**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q/A**

 

**AmendmentNo. 1**

 

| **(MARK  ONE)**                  |
|----------------------------------|
|                             |
| **ý**                       |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                             |   |   |
|                             |   | **For  the quarterly period ended March 31, 2003** |
|                             |   |   |
|                             |   | **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.**                                                         |
|-----------------------------------------------------------------------------|
| (Exact name 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 markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  ý  No o

 

Indicate by check markwhether the Registrant is an accelerated filer (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934).  Yes  o  No  ý

 

As of April 30, 2003,10,866,365 shares of common stock, par value $.01 per share, of DSI Toys, Inc.were outstanding.

 

 

----

 

This Amendment No. 1 onForm 10-Q/A (this “Amendment”) is being filed in order to amend theRegistrant’s Quarterly Report on Form 10-Q for the quarter ended March 31,2003, filed with the Securities and Exchange Commission on May 15, 2003 (“Form10-K”), to revise the Consolidated Financial Statements and the Notes thereto.

 

This Amendment is limited in scope to the portions ofthe Form 10-Q set forth above and does not in any way amend, update or changeany other items or disclosures contained in the Form 10-Q.

 

**PART I —FINANCIAL INFORMATION**

 

**Item1.            Financial Statements**

 

**DSIToys, Inc.**

**ConsolidatedBalance Sheet**

 
|                                                                                                                                                         |   | **March 31  2003** |       | **December  31,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------------|--------|
|                                                                                                                                                         |   | **(Unaudited)**    |       |
| ASSETS                                                                                                                                                       |   |               |       |                    |   |
| Current assets:                                                                                                                                              |   |               |       |                    |   |
| Cash                                                                                                                                                         |   | $                  | 406,064    |                    | $      | 1,737,329 |   |
| Accounts  receivable, net                                                                                                                                    |   | 1,992,465          |       | 4,861,391               |   |
| Inventories                                                                                                                                                  |   | 4,729,998          |       | 6,588,547               |   |
| Prepaid expenses                                                                                                                                             |   | 4,060,700          |       | 3,164,281               |   |
| Total current  assets                                                                                                                                        |   | 11,189,227         |       | 16,351,548              |   |
|                                                                                                                                                         |   |               |       |                    |   |
| Property and  equipment, net                                                                                                                                 |   | 2,163,062          |       | 2,192,941               |   |
| Goodwill, net                                                                                                                                                |   | 9,241,128          |       | 9,241,128               |   |
| Other assets                                                                                                                                                 |   | 837,568            |       | 885,085                 |   |
| Total assets                                                                                                                                                 |   | $                  | 23,430,985 |                    | $      | 28,670,702 |   |
|                                                                                                                                                         |   |               |       |                    |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                    |   |               |       |                    |   |
| Current  liabilities:                                                                                                                                        |   |               |       |                    |   |
| Accounts payable  and accrued liabilities                                                                                                                    |   | $                  | 13,837,435 |                    | $      | 13,517,790 |   |
| Current portion  of long-term debt                                                                                                                           |   | 5,150,010          |       | 8,240,923               |   |
| Current portion  of long-term debt due to a related party                                                                                                    |   | 1,119,557          |       | 960,510                 |   |
| Income taxes  payable, foreign                                                                                                                               |   | 112,364            |       | 112,364                 |   |
| Total current  liabilities                                                                                                                                   |   | 20,219,366         |       | 22,831,587              |   |
|                                                                                                                                                         |   |               |       |                    |   |
| Long-term debt  due to a related party                                                                                                                       |   | 4,808,190          |       | 4,554,042               |   |
| Deferred income  taxes                                                                                                                                       |   | 179,902            |       | 179,902                 |   |
| Total  liabilities                                                                                                                                           |   | 25,207,458         |       | 27,565,531              |   |
|                                                                                                                                                         |   |               |       |                    |   |
| Shareholders’  equity (deficit):                                                                                                                        |   |               |       |                    |   |
| Preferred stock,  $.01 par value, 5,000,000 shares authorized, none issued or outstanding                                                                    |   |               |       |                    |   |
| Common stock,  $.01 par value, 35,000,000 shares authorized, 10,866,365 shares issued and  outstanding, respectively at March 31, 2003 and December 31, 2002 |   | 108,664            |       | 108,664                 |   |
| Additional  paid-in capital                                                                                                                                  |   | 7,855,465          |       | 7,855,465               |   |
| Common stock  warrants                                                                                                                                       |   | 102,500            |       | 102,500                 |   |
| Accumulated  other comprehensive loss                                                                                                                        |   | (90,117            | )          | (87,129                 | )      |
| Accumulated  deficit                                                                                                                                         |   | (9,752,985         | )          | (6,874,329              | )      |
| Total  shareholders’ equity (deficit)                                                                                                                   |   | (1,776,473         | )          | 1,105,171               |   |
| Total  liabilities and shareholders’ equity                                                                                                             |   | $                  | 23,430,985 |                    | $      | 28,670,702 |   |

 

See accompanying notes toconsolidated financial statements.

 

 

1

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**DSIToys, Inc.**

**ConsolidatedStatement of Operations**

**(Unaudited)**

 
|                                          |   | **Three  Months Ended March 31,** |       |
|-----------------------------------------------|--------|-----------------------------------|------------|
|                                          |   | **2003**                          |       | **2002** |   |
|                                          |   |                              |       |   |   |
| Net sales                                     |   | $                                 | 3,756,134  |   | $ | 5,189,853 |   |
| Costs of goods  sold                          |   | 3,392,014                         |       | 4,086,701 |   |
| Gross profit                                  |   | 364,120                           |       | 1,103,152 |   |
| Selling, general  and administrative expenses |   | 3,042,372                         |       | 3,040,057 |   |
| Operating loss                                |   | (2,678,252                        | )          | (1,936,905 | ) |
| Interest expense                              |   | (211,349                          | )          | (197,868 | ) |
| Other income                                  |   | 10,945                            |       | 144,752 |   |
| Loss before  income taxes                     |   | (2,878,656                        | )          | (1,990,021 | ) |
| Benefit from  income taxes                    |   |                              |       | 676,607 |   |
| Net loss                                      |   | $                                 | (2,878,656 | ) | $ | (1,313,414 | ) |
|                                          |   |                              |       |   |   |
| Basic earnings  (loss) per share              |   |                              |       |   |   |
| Loss per share                                |   | $                                 | (0.26      | ) | $ | (0.14 | ) |
| Weighted average  shares outstanding          |   | 10,866,365                        |       | 9,066,365 |   |
|                                          |   |                              |       |   |   |
| Diluted earnings  (loss) per share            |   |                              |       |   |   |
| Loss per share                                |   | $                                 | (0.26      | ) | $ | (0.14 | ) |
| Weighted average  shares outstanding          |   | 10,866,365                        |       | 9,066,365 |   |

 

See accompanying notes toconsolidated financial statements.

 

2

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**DSIToys, Inc.**

**ConsolidatedStatement of Cash Flows**

**(Unaudited)**

 
|                                                                             |   | **Three  Months Ended March 31** |       |
|----------------------------------------------------------------------------------|--------|----------------------------------|------------|
|                                                                             |   | **2003**                         |       | **2002** |   |
| Cash flows from  operating activities:                                           |   |                             |       |   |   |
| Net loss                                                                         |   | $                                | (2,878,656 | ) | $ | (1,313,414 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities: |   |                             |       |   |   |
| Depreciation and  amortization                                                   |   | 266,136                          |       | 214,358 |   |
| Amortization and  write-off of debt discount and issuance costs                  |   | 10,017                           |       | 13,664 |   |
| Provision for  doubtful accounts, net                                            |   | 706                              |       | 790 |   |
| Deferred income  taxes                                                           |   |                             |       | (621,684 | ) |
| Changes in  assets and liabilities:                                              |   |                             |       |   |   |
| Accounts  receivable                                                             |   | 2,868,220                        |       | 6,022,406 |   |
| Inventories                                                                      |   | 1,858,549                        |       | 843,790 |   |
| Prepaid expenses                                                                 |   | (896,419                         | )          | (804,050 | ) |
| Accounts payable  and accrued liabilities                                        |   | 319,645                          |       | 576,200 |   |
| Net cash  provided by operating activities                                       |   | 1,548,198                        |       | 4,932,060 |   |
|                                                                             |   |                             |       |   |   |
| Cash flows from  investing activities:                                           |   |                             |       |   |   |
| Capital  expenditures                                                            |   | (236,257                         | )          | (148,014 | ) |
| Decrease in  other assets                                                        |   | 37,500                           |       |   |   |
| Net cash used in  investing activities                                           |   | (198,757                         | )          | (148,014 | ) |
|                                                                             |   |                             |       |   |   |
| Cash flows from  financing activities:                                           |   |                             |       |   |   |
| Net payments of  debt                                                            |   | (3,090,913                       | )          | (5,199,626 | ) |
| Net borrowings  of long-term debt due to related party                           |   | 413,195                          |       | 421,388 |   |
| Net cash used by  financing activities                                           |   | (2,677,718                       | )          | (4,778,238 | ) |
| Effect of  exchange rate changes on cash                                         |   | (2,988                           | )          | (1,611 | ) |
| Net increase  (decrease) in cash                                                 |   | (1,331,265                       | )          | 4,197 |   |
| Cash and cash  equivalents, beginning of period                                  |   | 1,737,329                        |       | 284,637 |   |
| Cash and cash  equivalents, end of period                                        |   | $                                | 406,064    |   | $ | 288,834 |   |

 

See accompanying notes toconsolidated financial statements.

 

 

3

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**DSIToys, Inc.**

**ConsolidatedStatement of Shareholders’ Equity (Deficit)**

**(Unaudited)**

 
|                                          |   |       |   | **Additional  Paid-in Capital** |    | **Common  Stock Warrants** |   | **Accumulated  Other Comprehensive Loss** |   | **Accumulated  Earnings (Deficit)** |      | **Totals** |   |
|-----------------------------------------------|--------|------------|--------|---------------------------------|---------|----------------------------|--------|-------------------------------------------|--------|-------------------------------------|-----------|------------|--------|
|                                          |
| **Common  Stock**                             |
| **Shares**                                    |   | **Amount** |
|                                          |   |       |   |                            |    |                       |   |                                      |   |                                |      |       |   |   |   |
| 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                                      |   |       |   |                            |    |                       |   |                                      |   |                                |      | (8,012,226 | )      | (8,012,226 | ) |
| Foreign currency  translation adj. net of tax |   |       |   |                            |    |                       |   |                                      |   |                                |      |       |   | (16,201 | ) |
| Comprehensive  loss                           |   |       |   |                            |    |                       |   |                                      |   |                                |      |       |   | (8,028,427 | ) |
| Warrants  Exercised                           |   | 1,800,000  |   | 18,000                          |    | 2,682,000                  |   | (2,700,000                                | )      |                                |      |       |   |   |   |
| Balance,  December 31, 2002                   |   | 10,866,365 |   | 108,664                         |    | 7,855,465                  |   | 102,500                                   |   | (87,129                             | )         | (6,874,329 | )      | 1,105,171 |   |
|                                          |   |       |   |                            |    |                       |   |                                      |   |                                |      |       |   |   |   |
| Comprehensive  loss:                          |   |       |   |                            |    |                       |   |                                      |   |                                |      |       |   |   |   |
| Net loss                                      |   |       |   |                            |    |                       |   |                                      |   |                                |      | (2,878,656 | )      | (2,878,656 | ) |
| Foreign currency  translation adj. net of tax |   |       |   |                            |    |                       |   |                                      |   |                                |      | (2,988     | )      | (2,988 | ) |
| Comprehensive  loss                           |   |       |   |                            |    |                       |   |                                      |   |                                |      |       |   | (2,881,644 | ) |
| Balance, March  31, 2003                      |   | 10,866,365 |   | $                               | 108,664 |                       | $      | 7,855,465                                 |   | $                                   | 102,500   |       | $      | (90,117 | ) | $ | (9,752,985 | ) | $ | (1,776,473 | ) |

 

See accompanying notes toconsolidated financial statements.

 

 

4

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**DSIToys, Inc.Notes to Consolidated Financial Statements(Unaudited)**

 

**1.****                                      Basisof Presentation**

 

The accompanying unaudited consolidated financialstatements of DSI Toys, Inc. and its wholly-owned subsidiary (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 theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements and should beread in conjunction with the financial statements and notes thereto appearingin the Company’s Annual Report on Form 10-K and Form 10-K/A for the fiscal yearended December 31, 2002.

 

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 consistonly of normal recurring items. Additionally, certain reclassifications havebeen made to the prior year financial information to make the presentationconsistent with the current year financial presentation.

 

The results of operations for the three months endedMarch 31, 2003, are not necessarily indicative of the results expected for thefull year ending December 31, 2003.

 

*Liquidityand Going Concern*

 

The Company’s viability as a going concern isdependent upon the successful completion of the going- private transaction (see“*Going-Private Transaction*”), theobtainment of a new credit facility to replace the Company’s Revolver (see Note6. “Liquidity”), and additional capital infusion, as well as sustainedprofitable operations. The accompanying financial statements do not include anyadjustments that might be necessary if the Company is unable to continue as agoing concern.

 

To the extent the Company’s cash reserves and cashflows from operations are insufficient to meet future cash requirements, theCompany will need to successfully raise additional capital through an equityinfusion or the issuance of debt.  Management believes that thegoing-private transaction, if consummated, and subsequent actions, will providethe necessary equity infusion and/or debt which will allow the Company tocontinue its normal operations for the foreseeable future.

 

Additionally, the Company has held negotiations withseveral lenders regarding a credit facility to replace the Revolver. One ofthose financial institutions has indicated a willingness to provide the Companywith additional working capital effective at the close of the going-privatetransaction. The financial institution’s willingness to lend to the Company isbased on the Company improving its financial condition by means of thegoing-private transaction, and a subsequent capital infusion and personalguaranty by E. Thomas Martin, the Chairman of the Company’s Board ofDirectors.  Mr. Martin has indicated that his willingness to provide theCompany with any additional working capital is conditioned on the completion ofthe going-private transaction.  Management believes that the going-privatetransaction will close and that the Company will be able to continue operationsuntil that time.

 

*Delisting*

 

On February 14, 2002, theCompany received notice from The Nasdaq Stock Market, Inc. that the Company’scommon stock had closed below the minimum price of $1.00 per share requirementfor continued listing on the Nasdaq SmallCap Market under Marketplace Rule4310(c)(4) (the “Rule”).  The Company was granted a 180 calendar day graceperiod to comply with the Rule, but was still not in compliance with the Ruleon August 13, 2002, the final day of the grace period.  However, at suchtime the Company was granted an additional 180 calendar day grace period tocomply with the Rule because it did meet the initial listing criteria for theNasdaq SmallCap Market under Marketplace Rule 4310(c)(2)(A). The additionalgrace period expired on February 10, 2003, without the Company being incompliance with the Rule.  On March 18, 2003, the Company receivednotification that its securities would be delisted from the Nasdaq SmallCapMarket at the opening of business on March 27, 2003.  The Company electednot to appeal the delisting determination and its common stock commenced tradingon the 

 

5

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over-the-counter BulletinBoard electronic quotation system effective with the opening of business onMarch 27, 2003, under the ticker symbol “DSIT.”

 

*Going-PrivateTransaction*

 

Since the Company’s cashreserves and cash flows from operations no longer meet its cash requirements,the Company explored various alternatives to raise additional capital.

 

In January 2003, afterother alternatives for the Company had been exhausted, E. Thomas Martin, the Chairmanof the Company’s Board of Directors, and certain other officers, directors andshareholders of the Company (the “Buyer Group”) began serious consideration ofa going-private transaction.  On January 27, 2003, the Board of Directorsinvited the Buyer Group to submit an offer to the Company for a going-privatetransaction.

 

On January 28, 2003, theBuyer Group proposed to the Company a going-private transaction by way of amerger that would result in the purchase of shares of common stock held by theshareholders who are not members of the Buyer Group for $0.44 per share.

 

The Board of Directorsappointed a special committee to review the proposed transaction.

 

Based on a series ofnegotiations between the special committee and representatives of the BuyerGroup, the purchase price was increased to $0.47 per share.

 

On March 26, 2003, theBoard of Directors unanimously voted to approve the merger agreement andrecommended that the shareholders approve the merger agreement and the merger.

 

On March 27, 2003, themerger agreement was signed and the Company issued a press release announcingthe merger agreement.

 

On March 31, 2003, theCompany filed a Schedule 13E-3 and preliminary proxy statement with theSecurities and Exchange Commission in connection with the going-privatetransaction.  Amendments to these documents were filed with the Securitiesand Exchange Commission on May 15, 2003.

 

If the shareholders ofthe Company approve the merger, the Company’s shares will be delisted from theover-the-counter Bulletin Board electronic quotation system and its commonstock will be deregistered under the Securities Exchange Act of 1934. TheCompany will continue in business as a privately-held Texas corporation.

 

**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, thesejudgments are subject to an inherent degree of uncertainty.  These judgmentsare based on our historical experience, terms with current customers, ourobservance of trends in the industry, information provided by our customers andinformation available from other outside sources, as appropriate.  Oursignificant accounting policies include:

 

*RevenueRecognition*

 

The Company recognizes revenue when products areshipped and title passes to unaffiliated customers.  In most cases, titletransfers to our customers when the product has been presented to shipmentforwarders on FOB Asia sales and when the product is picked up from ourdistribution facilities on domestic sales.  Provision is made currentlyfor estimated returns of defective and slow-moving merchandise, priceprotection and customer allowances, and is included as a reduction of accountsreceivable and revenues.  The provision is primarily based on knownreturns and allowances provided to customers for sales activities, as well asan historically based estimate of potential unknown customers’ allowances andclaims. Shipping and handling revenues are included in net sales, and cost ofgoods sold includes the shipping and handling costs associated with inbound andoutbound freight.

 

 

6

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*Allowancefor Doubtful Accounts*

 

Accounts receivable are reduced by an allowance foramounts that may become uncollectible in the future.  The Company’sestimate for its allowance is based on two methods which are combined todetermine the total amount reserved.  First, the Company evaluates specificaccounts where we have information that the customer may have an inability tomeet its financial obligations (bankruptcy, etc.).  In these cases, theCompany uses its judgement, based on the best available facts andcircumstances, and records a specific reserve for that customer against amountsdue to reduce the receivable to the amount that is expected to becollected.  These specific reserves are reevaluated and adjusted asadditional information is received that impacts the amounts reserved.  Second,a general reserve is established for all other customers based on historicalcollection and write-off experience.  If circumstances change, theCompany’s estimates of the recoverability of amounts due the Company could bereduced by a material amount.

 

*Allowancefor Returns, Defectives and Accommodations*

 

The Company records a provision for estimated salesreturns, defectives and accommodations on sales in the same period as therelated revenue is recorded.  These allowances are included in net sales andas a reduction of accounts receivable.  Our sales to customers generallydo not give them the right to return products or to cancel firm orders. However, as is common in the industry, we sometimes accept returns for stockbalancing and negotiate accommodations to customers, which include pricediscounts, advertising credits and returns, when demand for specific productfalls below expectations.  Additionally, customers are given credit forany defective products they may have received.  The allowance estimatesare based on historical sales returns and defective rates, analysis of creditmemo data and other known factors.  If the data the Company uses tocalculate these estimates does not properly reflect future returns anddefectives, revenue could be overstated and future operating results adverselyaffected.

 

*Inventories*

 

Inventory is valued at the lower of cost or marketwith cost being determined on the average cost basis.  The Company reviewsthe book value of slow-moving items, discounted product lines and individualproducts to determine if these items are properly valued.  The Companyidentifies these items and assesses the ability to dispose of them at a pricegreater than cost.  If it is determined that cost is less than marketvalue, then cost is used for inventory valuation.  If market value is lessthan cost, then the Company establishes a reserve for the amount required tovalue the inventory at market.  If the Company is not able to achieve itsexpectations of the net realizable value of the inventory at its current value,the Company would adjust its reserve accordingly.

 

*DeferredTaxes*

 

The Company recognizes deferred tax assets andliabilities based on the differences between the financial statement carryingamounts and the tax bases of assets and liabilities.  Deferred tax expenseor benefit is the result of changes in deferred tax assets and liabilitiesduring the period.  Generally accepted accounting principles require thatwe review deferred tax assets for recoverability and if needed, establish avaluation allowance for those amounts deemed unrecoverable.  In estimatingfuture tax consequences, all expected future events are considered other thanenactments of changes in the tax law or rates, including historical taxableincome, projected future taxable income, and the expected timing of thereversals of temporary differences.  Deferred tax assets of the Companyare primarily the result of unused net operating loss carry-forwards andforeign tax credits which expire over a range of years.

 

4

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The Company recorded a $4.0 million charge in fiscalyear 2002 to establish a valuation allowance for all of its deferred taxassets, including $2.2 million of deferred tax assets generated in prior years. The valuation allowance was determined in accordance with the provisions ofStatement of Financial Accounting Standards (SFAS) 109, “Accounting for IncomeTaxes,” which places primary importance on the Company’s cumulative operatingresults in the most recent periods when assessing the need for a valuationallowance. The primary factors considered in evaluating the realizability ofthe deferred tax assets and establishing the valuation allowance were continuedoperating losses for the Company through December 31, 2002, the Company’sprojection of future operating results and the number of years it will take torecover the tax assets in a difficult market.  This evaluation providessufficient negative evidence to establish an additional valuation allowanceunder the provisions of SFAS 109.  The Company intends to maintain a fullvaluation allowance for its deferred tax assets and net operating losscarryforwards until sufficient positive evidence exists to support reversal ofthe allowance.  The establishment of this valuation allowance in no wayaffects the Company’s ability to reduce future tax expense through utilizationof net operating losses and foreign income tax credits.  However,currently there can be no assurances that the net operating losses will beutilized.

 

*Goodwill*

 

The Company made anacquisition in 2000 that included a significant amount of goodwill and otherintangible assets.  Effective in 2002, goodwill is no longer amortized butis subject to at least an annual impairment test based on its estimated fairvalue.  Other intangible assets meeting certain criteria will continue tobe amortized over their useful lives and also subject to an impairmenttest.  There are many assumptions and estimates underlying thedetermination, including future cash flow and operating results. Management engaged an independent company to assist in valuing the Company’sgoodwill as of December 31, 2002.

 

**3.****                                      StockBased Compensation**

 

The Company accounts for its stock-based compensationplans under Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees.”  No stock-based employee compensation cost for theCompany’s stock option plans is reflected in its consolidated statement ofoperations, as all options granted under its plans have an exercise price equalto the market value of the underlying common stock on the date of the grant.

 

The following table illustrates the pro forma effecton net loss and loss per share if we had applied the fair value recognitionprovisions of SFAS No. 123, “Accounting for Stock-based Compensation,” asamended by SFAS No. 148, for the three months ended March 31, 2003 and 2002 (inthousands, except per share amounts).

 
|                                                                                                   |   | **Three  Months Ended  March 31** |       |
|--------------------------------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                                                   |   | **2003**                          |       | **2002** |   |
|                                                                                                   |   |                              |       |   |   |
| Net  loss                                                                                              |   | $                                 | (2,878,656 | ) | $ | (1,313,414 | ) |
|                                                                                                   |   |                              |       |   |   |
| Add  (Deduct):                                                                                         |   |                              |       |   |   |
| Total  stock option employee compensation expense calculated using the fair value  method (net of tax) |   | (3,157                            | )          | 39,272 |   |
|                                                                                                   |   |                              |       |   |   |
| Pro  forma net loss                                                                                    |   | $                                 | (2,881,813 | ) | $ | (1,274,142 | ) |
|                                                                                                   |   |                              |       |   |   |
| Loss  per Share:                                                                                       |   |                              |       |   |   |
| Reported  basic and diluted                                                                            |   | $                                 | (0.26      | ) | $ | (0.14 | ) |
| Pro  forma basic and diluted                                                                           |   | $                                 | (0.27      | ) | $ | (0.14 | ) |

 

5

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**4.****                                      AccountsReceivable**

 

Accounts receivable consist of the following:

 
|                       |   | **March  31,  2003** |      | **December  31,  2002** |   |
|----------------------------|--------|----------------------|-----------|-------------------------|--------|
| Trade  receivables         |   | $                    | 5,640,825 |                    | $      | 9,205,491 |   |
| Provisions  for:           |   |                 |      |                    |   |
| Discounts  and markdowns   |   | (1,472,295           | )         | (1,905,000              | )      |
| Return  of defective goods |   | (109,692             | )         | (395,000                | )      |
| Doubtful  accounts         |   | (2,066,373           | )         | (2,044,100              | )      |
| Accounts  receivable, net  |   | $                    | 1,992,465 |                    | $      | 4,861,391 |   |

 

**5.****                                      SegmentInformation**

 

Financial information forthe three months ended March 31, 2003 and 2002 is as follows:

 
|                                |   | **United  States** |      | **Hong  Kong** |   | **Consolidated** |   |
|-------------------------------------|--------|--------------------|-----------|----------------|--------|------------------|--------|
| Three months ended March 31, 2003:  |   |               |      |           |   |             |   |
| Net  sales                          |   | $                  | 2,789,083 |           | $      | 967,051          |   | $ | 3,756,134 |   |
| Operating  loss                     |   | (2,272,276         | )         | (405,976       | )      | (2,678,252       | )      |
| Total  assets at March 31, 2003     |   | 19,827,372         |      | 3,603,613      |   | 23,430,985       |   |
|                                |   |               |      |           |   |             |   |
| Three  months ended March 31, 2002: |   |               |      |           |   |             |   |
| Net  sales                          |   | $                  | 2,744,614 |           | $      | 2,445,239        |   | $ | 5,189,853 |   |
| Operating  loss                     |   | (1,536,257         | )         | (400,648       | )      | (1,936,905       | )      |
| Total  assets at March 31, 2002     |   | 22,563,906         |      | 3,231,766      |   | 25,795,672       |   |

 

**6.****                                      Liquidity**

 

The Company’s net losses for the year ended December31, 2002 and the three months ended March 31, 2003, and its overall financialcondition resulted in the Company being out of compliance with the minimum networth and net income covenants, as well as the maximum borrowing amount allowedduring a specified time period required under the revolving credit facility betweenSunrock Capital Corp. (“Sunrock”) and the Company (the “Revolver”). Additionally, the Company has also violated the limitations on furtherindebtedness during the quarter by borrowing from MVII in excess of amountspermitted by the Revolver as described below.  The Company’s $4.5 milliondebt under the Revolver as of March 31, 2003, is classified as a currentliability.  As a result, the Company’s current liabilities exceeded itscurrent assets by $8.9 million as of March 31, 2003. If Sunrock were toaccelerate the Revolver, which it has the option to do, the $4.5 million debtwould become immediately due and payable.

 

The Company in the past has been successful innegotiating the Revolver amendments to bring the Company back intocompliance.  Primary operations for Sunrock were sold in February 2003,limiting the willingness of Sunrock to amend any remaining lendingagreements.  As a result, the Company has held negotiations with severallenders regarding a credit facility to replace the Revolver. One of thosefinancial institutions has indicated a willingness to provide the Company withadditional working capital effective at the close of the going-privatetransaction (see Note 1. “Basis of Presentation-*Going-Private Transaction*”). The financial institution’swillingness to lend to the Company is based on the Company improving itsfinancial condition by means of the going-private transaction, a subsequentcapital infusion and a personal guaranty by Mr. Martin, the Company’s Chairmanand a principal shareholder.  Mr. Martin has indicated that hiswillingness to provide the Company with any additional working capital isconditioned on the completion of the going-private transaction.

 

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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 re-borrowed on March 6, 2002, May 21, 2002, and March 10, 2003 a totalof $1.35 million of the original principal that the Company had paid on theMVII Note.  Also, on March 31, April 4, April 15, and May 6, 2003, MVIIadvanced the Company additional funds totaling $2.0 million.  The proceedswere used to finance the normal business operations of the Company.

 

To the extent theCompany’s cash reserves and cash flows from operations are insufficient to meetfuture cash requirements, the Company will need to successfully raiseadditional capital through an equity infusion or the issuance of debt. Management believes that the successful going-private transaction, ifconsummated, and subsequent actions, will provide the necessary equity infusionand/or debt which will allow the company to continue its normal operations forthe foreseeable future.

 

**7.****                                      LegalProceedings**

 

The Company is involved in various legal proceedingsand claims incident to the normal conduct of its business.  The Companybelieves that such legal proceedings and claims, individually and in theaggregate, are not likely to have a material adverse effect on its financialposition or results of operations.  The Company maintains productliability and general liability insurance in amounts it believes to bereasonable.

 

The Company is the defendant in a lawsuit which wasfiled on December 3, 2002, styled Rymax Corp. d/b/a Rymax Marketing Services,Inc. (“Rymax”) v. DSI Toys, Inc. in the Superior Court of New Jersey LawDivision:  Morris County; civil action docket number MRSL-3799-02. In the lawsuit, Rymax claims that the Company failed to pay commissions due toRymax and demands judgment for damages in the amount of $45,061.67 plusinterest, attorney fees and costs of court.  The Company does not believeit owes these damages.  The Company has brought a third party complaintagainst Brainstorm Logistics, Inc., a company which the Company believes is arelated corporation to Rymax Corp., for damages exceeding $75,000.00 for goodsshipped and sold to Brainstorm Logistics, Inc.  At this time, the Companyis attempting to negotiate a settlement of the entire controversy.

 

The Company is the defendant in a lawsuit which wasfiled on March 14, 2003, styled The Cartoon Network, LP, LLLP (“TCN”) v. DSIToys, Inc. in the State Court of Fulton County, State of Georgia, Civil ActionFile No. 03VS046924C.  In the lawsuit, TCN claims the Company is indebtedto TCN for $725,051.70 for television advertisements aired by TCN, togetherwith interest at the rate of 18% per annum until paid and attorney’sfees.  The Company is in negotiations with TCN and believes it hasrecorded an adequate amount for the ultimate settlement.

 

The Company is the defendant in a proceeding styled INRE Play Co. Toys & Entertainment Corp., Toys International.Com, Inc. andPlay Co. Toys Canyon Country, Inc., Debtors, Case Nos. 01-11756 (ALG), 01-11758(ALG) and 01-11759 (ALG), Ian Gazes as Chapter 7 Trustee of ToysInternational.Com, Inc. v. DSI Toys, Inc., Adversary Proceeding No. 03-02260 inthe United States Bankruptcy Court, Southern District of New York. TheAdversary Proceeding was filed on March 27, 2003.  The underlyingbankruptcy cases were converted to Chapter 7 liquidation cases on August 28,2001.  The Trustee alleges that a payment received by the Company fromToys International.Com, Inc. in the amount of $93,834.56 was a preferentialtransfer that is recoverable under Bankruptcy Code Sections 547 and 550. The Company has responded to the demand letter that the payment was a paymenton an invoice for delivered goods made in the regular course of business.Subject to approval of the Bankruptcy Court, the Company and the Trustee haveagreed upon the terms of a settlement and are finalizing the agreements. Accordingly, the Company has provided a reserve of $60,000 in the results ofoperations for the quarter ending March 31, 2003 for the agreed upon settlementamount.

 

**8.****                                      RecentAccounting Pronouncements**

 

In April 2002, SFAS No. 145, “*Recision of FASB Statements No. 4, 44 and 64,Amendment of FASB No. 13, and Technical*Corrections,” was issued bythe Financial Accounting Standards Board (FASB).  This statement providesguidance on the classification of gains and losses from the extinguishment ofdebt and on the accounting for certain specified lease transactions. Theadoption of this statement is not presently expected to have a material impacton the Company’s consolidated financial position, results of operations or cashflows.

 

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In June 2002, SFAS No. 146, “*Accounting for Costs Associated with Exit or DisposalActivities*,” was issued. This statement provides guidance on therecognition and measurement of liabilities associated with disposal activitiesand is effective on January 1, 2003. The adoption of this statement has not hadany impact on the Company’s consolidated financial position, results ofoperations or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “*Accounting for Stock-Based Compensation —Transition and Disclosure, An Amendment of FAS No. 123*.” This statement addresses the acceptable transitional methods when the fairvalue method of accounting for stock-based compensation covered in SFASNo. 123 is elected.  Additionally, the statement prescribes tabulardisclosure of specific information in the “*Summaryof Significant Accounting*Policies” regardless of the method usedand also required interim disclosure of similar information.  The Companyhas adopted this statement effective with the fiscal year endingDecember 31, 2002.  The Company has not elected the fair value method,but continues accounting for stock-based compensation by the intrinsic methodprescribed by APB Opinion 25.

 

In November 2002, the FASB issued FASB InterpretationNo. 45 (FIN 45), “*Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others*,” which established additional accounting anddisclosure requirements when an enterprise guarantees the indebtedness ofothers.  The enterprise providing the guarantee is required to recognize aliability for the fair value of the obligation assumed and disclose theinformation in its interim and annual financial statements.  The Companydoes not believe this will have a significant impact on its disclosures.

 

In January 2003, the FASB issued FASB InterpretationNo. 46 (FIN 46), “*Consolidation of VariableInterest Entities, an*interpretation*of ARB No. 51.*”  The interpretation defines when and whoconsolidates a “variable interest entity,” or “VIE.”  This newconsolidation model applies to entities (i) where the equity investors (ifany) do not have a controlling financial interest, or (ii) whose equityinvestment at risk is insufficient to finance that entity’s activities withoutreceiving additional subordinated financial support from other parties and requiresadditional disclosures for all enterprises involved with the VIE.  FIN 46is effective during 2003 depending on when the VIE is created.  TheCompany does not believe this will have a significant impact on its reportedresults of operations and financial condition.

 

In April 2003, the FASB issued FASB No. 149, “*Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities,*” which amends and clarifies the accountingguidance on derivative instruments and hedging activities.  FAS 149 is effectivefor derivative contracts and hedging relationships after June 30, 2003. The adoption of this statement is not expected to have a material impact on theCompany’s consolidated financial position, results of operations or cash flows.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
|                       |   | DSI Toys, Inc.                                                      |
|----------------------------|--------|---------------------------------------------------------------------|
|                       |   |                                                                |
|                       |   |                                                                |
| Dated:  June 10, 2003 | By:    | /s/ JOSEPH S. WHITAKER                                              |
|                       |   | Joseph S. Whitaker  President, Chief Executive Officer and Director |
|                       |   |                                                                |
|                       |   |                                                                |
| Dated:  June 10, 2003 | By:    | /s/ ROBERT L.  WEISGARBER                                           |
|                       |   | Robert L. Weisgarber  Chief Financial Officer                       |

 

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**CERTIFICATIONS**

 

I, Joseph S. Whitaker,President and Chief Executive Officer, certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q, as amended by Amendment No. 1on Form 10-Q/A, of DSI Toys, Inc. (“registrant”);

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      Presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation  as of the Evaluation Date;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrants auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a)                                      Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b)                                     Anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:  | June 10, 2003 | /s/ Joseph S. Whitaker                                    |
|--------|---------------|-----------------------------------------------------------|
|   |          | Joseph S. Whitaker  President and Chief Executive Officer |

 

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I, Robert L. Weisgarber,Chief Financial Officer certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q, as amended by Amendment No. 1on Form 10-Q/A, of DSI Toys, Inc. (“registrant”);

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      Presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation  as of the Evaluation Date;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrants auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a)                                      Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b)                                     Anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:  | June 10, 2003 | /s/ Robert L.  Weisgarber                     |
|--------|---------------|-----------------------------------------------|
|   |          | Robert L. Weisgarber  Chief Financial Officer |

 

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**Indexto 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)                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                   |
| 10.1   | Memorandum of  Reborrowing of Principal by and between the Company and MVII, LLC, dated  March 10, 2003 (filed as Exhibit 10.72 to the Company’s Form 10-K for the  quarterly period ending December 31, 2002), incorporated herein by reference. |
|   |                                                                                                                                                                                                                                                   |
| 10.2   | Agreement and Plan of  Merger, dated March 27, 2003, by and between the Company and DSI Acquisition,  Inc. (filed as Appendix A to the Company’s preliminary Proxy Statement filed  on March 31, 2003), incorporated herein by reference.         |
|   |                                                                                                                                                                                                                                                   |
| 99.1*  | Certification of the  Chief Executive Officer pursuant to Section 1350 of Chapter 63, Title 18 of  the United States Code for the quarterly period ending March 31, 2003.                                                                              |
|   |                                                                                                                                                                                                                                                   |
| 99.2*  | Certification of the  Chief Financial Officer pursuant to Section 1350 of Chapter 63, Title 18 of  the United States Code for the quarterly period ending March 31, 2003.                                                                              |

 

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(1)                                  Filedas a part of the Registrant’s Registration Statement on Form S-1 (No.333-23961) and incorporated herein by reference.

 

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