**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

| **(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 mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes  ý   No o

 

Indicate by check mark whether the Registrant is an accelerated filer(as defined in Rule 12b-2 of the Securities 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.

 

 

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**TABLE OFCONTENTS**

 
| **PART I - FINANCIAL  INFORMATION** |
|-------------------------------------|
|                                |   |
| Item 1.                             | Financial  Statements |
|                                |   |
|                                | Consolidated Balance Sheet  as of March 31, 2003 and December 31, 2002 |
|                                |   |
|                                | Consolidated  Statement of Operations for the Three Months ended March 31, 2003 and 2002 |
|                                |   |
|                                | Consolidated  Statement of Cash Flows for the Three Months Ended March 31, 2003 and 2002 |
|                                |   |
|                                | 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 |
|                                |   |
| Item 4.                             | Controls  and Procedures |
|                                |   |
| **PART II - OTHER INFORMATION**     |
|                                |   |
| Item 1.                             | Legal  Proceedings |
|                                |   |
| Item 5.                             | Other  Information |
|                                |   |
| Item 6.                             | Exhibits and Reports  on Form 8-K |
|                                |   |
| Signatures                          |
|                                |   |
| Certifications                      |

 

i

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**PART I –FINANCIAL INFORMATION**

 

**Item 1****.****            ****Financial Statements**

 

**DSI Toys, Inc.**

**Consolidated Balance 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 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

1

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**DSI Toys, Inc.**

**Consolidated Statement of Operations**

**(Unaudited)**

 
|                                         |   | **Three Months Ended March 31,** |       |
|----------------------------------------------|--------|----------------------------------|------------|
|                                         |   | **2003**                         |       | **2002** |   |
|                                         |   |                             |       |   |   |
| Net sales                                    |   | $                                | 3,752,484  |   | $ | 5,188,860 |   |
| Costs of goods sold                          |   | 3,388,364                        |       | 4,085,708 |   |
| 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 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

2

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**DSI Toys, Inc.**

**Consolidated Statement 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 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

3

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**DSI Toys, Inc.**

**Consolidated Statement of Shareholders’ Equity(Deficit)**

(Unaudited)

 
|                       |   | **Common Stock** |   |    |    | **Additional  Paid-in  Capital** |   | **Common  Stock  Warrants** |   | **Accumulated  Other  Comprehensive  Loss** |      | **Accumulated  Earnings  (Deficit)** |   | **Totals** |   |
|----------------------------|--------|------------------|--------|---------|---------|----------------------------------|--------|-----------------------------|--------|---------------------------------------------|-----------|--------------------------------------|--------|------------|--------|
| **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 to consolidatedfinancial statements.

 

4

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**DSIToys, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

**1.             Basisof Presentation**

 

The accompanying unaudited consolidated financialstatements of DSI Toys, Inc. and its wholly-owned subsidiary (the “Company”) havebeen prepared in accordance with accounting principles generally accepted inthe 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 requiredby accounting principles generally accepted in the United States of America forcomplete financial statements and should be read in conjunction with thefinancial statements and notes thereto appearing in the Company’s Annual Reporton Form 10-K and Form 10-K/A for the fiscal year ended 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 consist only of normal recurring items.

 

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 cash flowsfrom operations are insufficient to meet future cash requirements, the Companywill need to successfully raise additional capital through an equity infusionor the issuance of debt.  Managementbelieves that the going-private transaction, if consummated, and subsequentactions, will provide the necessary equity infusion and/or debt which willallow the Company to continue 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 of Directors.  Mr. Martin has indicated that hiswillingness to provide the Company with any additional working capital isconditioned on the completion of the 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, the Company received notice fromThe Nasdaq Stock Market, Inc. that the Company’s common stock had closed belowthe minimum price of $1.00 per share requirement for continued listing on theNasdaq SmallCap Market under Marketplace Rule 4310(c)(4) (the “Rule”).  The Company was granted a 180 calendar daygrace period to comply with the Rule, but was still not in compliance with theRule on August 13, 2002, the final day of the grace period.  However, at such time the Company wasgranted an additional 180 calendar day grace period to comply with the Rulebecause it did meet the initial listing criteria for the Nasdaq SmallCap Marketunder Marketplace Rule 4310(c)(2)(A). The additional grace period expired onFebruary 10, 2003, without the Company being in compliance 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 elected not to appeal the delisting determination andits common stock commenced trading on the 

 

5

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over-the-counter Bulletin Board electronic quotation system effectivewith the opening of business on March 27, 2003, under the ticker symbol “DSIT.”

 

*Going-PrivateTransaction*

 

Since the Company’s cash reserves and cash flows fromoperations no longer meet its cash requirements, the Company explored variousalternatives to raise additional capital.

 

In January 2003, after other alternatives for theCompany had been exhausted, E. Thomas Martin, the Chairman of the Company’sBoard of Directors, and certain other officers, directors and shareholders ofthe Company (the “Buyer Group”) began serious consideration of a going-privatetransaction.  On January 27, 2003, theBoard of Directors invited the Buyer Group to submit an offer to the Companyfor a going-private transaction.

 

On January 28, 2003, the Buyer Group proposed to theCompany a going-private transaction by way of a merger that would result in thepurchase of shares of common stock held by the shareholders who are not membersof the Buyer Group for $0.44 per share.

 

The Board of Directors appointed a special committee toreview the proposed transaction.

 

Based on a series of negotiations between the specialcommittee and representatives of the Buyer Group, the purchase price wasincreased to $0.47 per share.

 

On March 26, 2003, the Board of Directors unanimouslyvoted to approve the merger agreement and recommended that the shareholdersapprove the merger agreement and the merger.

 

On March 27, 2003, the merger agreement was signed andthe Company issued a press release announcing the 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 thesedocuments were filed with the Securities and Exchange Commission on May 15,2003.

 

If the shareholders of the Company approve the merger,the Company’s shares will be delisted from the over-the-counter Bulletin Boardelectronic quotation system and its common stock will be deregistered under theSecurities Exchange Act of 1934. The Company will continue in business as aprivately-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, these judgments are subject to an inherentdegree 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.  Our significant accounting policies include:

 

*RevenueRecognition*

 

The Company recognizes revenue when products areshipped and title passes to unaffiliated customers.  In most cases, title transfers to our customers when the producthas been presented to shipment forwarders on FOB Asia sales and when theproduct is picked up from our distribution facilities on domestic sales.  Provision is made currently for estimatedreturns of defective and slow-moving merchandise, price protection and customerallowances, and is included as a reduction of accounts receivable andrevenues.  The provision is primarilybased on known returns and allowances provided to customers for salesactivities, as well as an historically based estimate of potential unknowncustomers' allowances and claims. Shipping and handling revenues are not included in net sales, rather they are included as acontra-expense  in cost of goods sold withthe shipping and handling costs associated with inbound and outbound freight.

 

*Allowancefor Doubtful Accounts*

 

Accounts receivable are reduced by an allowance foramounts that may become uncollectible in the future.  The Company’s estimate for its allowance is based on two methodswhich are combined to determine 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, the Company uses its judgement, based on the bestavailable facts and circumstances, and records a specific reserve for thatcustomer against amounts due to reduce the receivable to the amount that isexpected to be collected.  These specificreserves are reevaluated and adjusted as additional information is receivedthat impacts the amounts reserved. Second, a general reserve is

 

6

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established for all other customers based on historical collection andwrite-off experience.  If circumstanceschange, the Company’s estimates of the recoverability of amounts due theCompany could be reduced 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.  Theseallowances are included in net sales and as a reduction of accounts receivable.  Our sales to customers generally do not givethem the right to return products or to cancel firm orders.  However, as is common in the industry, wesometimes accept returns for stock balancing and negotiate accommodations tocustomers, which include price discounts, advertising credits and returns, whendemand for specific product falls below expectations.  Additionally, customers are given credit for any defectiveproducts they may have received.  Theallowance estimates are based on historical sales returns and defective rates,analysis of credit memo data and other known factors.  If the data the Company uses to calculate these estimates doesnot properly reflect future returns and defectives, revenue could be overstatedand future operating results adversely affected.

 

*Inventories*

 

Inventory is valued at the lower of cost or marketwith cost being determined on the average cost basis.  The Company reviews the book value of slow-moving items,discounted product lines and individual products to determine if these itemsare properly valued.  The Companyidentifies these items and assesses the ability to dispose of them at a pricegreater than cost.  If it is determinedthat cost is less 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*

 

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 expense or benefit is the result of changes in deferredtax assets and liabilities during the period. Generally accepted accounting principles require that we review deferredtax assets for recoverability and if needed, establish a valuation allowancefor those amounts deemed unrecoverable. In estimating future tax consequences, all expected future events areconsidered other than enactments of changes in the tax law or rates, includinghistorical taxable income, projected future taxable income, and the expectedtiming of the reversals of temporary differences.  Deferred tax assets of the Company are primarily the result ofunused net operating loss carry-forwards and foreign tax credits which expireover a range of years.

 

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 prioryears.  The valuation allowance wasdetermined in accordance with the provisions of Statement of FinancialAccounting Standards (SFAS) 109, “Accounting for Income Taxes,” which placesprimary importance on the Company’s cumulative operating results in the mostrecent periods when assessing the need for a valuation allowance. The primaryfactors considered in evaluating the realizability of the deferred tax assetsand establishing the valuation allowance were continued operating losses forthe Company through December 31, 2002, the Company’s projection of futureoperating results and the number of years it will take to recover the tax assetsin a difficult market.  This evaluationprovides sufficient negative evidence to establish an additional valuationallowance under the provisions of SFAS 109. The Company intends to maintain a full valuation allowance for itsdeferred tax assets and net operating loss carryforwards until sufficientpositive evidence exists to support reversal of the allowance.  The establishment of this valuationallowance in no way affects the Company’s ability to reduce future tax expensethrough utilization of net operating losses and foreign income taxcredits.  However, currently there canbe no assurances that the net operating losses will be utilized.

 

*Goodwill*

 

The Company made an acquisition in 2000 that includeda significant amount of goodwill and other intangible assets.  Effective in 2002, goodwill is no longeramortized but is subject to at least an annual impairment test based on itsestimated fair value.  Other intangibleassets meeting certain criteria will continue to be amortized

 

7

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over their useful lives and also subject to an impairment test.  There are many assumptions and estimatesunderlying the determination, including future cash flow and operating results.  Management engaged an independent company toassist in valuing the Company’s goodwill as of December 31, 2002.

 

**3.             Stock Based Compensation**

 

The Company accounts for its stock-based compensationplans under Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees.”  No stock-basedemployee compensation cost for the Company’s stock option plans is reflected inits consolidated statement of operations, as all options granted under itsplans have an exercise price equal to the market value of the underlying commonstock 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 | ) |

 

**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 for the three months ended March 31, 2003 and2002 is as follows:

** **
|                               |   | **United States** |      | **Hong Kong** |   | **Consolidated** |   |
|------------------------------------|--------|-------------------|-----------|---------------|--------|------------------|--------|
| Three months ended March 31, 2003: |   |              |      |          |   |             |   |
| Net sales                          |   | $                 | 2,785,433 |          | $      | 967,051          |   | $ | 3,752,484 |   |
| 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                          |   | $                 | 2,743,621 |          | $      | 2,445,239        |   | $ | 5,188,860 |   |
| 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       |   |

 

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**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 facilitybetween Sunrock Capital Corp. (“Sunrock”) and the Company (the “Revolver”).  Additionally, the Company has also violatedthe limitations on further indebtedness during the quarter by borrowing fromMVII in excess of amounts permitted by the Revolver as described below.  The Company’s $4.5 million debt under theRevolver as of March 31, 2003, is classified as a current liability.  As a result, the Company’s currentliabilities exceeded its current assets by $8.9 million as of March 31, 2003.If Sunrock were to accelerate the Revolver, which it has the option to do, the$4.5 million debt would 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 forSunrock were sold in February 2003, limiting the willingness of Sunrock toamend any remaining lending agreements. As a result, the Company has held negotiations with several lendersregarding a credit facility to replace the Revolver. One of those financialinstitutions has indicated a willingness to provide the Company with additionalworking capital effective at the close of the going-private transaction (seeNote 1. “Basis of Presentation-*Going-PrivateTransaction*”). The financial institution’s willingness to lend tothe Company is based on the Company improving its financial condition by meansof the going-private transaction, a subsequent capital infusion and a personalguaranty by Mr. Martin, the Company’s Chairman and a principalshareholder.  Mr. Martin has indicated thathis willingness to provide the Company with any additional working capital isconditioned on the completion of the going-private transaction.

 

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 total of $1.35 million of the originalprincipal that the Company had paid on the MVII Note.  Also, on March 31, April 4, April 15, and May 6, 2003, MVIIadvanced the Company additional funds totaling $2.0 million.  The proceeds were used to finance the normalbusiness operations of the Company.

 

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 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 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 of operations.  The Company maintains product liability andgeneral liability insurance in amounts it believes to be reasonable.

 

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 actiondocket number MRSL-3799-02.  In thelawsuit, Rymax claims that the Company failed to pay commissions due to Rymaxand demands judgment for damages in the amount of $45,061.67 plus interest,attorney fees and costs of court.  TheCompany does not believe it owes these damages.  The Company has brought a third party complaint againstBrainstorm Logistics, Inc., a company which the Company believes is a relatedcorporation to Rymax Corp., for damages exceeding $75,000.00 for goods shippedand sold to Brainstorm Logistics, Inc. At this time, the Company is attempting to negotiate a settlement of theentire controversy.

 

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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 indebted to TCN for $725,051.70 for televisionadvertisements aired by TCN, together with interest at the rate of 18% perannum until paid and attorney’s fees. The Company is in negotiations with TCN and believes it has recorded anadequate 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 underlying bankruptcy cases were converted to Chapter 7liquidation cases on August 28, 2001. The Trustee alleges that a payment received by the Company from ToysInternational.Com, Inc. in the amount of $93,834.56 was a preferential transferthat is recoverable under Bankruptcy Code Sections 547 and 550.  The Company has responded to the demandletter that the payment was a payment on an invoice for delivered goods made inthe regular course of business. Subject to approval of the Bankruptcy Court,the Company and the Trustee have agreed upon the terms of a settlement and arefinalizing the agreements.  Accordingly,the Company has provided a reserve of $60,000 in the results of operations forthe quarter ending March 31, 2003 for the agreed upon settlement amount.

 

**8.             RecentAccounting Pronouncements**

 

In April 2002, SFAS No. 145, “*Recision of FASB Statements No. 4, 44and 64, Amendment of FASB No. 13, and Technical Corrections*,” wasissued by the Financial Accounting Standards Board (FASB).  This statement provides guidance on theclassification of gains and losses from the extinguishment of debt and on theaccounting for certain specified lease transactions. The adoption of thisstatement is not presently expected to have a material impact on the Company’sconsolidated financial position, results of operations or cash flows.

 

In June 2002, SFAS No. 146, “*Accounting for Costs Associated withExit or Disposal Activities*,” was issued. This statement providesguidance on the recognition and measurement of liabilities associated withdisposal activities and is effective on January 1, 2003. The adoption of thisstatement has not had any impact on the Company’s consolidated financialposition, results of operations or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “*Accountingfor Stock-Based Compensation — Transition and Disclosure, An Amendment ofFAS No. 123*.”  Thisstatement addresses the acceptable transitional methods when the fair valuemethod of accounting for stock-based compensation covered in SFAS No. 123is elected.  Additionally, the statementprescribes tabular disclosure of specific information in the “*Summary ofSignificant Accounting Policies*” regardless of the method used andalso required interim disclosure of similar information.  The Company has adopted this statementeffective with the fiscal year ending December 31, 2002.  The Company has not elected the fair valuemethod, but continues accounting for stock-based compensation by the intrinsicmethod prescribed by APB Opinion 25.

 

In November 2002, the FASB issued FASB InterpretationNo. 45 (FIN 45), “*Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others*,” whichestablished additional accounting and disclosure requirements when an enterpriseguarantees the indebtedness of others. 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 Company does not believe this will havea significant impact on its disclosures.

 

In January 2003, the FASB issued FASB InterpretationNo. 46 (FIN 46), “*Consolidation of Variable Interest Entities, an interpretation of ARBNo. 51.*”  Theinterpretation defines when and who consolidates a “variable interest entity,”or “VIE.”  This new consolidation modelapplies to entities (i) where the equity investors (if any) do not have acontrolling financial interest, or (ii) whose equity investment at risk isinsufficient to finance that entity’s activities without receiving additionalsubordinated financial support from other parties and requires additionaldisclosures for all enterprises involved with the VIE.  FIN 46 is effective during 2003 depending onwhen the VIE is created.  The Companydoes not believe this will have a significant impact on its reported results ofoperations and financial condition.

 

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In April 2003, the FASB issued FASB No. 149, “*Amendment ofStatement 133 on Derivative Instruments and Hedging Activities,*”which amends and clarifies the accounting guidance on derivative instrumentsand hedging activities.  FAS 149 iseffective for derivative contracts and hedging relationships after June 30, 2003.  The adoption of this statement is notexpected to have a material impact on the Company’s consolidated financialposition, results of operations or cash flows.

 

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**Item2.****    Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**Exceptas otherwise indicated, references to the “Company” refer to DSI Toys, Inc. andits  wholly-owned Hong Kong subsidiary,DSI (HK) Limited (“DSI(HK)”).  The terms“fiscal year” and “fiscal” refer to the Company’s fiscal year, which is theyear ending December 31 of the calendar year mentioned (*e.g*.,a reference to fiscal 2002 is a reference to the fiscal year ended December 31,2002).**

 

**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*® communicationproducts, KAWASAKI® electronic musical instruments, radio control vehicles, *DJSkribble®’s Spinheads*TM musical figures and toys, a full range ofspecial feature doll brands including*Sweet Faith®, Pride & Joy®, Too Cute Twins®,*andlife-like dolls, *Baby Knows Her NameTM*talking doll, *Childhood Verses*TM nurseryrhyme dolls*,Little Darlings®*dolls, and collectible plush.

 

The Company has four major product categories: YouthElectronics (formerly Youth Communications), Musical Instruments, Girls’ Toysand Boys’ Toys.

 

*Youth Electronics*

 

The Youth Electronics product line includeswalkie-talkies, wristwatch walkie-talkies, audio products and noveltyelectronic products.  The categorybrands include *Tech-Link*® and *Micro Link*® communications products,  bike alarms, *BioScan*TM *RoomGuardianTM,*and the Company’s new *DJ Skribble®’s SpinheadsTM* line of musicalfigures and toys.

 

*Musical Instruments*

 

The Musical Instrument line includes the branded lineof KAWASAKI® guitars, drum pads, saxophones and keyboards.  The Company successfully completednegotiations and amended its license agreement with Kawasaki Motors Corp.,U.S.A., allowing the Company to continue to utilize the KAWASAKI® trademark, aswell as other marks, on toy musical instruments, and other products, throughDecember 31, 2007.

 

*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*BabyKnows Her NameTM, Lovin’ TouchTM, Childhood VersesTM, Pride & Joy®,*and*LittleDarlings®,*along with interactive plush products and girls’ activityproducts such as *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*TM radio control vehicles,including the *Insector*®, the unique ultra-articulated *Street SavageTM*and *Crazy Taxi*TM,based on the popular Sega of America, Inc. arcade and home video game of thesame name.

 

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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:

 
|                                          |   | **Three  Months Ended  March 31** |   |
|-----------------------------------------------|--------|-----------------------------------|--------|
|                                          |   | **2003**                          |   | **2002** |   |
| Net sales                                     |   | 100.0                             | %      | 100.0 | % |
| Costs of goods  sold                          |   | 90.3                              |   | 78.7 |   |
| Gross profit                                  |   | 9.7                               |   | 21.3 |   |
| Selling, general  and administrative expenses |   | 81.1                              |   | 58.6 |   |
| Operating loss                                |   | (71.4                             | )      | (37.3 | ) |
| Interest expense                              |   | (5.6                              | )      | (3.8 | ) |
| Other income                                  |   | .3                                |   | 2.8 |   |
| Loss before  income taxes                     |   | (76.7                             | )      | (38.3 | ) |
| Benefit from  income taxes                    |   |                              |   | 13.0 |   |
| Net loss                                      |   | (76.7                             | )%     | (25.3 | )% |

 

***Three Months EndedMarch 31, 2003, Compared to the Three Months Ended March 31, 2002***

 

*Netsales*

 

Net sales for the three months ended March 31, 2003,decreased $1.4 million, or 28%, to $3.8 million, from $5.2 million in the firstquarter of 2002.  The decrease was dueto the continued slow economic conditions, resulting in both consumers andcustomers buying reluctance. Additionally, the Company discontinued, and did not replace, sales ofsome Spring plush items in 2003.

 

Net sales of youth electronics products during thefirst quarter ended March 31, 2003, decreased $400,000, or 40%, to $700,000from $1.1 million in the first quarter of 2002.  The reduced sales reflects lower sales of the Micro-Linkwalkie-talkie watches and shades, which were introduced during fiscal 2001, andlower sales dollars generated on close-out sales of old walkie-talkie products.

 

Net sales of musical instrument products was $700,000during the first quarter of 2003, an increase of $300,000, or 86%, from the$400,000 sold during the quarter ending March 31, 2002.  Increased sales are due to the Company’sintroduction of the “mini-boom” line of its musical instruments, as well asclose-out sales of old keyboard and drumpad versions.

 

Net sales of girls’ toys decreased $1.4 million, or47%, to $1.7 million during the first quarter ended March 31, 2003, from $3.1million in the first quarter in 2002. The decreased sales of the first quarter are a result of reduced itemsin the Spring plush line from 2002, as well as lower sales of dolls, like *Hush Lil’BabyTM* and *Baby Pick-Me-Up*® in the internationalmarket.  Additionally, the *LittleDarlings*® doll line had reduced sales because of the loss of onecustomer’s business.

 

Net sales of boys’ toys decreased $100,000, or 31%, to$200,000 in the first quarter ended March 31, 2003, from $300,000 in the firstquarter of 2002.  The decreased salesprimarily resulted from reduced sales of the *Insector*® and *StreetSavage*TM R/C cars. Additionally, 2002 included close-out sales of *Data Dawg®*.

 

Net sales of products in other categories increased$300,000, or 123%, to $500,000 during the first quarter ended March 31, 2003,from $200,000 in the first quarter of 2002. The increase reflects continued sales of *LazerDoodle*TM, introduced inthe third quarter of fiscal 2002, offset by lower sales of doorbellproducts.  The *LazerDoodle*TM products weresold at close-out prices due to lack of consumer acceptance of the product linein 2002.

 

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Sales by the Company’s foreign subsidiary to customersin countries other than the United States for the three months ended March 31,2003, decreased $700,000, or 64%, to $400,000, from $1.1 million in the firstquarter of 2002.  The decrease wasreduced sales of items to Canada, Italy, and the United Kingdom, reflecting thegeneral world-wide concern over the Iraqi war and the slow general economicconditions.

 

*Grossprofit*

 

Gross profit decreased $700,000, or 67%, to $400,000for the first quarter ended March 31, 2003, from $1.1 million in the firstquarter of 2002.  Gross profit as apercentage of net sales decreased to 9.7% in the first quarter ended March 31,2002, from 21.3% in the first quarter of fiscal 2002.  The reduction in the gross margin percentage reflects the largevolume of close-out sales included in sales for quarter ending March 31,2003.  Close-out sales generated zero orlittle margin after applying any related inventory obsolescence allowance,resulting in an overall negative impact on the margin percentage.

 

*Selling,general and administrative expenses*

 

Selling, general and administrative expenses of $3.1million in the first quarter ended March 31, 2003, did not change significantlycompared with $3.1 million for the first quarter of 2002.  However, within selling, general andadministrative expenses, changes occurred in multiple areas, with reductions inemployee expense, commissions, and travel and entertainment, offset by increasesin attorney’s fees related to current lawsuits and the going-privatetransaction, and amounts negotiated to settle a lawsuit.

 

*Incometaxes*

 

The Company did not record a tax benefit for the firstquarter of 2003.  In accordance withSFAS 109, the Company established a valuation allowance during 2002 for its netdeferred tax assets based on an evaluation of its cumulative operating resultsin recent periods, estimated future taxable income and the volatility andseasonality of earnings of the industry in which it operates.  This evaluation provided sufficient negativeevidence to establish the valuation allowance.

 

The Company continues to reserve all of its deferredtax assets and net operating loss carryforwards until sufficient positiveevidence exists to support reversal of the allowance.  This valuation allowance in no way affects the Company’s abilityto reduce future tax expense through utilization of net operating losses andforeign income tax credits.  However,there can be no assurance that the net operating losses and foreign income taxcredits will be utilized.

 

**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 $1.5 million during the first quarter of fiscal 2003, consisting primarilyof decreases in accounts receivable and inventory and increases in accountspayable, offset by increases in prepaid expenses.  Net cash used in investing activities during the first quarter offiscal 2003 of approximately $200,000 was mostly due to capitalexpenditures.  Net cash used byfinancing activities was $2.7 million in the first quarter of fiscal 2003,resulting from payments on long-term debt net of related party borrowings.  The Company’s working capital at March 31,2003, was $(8.9) million and unrestricted cash was approximately $400,000.  (See *“TheRevolver”*, *“Additional Financing”*and *"Going Concern"*).

 

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 utilizes credit facilities collateralized principallyby accounts receivable and inventory. The Company maintains the Revolver, and through DSI(HK), a line ofcredit with Standard Chartered Bank (the “Standard Chartered Facility”).  The Company has guaranteed DSI(HK)’sobligations under the Standard Chartered Facility.

 

14

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Additionally, the Company borrows, as needed againstcustomers’ letters of credit with several Hong Kong banks.  The bank is selected based on the mostadvantageous terms to the Company and as directed by customers.

 

*TheRevolver*

 

The Revolver, which expires March 31, 2004, containscertain restrictive covenants and conditions, among which are a prohibition onpayment of dividends, limitations on further indebtedness, restrictions ondispositions and acquisitions of assets, certain defined maximum allowedborrowing amounts, limitations on advances to third parties, compliance withminimum net worth and net income amounts, and designation as “SeniorIndebtedness” with respect to the MVII, LLC (“MVII”) debt described below.

 

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. Additionally, the Company has also violated the limitations on furtherindebtedness during the quarter by borrowing from MVII, the Company’s largestshareholder, in excess of amounts permitted by the Revolver as describedbelow.  The Company’s $4.5 million debtunder the Revolver as of March 31, 2003, is classified as a currentliability.  As a result, the Company’scurrent liabilities exceeded its current assets by $8.9 million as of March 31,2003. If Sunrock were to accelerate the Revolver, which it has the option todo, the $4.5 million debt would 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 forSunrock were sold in February 2003, limiting the willingness of Sunrock toamend any remaining lending agreements. As a result, the Company has held negotiations with several lendersregarding a credit facility to replace the Revolver. One of those financialinstitutions has indicated a willingness to provide the Company with additionalworking capital effective at the close of the going-private transaction (see *“Going Concern”* and *“Going-Private Transaction”*). The financialinstitution’s willingness to lend to the Company is based on the Companyimproving its financial condition by means of the going-private transaction, asubsequent capital infusion and a personal guaranty by E. Thomas Martin, theCompany’s chairman and a principal shareholder.  Mr. Martin has indicated that his willingness to provide theCompany with any additional working capital is conditioned on the completion ofthe going-private transaction.

 

*StandardChartered Facility*

 

The Standard Chartered Facility was obtained on April29, 2002, is subject to periodic review, and may be canceled by the bank uponnotice.  The Standard Chartered Facilityaffords DSI(HK) a credit limit in the aggregate of up to HKD 19,000,000(approximately US $2.4 million as of March 31, 2003) in the form of a line ofcredit financing facility based on actual shipments of product and openedletters of credit and bears interest at the 3-month LIBOR rate plus 2%. TheStandard Chartered Facility expires June 20, 2003, but may be canceled by thebank upon notice.  The Company believesit will be able to either renew this facility or replace it with a similarcredit facility from another bank or lending institution. The Company hasguaranteed DSI(HK)’s obligations under the Standard Chartered Facility.

 

*AdditionalFinancing*

 

Previously, the Company had available an additionalcredit facility with Dao Heng Bank.  Thebank exercised its option to cancel this facility on April 15, 2003.  The Company does not believe this will haveany impact on its operating ability for the immediate future.

 

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 total of $1.35 million of the originalprincipal that the Company had paid on the MVII Note.  Also, on March 31, April 4, April 15, and May 6, 2003, MVIIadvanced the Company additional funds totaling $2.0 million.  The proceeds were used to finance the normalbusiness operations of the Company.

 

On August 19, 2002, the Company executed a Guaranteein favor of Standard Chartered Bank, guaranteeing the Standard CharteredFacility on behalf of DSI(HK) up to an amount not to exceed HKD 19,000,000(approximately US $2.4 million at March 31, 2003).  The Revolver was amended on August 14, 2002, to permit thisGuarantee.

 

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The Company is obligated to make future minimumroyalty payments under certain of its license agreements.  As of March 31, 2003, the Company wasrequired to make an aggregate of approximately $250,000 in payments ofguaranteed royalties under certain licenses in fiscal 2003 and $795,000thereafter through fiscal 2007. Included in these amounts, are minimum royalties due Kawasaki under aSeptember 11, 2002 amendment to the original license agreement, extending thelicense through 2007.

 

The Company has budgeted approximately $1.4 million incapital expenditures in fiscal 2003 consisting primarily of purchases of toolsand molds.

 

The Company purchases goods, services and suppliesfrom a number of vendors.  The Companycurrently is in arrears in making its payment obligations to certain of thesevendors.

 

The Company’s ability to meet its maturing debt andother cash requirements is dependent on the continuation of sufficient lendingarrangements, additional cash infusions, and/or cash from operations.  In connection with any future cash needs oracquisition opportunities, the Company may incur additional debt or issueadditional equity or debt securities depending on market conditions, as well asother factors.  However, there can be noassurance the Company will meet its projected operating results.

 

*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 *“The Revolver”*), and additional capitalinfusion, as well as sustained profitable operations. The accompanyingfinancial statements do not include any adjustments that might be necessary ifthe Company is unable to continue as a going 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 the going–private transaction, if consummated,and subsequent actions, will provide the necessary equity infusion and/or debtwhich will allow the Company to continue its normal operations for theforeseeable 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 indicatedthat his willingness to provide the Company with any additional working capitalis conditioned on the completion of the going-private transaction.  Management believes that the going-privatetransaction will close and that the Company will be able to continue operationsuntil that time.

 

*Going-Private Transaction*

 

Since the Company’s cash reserves and cash flows fromoperations no longer meet its cash requirements, the Company has exploredvarious alternatives to raise additional capital.  On March 27, 2003, the Company signed the definitive mergeragreement with DSI Acquisition, Inc., an entity controlled by Mr. Martin.  If the merger agreement is approved by theshareholders of the Company, DSI Acquisition, Inc. will merge with and into theCompany, with the Company surviving the going-private transaction. Holders ofthe Company’s common stock, except for members of the Buyer Group (as definedin the merger agreement), will receive $0.47 per share for each share of commonstock that they own immediately before the going-private transaction.  At the closing of the going-privatetransaction, the Company’s shares will be delisted from the over-the-counterBulletin Board electronic quotation system and its common stock will bederegistered under the Securities Exchange Act of 1934, as amended. The Companywill continue in business as a privately-held Texas corporation.

 

The Company believes that the going-privatetransaction will relieve the Company of certain expenses incident with being apublic company, eliminate various obligations applicable to a public company,and increase management’s flexibility to consider and initiate actions that maynot be appropriate for a public company. Furthermore, a financial institutionhas indicated a willingness to provide the Company with additional

 

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working capital effective at the close of the going-privatetransaction, contingent upon the consummation of the going-private transaction,a subsequent capital infusion by Mr. Martin, and a personal guaranty by Mr.Martin.  Mr. Martin has indicated thathis willingness to provide the Company with any additional working capital isconditioned on the completion of the going-private transaction.  (See "*GoingConcern*").

 

On March 31, 2003, the Company filed a Schedule 13E-3and preliminary proxy statement with the Securities and Exchange Commission inconnection with the going-private transaction. Amendments to these documents were filed with the Securities andExchange Commission on May 15, 2003.

 

 

**Recent Accounting Pronouncements**

## ** **

In April 2002, SFAS No. 145, “*Recision of FASB Statements No. 4, 44and 64, Amendment of FASB No. 13, and Technical Corrections*,” wasissued by the Financial Accounting Standards Board (FASB).  This statement provides guidance on theclassification of gains and losses from the extinguishment of debt and on theaccounting for certain specified lease transactions. The adoption of thisstatement is not expected to have a material impact on the Company’sconsolidated financial position, results of operations or cash flows.

 

In June 2002, SFAS No. 146, “*Accounting for Costs Associated withExit or Disposal Activities*,” was issued. This statement providesguidance on the recognition and measurement of liabilities associated withdisposal activities and is effective on January 1, 2003. The adoption of thisstatement did not have any material impact on the Company’s consolidated financialposition, results of operations or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “*Accountingfor Stock-Based Compensation — Transition and Disclosure, An Amendment ofFAS No. 123*.”  Thisstatement addresses the acceptable transitional methods when the fair valuemethod of accounting for stock-based compensation covered in SFAS No. 123is elected.  Additionally, the statementprescribes tabular disclosure of specific information in the “*Summary ofSignificant Accounting Policies*” regardless of the method used andalso required interim disclosure of similar information.  The Company has adopted this statementeffective with the fiscal year ending December 31, 2002.  The Company has not elected the fair valuemethod, but continues accounting for stock-based compensation by the intrinsicmethod prescribed by APB Opinion 25.

 

In November 2002, the FASB issued FASB InterpretationNo. 45 (FIN 45), “*Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others*,” whichestablished additional accounting and disclosure requirements when anenterprise guarantees the indebtedness of others.  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 Company does not believe this will havea significant impact on its disclosures.

 

In January 2003, the FASB issued FASB InterpretatonNo. 46 (FIN 46), “*Consolidation of Variable Interest Entities, an interpretation of ARBNo. 51.*”  Theinterpretation defines when and who consolidates a “variable interest entity,”or “VIE.”  This new consolidation modelapplies to entities (i) where the equity investors (if any) do not have acontrolling financial interest, or (ii) whose equity investment at risk isinsufficient to finance that entity’s activities without receiving additionalsubordinated financial support from other parties and requires additional disclosuresfor all enterprises involved with the VIE. FIN 46 is effective during 2003 depending on when the VIE iscreated.  The Company does not believethis will have a significant impact on its reported results of operations andfinancial condition.

 

In April 2003, the FASB issued FASB No. 149, “*Amendment ofStatement 133 on Derivative Instruments and Hedging Activities,*”which amends and clarifies the accounting guidance on derivative instrumentsand hedging activities.  FAS 149 iseffective for derivative contracts and hedging relationships after June 30,2003.  The adoption of this statement isnot expected to have a material impact on the Company’s consolidated financialposition, results of operations or cash flows.

 

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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 isincreasing as the large toy retailers are becoming more efficient in theirinventory control 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 has previously financed its seasonal working capitalrequirements by using internally generated cash and borrowings under theStandard Chartered Facility and the Revolver.

 

**Cautionary Statement**

 

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 byforward-looking statements, please read carefully the information underItem 1, “Risk Factors”, in the Company’s 2002 Annual Report on Form 10-K,and any amendments thereto.  In additionto the Risk Factors and other important factors detailed herein and from timeto time in other reports filed by the Company with the Securities and ExchangeCommission, including Forms 8-K, 10-Q, and 10-K, and any amendments thereto,the following important factors could cause actual results to differ materiallyfrom those suggested by any forward-looking statements.

 

*MarketplaceRisks*

 

•                                          Increasedcompetitive pressure, both domestically and internationally, which maynegatively affect the sales of the Company’s products.

 

•                                          Changesin public and consumer taste, which may negatively affect the sales of theCompany’s products.

 

•                                          Significantchanges in the play patterns of children, whereby they are increasinglyattracted to more developmentally advanced products at younger ages, which mayaffect brand loyalty and the perceived value of and demand for the Company’sproducts.

 

•                                          Possibleweaknesses in economic conditions, both domestically and internationally, whichmay negatively affect the sales of the Company’s products and the costsassociated with manufacturing and distributing these products.

 

*FinancingConsiderations*

 

•                                          Currencyfluctuations, which may affect the Company’s reportable income.

 

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•                                          Significantchanges in interest rates, both domestically and internationally, which maynegatively affect the Company’s cost of financing both its operations andinvestments.

 

•                                          Theability of the Company to obtain the financing required for its ongoingoperations which may negatively affect the Company’s viability as a goingconcern.

 

*Other Risks*

 

•                                          Changesin laws or regulations, both domestically and internationally, including thoseaffecting consumer products or trade restrictions, which may lead to increasedcosts or interruption in normal business operations of the Company.

 

•                                          Futurelitigation or governmental proceedings, which may lead to increased costs orinterruption in normal business operations of the Company.

 

•                                          Labordisputes, which may lead to increased costs or disruption of any of theCompany’s operations.

 

The risks included herein are not exhaustive.  Other sections of this Form 10-Qmay include additional factors which could materially and adversely impact theCompany’s business, financial condition, and results of operations.  Moreover, the Company operates in a verycompetitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible formanagement to predict all such risk factors on the Company’s business,financial condition or results of operations or the extent to which any factor,or combination of factors, may cause actual results to differ materially fromthose contained in any forward-looking statements.  Given these risks and uncertainties, investors should not placeundue reliance on forward-looking statements as a prediction of actual results.

 

## **Item 3.**  Quantitative and QualitativeDisclosure About Market Risk

 

The Company’s primary financialmarket risks exposure consists of interest rate risk related to interest thatwe are obligated to pay on our variable-rate debt. Interest rate risk is therisk that the Company’s earnings are subject to fluctuations in interest rateson debt and is fully dependent upon the volatility of these rates.

 

The Company does not usederivative instruments to moderate its exposure to interest rate risk.  As a result, we will benefit from decreasinginterest rates, but also be harmed by rising interest rates, on the fluctuatingportion of our debt.  Accordingly, if wemaintain our current level of debt, a 100 basis point decrease in interestrates would result in an increase in pre-tax income of approximately $24,000for a given quarter.  However, a 100basis point increase in interest rates would result in a decrease in pre-taxincome of approximately $24,000 for the same period.

 

**Item 4.****    Controls andProcedures**

 

With the participation ofmanagement, the Company’s President and Chief Executive Officer and its ChiefFinancial Officer evaluated the Company’s disclosure controls and procedures within90 days of the filing of this report. Based upon this evaluation, the President and Chief Executive Officerand the Chief Financial Officer believe that:

 

•                                          theCompany’s disclosure controls and procedures are designed to ensure thatinformation the Company is required to disclose in the reports it files orsubmits under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms; and

 

•                                          theCompany’s disclosure controls and procedures were effective to ensure thatmaterial information was accumulated and communicated to management, includingthe Company’s principal executive officer and principal financial officer, asappropriate, to allow timely decisions regarding required disclosure.

 

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There were no significantchanges in internal controls or in other factors that could significantlyaffect these controls subsequent to the date of their evaluation.  We have not identified any significantdeficiencies or material weaknesses, and, therefore, no corrective actions havebeen taken.

 

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**PART II - OTHER INFORMATION**

#### ** **

## **Item 1.**  Legal Proceedings

 

The Company is involvedin various legal proceedings and claims incident to the normal conduct of itsbusiness.  The Company believes thatsuch legal proceedings and claims, individually and in the aggregate, are notlikely to have a material adverse effect on its financial position or resultsof operations.  The Company maintainsproduct liability 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 actiondocket number MRSL-3799-02.  In thelawsuit, Rymax claims that the Company failed to pay commissions due to Rymaxand demands judgment for damages in the amount of $45,061.67 plus interest,attorney fees and costs of court.  TheCompany does not believe it owes these damages.  The Company has brought a third party complaint againstBrainstorm Logistics, Inc., a company which the Company believes is a relatedcorporation to Rymax Corp., for damages exceeding $75,000.00 for goods shippedand sold to Brainstorm Logistics, Inc. At this time, the Company is attempting to negotiate a settlement of theentire 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 indebted to TCN for $725,051.70 for televisionadvertisements aired by TCN, together with interest at the rate of 18% perannum until paid and attorney’s fees. The Company is in negotiations with TCN and believes it has recorded anadequate 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 underlying bankruptcy cases were converted to Chapter 7liquidation cases on August 28, 2001. The Trustee alleges that a payment received by the Company from ToysInternational.Com, Inc. in the amount of $93,834.56 was a preferential transferthat is recoverable under Bankruptcy Code Sections 547 and 550.  The Company has responded to the demandletter that the payment was a payment on an invoice for delivered goods made inthe regular course of business. Subject to approval of the Bankruptcy Court,the Company and the Trustee have agreed upon the terms of a settlement and arefinalizing the agreements.  Accordingly,the Company has provided a reserve of $60,000 in the results of operations forthe quarter ending March 31, 2003 for the agreed upon settlement amount.

 

## **Item 5.**  Other Information

 

On February 14,2002, the Company received notice from The Nasdaq Stock Market, Inc. that theCompany’s common stock had closed below the minimum price of US$1.00 per sharerequirement for continued listing on the Nasdaq SmallCap Market underMarketplace Rule 4310(c)(4) (the “Rule”). The Company was granted a 180 calendar day grace period to comply withthe Rule, but was still not in compliance with the Rule on August 13, 2002, thefinal day of the grace period.  However,at such time the Company was granted an additional 180 calendar day graceperiod to comply with the Rule because it did meet the initial listing criteriafor the Nasdaq 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 received notification that its securities would be delistedfrom the Nasdaq SmallCap Market at the opening of business on March 27,2003.  The Company elected not to appealthe delisting determination and its common stock commenced trading on theover-the-counter Bulletin Board electronic quotation system effective with theopening of business on March 27, 2003, under the ticker symbol “DSIT.”

 

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

 

a)              Exhibits

 

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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)             Reportson Form 8-K

 

c)              1.     The Company filed a Form 8-K dated January28, 2003, (filed on January 30, 2003) for the purpose of reporting the receiptof the initial proposal in connection with the going-private transactiondescribed more fully in Item 2 of Part I of this report.

 

2.               TheCompany filed a Form 8-K dated March 18, 2003, (filed March 21, 2003) for thepurpose of reporting the receipt of a delisting determination from the NasdaqSmallCap Market described more fully in Item 5 of  Part II of this report.

 

3.               TheCompany filed a Form 8-K dated March 27, 2003, (filed on March 28, 2003) forthe purpose of reporting the signing of the definitive merger agreement for thegoing-private transaction described more fully in Item 2 of Part I of thisreport.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                      |   | DSI Toys, Inc.                                |
|---------------------------|--------|-----------------------------------------------|
|                      |   |                                          |
| Dated: May 15, 2003       |   | By:                                           | /s/ Joseph S. Whitaker |   |
|                      |   | Joseph  S. Whitaker                           |
|                      |   | President  and  Chief Executive Officer  |
|                      |   |                                          |
|                      |   |                                          |
|                      |   |                                          |
| Dated:  May 15, 2003 |   | By:                                           | /s/ Robert L.  Weisgarber |   |
|                      |   | Robert  L. Weisgarber                         |
|                      |   | Chief  Financial Officer                      |
|                      |   | (Principal  Financial and Accounting Officer) |
|                           |        |                                               |  |  |  |

 

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**CERTIFICATIONS**

 

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

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q 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 equivalentfunction):

 

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

 

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:  | May 15, 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 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 equivalentfunction):

 

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

 

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:  | May 15, 2003 | /s/  Robert L. Weisgarber |   |
|--------|--------------|-------------------------------------|--------|
|   |         | Robert L. Weisgarber                |
|   |         | Chief Financial Officer             |

 

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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)                                                                                                                                                                                       |
| 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  annual 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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