FORM 10-Q


                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


(MARK ONE)

[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 1997

      OR

[ ]   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                    (I.R.S. Employer
        of incorporation or organization)                Identification No.)

       1100 WEST SAM HOUSTON PARKWAY NORTH
                 HOUSTON, TEXAS                                 77043
    (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 reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]  No [ ]

As of December 11, 1997, 6,000,000 shares of common stock, par value $.01 per
share, of DSI Toys, Inc. were outstanding.
<PAGE>
                                TABLE OF CONTENTS


                                                                            PAGE

                         PART I - FINANCIAL INFORMATION


Item 1. FINANCIAL STATEMENTS

        Consolidated Balance Sheet as of October 31, 1997 and 
         January 31, 1997....................................................  1

        Consolidated Statement of Operations for the Three Months Ended 
         October 31, 1997 and 1996 and the Nine Months Ended October 31,
         1997 and 1996.......................................................  2

        Consolidated Statement of Cash Flows for the Nine Months Ended
         October 31, 1997 and 1996...........................................  3

        Notes to Consolidated Financial Statements...........................  4

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
        RESULTS OF OPERATIONS................................................  6

                           PART II - OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS.................................................... 10

Item 6. EXHIBITS AND REPORTS ON FORM 8-K..................................... 10

Signatures................................................................... 11

                                      -i-
<PAGE>
                         PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                                 DSI TOYS, INC.
                           CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
                                                                        October 31,     January 31,
                                                                            1997            1997
                                                                        ------------    ------------
                                                                         (Unaudited)
<S>                                                                     <C>             <C>         
                                     ASSETS
Current assets:
        Cash ........................................................   $    988,879    $  1,501,992
        Restricted cash .............................................        150,000         150,000
        Accounts receivable, net of allowance for doubtful
               accounts of $173,313 and $104,781 ....................     12,351,700       4,219,942
        Due from shareholder ........................................           --           151,667
        Shareholder insurance proceeds receivable ...................           --           511,765
        Inventories .................................................     13,284,015       4,615,087
        Prepaid expenses ............................................        894,286       1,462,189
        Deferred income taxes .......................................        370,000         362,000
                                                                        ------------    ------------
               Total current assets .................................     28,038,880      12,974,642

Property and equipment, net .........................................      1,267,453       1,190,498
Shareholder insurance proceeds receivable ...........................      1,212,048         920,987
Deferred income taxes ...............................................        404,027            --
Deferred debt issuance costs ........................................           --           679,906
Other assets ........................................................        169,655         537,868
                                                                        ------------    ------------
               Total assets .........................................   $ 31,092,063    $ 16,303,901
                                                                        ============    ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
        Accounts payable and accrued liabilities ....................   $ 18,541,753    $  7,247,254
        Current portion of long-term debt ...........................      2,893,230       2,755,789
        Income taxes payable ........................................           --           193,211
        Deferred income taxes .......................................        100,225         158,000
                                                                        ------------    ------------
               Total current liabilities ............................     21,535,208      10,354,254
Long-term debt ......................................................      4,500,000       8,203,108
Notes payable -- shareholder ........................................           --         6,000,000
Deferred income taxes ...............................................           --         1,169,000
                                                                        ------------    ------------
               Total liabilities ....................................     26,035,208      25,726,362

Shareholders' equity (deficit):
        Preferred stock, $.01 par value, 5,000,000 shares
               authorized,none issued or outstanding ................           --              --
        Common stock, $.01 par value, 20,000,000 shares authorized,
                8,719,000 shares issued, 6,000,000 shares outstanding         87,190          62,190
        Additional paid-in capital ..................................     21,171,277       3,443,093
        Common stock warrants .......................................        102,500         100,000
        Retained earnings ...........................................      6,311,089       9,623,350
        Cumulative translation adjustment ...........................         45,391           9,498
                                                                        ------------    ------------
                                                                          27,717,447      13,238,131
        Less:  treasury stock, 2,719,000 shares, at cost ............    (22,660,592)    (22,660,592)
                                                                        ------------    ------------
               Total shareholders' equity (deficit) .................      5,056,855      (9,422,461)
                                                                        ------------    ------------
               Total liabilities and shareholders' equity ...........   $ 31,092,063    $ 16,303,901
                                                                        ============    ============
</TABLE>
          See accompanying notes to consolidated financial statements.

                                      -1-
<PAGE>
                                 DSI TOYS, INC.
                      CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>

                                                              Three Months Ended October 31,         Nine Months Ended October 31,
                                                              -------------------------------       -------------------------------
                                                                   1997               1996               1997               1996
                                                              ------------       ------------       ------------       ------------
<S>                                                           <C>                <C>                <C>                <C>         
Net sales ..............................................      $ 30,018,242       $ 29,348,377       $ 61,828,627       $ 53,301,357
Costs of goods sold ....................................        22,643,185         18,369,112         44,531,494         35,420,059
                                                              ------------       ------------       ------------       ------------
Gross profit ...........................................         7,375,057         10,979,265         17,297,133         17,881,298
Selling, general and administrative expenses ...........        13,434,338          7,252,080         20,779,001         12,512,459
                                                              ------------       ------------       ------------       ------------
Operating income (loss) ................................        (6,059,281)         3,727,185         (3,481,868)         5,368,839
Interest expense .......................................           286,124            802,565          1,158,138          1,990,172
Other income ...........................................           (49,771)          (311,742)          (215,778)          (347,127)
                                                              ------------       ------------       ------------       ------------
Income (loss) before income taxes ......................        (6,295,634)         3,236,362         (4,424,228)         3,725,794
Provision for (benefit from) income taxes ..............        (2,266,428)         1,174,674         (1,592,721)         1,341,081
                                                              ------------       ------------       ------------       ------------
Income (loss) before extraordinary item ................        (4,029,206)         2,061,688         (2,831,507)         2,384,713
Extraordinary item (net of tax) ........................              --                 --             (480,754)              --
                                                              ------------       ------------       ------------       ------------
Net income (loss) ......................................      $ (4,029,206)      $  2,061,688       $ (3,312,261)      $  2,384,713
                                                              ============       ============       ============       ============
Earnings (loss) per share before
        extraordinary item .............................      $      (0.67)      $       0.55       $      (0.56)      $       0.65
                                                              ============       ============       ============       ============
Earnings (loss) per share ..............................      $      (0.67)      $       0.55       $      (0.66)      $       0.65
                                                              ============       ============       ============       ============
Weighted average shares outstanding ....................         6,000,000          3,758,169          5,033,814          3,657,294
                                                              ============       ============       ============       ============
</TABLE>
          See accompanying notes to consolidated financial statements.

                                      -2-
<PAGE>
                                 DSI TOYS, INC.
                      CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                                                     Nine months ended October 31,
                                                                                                  ---------------------------------
                                                                                                      1997                 1996
                                                                                                  ------------          -----------
<S>                                                                                               <C>                   <C>        
Cash flows from operating activities:
        Net income (loss) ...............................................................         $ (3,312,261)         $ 2,384,713
        Adjustments to reconcile net income (loss) to net cash used in
               operating activities:
               Extraordinary item .......................................................              480,754                 --
               Depreciation .............................................................              585,854              489,731
               Amortization of debt discount and issuance costs .........................              199,152              120,246
               Provision for doubtful accounts ..........................................               74,487              402,788
               Gain (loss) on sale of equipment .........................................               (3,355)              12,513
               Deferred income taxes ....................................................           (1,638,802)                --
               Changes in assets and liabilities:
                      Accounts receivable ...............................................           (8,206,246)          (9,667,124)
                      Due from shareholder ..............................................              151,667              669,649
                      Inventories .......................................................           (8,668,928)          (4,499,339)
                      Prepaid expenses ..................................................              567,903             (275,485)
                      Accounts payable and accrued liabilities ..........................           11,294,499            7,129,906
                      Income taxes payable ..............................................             (193,211)           1,333,435
                                                                                                  ------------          -----------
                             Net cash used in operating activities ......................           (8,668,487)          (1,898,967)
Cash flows from investing activities:
        Capital expenditures ............................................................             (665,595)            (254,561)
        Proceeds from sale of equipment .................................................                6,140                 --
        Decrease (increase) in insurance receivable from shareholder ....................              220,704             (223,541)
        Decrease (increase) in other assets .............................................              368,213             (122,871)
                                                                                                  ------------          -----------
                             Net cash used in investing activities ......................              (70,538)            (600,973)
Cash flows from financing activities:
        Net borrowings under revolving lines of credit ..................................            3,861,560            1,768,412
        Payments on long-term debt ......................................................          (13,427,225)            (732,792)
        Net proceeds from issuance of common stock ......................................           17,753,184                 --
        Proceeds from sale of warrants to underwriters ..................................                2,500                 --
                                                                                                  ------------          -----------
                             Net cash provided by financing activities ..................            8,190,019            1,035,620
Effect of exchange rate changes on cash .................................................               35,893               23,285
                                                                                                  ------------          -----------
Net decrease in cash ....................................................................             (513,113)          (1,441,035)
Cash, beginning of period ...............................................................            1,501,992            2,660,456
                                                                                                  ------------          -----------
Cash, end of period .....................................................................         $    988,879          $ 1,219,421
                                                                                                  ============          ===========

Supplemental disclosures of cash flow information:
        Interest paid during the period .................................................         $  1,085,097          $ 1,683,558
        Income taxes paid during the period .............................................         $    279,443          $   872,708
</TABLE>
          See accompanying notes to consolidated financial statements.

                                      -3-
<PAGE>
                                 DSI TOYS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

1.      Basis of Presentation

      The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and the instructions for Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the unaudited consolidated
financial statements of DSI Toys, Inc., together with its wholly owned
subsidiary, ("the Company") as of October 31, 1997 and for the three months and
nine months ended October 31, 1997 and 1996 include all adjustments, consisting
only of normal recurring adjustments, which are necessary to present fairly the
financial position, results of operations and cash flows of the Company for the
periods indicated. These interim results are not necessarily indicative of
results for a full year. The balance sheet at January 31, 1997 has been derived
from the audited consolidated financial statements at that date.

      Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted in this Form 10-Q pursuant to the
rules and regulations of the Securities and Exchange Commission. Accordingly,
the financial information included herein should be read in conjunction with the
Company's consolidated financial statements and related notes included in
Amendment No. 2 to the Company's Registration Statement on Form S-1 (No. 333-
23961) filed with the Securities and Exchange Commission on May 28, 1997.

      The terms "fiscal year" and "fiscal" refer to the Company's fiscal year
which is the year ending January 31 of the following calendar year mentioned
(e.g., a reference to fiscal 1996 is a reference to the fiscal year ended
January 31, 1997).

2. NOTES PAYABLE

Indebtedness consists of the following:


                                                     October 31,     January 31,
                                                       1997             1997
                                                     -----------     -----------
Bank revolver ..................................     $ 4,500,000     $ 3,055,000
Subordinated bank note .........................            --         1,418,918
Bank note ......................................            --         5,000,000
Subordinated note payable to shareholder .......            --         6,000,000
Subordinated note payable to shareholder .......            --         1,000,000
Hong Kong credit facility ......................       2,893,230         484,979
                                                     -----------     -----------
                                                       7,393,230      16,958,897
Less - current portion .........................       2,893,230       2,755,789
                                                     -----------     -----------
                                                     $ 4,500,000     $14,203,108
                                                     ===========     ===========

      In June 1997, the Company renegotiated the Hong Kong credit facility,
which is available primarily for negotiating and collecting export sales,
opening back-to-back letters of credit secured by letters of credit from its
customers and purchasing component parts inventory. The credit limit was
increased to $8 million, and the facility is secured by a cash deposit of
$150,000 and the accounts receivable and inventory of DSI (HK) Ltd., the wholly
owned subsidiary of DSI Toys, Inc. Outstanding borrowings under the loan bear
interest at the banks prime rate of interest.

      In October 1997, the Company amended the bank revolver. The credit limit
was increased to $10 million, and the maturity date was extended to October 22,
2000. Interest on borrowings outstanding under this revolver is payable monthly
at an annual rate equal to, at the Company's option, (a) the LIBOR rate plus 2%
for minimum $1 million and 30 day commitment or (b) banks prime rate of
interest.

                                      -4-
<PAGE>
3. INITIAL PUBLIC OFFERING

      On June 3, 1997, the Company completed its initial public offering of
2,500,000 shares of Common Stock, which provided the Company net proceeds of
$17.7 million. All of the net proceeds were used to repay debt of the Company.
In connection with the offering, the Company issued warrants to purchase 250,000
shares of common stock to the lead underwriters. Such warrants are exercisable
at $10.80 per share and expire May 28, 2002.

4. RECENT ACCOUNTING PRONOUNCEMENTS

      In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS
128") which establishes standards for computing and presenting earnings per
share. This statement simplifies the standards for computing earnings per share
("EPS") previously found in APB Opinion No. 15, "Earnings per Share". The new
standard, which is effective for periods ending after December 15, 1997,
replaces the presentation of primary EPS with a presentation of basic EPS. It
also requires dual presentation of basic and diluted EPS on the face of the
income statement for all entities with complex capital structures and requires a
reconciliation of the numerator and denominator of the basic EPS computation to
the numerator and denominator of the diluted EPS computation. Basic EPS excludes
dilution and is computed by dividing income available to common stockholders by
the weighted-average number of common shares outstanding for the period. Diluted
EPS reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
company. For the three month and nine month periods ended October 31, 1997 and
1996, SFAS 128 would have had no material impact on the reported EPS.

                                      -5-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

GENERAL

      The Company designs, develops, markets and distributes a variety of toys
and children's consumer electronics. The Company's core product categories are
(i) juvenile audio products, including walkie-talkies, pre- school audio
products, pre-teen audio products and musical toys; (ii) girl's toys, including
dolls, play sets and accessories; and (iii) boy's toys, including radio control
vehicles, action figures and western and military action toys. Historically, the
majority of the Company's sales have been made to customers based in the United
States. All of the Company's international sales are denominated in United
States dollars. Therefore, the Company is not subject to exchange rate risk with
respect to international sales.

      In December 1995, a series of transactions (the "Recapitalization") was
consummated whereby the Company repurchased 77.7% of the then outstanding Common
Stock from the then sole shareholder of the Company for $22.2 million and issued
2,719,000 shares of Common Stock to a group of new investors. The
Recapitalization resulted in the incurrence of an aggregate of $17.9 million of
additional indebtedness. The stock purchased by the Company from its former sole
shareholder is held as treasury stock. On June 3, 1997, the Company completed
its initial public offering of 2,500,000 shares of its Common Stock, which
resulted in net proceeds to the Company of $17.7 million. All of the net
proceeds were used to repay debt of the Company.

      A portion of the annual advertising expenses will be accrued during each
fiscal quarter based on the amount of net sales of the related product for such
fiscal quarter compared to the projected annual net sales for such product. To
the extent actual net sales vary from estimates, adjustments in the quarterly
accruals of advertising expenses will be made.

RESULTS OF OPERATIONS

      The following table sets forth for the periods indicated certain income
and expense items expressed as a percentage of net sales:

                                                Percent of Net Sales    
                                       ---------------------------------------
                                      Three Months Ended      Nine Months Ended
                                       -----------------     -----------------
                                          October 31,            October 31,
                                       -----------------     -----------------
                                         1997       1996       1997       1996
                                       ------     ------     ------     ------
Net sales ..........................    100.0%     100.0%     100.0%     100.0%
Costs of goods sold ................     75.4       62.6       72.0       66.5
                                       ------     ------     ------     ------
Gross profit .......................     24.6       37.4       28.0       33.5
Selling, general and
  administrative expenses ..........     44.8       24.7       33.6       23.5
                                       ------     ------     ------     ------
Operating income (loss) ............    (20.2)      12.7       (5.6)      10.0
Interest expense ...................      1.0        2.7        1.9        3.7
Other income .......................     (0.2)      (1.1)      (0.3)      (0.7)
                                       ------     ------     ------     ------
Income (loss) before income taxes ..    (21.0)      11.1       (7.2)       7.0
Provision for (benefit from)
  income taxes .....................     (7.6)       4.0       (2.6)       2.5
                                       ------     ------     ------     ------
Income (loss) before extraordinary
  item .............................    (13.4)       7.1       (4.6)       4.5
Extraordinary item (net of tax) ....      0.0        0.0       (0.8)       0.0
                                       ------     ------     ------     ------
Net income (loss) ..................    (13.4)%      7.1%      (5.4)%      4.5%
                                       ======     ======     ======     ======

                                      -6-
<PAGE>
THREE MONTHS ENDED OCTOBER 31, 1997 COMPARED TO THE THREE MONTHS ENDED OCTOBER
31, 1996

      NET SALES. Net sales for the three months ended October 31, 1997 increased
$670,000, or 2.3%, to $30.0 million, from $29.3 million in the comparable period
in 1996.

      Net sales of juvenile audio products increased $3.8 million, or 29.0%, to
$16.7 million during the third quarter ended October 31, 1997, from $12.9
million in the comparable period in 1996. This increase was due primarily to
increased sales of walkie-talkies. Net sales of girls' toys decreased $6.3
million, or 43.4%, to $8.2 million during the third quarter ended October 31,
1997, from $14.4 million in the comparable period in 1996. The decrease was due
primarily to decreased sales of dolls related to the softness of large doll
sales industry-wide. Net sales of boys' toys increased $1.0 million, or 89.2%,
to $2.2 million in the third quarter ended October 31, 1997, from $1.2 million
in the comparable period in 1996. The growth in net sales of boys' toys was
primarily attributable to the newly introduced Kawasaki(R) Ninja(R)
Supergyro(TM) Motorcycle. Net sales of products in other categories increased
$2.1 million, or 251.4%, to $3.0 million, during the third quarter ended October
31, 1997, from $852,000 in the comparable period in 1996. This increase was due
primarily to the introduction of the Hoppin' Poppin' Spaceballs(TM) game.

      International net sales for the three months ended October 31, 1997
increased $2.1 million, or 44.4%, to $6.8 million, from $4.7 million in the
comparable period in 1996. The growth was due primarily to the increase in net
sales to Canada, the United Kingdom, Spain, Greece and Australia.
 
      GROSS PROFIT. Gross profit decreased 32.8% to $7.4 million for the third
quarter ended October 31, 1997, from $11.0 million in the comparable period in
1996. Gross profit as a percentage of net sales decreased to 24.6% in the third
quarter ended October 31, 1997 from 37.4% in the third quarter of fiscal 1996.
Such decrease was related primarily to the decrease in sales of TV-promoted
dolls, which generally have higher margins.

      SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased 85.3% to $13.4 million in the third quarter
ended October 31, 1997 from $7.3 million in the third quarter of fiscal 1996.
The increase resulted primarily from television advertising related to the
introduction of several new products. The Company has produced commercials and
purchased significant airtime for four products for fiscal 1997 as compared to
two products for the prior year. In addition, in the third quarter, the Company
accelerated the recognition of advertising costs related to large doll products
for which the projected contribution from future sales will not cover the
remaining committed advertising costs.

      INTEREST EXPENSE. As a result of debt repayment using the proceeds of the
Company's initial public offering, interest expense decreased $516,000 to
$286,000 in the third quarter ended October 31, 1997 from $803,000 in the
comparable period in 1996.

      OTHER INCOME. Other income decreased $262,000, to $50,000 in the third
quarter ended October 31, 1997 from $312,000 in the comparable period in 1996.
This decrease was due primarily to decreased interest income on certain
insurance proceeds in the third quarter of 1997.

NINE MONTHS ENDED OCTOBER 31, 1997 COMPARED TO THE NINE MONTHS ENDED OCTOBER 31,
1996

      NET SALES. Net sales in the nine months ended October 31, 1997 increased
$8.5 million, or 16.0%, to $61.8 million, from $53.3 million in the comparable
period in fiscal 1996.

      Net sales of juvenile audio products increased $6.6 million, or 25.2%, to
$32.8 million during the nine months ended October 31, 1997, from $26.2 million
in the comparable period in 1996. This increase was due primarily to increased
sales of walkie-talkies. Net sales of girls' toys decreased by $4.0 million, or
18.4%, to $17.8 million during the nine months ended October 31, 1997, from
$21.8 million in the comparable period in 1996. The decrease was due primarily
to decreased sales of dolls related to the softness of large doll sales
industry-wide. Net sales of boys' toys increased $3.3 million, or 98.9%, to $6.6
million in the nine months ended October 31, 1997 from $3.3 million in the
comparable period in 1996. The growth in net sales of boys' toys was primarily
attributable to the newly introduced Kawasaki(R) Ninja(R) Supergyro(TM)
Motorcycle. Net sales of products in other categories

                                      -7-
<PAGE>
increased $2.7 million, or 133.5%, to $4.7 million during the nine months ended
October 31, 1997, from $2.0 million in the comparable period in 1996. This
increase was due primarily to the introduction of the Hoppin' Poppin'
Spaceballs(TM) game.

      International net sales for the nine months ended October 31, 1997
increased $2.4 million, or 21.9%, to $13.2 million, from $10.8 million in the
comparable period in fiscal 1996. The growth was due primarily to increased net
sales to the United Kingdom, Canada, Spain, France and Australia and partially
offset by decreased net sales to Germany and Japan.

      GROSS PROFIT. Gross profit decreased approximately 3.3% to $17.3 million
during the nine months ended October 31, 1997, from $17.9 million in the
comparable period in 1996. Gross profit as a percentage of net sales decreased
to 28.0% during the nine months ended October 31, 1997 from 33.5% in the
comparable period in 1996. Such decrease was related primarily to the decrease
in sales of TV-promoted dolls, which generally have higher margins.

      SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased 66.1% to $20.8 million during the nine months
ended October 31, 1997 from $12.5 million in the comparable period in 1996. The
increase resulted primarily from television advertising expenses related to the
introduction of several new products. The Company has produced commercials and
purchased significant airtime for four products for fiscal 1997 as compared to
two products for the prior year. In addition, in the third quarter, the Company
accelerated the recognition of advertising costs related to large doll products
for which the projected contribution from future sales will not cover the
remaining committed advertising costs.

      INTEREST EXPENSE. As a result of debt repayment using the proceeds of the
Company's initial public offering, interest expense decreased $832,000 to $1.2
million during the nine months ended October 31, 1997 from $2.0 million in the
comparable period of the prior year.

      OTHER INCOME. Other income decreased $131,000, to $216,000 during the nine
months ended October 31, 1997 from $347,000 in the comparable period in 1996.
This decrease was due primarily to decreased interest income on certain
insurance proceeds.

      EXTRAORDINARY ITEM. As a result of debt repayment using proceeds of the
Company's initial public offering, $481,000 of debt issuance cost (net of tax)
was written off.

LIQUIDITY AND CAPITAL RESOURCES

      The Company historically has funded its operations and capital
requirements by cash generated from operations and borrowings. The Company's
primary capital needs have consisted of acquisitions of inventory, financing
accounts receivable and capital expenditures for product development. The
Company's working capital at October 31, 1997 was $6.5 million and unrestricted
cash was $1.0 million.

      The Company's operating activities used net cash of $8.7 million during
the nine months ended October 31, 1997, consisting primarily of the net loss and
a net increase in inventories, accounts receivable and prepaid income taxes,
partially offset by increases in accounts payable and accrued liabilities. Net
cash used in investing activities during the nine months ended October 31, 1997
was $71,000, and was the net result of the repayment of an insurance receivable
from a shareholder offset by capital expenditures. Net cash provided by
financing activities was $8.2 million during the nine months ended October 31,
1997 and represented net borrowings under revolving lines of credit, payments on
long-term debt, and net proceeds from a public offering.

      The seasonal nature of the toy business results in complex working capital
needs. The Company's working capital needs, which the Company generally
satisfies through short-term borrowings, are greatest in the first two fiscal
quarters. To manage these working capital requirements, the Company maintains a
line of credit facility (the "Hong Kong Credit Facility") with State Street Bank
and Trust Company, Hong Kong Branch, and a revolving credit facility with Bank
One, Texas, N.A. (the "Revolver").

                                      -8-
<PAGE>
      The Company believes that available borrowings under the Revolver and the
Hong Kong Credit Facility and cash from operations will be sufficient to meet
the Company's operating cash requirements, fund the Company's anticipated
capital expenditures and fund scheduled debt service for the foreseeable future.
At October 31, 1997 the Company was not in compliance with certain of the
covenants contained in the Revolver; however, the Company has obtained a waiver
of these covenants for the quarter ended October 31, 1997 from Bank One. It is
anticipated that the Company will not come into compliance with these covenants
prior to January 31, 1998. Based on discussions with Bank One, the Company
believes that it will be successful in either obtaining additional waivers or in
amending the Revolver. In the alternative, the Company believes that it could
obtain a suitable replacement credit facility.

      The Company has budgeted approximately $850,000 for capital expenditures,
consisting of purchases of tools, molds, office equipment and furnishings, for
fiscal 1997. At December 5, 1997, the Company had an additional borrowing
capacity of an aggregate of $3.2 million under the Revolver and the Hong Kong
Credit Facility.

      The Company is obligated to make future minimum royalty payments under
certain of its license agreements. As of October 31, 1997, the Company was
required to pay $15,000 of guaranteed royalties under these licenses in fiscal
1997 and $315,000 thereafter.

      As a part of the Company's strategy, the Company will evaluate potential
acquisitions of other toy businesses or product lines which the Company believes
would complement its existing business. The Company has no present understanding
or agreement with respect to any acquisition.

      In connection with any future cash needs or acquisition opportunities, the
Company may incur additional debt or issue additional equity or debt securities
depending on market conditions and other factors.

SEASONALITY

      The toy industry is very seasonal with the Christmas holiday season
representing over two-thirds of total annual retail toy sales. The Company has
experienced this seasonal pattern in its net sales. To accommodate this peak
selling season, holiday toy lines are introduced early in the first calendar
quarter. Retailers generally commit to their holiday season purchases during the
first two calendar quarters and those orders are generally shipped from Asia to
the retailers' distribution centers on a scheduled basis from May through
September. As a result of the seasonality of the Company's business, the Company
expects to incur a loss in the first quarter of each fiscal year for the
foreseeable future and may incur a loss in the fourth quarter of such fiscal
year depending upon the timing of product shipments.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

      This Report on Form 10-Q includes "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. All statements other
than statements of historical facts included in this Form 10-Q, including
statements in this Management's Discussion and Analysis of Financial Condition
and Results of Operations regarding the Company's financial position, business
strategy, plans and objectives of management of the Company for future
operations, liquidity and capital resources, and debt service requirements, are
forward-looking statements. The words "anticipate," "believe," "expect," "plan,"
"intend," "estimate," "project," "will," "could," "may" and similar expressions
are intended to identify forward-looking statements. Although the Company
believes that the expectations reflected in these forward-looking statements are
reasonable, there can be no assurance that the actual results or developments
anticipated by the Company will be realized or, even if substantially realized,
that they will have the expected effects on its business or operations. Among
the factors that could cause actual results to differ materially from the
Company's expectations are general economic conditions, changing consumer
preferences, lack of success of new products, loss of one of the Company's
largest customers, dependence on independent designers, licenses and other
proprietary rights, reliance on manufacturers based in Hong Kong and China,
reliance on key personnel, competition and government regulation. All subsequent
oral and written forward-looking statements attributable to the Company or
persons acting on its behalf are expressly qualified in their entirety by these
factors. The Company assumes no obligation to update any of these statements.

                                      -9-
<PAGE>
                          PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

      The Company is involved in various legal proceedings and claims incident
to the normal conduct of its business. The Company believes that such legal
proceedings and claims, individually and in the aggregate, are not likely to
have a material adverse effect on its financial position or results of
operations. The Company maintains product liability and general liability
insurance in amounts it believes to be reasonable. There have been no material
developments in the legal proceedings noted in Amendment No. 2 to the Company's
Registration Statement on Form S-1 (No. 333-23961) filed with the Securities and
Exchange Commission on May 28, 1997 and in the Quarterly Reports on Form 10-Q
for the periods ended April 30, 1997 and July 31, 1997 filed with the Securities
and Exchange Commission on June 23 and September 12, 1997, respectively.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)   Exhibits

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

(b)   Reports Submitted on Form 8-K: None.

                                      -10-
<PAGE>
                                   SIGNATURES

      Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                 DSI Toys, Inc.


Dated:  December 11, 1997        /s/ M. D. DAVIS
                                     M. D. Davis
                                     Chairman and Chief Executive Officer

Dated:  December 11, 1997     By:/s/ J. RUSSELL DENSON
                                     J. Russell Denson
                                     Executive Vice President and Chief 
                                     Financial Officer (Principal Financial and
                                     Accounting Officer)

                                      -11-
<PAGE>
                               INDEX TO EXHIBITS

EXHIBIT
NUMBER                        EXHIBIT

10.1  Amended and Restated Bank One Letter Loan Agreement dated October 22,
      1997.

11    Computation of Earnings Per Share.

27    Financial Data Schedule.

                                      -12-