSIToys, Inc.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

**1.****             Basis of Presentation**

 

The accompanying unaudited consolidated financialstatements of DSI Toys, Inc. and its wholly-owned subsidiaries (the “Company”)have been prepared in accordance with accounting principles generally acceptedin the United States of America for interim financial information and with theinstructions to Form 10-Q.  Accordingly,they do not include all of the information and footnotes required by accountingprinciples generally accepted in the United States of America for completefinancial statements and should be read in conjunction with the financialstatements and notes thereto appearing in the Company’s Annual Report on Form10-K and Form 10-K/A for the fiscal year ended December 31, 2001.

 

In the opinion of the Company’s management, alladjustments necessary for the fair presentation of the results of operationsfor all periods reported have been included. Such adjustments consist only of normal recurring items.

 

The results of operations for the six months endedJune 30, 2002, are not necessarily indicative of the results expected for thefull year ending December 31, 2002.

 

**2.****             SignificantAccounting Policies**

 

Certain of our accounting policies require theapplication of significant judgment by management in selecting the appropriateassumptions for calculating financial estimates.  By their nature, these judgments are subject to an inherent degreeof uncertainty.  These judgments are basedon our historical experience, terms with current customers, our observance oftrends in the industry, information provided by our customers and informationavailable from other outside sources, as appropriate.  Our significant accounting policies include:

 

*RevenueRecognition  –*The Company recognizes revenue when products are shipped and title passes tounaffiliated customers.  In most cases,title transfers to our customers when the product has been presented toshipment forwarders on FOB Asia sales and when the product is picked up fromour distribution facilities on domestic sales.

 

*Allowancefor Doubtful Accounts  –*Accounts receivable are reduced by an allowance for amounts that may becomeuncollectible in the future.  TheCompany’s estimate for its allowance is based on two methods which are combinedto determine the total amount reserved. First, the Company evaluates specific accounts where we have informationthat the customer may have an inability to meet its financial obligations(bankruptcy, etc.).  In these cases, theCompany uses its judgment, based on the best available facts and circumstances,and records a specific reserve for that customer against amounts due to reducethe receivable to the amount that is expected to be collected.  These specific reserves are reevaluated andadjusted as additional information is received that impacts the amountsreserved.  Second, a reserve isestablished for all other customers based on historical collection and write-offexperience.  If circumstances change,the Company’s estimates of the recoverability of amounts due the Company couldbe reduced by a material amount.

 

*Allowancefor Returns and Defectives  –*The Company records a provision for estimated sales returns and defectives onsales in the same period as the related revenue is recorded.  Our sales to customers generally do not givethem the right to return product or to cancel firm orders.  However, as is common in the industry, wesometimes accept returns for stock balancing and negotiate accommodations tocustomers, which includes price discounts, credits and returns when demand forspecific products fall below expectations. Additionally, customers are given credit for any defective products theymay have received.  The allowanceestimates are based on historical sales returns and defective rates, analysisof credit memo data and other known factors. If the data the Company uses to calculate these estimates does notproperly reflect future returns and defectives, revenue could be overstated andfuture operating results adversely affected.

 

5

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*Inventories *– Inventory isvalued at the lower of cost or market. The Company reviews the book value of slow-moving items, discountedproduct lines and individual products to determine if these items are properlyvalued.  The Company identifies theseitems and assesses the ability to dispose of them at a price greater thancost.  If it is determined that cost isless than market value, then cost is used for inventory valuation.  If market value is less than cost, then theCompany establishes a reserve for the amount required to value the inventory atmarket.  If the Company is not able toachieve its expectations of the net realizable value of the inventory at itscurrent value, the Company would adjust its reserve accordingly.

 

*DeferredTaxes *– TheCompany recognizes deferred tax assets and liabilities based on the differencesbetween the financial statement carrying amounts and the tax bases of assetsand liabilities.  Generally acceptedaccounting principles require that we review deferred tax assets forrecoverability and if needed, establish a valuation allowance for those amountsdeemed unrecoverable.  The reviewconsiders historical taxable income, projected future taxable income, and theexpected timing of the reversals of temporary differences.  Deferred tax assets of the Company areprimarily the result of unused net operating loss carry-forwards and foreigntax credits which expire over a range of years.  In 2001, the Company recorded a valuation allowance of $566,000related to foreign tax credits expiring in 2002, as it was determined that itwas more likely than not that these credits would not be realized.

 

*Impairmentof assets *– The Company reviews for the impairment oflong-lived assets, including goodwill, whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable.

** **

Goodwill has been amortizedover 20 years using the straight-line method in 2001.  In 2002, the Company adopted Statement of Financial AccountingStandards, No. 142, “Goodwill and Other Intangible Assets”, which eliminatesamortization of goodwill beginning in January 2002 and requires an annualimpairment assessment based on its estimated fair value, using futurediscounted cash flow and other factors. The initial December 31, 2001 fair value assessment was completed by anindependent company during the  firstquarter of 2002.  Based on this reviewan impairment adjustment is not required.

 

**3.****             Accounts Receivable**

 

Accounts receivable consist of the following:

 
|                       |   | **June 30,  2002** |            | **December  31,  2001** |   |
|----------------------------|--------|--------------------|-----------------|-------------------------|--------|
| Trade  receivables         |   | $                  |  7,843,161 |                    | $      |  12,717,550 |   |
| Provisions for:            |   |               |            |                    |   |
| Discounts and  markdowns   |   | (800,195           | )               | (1,472,706              | )      |
| Return of defective  goods |   | (242,581           | )               | (777,294                | )      |
| Doubtful  accounts         |   | (1,731,385         | )               | (1,700,000              | )      |
| Accounts  receivable, net  |   | $                  |  5,069,000 |                    | $      |  8,767,550 |   |

 

**4.****             Segment Information**

 

Financial information for the six months ended June 30, 2002 and 2001is as follows:

** **
|                             |   | **United States** |      | **Hong Kong** |   | **Consolidated** |   |
|----------------------------------|--------|-------------------|-----------|---------------|--------|------------------|--------|
| Six months ended  June 30, 2002: |   |              |      |          |   |             |   |
| Net sales                        |   | $                 | 5,155,106 |          | $      | 8,985,411        |   | $ | 14,140,517 |   |
| Operating income  (loss)         |   | (2,573,976        | )         | 213,554       |   | (2,360,422       | )      |
| Total assets at  June 30, 2002   |   | 23,212,156        |      | 6,572,004     |   | 29,784,160       |   |
|                             |   |              |      |          |   |             |   |
| Six months ended  June 30, 2001: |   |              |      |          |   |             |   |
| Net sales                        |   | $                 | 6,315,512 |          | $      | 9,821,895        |   | $ | 16,137,407 |   |
| Operating loss                   |   | (4,032,601        | )         | (225,869      | )      | (4,258,470       | )      |
| Total assets at  June 30, 2001   |   | 27,000,984        |      | 6,389,715     |   | 33,390,699       |   |

 

6

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**Item 2.    Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

**Except as otherwise indicated, references to the “Company”refer to DSI Toys, Inc. and its four wholly-owned Hong Kong subsidiaries,DSI(HK) Limited (“DSI(HK)”), Meritus Industries Limited, RSP Products Limitedand Elite Dolls Limited. The terms “fiscal year” and “fiscal” refer to theCompany’s fiscal year, which is the year ending December 31 of thecalendar year mentioned (*e.g*., a reference to fiscal 2001 is areference to the fiscal year ended December 31, 2001).**

 

**General**

The following discussion and analysis should be readin conjunction with the financial statements and notes thereto, and theinformation included elsewhere herein.

 

The Company designs, develops, markets and distributeshigh quality, innovative dolls, toys and consumer electronics products.  Core products include *Tech-Link*® communicationsproducts, KAWASAKI® electronic musical instruments, *GearHead®* remote controlvehicles, *LazerDoodle*TM, the electronic drawing toy,**and a full range of specialfeature doll brands including *Sassy SecretsTM, Somersault SaraTM, Too Cute TwinsTM,Childhood VersesTM, Pride & Joy®, Little Darlings®,*along withinteractive plush products including *Kitty Kitty Kittens®, Frisky KittensTM, Puppy PuppyPuppies®,*and girls’ activity products, *Air Nails SalonTM,*and*Twist andTwirl BraiderTM.*

 

The Company has four major product categories: YouthCommunications, Musical Instruments, Girls’ Toys and Boys’ Toys.

 

*Youth Communications*

 

The Youth Communications product line includeswalkie-talkies, wrist watch walkie-talkies, audio products and noveltyelectronic products.  The categorybrands include *Tech-Link*® and *Micro Link*® communications products,Harley-Davidson*®* walkie-talkies and bike alarms, and the Company’s new *BioScan*TM*RoomGuardianTM.*

 

*Musical Instruments*

 

The Musical Instrument line includes the branded lineof KAWASAKI® guitars, drum pads, saxophones and keyboards.

 

*Girls’Toys*

 

The Girls’ Toys product category includes dolls,interactive plush toys, play sets, accessories, and girls’ activity toys.  The Girls’ Toys portfolio of brands includes*SassySecretsTM, Somersault SaraTM, Too Cute TwinsTM, Childhood VersesTM, Pride &Joy®, Little Darlings®,*along with interactive plush productsincluding *KittyKitty Kittens®, Frisky KittensTM, Puppy Puppy Puppies®,*and girls’activity products, *Air Nails SalonTM,*and*Twist and Twirl BraiderTM.*

 

*Boys’Toys*

 

The Boys’ Toys product category includes radio controland infra-red control vehicles.  Thebrands in this product category are *GearHead*® radio control vehicles,including the *Insector*®, and the unique ultra-articulated *StreetSavageTM*.  The *GearHead*®brand also includes *GearHead® Jr*. infra-red control vehicles.

 

7

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**Results of Operations**

** **

The following table sets forth for the periodsindicated certain income and expense items expressed as a percentage of netsales:

 
|                                          |   | **Percent of  Net Sales**          |       |
|-----------------------------------------------|--------|------------------------------------|------------|
|                                          |   | **Three  Months Ended   June 30,** |       | **Six Months  Ended    June 30,** |   |
|                                          |   | **2002**                           | ** ** | **2001** | ** ** | **2002** | ** ** | **2001** | ** ** |
| Net sales                                     |   | 100.0                              | %          | 100.0 | % | 100.0 | % | 100.0 | % |
| Costs of goods  sold                          |   | 72.0                               |       | 79.5 |   | 74.5 |   | 77.0 |   |
| Gross profit                                  |   | 28.0                               |       | 20.5 |   | 25.5 |   | 23.0 |   |
| Selling, general  and administrative expenses |   | 32.7                               |       | 42.4 |   | 42.2 |   | 49.4 |   |
| Operating loss                                |   | (4.7                               | )          | (21.9 | ) | (16.7 | ) | (26.4 | ) |
| Interest expense                              |   | (2.8                               | )          | (3.0 | ) | (3.2 | ) | (3.3 | ) |
| Other income  (expense)                       |   | (0.7                               | )          | 0.4 |   | 0.6 |   | 0.3 |   |
| Loss before  income taxes                     |   | (8.2                               | )          | (24.5 | ) | (19.3 | ) | (29.4 | ) |
| Benefit from  income taxes                    |   | 2.8                                |       | 8.8 |   | 6.6 |   | 10.6 |   |
| Net loss                                      |   | (5.4                               | )%         | (15.7 | )% | (12.7 | )% | (18.8 | )% |

 

***Three Months EndedJune 30, 2002, Compared to the Three Months Ended June 30, 2001***

* *

*Netsales.*  Net sales forthe three months ended June 30, 2002, decreased approximately $500,000, or4.9%, to $8.9 million, from $9.4 million in the second quarter of 2001.  All product categories reflected a salesdecrease, except Musical Instruments, as toy retailers continue to emphasizeminimum inventories in non-Christmas seasons, combined with their caution dueto the overall U.S. economic conditions. See *“Seasonality”.*

 

Net sales of Youth Communications products during thesecond quarter ended June 30, 2002, decreased approximately $100,000, or 3%, to$1.8 million from $1.9 million in the second quarter of 2001.   This small sales decrease reflectsretailers’ reluctance to increase inventory stock, due to reduced consumerstore traffic and the economy.

 

Net sales of Musical Instrument products was $2.9million during the second quarter of 2002, an increase of $400,000, or 18%,from the $2.5 million sold during the quarter ending June 30, 2001. The salesincrease is caused by retailer acceptance of new product packaging andheightened interest in the new Pro series line of keyboards and drum-padspartially offset by reduced sales of sing-along products.

 

Net sales of Girls’ Toys declined approximately$600,000, or 19%, to $2.9 million during the second quarter ended June 30,2002, from $3.6 million in the second quarter of 2001. The decrease reflectsthe decline in sales of dolls in the *Pride and Joy*® and *Little Darlings*® lines,partially offset by increases in sales of the *Air Nails Salon*TM girlsactivity toy and the *Two Cute Twins*TM doll (which wereintroduced in the  thirdQuarter of 2001), and increased plush toys sales, such as *Kitty, Kitty, Kittens*® *and FriskyKittens*TM.

 

Net sales of Boys’ Toys were down approximately$100,000, or 11%, to  $1.1 million inthe second quarter ended June 30, 2002, from $1.2 million in the second quarterof 2001.   This decrease reflectsslowing sales of *Insector*® and other older radio-controlled (“R/C”) productspartially offset by increased sales of the *Street Savage*TM R/C and boys military toys.

 

Net sales of products in other categories during thesecond quarter ended June 30, 2002, decreased approximately $100,000, or 41%,to approximately $170,000 from approximately $270,000 in the second quarter of2001.  The decrease is primarily relatedto decreased sales of preschool toys as a result of the decision to discontinuedevelopment of this line.

 

8

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International net sales for the three months endedJune 30, 2002, declined approximately $100,000, or 6%, to $1.8 million, from$1.9 million in the second quarter of 2001. The decrease is due to latercustomer requested shipment dates as a result of the depressed world-wideeconomy, manufacturers selling direct to retailers, and the continued strengthof the U.S. dollar as compared to some other currencies, partially offset bythe initial introduction of some products into the international market.

 

*Grossprofit.*  Gross profitincreased approximately $600,000, or 30%, to $2.5 million for the secondquarter ended June 30, 2002, from $1.9 million in the second quarter of2001.  Gross profit as a percentage ofnet sales increased to 28.0% in the second quarter ended June 30, 2002, from20.5% in the second quarter of fiscal 2001. The gross profit dollar and gross profit as a percentage of net salesincrease is due primarily the following events that occurred in the secondquarter of 2001;  the Companyexperienced delays in shipping of new, higher margin product introductions; theCompany had a sales mix tilted toward lower margin products; and the Companyincurred a provision for inventory obsolescence.

* *

*Selling,general and administrative expenses.*  Selling, general and administrative expensesdecreased to $2.9 million in the second quarter ended June 30, 2002, comparedwith approximately $4.0 million for the second quarter of 2001, a decrease ofapproximately $1.1 million.  Includedare decreases in employee expense, facility operating expense, salescommissions, and travel and entertainment expenses of approximately $250,000,$150,000, $100,000, and $75,000, respectively. Television and print advertising expenses also decreased $300,000, asmanagement determined that  advertisingbenefits would be minimized due to general consumer economic concerns.  Additionally, in 2001 the Company recordedapproximately $130,000 in goodwill amortization, which is not recorded in 2002due to the Company’s adoption of  SFAS #142, “Goodwill and Other Intangibles”.  *SeeSignificant Accounting Policies.*

* *

*Interestexpense.*  Interestexpense during the second quarter ended June 30, 2002, decreased toapproximately $250,000 from approximately $280,000 in the second quarter of2002 due to lower interest rates in 2002 as compared to the same period in 2001.

 

***Six Months EndedJune 30, 2002, Compared to the Six Months Ended June 30, 2001***

 

*Netsales.*  Net sales forthe six months ended June 30, 2002, decreased $2.0 million, or 12%, to $14.1million, from $16.1 million in the comparable period in 2001.  Sales were down in nearly all productcategories, as retailers continued to focus on minimizing inventory due to theslow retail climate. See *“Seasonality”.*

 

Net sales of Youth Communications products during thesix months ended June 30, 2002, decreased approximately $840,000, or 22%, to$2.9 million from $3.8 million in the first six months of 2001. The reducedsales reflects a major customer’s focus on changing from youth communicationSKU’s to products in a different category.

 

Net sales of Musical Instrument products was $3.4million during the first six months of 2002, an increase of $60,000, or 2%,from the $3.3 million sold during the six months ending June 30, 2001. Thissmall increase reflects the  secondquarter introduction of new product packaging and the new Pro series line ofproducts, offset by the  firstquarter sales decline as customers waited to purchase the re-packaged products.

 

Net sales of Girls’ Toys declined approximately$500,000, or 8%, to $6.0 million during the first six months ended June 30,2002, from $6.5 million during the comparable period in 2001. The decreasereflects reduced sales of the *Elite*TM, *Little Darlings*® and *Pride andJoy*® doll lines, partially offset by increased sales of the *Two CuteTwins*TM doll, *Air Nails Salon*TM activity toy, *SassySecrets*TM doll (introduced in the first quarter of 2002) and plushtoys *Kitty,Kitty, Kittens*® and *Frisky Kittens*TM.

 

Net sales of Boys’ Toys decreased approximately$600,000, or 30%, to $1.4 million in the first six months ended June 30, 2002,from $2.0 million in the first six months of 2001. The decrease reflectsincreases in sales of boys military products and the *Street Savage*TM R/C, offsetby decreases in sales of  the *Insector*®R/C.  Additionally, the decreaseincludes the effect of close-out sales of *Data Dawg*TM in the first quarter of 2001.

 

9

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Net sales of products in other categories during thefirst six months ended June 30, 2002, decreased approximately $200,000, or 35%,to approximately $370,000 from approximately $570,000 in the first six monthsof 2001.  The sales decrease is due toreduced sales of video phones and pre-school products, both of which have beeneliminated from the 2002 product line, based upon a determination by theCompany that these products do not match with the future direction of theCompany’s product line.

 

International net sales for the six months ended June30, 2002, increased $100,000, or 4%, to $2.9 million, from $2.8 million in thefirst six months of 2001. The increase reflects the earlier introduction ofspring product into the international market, offset by later customerrequested ship dates of Christmas items, and the continued strength of the U.S.dollar as compared to some other currencies.

 

*Grossprofit.*  Gross profitdecreased approximately $100,000, or 3%, to $3.6 million for the first sixmonths ended June 30, 2002, from $3.7 million in the first six months of2001.  Gross profit as a percentage ofnet sales increased to 25.5% in the first six months ended June 30, 2002, from23.0% in the first six months of fiscal 2001. The decrease in gross profitdollars results from the decrease in sales, partially offset by the increase ingross profit as a percentage of sales. This percentage increase reflects changes in the 2002 sales mix towardhigher margin products versus the same period in 2001 and fewer close-out salesat lower margins than the Company experienced in 2001.

 

*Selling,general and administrative expenses.*  Selling, general and administrative expensesdecreased to $6.0 million in the first six months ended June 30, 2002, comparedwith $8.0 million for the first six months of fiscal 2001, a decrease of $2.0million. The decrease occurred in all areas, driven primarily by reductions inemployee expense, professional fees, sales commissions, travel and entertainment expense, depreciation andoffice expense of approximately $400,000, $130,000, $225,000, $173,000,$100,000 and $285,000 respectively. Advertising expense in 2002 was reduced by approximately $400,000,reflecting management’s belief that the advertising benefits would be minimizeddue to general consumer economic concerns. Additionally, in 2001 the Companyrecorded approximately $260,000 in goodwill amortization, which is not recordedin 2002 due to the Company’s adoption of SFAS # 142, “Goodwill and Other Intangibles”.  *See Significant Accounting Policies.*

 

*Interestexpense.*  Interestexpense during the first six months ended June 30, 2002, decreased toapproximately $450,000 from approximately $540,000 in the first six months of2001 due to lower interest borrowing rates in 2002 as compared to the sameperiod in 2001.

 

**Liquidity and Capital Resources**

 

The Company historically has funded its operations andcapital requirements by cash generated from operations and borrowings.  The Company’s primary capital needs haveconsisted of acquisitions of inventory, financing accounts receivable andcapital expenditures for product development.

 

The Company’s operating activities provided net cashof $3,658,119 million during the first six months of fiscal 2002, resultingprimarily from decreases in accounts receivable and inventories, and increasesin accounts payable, offset by increases in prepaid expense.  Net cash used in investing activities duringfirst six months of fiscal 2002 was $769,162 and was primarily a result ofcapital expenditures.  Net cash used infinancing activities was approximately $2.5 million in the first six months offiscal 2002 as a result of payments of long-term debt, partially offset byborrowings on lines of credit and net borrowings from related parties.  The Company’s working capital as of June 30,2002, was $4.3 million and unrestricted cash was $660,000 compared to workingcapital of $3.0 million and unrestricted cash of $90,000 as of June 30, 2001.

 

The seasonal nature of the toy business results incomplex working capital needs.  TheCompany’s working capital needs, which the Company generally satisfies throughshort-term borrowings, are greatest in the last two fiscal quarters.  To manage these working capitalrequirements, the Company maintains credit facilities collateralizedprincipally by accounts receivable and inventory.  The Company currently maintains a line of credit facility withDao Heng Bank Limited (the “Dao Heng Credit Facility”), a line of creditfacility with Standard Chartered Bank [Hong Kong] (the “Standard CharteredFacility”) and a revolving credit facility with Sunrock Capital Corp. (the

 

10

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“Revolver”).  As of  August 12, 2002, the Company had additionaleligible borrowing capacity of $100,000 under the Revolver.

 

The Standard Chartered Facility was entered into the29th day of April, 2002, and affords the Company a credit limit inthe aggregate of up to HKD$19,000,000 (approximately US$2,436,000 at June 30,2002) in the form of a line of credit financing facility based on actualshipments of product and on opened letters of credit.  The facility is similar to the Dao Heng facility.

 

On March 19, 2001, the Company issued to MVII, LLC(“MVII”), an Investment Warrant to acquire 1.8 million shares of the Company’sCommon Stock at a purchase price of $2.7 million.  The Investment Warrant is exercisable in whole or in part for aten-year period beginning on June 3, 2002. As issued, the Investment Warrant was subject to certain anti-dilutionadjustments.  In connection with theissuance of the Investment Warrant, the Company and MVII entered into aRegistration Rights Agreement, pursuant to which MVII was granted certainpiggyback registration rights with respect to the shares of the Common Stockunderlying the Warrant.  Shares ofCommon Stock acquired by MVII upon exercise of the Warrant are subject to theterms of a Shareholders’ and Voting Agreement dated as of April 5, 1999, amongMVII and certain of the Company’s other shareholders.  Proceeds from the sale of the Investment Warrant were used by theCompany for current working capital.

 

On January 31, 2002, at the request of NASDAQ and withthe agreement of MVII, the Company issued an amended and restated InvestmentWarrant, which amended and restated in its entirety the Investment Warrant byremoving all anti-dilution provisions. In addition, the Company and MVII entered into an Amended and RestatedRegistration Rights Agreement, which amended and restated in its entirety theRegistration Rights Agreement, by removing all of the provisions regarding theanti-dilution provisions of the original Investment Warrant.

 

In connection with the acquisition of MeritusIndustries, Inc., in January 2000, the Company borrowed $5 million from MVII,evidenced by a promissory note dated January 7, 2000 (the “MVII Note”).  The Company reborrowed on March 6, 2002 andMay 21, 2002, a total of $1,000,000 of the original principal that the Companyhad paid on the MVII Note.  The proceedswere used to finance the normal business operations of the Company.

 

The Company and Sunrock amended the Revolver on June12, 2002, thereby extending the Seasonal Inventory Advance and lowering therequired thresholds in the Net Worth and Net Income covenants.  The Company is in compliance with thequarterly financial covenants of the Revolver..  If the Company falls out of compliance with the financialcovenants of the Revolver, based on the historical relationship with Sunrock,the Company believes it would be able to either obtain a waiver of suchcovenants or amend the Revolver.  In theevent the Company were out of compliance with the Revolver and could not obtaina waiver or an amendment, the Company believes it would be able to obtainalternative financing to maintain normal business operations.

 

The Company is obligated to make future minimumroyalty payments under certain of its license agreements.  As of June 30, 2002, the Company wasrequired to make an aggregate of approximately $168,750 in payments of guaranteedroyalties under certain licenses in fiscal 2002 and $150,000 thereafter throughfiscal 2003.

 

The Company has budgeted approximately $1.3 millionfor capital expenditures for fiscal 2002 consisting primarily of purchases oftools, molds and information technology systems.  Based on projected fiscal 2002 operating results, the Companybelieves cash flows from operations and available borrowings under theRevolver, the Dao Heng Credit Facility and the Standard Chartered Facility  will be sufficient to meet the Company’soperating cash requirements and fund its anticipated capital expenditures.  However, there can be no assurance theCompany will meet its projected operating results.  In connection with any future cash needs or acquisitionopportunities, the Company may incur additional debt or issue additional equityor debt securities depending on market conditions, as well as other factors.

 

11

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**Seasonality**

 

Retail sales of toy products are seasonal, with amajority of retail sales occurring during the Christmas holiday period:September through December.  As aresult, shipments of toy products to retailers are typically greater in each ofthe third and fourth quarters than in the first and second quarterscombined.  This seasonality is increasingas the large toy retailers are becoming more efficient in their inventorycontrol systems.

 

In anticipation of this seasonal increase in retailsales, the Company significantly increases its production in advance of thepeak selling period during the second quarter, with a corresponding build-up ofinventory levels.    This results insignificant peaks in the second and third quarters in the respective levels ofinventories and accounts receivable, which result in seasonal working capitalfinancing requirements.  See *“SeasonalFinancing.”*

 

**Seasonal Financing**

 

The Company’s financing ofseasonal working capital typically peaks in the third quarter of the year, whenaccounts receivable are at their highest due to increased sales volume andsales programs, and when inventories are at their highest in anticipation ofexpected second half sales volume.  See *“Seasonality.”*  The Company finances its seasonal workingcapital requirements by using internally generated cash and borrowings underthe Dao Heng Credit Facility, the Standard Chartered Facility and the Revolver.

 

**CautionaryStatement**

 

Certain written and oral statements made orincorporated by reference from time to time by the Company or itsrepresentatives in this Form 10-Q, other filings or reports with the Securitiesand Exchange Commission, press releases, conferences, or otherwise, are“forward-looking statements” within the meaning of the Private SecuritiesLitigation Reform Act of 1995.  TheCompany is including this Cautionary Statement to make applicable and takeadvantage of the safe harbor provisions of the Private Securities LitigationReform Act of 1995 for any such forward-looking statements.  Forward-looking statements can be identifiedby the use of terminology such as “believe,” “anticipate,” “expect,”“estimate,” “may,” “will,” “should,” “project,” “continue,” “plans,” “aims,”“intends,” “likely,” or other words or phrases of similar terminology.  Management cautions you that forward-lookingstatements involve risks and uncertainties which may cause actual results todiffer materially from the forward-looking statements.  For a discussion of some of the factors thatmay cause actual results to differ materially from those suggested by forward-lookingstatements, please read carefully the information under Item 1, “RiskFactors”, in the Company’s 2000 Annual Report on Form 10-K.  In addition to the Risk Factors and otherimportant factors detailed herein and from time to time in other reports filedby the Company with the Securities and Exchange Commission, including Forms8-K, 10-Q, and 10-K, and any amendments thereto, the following importantfactors could cause actual results to differ materially from those suggested byany forward-looking statements.

* *
| *Marketplace  Risks*        |
|-----------------------------|
|                        |   |
| •                      | Increased competitive pressure, both domestically  and internationally, which may negatively affect the sales of the Company’s  products; |
|                        |   |
| •                      | Changes in public and consumer taste, which may  negatively affect the sales of the Company’s products; |
|                        |   |
| •                      | Significant changes in the play patterns of  children, whereby they are increasingly attracted to more developmentally  advanced products at younger ages, which may affect brand loyalty and the  perceived value of and demand for the Company’s products; and |
|                        |   |
| •                      | Possible weaknesses in economic conditions, both  domestically and internationally, which may negatively affect the sales of  the Company’s products and the costs associated with manufacturing and  distributing these products. |
|                        |   |
| *Financing  Considerations* |
|                        |   |
| •                      | Currency fluctuations, which may affect the  Company’s reportable income; significant changes in interest rates, both  domestically and internationally, which may negatively affect the Company’s  cost of financing both its operations and investments. |

 

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| *Other  Risks* |
|----------------|
|           |   |
| •         | Changes in laws or regulations, both domestically  and internationally, including those affecting consumer products or trade  restrictions, which may lead to increased costs or interruption in normal  business operations of the Company; |
|           |   |
| •         | Future litigation or governmental proceedings, which  may lead to increased costs or interruption in normal business operations of  the Company; and |
|           |   |
| •         | Labor disputes, which may lead to increased costs or  disruption of any of the Company’s operations. |
|           |   |
| •         | Failure to demonstrate compliance with Nasdaq  Marketplace Rules could cause the Company’s securities to be delisted.  *See Part II, Item 5.* |

** **

The risks included hereinare not exhaustive.  Other sections ofthis Form 10-Q may include additional factors which could materially andadversely impact the Company’s business, financial condition, and results ofoperations.  Moreover, the Companyoperates in a very competitive and rapidly changing environment.  New risk factors emerge from time to timeand it is not possible for management to predict all such risk factors on theCompany’s business, financial condition or results of operations or the extentto which any factor, or combination of factors, may cause actual results todiffer materially from those contained in any forward-looking statements.  Given these risks and uncertainties,investors should not place undue reliance on forward-looking statements as aprediction of actual results.

 

**Item 3.  Quantitative and Qualitative Disclosure About Market Risk**

 

The Company does not hold any investments in marketrisk sensitive instruments. Accordingly, the Company believes that it is not subject to any materialrisks arising from changes in interest rates, foreign currency exchange rates,commodity prices, equity prices or other market changes that affect market riskinstruments.

 

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**PART II****- OTHERINFORMATION**

 

**Item 1.    Legal Proceedings**

 

The Company is involved in various legal proceedingsand claims incident to the normal conduct of its business.  The Company believes that such legalproceedings and claims, individually and in the aggregate, are not likely tohave a material adverse effect on its financial position or results ofoperations.  The Company maintainsproduct liability and general liability insurance in amounts it believes to bereasonable.

 

**Item 2.    Changes in Securities and Use of Proceeds**

 

On March 19, 2001, the Company issued to MVII anInvestment Warrant to acquire 1.8 million shares of the Company’s Common Stockat a purchase price of $2.7 million. The Investment Warrant is exercisable in whole or in part for a ten-yearperiod beginning on June 3, 2002.  Asissued, the Investment Warrant was subject to certain anti-dilutionadjustments.  In connection with theissuance of the Investment Warrant, the Company and MVII entered into aRegistration Rights Agreement, pursuant to which MVII was granted certainpiggyback registration rights with respect to the shares of the Common Stockunderlying the Warrant.  Shares ofCommon Stock acquired by MVII upon exercise of the Warrant are subject to theterms of a Shareholders’ and Voting Agreement dated as of April 5, 1999, amongMVII and certain of the Company’s other shareholders.  Proceeds from the sale of the Investment Warrant were used by theCompany for current working capital.

 

On January 31, 2002, at the request of NASDAQ and withthe agreement of MVII, the Company issued an amended and restated Investment Warrant,which amended and restated in its entirety the Investment Warrant by removingall anti-dilution provisions.  Inaddition, the Company and MVII entered into an Amended and RestatedRegistration Rights Agreement, which amended and restated in its entirety theRegistration Rights Agreement, by removing all of the provisions regarding theanti-dilution provisions of the original Investment Warrant.  *See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations – Liquidity and Capital Resources.”*

 

**Item4.    Submission of Matters to a Vote ofSecurity Holders**

 

The Company held its annual meeting of shareholders onJune 18, 2002.  At that meeting, theshareholders were presented with proposals with respect to (i) the election of directorswhose three-year terms expire in 2005, and (ii) the approval and retention ofPricewaterhouse Coopers LLP as the independent public accounting firm for thefiscal year ending December 31, 2002, to perform audits and other services.  The results of the vote of the shareholdersat its annual meeting are set forth below with respect to each of the proposalspresented.

 

(i)            Messrs. E. ThomasMartin and Joseph S. Whitaker were the nominees for the class of directorswhose three-year terms will expire in 2005. Shares of the Company’s Common Stock with respect to the election ofsuch directors were voted as follows: with respect to Mr. Martin, the number ofvotes that were cast for his election were 8,562,417 and the number of voteswithheld were 3,809; with respect to Mr. Whitaker, the number of votes thatwere cast for his election were 8,562,417 and the number of votes withheld were3,809.  Messrs. Martin and Whitaker wereelected for terms expiring on the date of the annual meeting of shareholders in2005.

 

(ii)           With respect to theproposal to retain PricewaterhouseCoopers LLP as the independent publicaccounting firm for the fiscal year ending December 31, 2002 to perform auditsand other services, shares of the Company’s Common Stock were voted as follows:the number of votes cast for such proposal was 8,559,817, the number of votescast against was 4,209, and the number of votes abstaining was 2,200.

 

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**Item5.    Other Information**

 

On February 14, 2002, the Company received notice fromThe Nasdaq Stock Market, Inc. that the Company’s common stock had closed belowthe minimum of $1.00 per share requirement for continued inclusion on theNasdaq SmallCap Market under Marketplace Rule 4310(c)(4) (the “Rule”).  Although the Company was not in compliancewith the Rule on August 13, 2002, the Company met the initial listing criteriafor the Nasdaq SmallCap Market under Marketplace Rule 4310(c)(2)(A), and thusthe Company will be granted an additional 180 calendar day grace period todemonstrate compliance with the Rule. Upon the expiration of the grace period, the Company will receivenotification that its securities will be de-listed if it is not in compliancewith the Rule during such additional 180 day period.  If this occurs, the Company may appeal the de-listingdetermination to a  Nasdaq ListingQualifications Panel.

 

On August 5, 2002, the Company completed itsrelocation to its new corporate headquarters located at 10110 West Sam HoustonParkway, South, Suite 150, Houston, TX 77099, pursuant to a 67 month leasecommencing April 1, 2002. The Company's lease on its previous office/warehouselocation terminates on August 31, 2002.

 

**Item6.    Exhibits and Reports on Form 8-K**

 

a)   Exhibits

The information required by this Item 6 (a) is setforth in the Index to Exhibits accompanying this quarterly report and isincorporated herein by reference.

 

b)   Reports on Form 8-K

There were no reports on Form 8-K filed by the Companyin the second quarter ending June 30, 2002.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 

 
|                          |   | DSI Toys, Inc.                                       |
|-------------------------------|--------|------------------------------------------------------|
|                          |   |                                                 |
|                          |   |                                                 |
| Dated:   August 13, 2002 |   |   /s/ JOSEPH  S. WHITAKER                       |
|                          |   |   Joseph S.  Whitaker                           |
|                          |   |   President  and  Chief Executive Officer  |
|                          |   |                                                 |
|                          |   |                                                 |
|                          |   |                                                 |
| Dated:   August 13, 2002 | By:    |   /s/ ROBERT  L. WEISGARBER                     |
|                          |   |   Robert L.  Weisgarber                         |
|                          |   |   Chief  Financial Officer                      |
|                          |   |   (Principal  Financial and Accounting Officer) |

 

16

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**Index to Exhibits**

 
| 3.1    |   | Amended and Restated Articles of Incorporation of  the Company. (1)                                                                                                                                                                                                  |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                 |
| 3.1.1  |   | Amendment to Amended and Restated Articles of  Incorporation of the Company (filed as Exhibit 3.1.1 to the Company’s Form  10-Q for the quarterly period ended April 30, 1999), incorporated herein by  reference.                                              |
|   |   |                                                                                                                                                                                                                                                                 |
| 3.2    |   | Amended and Restated Bylaws of the Company. (1)                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                 |
| 3.3    |   | Amendment to Amended and Restated Bylaws of the  Company. (1)                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                 |
| 4.1    |   | Amended and Restated Investment Warrant by and  between the Company and MVII, LLC, dated January 31, 2002 (filed as Exhibit  4.8 to the Company’s Form 10-K for the fiscal year ended December 31, 2001),  incorporated herein by reference.                    |
|   |   |                                                                                                                                                                                                                                                                 |
| 4.2    |   | Amended and Restated Registration Rights Agreement  by and between the Company and MVII, LLC dated January 31, 2002 (filed as  Exhibit 4.9 to the Company’s Form 10-K for the fiscal year ended December 31,  2001), incorporated herein by reference.          |
|   |   |                                                                                                                                                                                                                                                                 |
| 10.1   |   | Memorandum of Re-borrowing of Principal by and  between the Company and MVII, LLC dated March 6, 2002 (filed as Exhibit 10.63  to the Company’s Form 10-K for the fiscal year ended December 31, 2001),  incorporated herein by reference.                      |
|   |   |                                                                                                                                                                                                                                                                 |
| 10.2   |   | Amendment No. 7 dated March 20, 2002, to Loan and  Security Agreement by and between Sunrock Capital Corp. and the Company  (filed as Exhibit 10.64 to the Company’s Form 10-K for the fiscal year ended  December 31, 2001), incorporated herein by reference. |
|   |   |                                                                                                                                                                                                                                                                 |
| 10.3   |   | Unconditional Guaranty Agreement dated March 20,  2002, by the Company and Dao Heng Bank Limited (filed as Exhibit 10.65 to the  Company’s Form 10-K for the fiscal year ended December 31, 2001),  incorporated herein by reference.                           |
|   |   |                                                                                                                                                                                                                                                                 |
| 10.4   |   | Amendment No. 8 dated March 29, 2002, to Loan and  Security Agreement by and between Sunrock Capital Corp. and the Company  (filed as Exhibit 10.66 to the Company’s Form 10-K for the fiscal year ended  December 31, 2001), incorporated herein by reference. |
|   |   |                                                                                                                                                                                                                                                                 |
| *10.5  |   | Banking Facility Agreement by and between Standard  Chartered Bank and the Company dated April 29, 2002                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                 |
| *10.6  |   | Memorandum of Reborrowing of Principal by and  between the Company and MVII, LLC dated May 21, 2002.                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                 |
| *10.7  |   | Amendment No. 9 dated June 12, 2002, to Loan and  Security Agreement by and between Sunrock Capital Corp. and the Company.                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                 |
| *99.1  |   | Certification of the Chief Executive Officer  pursuant to Section 1350 of Chapter 63, Title 18 of the United States Code  for the period ending June 30, 2002.                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                 |
| *99.2  |   | Certification of the Chief Financial Officer  pursuant to Section 1350 of Chapter 63, Title 18 of the United States Code  for the period ending June 30, 2002.                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                 |
| (1)    |   | Filed as a part of the Registrant’s Registration  Statement on Form S-1 (No. 333-23961) and incorporated herein by reference.                                                                                                                                   |

 

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| * |   | Filed herewith. |
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