AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 27, 1997
REGISTRATION NO. 333-23961

---------------

AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

---------------

DSI TOYS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

TEXAS 5092 74-1673513
(STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
OF INCORPORATION OR CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
ORGANIZATION)

---------------

M. D. DAVIS
CHAIRMAN AND CEO
DSI TOYS, INC.
1100 WEST SAM HOUSTON PARKWAY (NORTH) 1100 WEST SAM HOUSTON PARKWAY (NORTH)
SUITE A SUITE A
HOUSTON, TEXAS 77043 HOUSTON, TEXAS 77043
(713) 365-9900 (713) 365-9900

(ADDRESS, INCLUDING ZIP CODE AND (NAME, ADDRESS, INCLUDING ZIP CODE AND
TELEPHONE NUMBER, INCLUDING AREA TELEPHONE NUMBER, INCLUDING AREA CODE,
CODE, OF REGISTRANT'S PRINCIPAL OF REGISTRANT'S AGENT FOR SERVICE)
EXECUTIVE OFFICES)

---------------

COPIES OF COMMUNICATION TO:

MICHAEL L. BENGTSON, ESQ. GLENN D. SMITH, ESQ.
THOMPSON & KNIGHT, P.C. STROOCK & STROOCK & LAVAN LLP
1700 PACIFIC AVENUE, SUITE 3300 2029 CENTURY PARK EAST, SUITE 1800
DALLAS, TEXAS 75201 LOS ANGELES, CALIFORNIA 90067
(214) 969-1700 (310) 556-5800

---------------

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]

If delivery of the Prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.

- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

SUBJECT TO COMPLETION, DATED MAY 27, 1997

PROSPECTUS

3,000,000 Shares

LOGO
[LOGO OF DSI TOYS, INC. APPEARS HERE]

Common Stock

Of the 3,000,000 shares of common stock (the "Common Stock") offered hereby,
2,500,000 shares are being sold by DSI Toys, Inc. (the "Company") and 500,000
shares are being sold by a certain shareholder of the Company (the "Selling
Shareholder"). See "Principal and Selling Shareholders." The Company will not
receive any of the proceeds from the sale of the shares by the Selling
Shareholder. The Common Stock has been approved for listing in The Nasdaq Stock
Market's National Market (the "Nasdaq National Market") under the symbol
"DSIT," subject to official notice of issuance. Prior to this offering, there
has been no public market for the Common Stock. It is currently anticipated
that the initial public offering price will be between $9.00 and $11.00 per
share. See "Underwriting" for a discussion of the factors to be considered in
determining the initial public offering price.

-----------

The Common Stock offered hereby involves a high degree of risk.
See "Risk Factors" commencing on page 6.

-----------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

Proceeds
Underwriting Proceeds to to Selling
Price to Public Discount(1) Company(2) Shareholder
- --------------------------------------------------------------------------------

Per Share ................ $ $ $ $
- --------------------------------------------------------------------------------
Total(3) ................. $ $ $ $

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1) Excludes warrants to purchase 250,000 shares of Common Stock for an
exercise price equal to 120% of the initial public offering price, to be
issued to the Representatives of the Underwriters. The Company and the
Selling Shareholder have agreed to indemnify the Underwriters against
certain liabilities, including liabilities under the Securities Act of
1933, as amended. See "Underwriting."
(2) Before deduction of expenses estimated to be $620,000, payable by the
Company.
(3) The Company, the Selling Shareholder and an additional shareholder of the
Company have granted to the Underwriters a 45-day option to purchase up to
a maximum of 450,000 additional shares of Common Stock to cover over-
allotments, if any. If such option is exercised in full, the total "Price
to Public," "Underwriting Discount," "Proceeds to Company" and "Proceeds to
Selling Shareholder" will be $ , $ , $ and $ , respectively.
In addition, such additional shareholder will receive proceeds of $ if
such option is exercised in full. See "Underwriting."

-----------

The shares of Common Stock are offered by the Underwriters, subject to prior
sale, when, as and if delivered to and accepted by the Underwriters and subject
to their right to reject orders in whole or in part. It is expected that
delivery of the shares of Common Stock will be made in Boston, Massachusetts,
on or about , 1997.

Tucker Anthony Sutro & Co. Incorporated
Incorporated

The date of this Prospectus is , 1997

[PHOTOS OF REPRESENTATIVE PRODUCTS]

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK OF
THE COMPANY, INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING
TRANSACTIONS AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and financial statements appearing elsewhere in this Prospectus.
Except as otherwise indicated, the information contained in this Prospectus (i)
assumes the Underwriters' over-allotment option will not be exercised and (ii)
assumes an initial public offering price of $10.00 per share. Except as
otherwise indicated, references to the "Company" refer to DSI Toys, Inc. and
its wholly owned subsidiary, DSI (HK) Ltd. ("DSI(HK)"). Investors should
carefully consider the information set forth under the heading "Risk Factors."
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).

THE COMPANY

The Company designs, develops, markets and distributes high quality, value-
priced 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) girls'
toys, including dolls, play sets and accessories; and (iii) boys' toys,
including radio control vehicles, action figures and western and military
action toys. Founded in 1970, the Company historically was principally a
supplier of non-proprietary toys to deep discount stores and regional drug
store chains. With the addition of new senior management personnel in 1990, the
Company began to market its expanding product line to major toy retailers by
emphasizing innovative packaging and developing in-house brands. Further, in
fiscal 1993, the Company began to emphasize the development and marketing of
proprietary products, consisting of toys developed by the Company incorporating
concepts licensed from outside inventors, products designed in-house, products
for which the Company owns the mold and products incorporating well-known
trademarks licensed to the Company. The Company introduced its first
television-promoted proprietary product, the Rosie(R) doll, in fiscal 1995.
Rosie(R) ranked as the number two selling doll, by dollar amount (and number
three by unit), in the large doll category during calendar 1995, as measured by
the Toy Retail Sales Tracking Service.

Traditionally a supplier of juvenile audio products and boys' toys, the
Company has diversified its product offerings over the last two fiscal years,
primarily through its expansion into the girls' toys category with the
introduction of the Rosie(R) doll in fiscal 1995 and the Pattie(TM) doll in
fiscal 1996. For fiscal 1997, the Company has introduced new products in its
three core categories, as well as a new children's action game, Hoppin' Poppin'
Spaceballs(TM). The Company seeks to enhance its position as a leading supplier
of high quality, value-priced toys and intends to continue developing
proprietary products, primarily through pursuing opportunities to license toy
concepts from outside inventors and to license recognized trademarks. The
Company believes that it offers its customers many value-priced products, which
the Company believes are lower-priced alternatives to comparable products sold
by other toy companies. The Company believes that this strategy of offering
lower priced products to its customers provides them with opportunities to
realize higher margins on sales of the Company's products as compared to sales
of products offered by other toy companies.

Since fiscal 1993, the Company's net sales have grown from $36.7 million to
$63.2 million (or 72%) for fiscal 1996, and net income has grown from $362,000
to $2.2 million (or 494%) during the same period. The Company believes that
this growth is attributable to several factors, including its ability to
identify new products with broad appeal and to rapidly develop and market these
products. The Company believes that its use of innovative packaging and
increased utilization of brand names have also contributed to its growth. The
Company offers several licensed products under the Kawasaki(R) brand name,
including a radio-controlled motorcycle, guitars, keyboards and a percussion
instrument. The Company also has developed and currently is marketing products
incorporating several in-house brand names, including Digi-Tech(TM) (walkie-
talkies), LA Rock(R) (musical toys and audio products), American Frontier(TM)
(western role play toys), Combat Force Rangers(TM) (military role play toys)
and My Music Maker(R) (musical toys and pre-school audio products). The Company
believes that its use of brand names to market its products has increased name
recognition of its products and

contributed to the Company's increase in net sales over the past four fiscal
years. The Company believes that it is the leading supplier of walkie-talkies
to the top five United States toy retailers.

The Company sells primarily to retailers, including mass merchandising
discounters such as Wal-Mart Stores, Inc., Kmart Corporation and Target Stores
(a division of Dayton Hudson Corp.), specialty toy stores such as Toys "R" Us,
Inc., Kay-Bee Toy & Hobby Shops, Inc. and F.A.O. Schwarz, and deep discount
stores such as Family Dollar Stores, Inc., Consolidated Stores Corp. and Value
City Department Stores, Inc. Wal-Mart (19.5%), Kmart (13.7%) and Toys "R" Us
(12.0%) each accounted for more than 10% of the Company's net sales for fiscal
1996. Although the Company's sales have been made primarily to customers based
in the United States, international net sales accounted for approximately 19%
of the Company's net sales during fiscal 1996.

Approximately 56% of the Company's net sales were made FOB Asia during fiscal
1996. Products sold FOB Asia are shipped directly to customers from the factory
and are not carried by the Company in inventory, thereby improving working
capital utilization. The Company also maintains an inventory of certain
products in its Houston, Texas facility, principally to support sales by the
Company's customers who offer such products on a year-round basis. In addition,
the Company's Houston facility maintains inventory to support the Company's
television-promoted proprietary products.

The principal executive offices of the Company are located at 1100 West Sam
Houston Parkway (North), Suite A, Houston, Texas 77043, and its telephone
number is (713) 365-9900.

THE OFFERING

Common Stock Offered by the Company................ 2,500,000 shares
Common Stock Offered by the Selling Shareholder.... 500,000 shares (1)
Common Stock to be Outstanding after the Offering.. 6,000,000 shares (2)
Use of Proceeds.................................... For (i) repayment of
approximately $19.5
million in debt of the
Company, consisting of a
senior term loan of
approximately $4.8
million, a subordinated
term loan of approximately
$1.6 million, outstanding
principal under a
revolving line of credit
of approximately $6.0
million, and indebtedness
to the Estate of Mr. Moss
of approximately $7.1
million, and (ii) $3.0
million for working
capital and general
corporate purposes. See
"Use of Proceeds."
Nasdaq National Market Symbol...................... DSIT

- --------
(1) The Selling Shareholder is the Tommy Moss Living Trust, a trust formed by
Tommy Moss, the founder and former sole shareholder of the Company. In
December 1995, a recapitalization transaction occurred which resulted in
the sale by Mr. Moss of approximately 77.7% of the then outstanding Common
Stock. Mr. Moss died in November 1996. See "The Recapitalization" and
"Principal and Selling Shareholders."
(2) Excludes (i) 600,000 shares of Common Stock reserved for issuance under the
Company's 1997 Stock Option Plan, of which options covering 90,000 shares
will be outstanding after the Offering, and (ii) 638,888 shares of Common
Stock issuable upon exercise of warrants to be outstanding after the
Offering. If the Underwriters' over-allotment option is exercised in full,
after the Offering there will be 6,169,000 shares of Common Stock
outstanding and 488,888 shares issuable upon the exercise of outstanding
warrants. See "Management--1997 Stock Option Plan," "Principal and Selling
Shareholders," "Description of Capital Stock" and "Underwriting."

The offering of the shares of Common Stock described herein is referred to as
the "Offering."

SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)

FISCAL YEAR
---------------------------------------
1992 1993 1994 1995 1996
------- ------- ------- ------- -------

INCOME STATEMENT DATA:
Net sales............................. $36,576 $36,734 $45,219 $63,146 $63,219
Gross profit.......................... 7,484 6,612 11,605 19,718 21,196
Selling, general and administrative
expenses............................. 4,524 5,680 7,910 14,625 15,569
Former sole shareholder bonus (1)..... 1,380 347 2,000 1,000 --
Operating income...................... 1,580 585 1,695 4,093 5,627
Interest expense...................... 226 147 333 701 2,600
Net income............................ 907 362 969 2,327 2,151
Earnings per share (2)................ $ 0.26 $ 0.10 $ 0.28 $ 0.66 $ 0.58
Weighted average shares outstanding
(2).................................. 3,500 3,500 3,500 3,500 3,739

END OF FISCAL YEAR
--------------------------------------------------------
1992 1993 1994 1995 1996
------ ------ ------- -------- ------------------------
ACTUAL AS ADJUSTED(3)
-------- --------------

BALANCE SHEET DATA:
Working capital........ $2,093 $1,569 $ 2,121 $ 3,510 $ 2,621 $ 8,902
Total assets........... 8,349 7,460 10,389 17,390 16,304 22,254
Long-term debt (less
current portion)(4)... -- -- 17 18,188 14,203 --
Shareholders' equity
(deficit) (4)......... 3,817 4,179 5,147 (11,582) (9,422) 13,083

- --------
(1) Consists of bonus paid to the Company's former sole shareholder. Bonuses
paid to other officers and employees are included in selling, general and
administrative expenses. See "Management--Bonuses."
(2) Earnings per share is calculated using the weighted average number of
common and dilutive common equivalent shares outstanding during the period.
(3) Adjusted to reflect the sale by the Company of 2,500,000 shares of Common
Stock offered hereby and the anticipated use of net proceeds to the Company
therefrom. See "Use of Proceeds" and "Capitalization."
(4) For a description of the recapitalization transaction that occurred in
December 1995, resulting in the incurrence of approximately $17.9 million
of indebtedness and a shareholders' deficit at the end of fiscal 1995 and
fiscal 1996, see "The Recapitalization."

NOTICE REGARDING FORWARD-LOOKING STATEMENTS

This Prospectus contains 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. These statements include information regarding expected
introduction of products in the market, the buying attitudes and preferences of
its customers, and the Company's relationship with independent inventors,
holders of trademark rights and independent foreign manufacturers. Such
statements reflect the Company's current views with respect to future events
and financial performance and involve risks and uncertainties, including
without limitation the risks described in "Risk Factors." Should one or more of
these risks or uncertainties occur, or should underlying assumptions prove
incorrect, actual results may vary materially and adversely from those
anticipated, believed, estimated or otherwise indicated.

RISK FACTORS

In addition to the other information contained in this Prospectus, the
following factors should be considered carefully in evaluating an investment
in the Common Stock.

CHANGING CONSUMER PREFERENCES; RELIANCE ON NEW PRODUCT INTRODUCTION. As a
result of changing consumer preferences, many toys are successfully marketed
for only one or two years. There can be no assurance that (i) any of the
Company's current products or product lines will continue to be popular with
consumers for any significant period of time or (ii) new products and product
lines introduced by the Company will achieve an acceptable degree of market
acceptance, or that if such acceptance is achieved, it will be maintained for
any significant period of time. Furthermore, sales of the Company's existing
products are expected to decline over time and may decline at rates faster
than expected. The Company's success will be dependent upon the Company's
ability to enhance existing product lines and develop new products and product
lines. The failure of the Company's new products and product lines to achieve
and sustain market acceptance and to produce acceptable margins could have a
material adverse effect on the Company's financial condition and results of
operations.

DEPENDENCE ON LIMITED NUMBER OF CUSTOMERS. For fiscal 1996, the Company's
five largest customers accounted for 54.5% of the Company's net sales. Sales
to Wal-Mart, Kmart and Toys "R" Us, the Company's three largest customers,
aggregated 45.2% of the Company's net sales during the same period. The
Company expects to continue to rely on a relatively small number of customers
for a significant percentage of sales for the foreseeable future. Because of
the large portion of the Company's sales to the Company's three largest
customers and the significant share of the market for toy sales to consumers
represented by these same customers, the loss of any one of them as a
customer, or a significant reduction in sales to any one of them, would have a
material adverse effect on the Company's financial condition and results of
operations. See "Business--Customers."

DEPENDENCE ON INDEPENDENT DESIGNERS; LICENSES AND OTHER PROPRIETARY
RIGHTS. For certain of its proprietary products, the Company is dependent on
concepts, technologies and other intellectual property rights licensed from
third parties, such as rights to trademarks. For each of these proprietary
products and product lines, the Company typically enters into a license
agreement with the owner of the intellectual property to permit the Company to
use the intellectual property. These license agreements typically provide for
royalty payments by the Company to the licensor based on the net sales of the
product incorporating the licensed property. For fiscal 1996, net sales of
products developed and sold under the Company's license agreements accounted
for 51.3% of the Company's net sales, including 9.9% of net sales of products
incorporating the Kawasaki(R) trademark. The Company's existing license
agreements generally have terms ranging from 2 to 15 years. The Company's
license agreement with Kawasaki Motors Corp., USA expires in December 1998.
There can be no assurance that the Company will be able to procure new license
agreements, renew existing license agreements (on commercially reasonable
terms, or at all), or that existing license agreements will not be terminated.
The Company's license agreements may contain restrictions on products
manufactured and permitted sales territories, and may give the licensor the
right to approve the manufacturer to be utilized by the Company to produce the
product. Certain of the Company's license agreements are non-exclusive.
Licenses that overlap the Company's licenses with respect to products,
geographic areas and markets have been and may continue to be granted to
competitors of the Company. See "Business--License Agreements."

In addition to rights licensed from third parties, the Company also relies
on a combination of design patent, copyright, trademark and trade secret
protection and non-disclosure agreements with employees to establish and
protect the proprietary rights that the Company has in its products. There can
be no assurance that the Company's competitors will not independently develop
or acquire proprietary technologies that are substantially equivalent or
superior to those of the Company. There also can be no assurance that the
measures adopted by the Company to protect its proprietary rights will be
adequate to do so. The ability of the Company's competitors to develop

or acquire technologies or other proprietary rights equivalent or superior to
those of the Company or the inability of the Company to enforce its
proprietary rights could have a material adverse effect on the Company.

The Company does not believe that any of its products infringe on the
proprietary rights of third parties in any material respect. There can be no
assurance, however, that third parties will not claim infringement by the
Company with respect to current or future products. Any such claim, with or
without merit, could be time-consuming, result in costly litigation, cause
product shipment delays or require the Company to enter into royalty or
licensing agreements. Such royalty or licensing agreements, if required, may
not be available on terms acceptable to the Company or at all, which could
have a material adverse effect on the business, results of operations and
financial condition of the Company.

INVENTORY MANAGEMENT. Most of the Company's largest retail customers utilize
an inventory management system to track sales of products and rely on reorders
being rapidly filled by the Company and other suppliers rather than
maintaining large product inventories. These types of systems put pressure on
suppliers like the Company to promptly fill customer orders and shift some of
the inventory risk from the retailer to suppliers. Production of excess
products by the Company to meet anticipated retailer demand could result in
price markdowns and increased inventory carrying costs for the Company.
Similarly, if the Company fails to predict consumer demand for a product, it
may not be able to deliver an adequate supply of products on a timely basis
and will, as a result, lose sales opportunities. See "Business--Distribution."

RETURNS AND MARKDOWNS. The Company historically has permitted certain
customers to return slow-moving items for credit or has provided price
protection by making any price reductions effective as to certain products
then held by retailers in inventory. The Company expects that it will continue
to be required to make such accommodations in the future. Any significant
increase in the amount of returns or markdowns could have a material adverse
effect on the Company's financial condition and results of operations. See
"Business--Sales and Marketing."

SEASONALITY AND QUARTERLY FLUCTUATIONS. The Company's sales are seasonal in
that a substantial portion of net sales is made to retailers in anticipation
of the Christmas holiday season. During fiscal 1996, 75.1% of the Company's
net sales were made during the Company's second and third fiscal quarters (May
through October) in connection with retail sales for the Christmas holiday
season. Adverse business or economic conditions during these periods may
adversely affect results of operations for the full year. As a result of the
seasonality of the Company's net sales, 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. The Company's financial results for a particular quarter
may not be indicative of results for an entire year, and the Company's
revenues and/or expenses will vary from quarter to quarter. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Seasonality" and "Business--Seasonal Patterns."

RELIANCE ON MANUFACTURERS BASED IN HONG KONG AND CHINA; TRADE RELATIONS. To
date, most of the Company's products have been manufactured by Hong Kong
manufacturers at facilities located in the Peoples' Republic of China (the
"PRC"). According to reports published by the Toy Manufacturers Association
("TMA"), an industry trade group, the PRC is the world's largest producer of
toys. The Company does not have any long-term contracts with its
manufacturers. There is still some uncertainty surrounding the June 1997
political and economic consolidation of Hong Kong with the PRC and the extent
to which such consolidation could disrupt business in Hong Kong or in the PRC.
In the event of any such disruption or other political or economic change in
Hong Kong or the PRC affecting the Company's business, the Company would be
required to seek alternate manufacturing sources. The Company currently does
not have in place plans or arrangements for securing alternate manufacturing
sources in the event that its present relationships with manufacturers prove
impracticable to maintain, and there can be no assurance that there would be
sufficient alternative facilities to meet the increased demand for production
that would likely result from a disruption of manufacturing operations in the
PRC. Furthermore, such a shift to alternate facilities would likely result in
increased manufacturing costs and could subject the Company's products to
increased duties, tariffs or other restrictions. During fiscal 1996,

three manufacturers accounted for approximately 56% of the Company's purchases
of products. The loss of any one of these manufacturers, or a substantial
interruption of the Company's manufacturing arrangements with any one of these
manufacturers, could cause a delay in production of the Company's products for
delivery to its customers and could have a material adverse effect on the
Company. While the Company believes that alternate manufacturers exist, there
can be no assurance that alternate arrangements could be provided in a timely
manner or on terms acceptable to the Company. See "Business--Manufacturing"
and "Business--Tariffs and Duties."

Currently, the PRC has Most Favored Nation ("MFN") trade status. As such,
most toys imported into the United States from the PRC are not subject to
import duties. Recently, however, the United States and the PRC have at times
been at odds over trade policies. There can be no assurance that in the future
trade relations between the United States and the PRC will not deteriorate or
that the MFN status of the PRC will not be altered or revoked such that, as a
result, the United States would impose duties or other trade sanctions that
would affect the cost of toys imported from the PRC. The imposition of such
duties could have a material adverse effect on the Company. See "Business--
Tariffs and Duties."

GENERAL RISKS OF FOREIGN OPERATIONS. Foreign operations are generally
subject to risks such as transportation delays and interruptions, political
and economic disruptions, the imposition of tariffs and import and export
controls, difficulties in staffing and managing foreign operations, longer
payment cycles, problems in collecting accounts receivable, changes in
governmental policies, restrictions on the transfer of funds, currency
fluctuations and potentially adverse tax consequences. While the Company to
date has not experienced any material adverse effects due to its foreign
operations, there can be no assurance that such events will not occur in the
future. Any growth of the Company's international operations will subject the
Company to greater exposure to risks of foreign operations. The occurrence of
such an event, particularly one affecting the Company's relations with its
manufacturers in the PRC, would have a material adverse effect on the Company.

RISKS ASSOCIATED WITH GROWTH. Between fiscal 1993 and fiscal 1996, the
Company has experienced continuous growth in net sales. There can be no
assurance that such growth will continue or that the Company will be able to
maintain its present level of net sales or profitability. Furthermore, future
growth, if achieved, might place a strain on the Company's management and
financial control systems, and there can be no assurance that management of
the Company would be able to manage such growth effectively. Failure to manage
any future growth experienced by the Company could have a material adverse
effect on the Company.

RELIANCE ON KEY PERSONNEL. The Company's future success will be dependent on
the continued efforts of Richard Neitz, the Company's current President and
Chief Operating Officer, and Yau Wing Kong ("Tommy Yau"), Managing Director of
DSI(HK). The Company has entered into employment and non-competition
agreements with Mr. Neitz and Mr. Yau. The loss of the services of one or both
of such individuals could have a material adverse effect on the Company. The
Company does not maintain key man insurance on the lives of either of these
individuals. The Company's success is also dependent on the Company's ability
to attract and/or retain key managerial, sales, marketing, product development
and other personnel. There can be no assurance that the Company will be
successful in attracting and/or retaining such personnel. See "Management."

PRODUCT SAFETY AND LIABILITY; REGULATION. Products that have been or may be
developed or sold by the Company may expose the Company to potential liability
from personal injury or property damage claims by end-users of such products.
The Company has never been and is not presently a defendant in any product
liability lawsuit; however, there can be no assurance that such a suit will
not be brought in the future against the Company. The Company currently
maintains product liability insurance coverage in the amount of $1.0 million
per occurrence, with a $6.0 million excess product liability policy. There can
be no assurance that the Company will be able to maintain such coverage or
obtain additional coverage on acceptable terms, or that such insurance will
provide adequate coverage against all potential claims. Moreover, even if the
Company maintains adequate insurance, any successful claim could materially
and adversely affect the reputation and prospects of the Company, as well as
divert management time. The United States Consumer Products Safety Commission
(the

"CPSC") has the authority under certain federal laws and regulations to
protect consumers from hazardous goods. The CPSC may exclude from the market
goods it determines are hazardous, and may require a manufacturer to
repurchase such goods under certain circumstances. Some state, local and
foreign governments have similar laws and regulations. In the event that such
laws or regulations change or the Company is found in the future to have
violated any such law or regulation, the sale of the relevant product could be
prohibited and the Company could be required to repurchase such products. See
"Business--Government and Industry Regulation."

COMPETITION. The toy industry is highly competitive. Many of the Company's
competitors have longer operating histories, broader product lines and greater
financial resources and advertising budgets than the Company. In addition, the
toy industry has nominal barriers to entry. Competition is based primarily on
the ability to design and develop new toys, procure licenses for popular
products, characters and trademarks, and successfully market products. Many of
the Company's competitors offer similar products or alternatives to the
Company's products. The Company's products compete with other products for
retail shelf space. There can be no assurance that shelf space in retail
stores will continue to be available to support the Company's existing
products or any expansion of the Company's products and product lines. There
can be no assurance that the Company will be able to continue to compete
effectively in this marketplace. See "Business--Competition."

CONTROL BY CURRENT MANAGEMENT. Immediately following the completion of the
Offering, the directors and officers of the Company and their affiliates will
beneficially own, or have the right to vote, in the aggregate approximately
36.4% of the outstanding Common Stock (35.4% if the Underwriters' over-
allotment is exercised in full). As a result of such persons' ownership and/or
control of Common Stock and their directorship and management positions, they
will have significant influence over all matters requiring approval by the
shareholders of the Company, including the election of directors. See
"Management" and "Principal and Selling Shareholders."

DILUTION. Purchasers of shares of Common Stock in the Offering will
experience immediate and substantial dilution of $7.82 per share in the net
tangible book value per share of Common Stock from the assumed initial public
offering price of $10.00 (the midpoint of the range of the anticipated initial
public offering price). See "Dilution."

ABSENCE OF PUBLIC MARKET AND POSSIBLE VOLATILITY OF STOCK PRICE. Prior to
this Offering, there has been no public market for the Common Stock. Although
the Common Stock has been approved for listing in the Nasdaq National Market,
subject to official notice of issuance, there can be no assurance that an
active market for the Common Stock will develop or be sustained following this
Offering. The initial public offering price for the shares of Common Stock
offered hereby was determined through negotiation between the Underwriters and
the Company and does not necessarily reflect the market price for the Common
Stock following this Offering. The market price of the Common Stock may be
highly volatile and could be subject to wide fluctuations in response to
quarterly variations in operating results, announcements of new products by
the Company or its competitors, changes in financial estimates by securities
analysts, or other events or factors. In the event that the Company's
operating results are below the expectations of public market analysts and
investors in one or more future quarters, it is likely that the price of the
Common Stock will be materially adversely affected. General market
fluctuations may adversely affect the market price of the Common Stock. See
"Underwriting."

SHARES ELIGIBLE FOR FUTURE SALE. Sales of substantial amounts of Common
Stock in the public market following the Offering could adversely affect the
market price for the Common Stock. In general, the 3,000,000 shares offered
hereby will be eligible for immediate sale in the public market without
restriction. Beginning 180 days after the date of this Prospectus (or earlier
upon consent of the Representatives of the Underwriters), 3,000,000 shares of
Common Stock will be available for immediate sale in the public market upon
the expiration of certain stock transfer restriction agreements with the
Underwriters. The sale of all such shares will be subject to the volume
limitations and other restrictions of Rule 144 of the Securities Act of 1933,
as amended (the "Securities Act"). In addition, the Selling Shareholder and
the holders of warrants issued to Hibernia

Corporation and the Representatives have the right to demand that the Company
file a registration statement under the Securities Act covering the sale of
all or any part of their Common Stock holdings. See "Description of Capital
Stock--Registration Rights," "Shares Eligible for Future Sale" and
"Underwriting."

POTENTIAL ADVERSE IMPACT OF ANTI-TAKEOVER PROVISIONS. The Company's Articles
of Incorporation and Bylaws (and the provisions of the Texas Business
Corporation Act) contain provisions that may have the effect of delaying,
deterring or preventing a change in control or an acquisition of the Company,
even though such an attempt might be economically beneficial to the holders of
Common Stock. Such provisions may have an adverse effect from time to time on
the price of the Common Stock. Such provisions authorize, among other things,
the issuance of shares of preferred stock, with respect to which the Board of
Directors has the power to fix the rights, preferences, privileges and
restrictions without any further vote or action of the shareholders. See
"Description of Capital Stock."

THE RECAPITALIZATION

In December 1995, a series of transactions (the "Recapitalization") was
consummated between the then sole shareholder of the Company, Tommy Moss, and
Rosie Acquisition Company, L.L.C. ("RAC"), an entity controlled by M. D.
Davis, Barry B. Conrad, Jack R. Crosby and Joseph N. Matlock, whereby RAC
acquired a controlling interest in the Company. Pursuant to the
Recapitalization, (i) the Company repurchased from Mr. Moss 2,719,000 shares
(77.7%) of Common Stock for $22.2 million ($8.15 per share) and (ii) RAC
acquired 2,719,000 shares of newly issued Common Stock from the Company for
$3.8 million (approximately $1.40 per share). The purchase price for
Mr. Moss's shares consisted of (i) $14.4 million of cash funded by (a) $6.0
million of proceeds from a new five year term loan with Bank One, Texas, N.A.
(the "Bank One Loan"), (b) $3.0 million of proceeds from a new five year
subordinated term loan with Hibernia Corporation (the "Hibernia Loan"), (c)
$3.8 million from the proceeds of the sale of Common Stock to RAC and (d) $1.6
million from an advance under the Company's existing revolving credit facility
with Bank One, Texas, N.A. (the "Revolver"), (ii) two notes issued by the
Company to Mr. Moss in the respective principal amounts of $6.0 million (the
"Moss Note") and $1.3 million, including the grant of a warrant to Mr. Moss to
purchase 700 million shares of Common Stock at $.001 per share, exercisable in
the event of a payment default (which warrant will terminate upon repayment of
the notes with a portion of the net proceeds from this Offering), and (iii)
the conveyance to Mr. Moss of two tracts of land which had a book value of
approximately $452,000. The obligation of the Company under the $1.3 million
term note issued to Mr. Moss was offset against a $1.3 million term note
issued by Mr. Moss to the Company evidencing the obligation of Mr. Moss to
repay advances previously made by the Company to Mr. Moss. For a description
of the terms of the outstanding notes, see "Use of Proceeds." In connection
with the subordinated term loan, the Company issued to Hibernia Corporation
warrants to purchase an aggregate of 388,888 shares of Common Stock at an
exercise price of $2.00 per share. See "Description of Capital Stock--
Warrants." The difference between the amount paid by RAC to the Company and
the amount paid to Mr. Moss by the Company is due to the fact that, following
the purchase of Mr. Moss's shares, the Company had additional indebtedness of
approximately $17.9 million and a reduced net worth resulting from such
additional indebtedness and the payment of transaction expenses of $1.9
million.

In connection with the Recapitalization, the Company entered into a
consulting agreement with Mr. Moss, pursuant to which Mr. Moss was to serve as
a consultant to the Company for three years in exchange for compensation in
the amount of $300,000 per year. The consulting agreement also required the
Company to maintain health and disability insurance policies for the benefit
of Mr. Moss for the term of his life. Pursuant to the consulting agreement,
the Company agreed to maintain Mr. Moss's office space for his use for the
term of the consulting agreement and to provide to Mr. Moss for 180 days the
services of certain Company employees for his outside business, provided that
such services did not exceed 30% of the time of each of such employees. This
agreement terminated upon Mr. Moss's death on November 19, 1996. In addition,
the Company issued a $1.0 million note to Mr. Moss (the "Moss Bonus Note") on
January 3, 1996.

In connection with services rendered by Mr. Matlock relating to the
Recapitalization, the Company agreed to pay Mr. Matlock the sum of $240,000 in
three equal payments due on January 1, 1996, 1997 and 1998. See "Certain
Transactions." As compensation for services provided by Conrad/Collins
Merchant Banking Group Ltd. ("MBG") in connection with the Recapitalization,
the Company paid MBG a fee of $400,000 and repaid its out-of-pocket expenses
in the amount of approximately $15,000.

RAC was formed in connection with the Recapitalization by Messrs. Davis,
Conrad, Crosby and Matlock who, prior to the Recapitalization, had no
relationship with the Company. These four individuals (or entities controlled
by such individuals) collectively hold approximately 61% of the membership
interests in RAC. The remaining membership interests are held primarily by
employees of the Company. Messrs. Davis, Conrad, Crosby and Matlock were
elected as directors of the Company following the Recapitalization.
In connection with the sale of the shares of Common Stock pursuant to this
offering, RAC will be dissolved and the 2,719,000 shares of Common Stock held
by RAC will be distributed to the members of RAC. See "Principal and Selling
Shareholders" and "Shares Eligible for Future Sale."

USE OF PROCEEDS

The net proceeds to the Company from the sale of 2,500,000 shares of Common
Stock offered hereby, assuming an initial offering price of $10.00 per share
(the midpoint of the range of the anticipated initial offering price), are
expected to be approximately $22.5 million ($23.0 million if the Underwriters'
over-allotment option is exercised in full) after deducting underwriting
discounts and commissions and estimated offering expenses, including a fee of
$100,000 payable to MBG for financial advisory services. See "Certain
Transactions--Financial Advisory Fee." The Company intends to use such net
proceeds as follows:

APPROXIMATE AMOUNT
------------------
(IN MILLIONS)

Repayment of Bank One Loan .................................. $4.8
Reduction of indebtedness under Revolver..................... 6.0
Repayment of Hibernia Loan................................... 1.6
Repayment of Moss Note....................................... 6.1
Repayment of Moss Bonus Note................................. 1.0
Working capital and general purposes......................... 3.0
-----
Total.................................................... $22.5
=====

From time to time the Company may examine potential opportunities to acquire
companies engaged in the toy business. The Company currently has no plans to
make any such acquisitions. Pending use of the net offering proceeds, the
Company will invest the proceeds in short-term, investment grade, interest-
bearing securities.

At January 31, 1997, the Company's outstanding indebtedness under the Bank
One Loan was $5.0 million. The outstanding indebtedness under the Bank One
Loan bears interest at a rate per annum equal to the prime rate of Bank One,
Texas, N.A. ("Bank One") plus 1%, which at March 31, 1997 was 9.5%. The
principal of the Bank One Loan is payable in quarterly installments of
$250,000 with a final maturity on December 11, 2000. Repayment of the Bank One
Loan is secured by a lien on all the Company's assets, 65% of the stock of
DSI(HK) held by the Company, and the shares of Common Stock held by RAC. The
Company intends to use a portion of the net proceeds of the Offering to repay
all outstanding indebtedness under the Bank One Loan. The terms of the Bank
One Loan do not include any prepayment penalties.

At January 31, 1997, the Company's outstanding indebtedness under the
Revolver was $3.1 million. The Company anticipates that the amount of
outstanding indebtedness at the date of closing of the Offering will be
approximately $6.0 million. The advances under the Revolver have been used by
the Company to provide working capital, including $3.0 million which was used
to pay outstanding indebtedness to Mr. Moss and certain expenses incurred in
connection with the Recapitalization. The outstanding indebtedness under the
Revolver bears interest at a rate per annum equal to Bank One's prime rate
plus 0.75% and is repayable on May 31, 1998. At March 31, 1997, the
outstanding indebtedness accrued interest at the rate of 9.25%. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."

At January 31, 1997, the Company's outstanding indebtedness under the
Hibernia Loan was $1.5 million. The outstanding indebtedness under the
Hibernia Loan bears interest at 13% per annum. The principal of the Hibernia
Loan is payable in quarterly installments of $75,000 and a final maturity on
January 31, 2002. Repayment of principal prior to the scheduled date of
repayment requires a prepayment penalty of 4% of any principal amount prepaid
prior to January 31, 1998 and 3% of any principal amount prepaid thereafter.
The Hibernia Loan is secured by a subordinated lien on all the Company's
assets and is subordinated to the Bank One Loan and the Revolver. For more
information regarding the Bank One Loan, the Moss Note and the Hibernia Loan,
see "The Recapitalization" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources."

At January 31, 1997, the Company's outstanding indebtedness under the Moss
Note was $6.0 million. The outstanding indebtedness under the Moss Note
currently bears interest at the rate of 12% per annum. The

principal due under the Moss Note is payable in $1.0 million annual
installments beginning on March 31, 1998, with an additional $1.0 million
installment due December 31, 2000, with the full amount of outstanding
principal and accrued unpaid interest due upon the earlier of the third
business day after the closing of the Company's initial public offering or
March 31, 2001.

At January 31, 1997, the Company's outstanding indebtedness under the Moss
Bonus Note was $1.0 million. The outstanding indebtedness under the Moss Bonus
Note currently bears interest at the rate of 12% per annum. The principal of
the Moss Bonus Note is payable on the earlier to occur of the third business
day after the closing of the Company's initial public offering or May 31,
1997.

The Company will not receive any proceeds from the sale of shares of Common
Stock by the Selling Shareholder. In the event the Underwriters' over-
allotment option is exercised in full, the Company will not receive any
proceeds from the sale of shares by Hibernia Corporation, but will receive
$300,000 upon exercise of the warrants related to such shares.

DIVIDEND POLICY

The Company has never declared or paid a cash dividend on the Common Stock.
The Company currently intends to retain any earnings for use in the operation
and expansion of its business and does not anticipate declaring or paying any
cash dividends in the foreseeable future. In deciding whether or not to
declare or pay dividends in the future, the Board of Directors will consider
all relevant factors, including the Company's earnings, working capital, and
capital expenditure requirements, any restrictions contained in any financing
or other agreements the Company may enter into in the future, and general
business conditions. Under the terms of the Revolver, the Company cannot pay
dividends on the Common Stock without the written consent of Bank One.

DILUTION

Purchasers of the shares of Common Stock offered hereby will experience an
immediate and substantial dilution in the net tangible book value per share of
their Common Stock from the initial offering price. As of January 31, 1997,
the net tangible deficit of the Common Stock was $9.4 million or $2.69 per
share. Net tangible deficit per share represents the amount of total tangible
assets less total liabilities, divided by the number of shares of Common Stock
outstanding. Assuming no changes in the net tangible deficit after January 31,
1997, other than to give effect to the sale by the Company of 2,500,000 shares
of Common Stock offered hereby at an assumed initial offering price of $10.00
per share (the midpoint of the range of the anticipated initial offering
price) and after deducting underwriting discounts and estimated offering
expenses payable by the Company, the pro forma net tangible book value of the
Company as of January 31, 1997 would have been $13.1 million, or $2.18 per
share ($2.20 per share assuming the Underwriters' over-allotment option is
exercised in full), representing an immediate increase in net tangible book
value per share of $4.87 to existing shareholders and an immediate dilution of
$7.82 per share to new investors purchasing shares of Common Stock in the
Offering. The following table illustrates this per share dilution:

Assumed initial offering price per share................. $10.00
------
Net tangible deficit per share before the Offering....... $(2.69)
Increase per share attributable to sale of shares to new
investors............................................... 4.87
------
Net tangible book value per share after the Offering..... 2.18
------
Dilution per share to new investors...................... $ 7.82
======

The following table sets forth as of January 31, 1997, the number of shares
of Common Stock purchased or to be purchased from the Company, the total
effective cash consideration paid or to be paid to the Company, and the
average price per share paid by existing shareholders and by new investors
purchasing shares sold by the Company in the Offering at an assumed initial
offering price of $10.00 per share.

SHARES PURCHASED(1) TOTAL CONSIDERATION
----------------------------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
----------- --------------------- ------- -------------

Existing shareholders
(1).................... 3,500,000 58.3% $ 3,802,500 13.2% $ 1.09
New investors........... 2,500,000 41.7% 25,000,000 86.8 $10.00
----------- ------- ----------- -----
Total................. 6,000,000 100.0% $28,802,500 100.0%
=========== ======= =========== =====

- --------
(1) Excludes 388,888 shares of Common Stock issuable upon exercise of warrants
issued to Hibernia Corporation at an exercise price of $2.00 per share and
250,000 shares issuable upon exercise of the Representatives' Warrants.
See "Principal and Selling Shareholders," "Description of Capital Stock"
and "Underwriting."

CAPITALIZATION

The following table sets forth the short-term debt and capitalization of the
Company as of January 31, 1997, on a historical basis and as adjusted to give
effect to the sale by the Company of 2,500,000 shares of Common Stock offered
hereby and the application of the estimated net proceeds therefrom:

JANUARY 31, 1997
-------------------
AS
HISTORICAL ADJUSTED
---------- --------
(IN THOUSANDS)

Short-term debt:
State Street revolving bank loan.......................... $ 485 $ 485
Bank One Loan............................................. 1,000 --
Hibernia Loan, net of $29,000 discount.................... 271 --
Moss Note................................................. 1,000 --
------- -------
Total short-term debt.................................... $ 2,756 $ 485
======= =======
Long-term debt (net of current maturities):
Revolver(1)............................................... $ 3,055 $ --
Bank One Loan............................................. 4,000 --
Hibernia Loan, net of $52,000 discount.................... 1,148 --
Moss Note................................................. 5,000 --
Moss Bonus Note........................................... 1,000 --
------- -------
Total long-term debt..................................... 14,203 --
------- -------
Shareholders' equity:
Preferred stock, $0.01 par value, 5,000,000 shares
authorized;
none issued.............................................. -- --
Common stock, $0.01 par value; 20,000,000 shares autho-
rized;
Issued: 6,219,000, actual; 8,719,000, as adjusted
Outstanding: 3,500,000, actual; 6,000,000, as adjusted
(2)...................................................... 62 87
Additional paid-in capital................................ 3,443 25,923
Common stock warrants..................................... 100 100
Retained earnings......................................... 9,624 9,624
Cumulative translation adjustment......................... 9 9
Less--Treasury stock, 2,719,000 shares, at cost........... (22,660) (22,660)
------- -------
Total shareholders' equity (deficit)..................... (9,422) 13,083
------- -------
Total capitalization.................................... $ 4,781 $13,083
======= =======

- --------
(1) The Company anticipates that the amount of outstanding indebtedness under
the Revolver at the date of closing of the Offering will be approximately
$6.0 million, of which the Company intends to repay the full amount using
net proceeds of the Offering.
(2) Excludes (i) 600,000 shares of Common Stock reserved for issuance under
the Company's 1997 Stock Option Plan, of which options covering 90,000
shares will be outstanding after the Offering and (ii) 638,888 shares of
Common Stock issuable upon exercise of warrants to be outstanding after
the Offering. See "Management--1997 Stock Option Plan," "Description of
Capital Stock" and "Underwriting."

SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

The following selected consolidated statement of income and balance sheet
data have been derived from the Company's consolidated financial statements
which have been audited by Price Waterhouse LLP. The selected consolidated
financial data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the
Consolidated Financial Statements and related notes included elsewhere in this
Prospectus.

FISCAL YEAR
-------------------------------------------
1992 1993 1994 1995 1996
------- ------- ------- ------- -------

STATEMENT OF INCOME DATA:
Net sales.................... $36,576 $36,734 $45,219 $63,146 $63,219
Cost of goods sold........... 29,092 30,122 33,614 43,428 42,023
------- ------- ------- ------- -------
Gross profit................. 7,484 6,612 11,605 19,718 21,196
Selling, general and
administrative expenses..... 4,524 5,680 7,910 14,625 15,569
Former sole shareholder bonus
(1)......................... 1,380 347 2,000 1,000 --
------- ------- ------- ------- -------
Operating income............. 1,580 585 1,695 4,093 5,627
Interest expense............. 226 147 333 701 2,600
Other income................. (28) (88) (111) (384) (344)
------- ------- ------- ------- -------
Income before income taxes... 1,382 526 1,473 3,776 3,371
Provision for income taxes... 475 164 504 1,449 1,220
------- ------- ------- ------- -------
Net income................... $ 907 $ 362 $ 969 $ 2,327 $ 2,151
======= ======= ======= ======= =======
Earnings per share (2)....... $ 0.26 $ 0.10 $ 0.28 $ 0.66 $ 0.58
Weighted average shares
outstanding(2).............. 3,500 3,500 3,500 3,500 3,739
Supplemental earnings per
share (3)................... $ 0.59

END OF FISCAL YEAR
------------------------------------------------
1992 1993 1994 1995 1996
------- ------- ------- ------- -------

BALANCE SHEET DATA:
Working capital (deficit).... $ 2,093 $ 1,569 $ 2,121 $ 3,510 $ 2,621
Property and equipment, net.. 1,513 425 2,336 1,514 1,190
Total assets................. 8,349 7,460 10,389 17,390 16,304
Long-term debt (less current
portion).................... -- -- 17 18,188 14,203
Shareholders' equity (defi-
cit)........................ 3,817 4,179 5,147 (11,582) (9,422)

- --------
(1) Consists of bonus paid to the Company's former sole shareholder. Bonuses
paid to other officers and employees are included in selling, general and
administrative expenses. See "Management--Bonuses."
(2) Earnings per share is calculated using the weighted average number of
common and dilutive common equivalent shares outstanding during the
period.
(3) Supplemental earnings per share is based on (i) the number of shares of
Common Stock assumed to be outstanding after the Offering of 5,878,000
shares at the end of fiscal 1996 (based on 2,139,000 shares to be sold at
the assumed initial public offering price necessary to raise sufficient
net proceeds, after paying underwriting discounts and commissions and
proportionate estimated offering expenses, to repay certain indebtedness
of the Company as described in "Use of Proceeds") and (ii) net income
increased by the effect of interest expense ($2,014,000), net of tax
($725,000), related to the indebtedness to be repaid.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The following Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with the Company's
Consolidated Financial Statements and the related notes appearing elsewhere in
this Prospectus.

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) girls' toys, including dolls,
play sets and accessories; and (iii) boys' toys, including radio control
vehicles, action figures and western and military action toys. Sales of
products in these categories accounted for approximately 49.5%, 40.9% and
6.0%, respectively, of the Company's net sales during fiscal 1996.
Historically, the Company's sales have been made primarily to customers based
in the United States, although its international net sales accounted for
approximately 18.6% of the Company's net sales during fiscal 1996. All the
Company's international sales are denominated in United States dollars.
Accordingly, the Company currently is not subject to exchange rate risk with
respect to international sales. FOB Asia sales accounted for 75.6%, 56.1% and
55.8% of the Company's net sales for fiscal 1994, fiscal 1995 and fiscal 1996,
respectively. Products sold FOB Asia are shipped directly to customers from
the factory and are not carried by the Company in inventory.

On December 11, 1995, in connection with the Recapitalization, the Company
repurchased 77.7% of the then outstanding Common Stock from Tommy Moss and
issued 2,719,000 shares of Common Stock to RAC for consideration of $3.8
million. The Recapitalization resulted in the incurrence of an aggregate of
$17.9 million of additional indebtedness and $1.9 million of expenses and a
reduction in the Company's net worth. Approximately $19.5 million of the net
proceeds of the Offering will be used to reduce the indebtedness incurred by
the Company, including indebtedness incurred in connection with the
Recapitalization. See "The Recapitalization" and "Use of Proceeds."

In the past, a significant part of the Company's profits has been
distributed as a bonus to the Company's former sole shareholder. The Company
will not distribute profits in this manner in the future. The Company has
entered into employment agreements with three executive officers, pursuant to
which the Company will pay performance bonuses based on the Company's
profitability if the Company's operations generate a specified level of
income. If paid, these bonuses will be included in selling, general and
administrative expenses. See "Management--Bonuses." The Company expects
general and administrative expenses in future periods to increase due to an
increase in salary expense relating to the recent hiring of new management
personnel and the incurrence of additional expenses associated with operating
as a public company.

The Company expects that the amounts it expends for advertising will
increase in connection with its greater emphasis on the development of
proprietary products. 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
----------------------
FISCAL YEAR
----------------------
1994 1995 1996
----- ----- -----

Net sales................................... 100.0% 100.0% 100.0%
Cost of goods sold.......................... 74.3 68.8 66.5
----- ----- -----
Gross profit................................ 25.7 31.2 33.5
Selling, general and ad-
ministrative expenses...................... 17.5 23.1 24.6
Former sole shareholder
bonus...................................... 4.4 1.6 --
Interest expense (net)...................... 0.7 1.1 4.1
Other income................................ (0.2) (0.6) (0.5)
----- ----- -----
Income before income
taxes...................................... 3.3 6.0 5.3
Provision for income
taxes...................................... 1.2 2.3 1.9
----- ----- -----
Net income.................................. 2.1% 3.7% 3.4%
===== ===== =====

FISCAL YEAR 1996 COMPARED TO FISCAL YEAR 1995

Net sales. Net sales increased $73,000, or 0.1%, to $63.2 million during
fiscal 1996, from $63.1 million during fiscal 1995.

Net sales of juvenile audio products increased $2.1 million, or 7.0%, to
$31.3 million during fiscal 1996, from $29.2 million during fiscal 1995. Net
sales of girls' toys increased $4.6 million, or 21.7%, to $25.8 million during
fiscal 1996, from $21.2 million during fiscal 1995. During fiscal 1996, the
Company introduced a new doll, Pattie(TM), which generated $11.8 million of
net sales during fiscal 1996. These new sales were partially offset by a
decline in sales of the Rosie(R) doll. The net sales increases in the juvenile
audio and girls' toys categories were mostly offset by a decrease in net sales
of boys' toys of $4.7 million, or 55.3%, to $3.8 million during fiscal 1996,
from $8.5 million during fiscal 1995. Net sales of boys' toys decreased
primarily as a result of a decline in popularity of action figures and toy
tool sets. Net sales of products in other categories decreased $1.9 million,
or 45.2%, to $2.3 million during fiscal 1996, from $4.2 million during fiscal
1995.

International net sales increased $739,000, or 6.7%, to $11.8 million for
fiscal 1996 from $11.0 million in fiscal 1995. International net sales
increased as a percentage of total net sales to 18.6% for fiscal 1996 from
17.5% for fiscal 1995.

Gross Profit. Gross profit was 33.5% of net sales during fiscal 1996,
compared to 31.2% during fiscal 1995. During fiscal 1996, gross profit
increased $1.5 million primarily due to (i) increased sales of proprietary
products, which generally have higher gross margins, and (ii) lower shipping
costs.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses were approximately $15.6 million, or 24.6% of net
sales, during fiscal 1996, compared to approximately $14.6 million, or 23.1%
of net sales, during fiscal 1995. The increase in expenses resulted
principally from an increase of approximately $2.9 million in advertising
costs related to the introduction of the Pattie(TM) doll during fiscal 1996.
The increase in advertising costs was partially offset by a decrease in
professional and consulting fees. The Company incurred approximately $1.9
million of selling, general and administrative expenses during fiscal 1995 in
connection with the Recapitalization.

Former Sole Shareholder Bonus. Former sole shareholder bonus decreased $1.0
million to $0.0 during fiscal 1996, from fiscal 1995.

Interest Expense. Interest expense increased $1.9 million, or 270.9%, to
$2.6 million during fiscal 1996 from $701,000 during fiscal 1995. This
increase was due primarily to the Recapitalization which ocurred in the fourth
quarter of fiscal 1995, which resulted in the incurrence of an aggregate of
$17.9 million of additional indebtedness. See "--General" and "The
Recapitalization."

Income Taxes. Provision for income taxes decreased $229,000, or 15.8%, to
$1.2 million during fiscal 1996 from $1.4 million during fiscal 1995. The
Company's effective income tax rate was 36.2% for fiscal 1996, compared to
38.4% for fiscal 1995. The decrease in the effective tax rate related
principally to certain nondeductible items and other matters relating to the
Recapitalization incurred in fiscal 1995.

Net Income. As result of the foregoing factors, net income decreased
$176,000, or 7.6% to $2.1 million during fiscal 1996 from $2.3 million during
fiscal 1995, and decreased as a percentage of net sales to 3.4% during fiscal
1996 from 3.7% during fiscal 1995.

FISCAL YEAR 1995 COMPARED TO FISCAL YEAR 1994

Net Sales. Net sales increased $17.9 million, or 39.6%, to $63.1 million
during fiscal 1995, from $45.2 million during fiscal 1994. This increase was
due primarily to (i) the introduction of the Rosie(R) doll during fiscal 1995,
(ii) an $8.7 million increase in net sales to Wal-Mart and (iii) the addition
of Target as a customer (accounting for $2.6 million in net sales during
fiscal 1995).

Net sales of juvenile audio products increased $7.3 million, or 33.3%, to
$29.2 million during fiscal 1995, from $21.9 million during fiscal 1994. This
increase was due primarily to increased sales of head set walkie talkies. Net
sales of girls' toys increased $19.4 million, or 1,055.4%, to $21.2 million
during fiscal 1995 from $1.8 million during fiscal 1994 due to sales of the
Rosie(R) doll. The net sales increases in the juvenile audio and girls' toy
categories were partially offset by a decline in net sales of boys' toys of
approximately $7.8 million, or 47.9%, to $8.5 million during fiscal 1995 from
$16.3 million during fiscal 1994. Net sales of boys' toys declined primarily
as a result of a decline in popularity of action figures and toy guns. Net
sales of products in other categories decreased $895,000, or 17.5%, to $4.2
million, during fiscal 1995, from $5.1 million during fiscal 1994.

International net sales increased $2.3 million, or 26.2%, to $11.0 million
during fiscal 1995, from $8.7 million in fiscal 1994. However, international
net sales declined as a percentage of total net sales to 17.5% during fiscal
1995 from 19.3% during fiscal 1994.

Gross Profit. Gross profit was 31.2% of net sales during fiscal 1995,
compared to 25.7% during fiscal 1994. During fiscal 1995, gross profit
increased due to (i) a $15.6 million increase in net sales of proprietary
toys, including the Rosie(R) doll, which generally have higher margins, (ii)
elimination of the United States customs duty rate applicable to most of the
Company's toys from the PRC (resulting in a $376,000 decrease in customs
duties), (iii) an $80,000 decrease in the costs associated with mock-up and
design (resulting from moving certain package design functions in-house) and
(iv) a slight decrease in depreciation associated with manufacturing and
tooling. The increase in gross profit was negatively impacted by increases in
the costs of freight, paper, plastic, computer chips and other materials
during fiscal 1995.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses were approximately $14.6 million, or 23.1% of net
sales, during fiscal 1995, compared to approximately $7.9 million, or 17.5% of
net sales during fiscal 1994. The increase in expenses resulted from (i) an
increase of approximately $3.1 million in advertising costs during fiscal 1995
related to the Company's television advertising campaign for the Rosie(R)
doll, (ii) the expenses of approximately $1.9 million incurred in connection
with the Recapitalization during fiscal 1995, (iii) the payment of $375,000 in
lawsuit settlements and (iv) other increased selling expenses, including
payroll-related costs, product insurance, and marketing and promotional
expenses.

Former Sole Shareholder Bonus. Former sole shareholder bonus decreased $1.0
million, or 50.0%, to $1.0 million during fiscal 1995 from $2.0 million during
fiscal 1994.

Interest Expense. Interest expense increased $368,000, or 110.7%, to
$701,000 during fiscal 1995, from $333,000 during fiscal 1994. The increase
was due principally to the Recapitalization which occurred in the fourth
quarter of fiscal 1995, which resulted in the incurrence of an aggregate of
$17.9 million of additional indebtedness. See "--General" and "The
Recapitalization."

Income Taxes. Provision for income taxes increased $946,000, or 187.6%, to
$1.4 million during fiscal 1995 from $504,000 during fiscal 1994. The
Company's effective tax rate was 38.4% for fiscal 1995, compared to 34.2% for
fiscal 1994. The increase in the effective tax rate related principally to
certain nondeductible items and other matters relating to the Recapitalization
incurred in fiscal 1995.

Net Income. As a result of the foregoing factors, net income increased $1.4
million, or 140.1%, to $2.3 million during fiscal 1995 from $969,000 during
fiscal 1994 and increased as a percentage of net sales to 3.7% during fiscal
1995 from 2.1% during fiscal 1994.

LIQUIDITY AND CAPITAL RESOURCES

The Company historically has funded its operations and capital requirements
from cash generated from operations and borrowings. The Company's primary
capital needs have consisted of acquisitions of inventory, funding accounts
receivable, obtaining letters of credit and capital expenditures for product
development. The Company's working capital at January 31, 1997 was
approximately $2.6 million and unrestricted cash was approximately $1.5
million.

The Company's operating activities provided net cash of $4.4 million during
fiscal 1996, consisting primarily of a net increase in deferred income taxes,
accounts payable and accrued liabilities and a decrease in accounts
receivable, partially offset by an increase in inventories. Net cash used in
investing activities during fiscal 1996 was $943,000, and consisted primarily
of capital expenditures for manufacturing molds and equipment and an increase
in shareholder insurance receivable and other assets. Net cash used by
financing activities was $4.6 million during fiscal 1996, and represented a
net repayment of the Company's borrowings.

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 ("State Street"), and the Revolver
with Bank One. Generally, the Company's factories provide open account credit
with terms ranging from net 7 days to net 20 days. During each of fiscal 1995
and 1996, approximately 69% of the Company's FOB Asia net sales was made to
customers that opened irrevocable letters of credit. This arrangement
obligates the bank which opened the letter of credit to pay the Company when
the finished product is delivered to the customer or the customer's freight
consolidator in Asia.

Under the Hong Kong Credit Facility, the Company may borrow up to 35% of the
stated value of a customer's letter of credit upon delivery of the letter of
credit, not to exceed $1.5 million for all letters of credit. The Company may
borrow up to 100% of the stated value of the letter of credit, up to the
available limit under the Hong Kong Credit Facility, when title passes to the
customer or the customer's freight consolidator. The letters of credit are
actually collected by State Street.

The Hong Kong Credit Facility is a $5.0 million line of credit facility with
State Street. Outstanding borrowings under the Hong Kong Credit Facility bear
interest at State Street's prime rate of interest. Each outstanding borrowing
under the line of credit is secured by a pledge of a letter of credit of like
amount issued to the Company by a customer. The Company has also pledged
$150,000 in cash as security for its obligations under the Hong Kong Credit
Facility. The Hong Kong Credit Facility is terminable by State Street in its
sole

discretion, at which time the Company's obligations to State Street will be
due and payable. In the event the Hong Kong Credit Facility is cancelled, the
Company would need to replace it with a substitute facility. There can be no
assurance the Company would be able to obtain such a substitute facility. As
of March 31, 1997, the Company had outstanding indebtedness under the Hong
Kong Credit Facility of $34,000, which accrued interest at 8.50%.

The Revolver is a revolving line of credit with Bank One under which the
Company may borrow up to the lesser of $9.0 million or its borrowing loan
limit. Under the terms of the Revolver, the Company's borrowing loan limit is
equal to (i) 80% of the Company's eligible accounts, plus (ii) 50% of the net
value of all the Company's inventory located in, or in transit, to the United
States, less (iii) principal amounts outstanding under the Revolver and the
Bank One Loan, less (iv) the amount of all outstanding letters of credit. As
of March 31, 1997, the borrowing loan limit calculated in this manner was $6.7
million. Borrowings under the Revolver bear interest at a fluctuating rate per
annum equal to Bank One's prime rate plus 0.75%. In addition, the Company is
required to pay a quarterly commitment fee equal to 0.25% of the average daily
undrawn amounts. The obligations of the Company under the Revolver are secured
by all the Company's United States accounts receivable, inventory, equipment,
general intangibles and fixtures and 65% of the capital stock of DSI(HK) held
by the Company. The Revolver contains various covenants, including, among
others, maintenance of a minimum defined net worth, restrictions on dividends,
and maintenance of certain financial ratios. The Revolver terminates on May
31, 1998, at which time all outstanding indebtedness is repayable in full. The
Company has received a commitment letter from Bank One which provides that the
termination date for the Revolver will be extended to May 31, 1999, upon the
completion of the Offering. As of March 31, 1997, the Company had outstanding
borrowings under the Revolver of approximately $5.8 million, which accrued
interest at 9.25% per annum.

The percentage of net sales represented by FOB Asia sales has decreased as
the Company has increased its sales of basic products (products carried on a
year-round basis) and has shifted its focus to sales of promoted products,
both of which have resulted in the Company carrying more Houston inventory and
related accounts receivable. To finance purchases of inventory and accounts
receivable, primarily during the peak selling season, the Company utilizes
borrowings under the Revolver and the Hong Kong Credit Facility. During fiscal
1996, the highest level of aggregate borrowings under the Revolver and the
Hong Kong Credit Facility was $9.9 million (on August 15, 1996).

The Company believes that available borrowings under the Revolver and the
Hong Kong Credit Facility, cash from operations and net proceeds from the
Offering to the Company 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. The Company has
budgeted approximately $850,000 for capital expenditures, consisting of
purchases of tools, molds, office equipment and furnishings, for fiscal 1997.
At March 31, 1997, the Company had an additional borrowing capacity of an
aggregate of $1.3 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 January 31, 1997, the Company was
required to make an aggregate of approximately $52,000 in payments of
guaranteed royalties under these licenses in fiscal 1997 and $180,000
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. As of the date of this
Prospectus, the Company has no present understanding or agreement with respect
to any acquisitions.

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 commit to their holiday season purchases during the first
two calendar quarters and those orders are 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.

The following table depicts the seasonality of the Company's net sales by
fiscal quarter for the 1994, 1995 and 1996 fiscal years:

NET SALES BY FISCAL QUARTER
--------------------------------------------------------
FISCAL 1994 FISCAL 1995 FISCAL 1996
------------------ ------------------ ------------------
FISCAL QUARTER AMOUNT PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE
- -------------- ------- ---------- ------- ---------- ------- ----------
(IN THOUSANDS EXCEPT PERCENTAGES)

First................. $ 3,225 7.1% $ 5,149 8.2% $ 5,856 9.3%
Second................ 18,004 39.8 19,314 30.6 18,097 28.6
Third................. 17,775 39.3 28,960 45.8 29,348 46.4
Fourth................ 6,215 13.8 9,723 15.4 9,918 15.7
------- ----- ------- ----- ------- -----
Total................ $45,219 100.0% $63,146 100.0% $63,219 100.0%
======= ===== ======= ===== ======= =====

INFLATION

The Company does not believe that the relatively moderate rates of inflation
in the United States in recent years have had a significant effect on its
operations. Although recent rates of inflation in the Asia have resulted in an
increase in the cost of manufacturing the Company's products, this increase in
costs has been partially offset by an increase in total product sales prices.
Thus, although increased costs have had a modest impact on margins, the
Company does not believe that inflation in Asia has had a materially adverse
effect on its operations.

RECENT ACCOUNTING PRONOUNCEMENTS

During the first quarter of fiscal 1995, the Company adopted Statement of
Financial Accounting Standard No. 121, Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to be Disposed Of ("SFAS 121"). The
adoption of SFAS 121 did not have any impact on the Company's financial
position or results of operations. Upon approval of the Company's 1997 Stock
Option Plan, the Company will adopt Statement of Financial Accounting Standard
No. 123, Accounting for Stock Based Compensation ("SFAS 123"). The Company
does not anticipate that the adoption of SFAS 123 will have any impact on its
financial position or results of operations. With the adoption of SFAS 123,
the Company will measure stock compensation costs using the intrinsic value
method prescribed by APB Opinion No. 25, Accounting for Stock Issued to
Employees, and will provide pro forma disclosures of net income and earnings
per share as if the fair value based method prescribed by SFAS 123 had been
applied in measuring compensation expense in its annual financial statements.

BUSINESS

GENERAL

The Company designs, develops, markets and distributes high quality, value-
priced 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) girls'
toys, including dolls, play sets and accessories; and (iii) boys' toys,
including radio control vehicles, action figures and western and military
action toys. Founded in 1970, the Company historically was principally a
supplier of non-proprietary toys to deep discount stores and regional drug
store chains. With the addition of new senior management personnel in 1990,
the Company began to market its expanding product line to major toy retailers
by emphasizing innovative packaging and developing in-house brands. Further,
in fiscal 1993, the Company began to emphasize the development and marketing
of proprietary products, consisting of toys developed by the Company
incorporating concepts licensed from outside inventors, products designed in-
house, products for which the Company owns the mold and products incorporating
well-known trademarks licensed to the Company. The Company introduced its
first television-promoted proprietary product, the Rosie(R) doll, in fiscal
1995. Rosie(R) ranked as the number two selling doll by dollar amount (and
number three by unit), in the large doll category during calendar 1995, as
measured by the Toy Retail Sales Tracking Service.

Traditionally a supplier of juvenile audio products and boys' toys, the
Company has diversified its product offerings over the last two fiscal years,
primarily through its expansion into the girls' toys category with the
introduction of the Rosie(R) doll in fiscal 1995 and the Pattie(TM) doll in
fiscal 1996. For fiscal 1997, the Company has introduced new products in its
three core categories, as well as a new children's action game, Hoppin'
Poppin' Spaceballs(TM). The Company seeks to enhance its position as a leading
supplier of high quality, value-priced toys and intends to continue developing
proprietary products, primarily through pursuing opportunities to license toy
concepts from outside inventors and to license recognized trademarks. The
Company believes that it offers its customers many value-priced products,
which the Company believes are lower-priced alternatives to comparable
products sold by other toy companies. The Company believes that this strategy
of offering lower priced products to its customers provides them with
opportunities to realize higher margins on sales of the Company's products as
compared to sales of products offered by other toy companies.

Since fiscal 1993, the Company's net sales have grown from $36.7 million to
$63.2 million (or 72%) for fiscal 1996, and net income has grown from $362,000
to $2.2 million (or 494%) during the same period. The Company believes that
this growth is attributable to several factors, including its ability to
identify new products with broad appeal and to rapidly develop and market
these products. The Company believes that its use of innovative packaging and
increased utilization of brand names have also contributed to its growth. The
Company offers several licensed products under the Kawasaki(R) brand name,
including a radio-controlled motorcycle, guitars, keyboards and a percussion
instrument. The Company also has developed and currently is marketing products
incorporating several in-house brand names, including Digi-Tech(TM) (walkie-
talkies), LA Rock(R) (musical toys and audio products), American Frontier(TM)
(western role play toys), Combat Force Rangers(TM) (military role play toys)
and My Music Maker(R) (musical toys and pre-school audio products). The
Company believes that its use of brand names to market its products has
increased name recognition of its products and contributed to the Company's
increase in net sales over the past four fiscal years. The Company believes
that it is the leading supplier of walkie-talkies to the top five United
States toy retailers.

The Company sells primarily to retailers, including mass merchandising
discounters such as Wal-Mart, Kmart and Target, specialty toy stores such as
Toys "R" Us, Kay-Bee Toy & Hobby and F.A.O. Schwarz, and deep discount stores
such as Family Dollar Stores, Inc., Consolidated Stores Corporation and Value
City Department Stores, Inc. Wal-Mart (19.5%), Kmart (13.7%) and Toys "R" Us
(12.0%) each accounted for more than 10% of the Company's net sales in fiscal
1996. Although the Company's sales have been made primarily to customers based
in the United States, international net sales accounted for approximately 19%
of the Company's net sales during fiscal 1996.

Approximately 56% of the Company's net sales (by dollar volume) were made
FOB Asia during fiscal 1996. Products sold FOB Asia are shipped directly to
customers from the factory and are not carried by the Company

in inventory, thereby improving working capital utilization. The Company also
maintains an inventory of certain products in its Houston, Texas facility,
principally to support sales by the Company's customers who offer such
products on a year-round basis. In addition, the Company's Houston facility
maintains inventory to support the Company's television-promoted proprietary
products.

INDUSTRY BACKGROUND

The TMA, which tracks toy industry data, reported that for 1996, total
domestic toy sales at the wholesale level, excluding video games, were
approximately $13.9 billion, up from $13.4 billion in 1995. Domestic toy sales
at the wholesale level, other than video games, have grown an average of 4.8%
per year since the beginning of 1992. According to TMA, the United States is
the world's largest market for toys, followed by Japan and Western Europe. The
Company believes that the international markets represent an opportunity for
future expansion.

According to TMA, the top five toy retailers in the United States are Toys
"R" Us, Wal-Mart, Kmart, Target and Kay-Bee Toy & Hobby. Collectively, these
retailers accounted for approximately 54.4% of the domestic market for retail
toy sales in 1995. The Company believes that the purchasing power of such
large, discount oriented retailers has required toy suppliers, including the
Company, to maintain competitive prices and to implement inventory control
methods in order to respond quickly to consumer demands.

STRATEGY

The Company seeks to enhance its position as a leading supplier of high
quality, value-priced toys. The key components of the Company's strategy to
achieve this goal are:

Expansion of Product Offerings. The Company plans to continue to
aggressively develop and market products in its three core categories, while
taking a more opportunistic approach with respect to development of products
outside its core categories. In furtherance of its strategy, in the girls' toy
category the Company has introduced Baby Pick Me Up(TM) and the Dreamie
Sweets(TM) line of dolls for fiscal 1997. In the juvenile audio category, the
Company recently introduced the Kawasaki(R) Air Guitar(TM) and the Kawasaki(R)
Big Bam Boom(TM) (an electronic percussion instrument), and in the boys' toys
category, the Company introduced the Kawasaki(R) Ninja(R) Supergyro(TM)
Motorcycle. The Company also has introduced its new children's action game,
Hoppin' Poppin' Spaceballs(TM), for sale in the Spring/Summer of 1997. The
Company intends to seek opportunities to acquire products, product lines and
businesses that are complementary to the Company's products and business.

Increased Emphasis on Proprietary Products. The Company intends to continue
to develop proprietary products, which include products (i) that are based on
concepts licensed from outside inventors (such as the Rosie(R) and Pattie(TM)
dolls), (ii) that incorporate trademarks licensed by the Company (such as
Kawasaki(R) guitars and keyboards), (iii) designed in-house or (iv) for which
the Company owns the mold to manufacture the toy (such as the American
Frontier(TM) line of western toy guns). Net sales of the Company's proprietary
products have increased from approximately $8.7 million in fiscal 1993 to
approximately $37.0 million in fiscal 1996. The Company believes that it has
an ability to quickly bring new toy concepts from the development stage to
market which, when successful, provides toy inventors with a royalty stream on
an expedited basis. As a result, toy inventors increasingly are approaching
the Company with innovative concepts, thus expanding the Company's access to
proprietary products. The Company plans to seek exclusive rights to market and
distribute toys licensed from toy inventors so that these toys, when
introduced, are unique in the marketplace. The Company also plans to pursue
trademark licensing opportunities with companies that have recognized names.
Consistent with its past practices, the Company plans to take an opportunistic
approach with respect to developing and marketing products based upon licenses
for entertainment characters.

Increased Utilization of Brands. The Company intends to continue to expand
its use of brands in marketing its toys. A key component of the Company's
strategy is to pursue attractive trademark licensing opportunities with
companies that have recognized brand names that can be incorporated into the
designs or

names of the Company's products. The Company currently licenses the
Kawasaki(R) brand name for use in the names and designs of toys modelled on
products that are not normally associated with the Kawasaki(R) name, such as
walkie-talkies, keyboards and toy musical instruments, as well as the new
Kawasaki(R) Ninja(R) Supergyro(TM) Motorcycle. The Company believes that the
Kawasaki(R) brand name is well-recognized by consumers of all ages and will
seek to continue to capitalize on this brand-recognition. The Company will
continue to seek opportunities to develop strategic relationships with other
companies with well-recognized brand names. The Company also plans to
introduce new products under its current in-house brand names and to develop
new brand names as it increases the diversity of its product offerings.
Current in-house brand names include Digi-Tech(TM), LA Rock(R), My Music
Maker(R), American Frontier(TM) and Combat Force Rangers(TM).

Emphasis on Marketing/Packaging and Pricepoint. The Company's innovative
packaging skills are an important element of its product marketing strategy.
The Company attempts to package products using eye-catching colors and
graphics, often using "try me" packaging that encourages consumers to try or
"self-demonstrate" a product still in its packaging. The Company believes that
such packaging often differentiates its products from its competitors'
products. The vast majority of the Company's products are priced at or below a
retail price of $20. The Company believes that its products generally offer
attractive, lower-priced alternatives to comparable products sold by other toy
companies.

Expansion of Distribution and Customer Base. The Company intends to seek
opportunities to increase sales to existing customers and to expand its
customer base in both the United States and international markets. In order to
generate additional sales to the Company's existing customers, the Company
will continue to emphasize new product offerings, product quality,
presentation and packaging, value pricing, product safety, and rapid and
accurate order fulfillment. The Company also believes that opportunities exist
for sales to additional retailers, international distributors and non-
traditional customers such as home television shopping networks. The Company
believes that television advertising will have a positive effect on sales to
its existing customers and will increase its opportunity to make sales to new
customers.

PRODUCTS

The Company's product philosophy is to provide high quality toys in
attractive and innovative packaging. The Company employs a value-pricing
concept, with the vast majority of its products priced at or below $20 retail.
The Company attempts to package products using eye-catching colors and
graphics, often using "try me" packaging that encourages consumers to try a
product still in its packaging. The following chart sets forth by category the
Company's major products:

CATEGORY/Lines REPRESENTATIVE PRODUCTS
-------------- ------------------------------------------------

GIRLS' TOYS
Dolls Rosie(R), a soft-body doll that sings the
children's song "Ring Around the Rosie" when
the doll's hands are held; available in 17
LOGO languages.
Rosie's Best Friend, Pattie(TM), a soft-body
doll that recites the children's rhyme "pattie-
cake" when her hands are clapped together;
LOGO available in four languages.
Baby Pick Me Up(TM), a soft-body doll that says,
"Pick me up, Mommy," laughs and giggles, and
LOGO asks to "Do it again." (New for fiscal 1997)
Dreamie Sweets(TM), a soft-body doll line
consisting of five separately-sold, 10-inch
dolls, each with a wand that lights up when her
LOGO hand is held. (New for fiscal 1997)
BOYS' TOYS
American Frontier(TM), a brand of western toy
Western Toys guns and play sets.
Combat Force Rangers(TM), a brand of military
Military Toys LOGO toy guns and play sets.
Real Tech(R), a brand of battery operated light
Fantasy Space Guns and sound space guns.
Radio Control Vehicles Kawasaki(R) Ninja(R) Supergyro(TM) Motorcycle, a
radio-controlled motorcycle that uses unique
gyroscope technology for stability. (New for
LOGO fiscal 1997)
JUVENILE AUDIO
PRODUCTS
Walkie-Talkies Digi-Tech(TM), Escort(R), Kawasaki(R) and Combat
Force Rangers(TM), brands of hand-held and
headset units, base station units and other
LOGO models.
Musical Toys Kawasaki(R) Power Chords(TM), a battery-operated
LOGO guitar.
My Music Maker(R) battery-operated keyboards.
Kawasaki(R) Air Guitar(TM), a battery-operated
guitar that plays six different bars of rock
music, with five control keys and a "whammy"
bar. (New for fiscal 1997)
Kawasaki(R) Big Bam Boom(TM), an electronic
percussion instrument with four drum pads and
nine buttons that allow children to create drum
riffs and other percussion effects. (New for
fiscal 1997)
Kawasaki(R) Country Guitar, a battery-operated
guitar that plays six different bars of country
music, with five control keys and a "whammy"
bar. (New for fiscal 1997)
My Music Maker(R) sing-along cassette players
Pre-school Audio and radios.
Pre-teen Audio LOGO LA Rock(R) personal cassette players and radios.
OTHER
Games Hoppin' Poppin' Spaceballs(TM), a table-top
action game for children aged four and older,
engaging two to four players who attempt to
LOGO capture colored balls that fly around in an
enclosed dome. (New for fiscal 1997)
Play Table Build-A-Lot(TM) block building table, a
children's play table that can be used as a
base for plastic building blocks. (New for
LOGO fiscal 1997)

The following table depicts the Company's net sales, as a percentage of
total net sales, by product category for the periods indicated.

FISCAL YEAR
-------------------
PRODUCT CATEGORY 1994 1995 1996
- ---------------- ----- ----- -----

Juvenile audio products.................................... 48.5% 46.3% 49.5%
Girls' toys................................................ 4.0 33.5 40.8
Boys' toys................................................. 36.2 13.5 6.0
Other...................................................... 11.3 6.7 3.7
----- ----- -----
Total.................................................. 100.0% 100.0% 100.0%
===== ===== =====

Between 30% and 40% of the Company's products (by dollar volume of net
sales) are replaced each year through the introduction of new products. As a
result of this turnover, product development is a critical and ongoing
concern. The Company develops both proprietary and non-proprietary products.
The Company's proprietary product lines currently consist of approximately 38
products (i) that are licensed from outside inventors and designers, (ii) that
incorporate trademarks licensed by the Company, (iii) designed in-house or
(iv) for which the Company owns the mold to manufacture the toy. For each
product in the fourth proprietary category, the Company or the inventor owns
the intellectual property of the design, and the Company owns the required
tooling, dies and molds necessary to manufacture the product. Proprietary toys
accounted for approximately 51% and 59% of the Company's net sales during
fiscal 1995 and fiscal 1996, respectively. The Company's proprietary products
generally yield higher gross margins to the Company than non-proprietary toys.

Non-proprietary products are defined by the Company as toys designed and
manufactured by independent toy manufacturers and marketed by the Company,
usually on an exclusive basis in the Company's primary markets. The Company
selects its non-proprietary product introductions on the basis of the
Company's evaluation of several factors, including the quality and pricing of
the product, as well as whether the product presents an opportunity for the
Company to utilize its packaging and marketing skills to differentiate the
product from other toys. The Company often markets these toys under in-house
brands, such as Digi-Tech(TM) and LA Rock(R). Non-proprietary products
accounted for approximately 49% and 41% of the Company's net sales for fiscal
1995 and fiscal 1996, respectively.

LICENSE AGREEMENTS

The Company enters into license agreements with toy inventors and designers
that give the Company the right to manufacture and market a product or
technology invented or designed by the inventor. In return, the Company agrees
to pay to the inventor a percentage of net sales of the Company's product that
is based on the inventor's product or technology. Typically, this annual
royalty ranges from 4% to 7% of net sales. Sales of products that are based on
products or technology acquired by the Company from the inventor thereof, such
as the Rosie(R) doll, accounted for approximately 31% and 41% of the Company's
net sales during fiscal 1995 and fiscal 1996, respectively. The acquisition of
licenses typically requires the payment of non-refundable advances and/or
guaranteed minimum royalties. As of January 31, 1997, minimum future
guaranteed payments by the Company under licenses aggregated approximately
$232,000. The Company has a license agreement with Kawasaki Motors Corp., USA
authorizing the Company to use the Kawasaki(R) brand name in connection with
several different products, including the Kawasaki(R) Ninja(R) Supergyro(TM)
Motorcycle, which the Company has introduced for fiscal 1997. See "Business--
Products."

The Company does not rely significantly upon licenses of characters and
trademarks from entertainment companies. During fiscal 1996, sales of toys
that were the subject of license agreements with entertainment companies
accounted for less than 1% of the Company's net sales. The Company believes
that although development of products under entertainment licenses can fuel
rapid growth, such licenses may also subject the licensee to substantial risk
and expense if they provide for substantial up-front royalty commitments, high
minimum guaranteed royalty payments and restrictions on product development.
Consistent with its past

practices, the Company plans to take an opportunistic approach with respect to
opportunities to develop and market products based upon licenses for
entertainment characters.

CUSTOMERS

The Company made sales to over 400 different customers in approximately 40
countries during fiscal 1996. The table below sets forth the Company's net
sales by geographic area as a percentage of total net sales for the specified
periods.

FISCAL YEAR
-------------------
GEOGRAPHIC AREA 1994 1995 1996
- --------------- ----- ----- -----

United States.............................................. 80.6% 82.5% 81.4%
Europe..................................................... 8.3 8.1 9.2
Other North America (Canada and Mexico).................... 5.0 4.2 3.7
Oceana..................................................... 2.9 2.7 2.4
South and Central America.................................. 2.3 1.5 1.7
Asia....................................................... 0.4 0.7 1.4
Other (Middle East and Africa)............................. 0.5 0.3 0.2
----- ----- -----
Total.................................................. 100.0% 100.0% 100.0%
===== ===== =====

The Company's principal customers are retailers, including mass
merchandising discounters such as Wal-Mart, Kmart and Target, specialty toy
stores such as Toys "R" Us, Kay Bee Toy & Hobby, F.A.O. Schwarz and Noodle
Kidoodle (Greenman Bros., Inc.), and deep discount stores such as Family
Dollar Stores, Consolidated Stores and Value City Department Stores. The
Company's top five customers accounted for approximately 54.5% of the
Company's net sales in fiscal 1996. Wal-Mart (19.5%), Kmart (13.7%) and Toys
"R" Us (12.0%) each accounted for more than 10% of the Company's net sales
during the same period. For the prior two fiscal years, the only customers
that accounted for more than 10% of the Company's net sales were Wal-Mart
(17.2%) and Kmart (12.7%) for fiscal 1995 and Kmart (11.3%) and West Coast
Liquidators (10.4%) for fiscal 1994. During fiscal 1996, the Company's sales
to Toys "R" Us, Wal-Mart, Kmart, Target and Kay-Bee Toy & Hobby, the five
largest toy retailers in the United States, increased as a percentage of the
Company's net sales to 54.5%, compared to 44.9% during fiscal 1995 and 27.9%
during fiscal 1994.

SALES AND MARKETING

The Company has implemented a selling strategy that consists of supporting
the marketing and sales efforts of its executive management with a combination
of in-house sales personnel and a network of independent, commission-based
sales representatives. All significant product presentations are made by
either executive management, in the case of new product presentations, or in-
house sales personnel. The independent sales representatives manage the day-
to-day account administration.

New toys are marketed primarily by members of the Company's executive
management at the Company's showrooms in Hong Kong, New York and Dallas during
the times when major, international toy shows are taking place in those cities
(Hong Kong in January, June and September/October, Dallas in January, and New
York in February). The Company believes that most of its customers are active
at these toy shows. The Company also maintains a showroom at its headquarters
in Houston.

The Company generally accepts returns for defective merchandise, although
the value of such returns has historically not been significant. In accordance
with industry practice, the Company sometimes allows retailers to return slow-
moving items for credit and also sometimes provides price protection by making
any price reductions effective as to all products then held by retailers in
inventory. The Company expects that it will continue to make such
accommodations in the future.

In international markets, the Company generally sells its products to
independent distributors. These distributors retain their own sales
representatives and product showrooms at which products such as the Company's
are marketed and sold. The Company also makes some sales directly to
international retailers, principally as a result of contacts made at the
Company's showrooms.

ADVERTISING

The Company currently allocates a majority of its advertising budget to
television promotion. The Company utilized a television campaign for the first
time in fiscal 1995 in connection with the introduction of the Rosie(R) doll.
The Company increased its television advertising budget in fiscal 1996, using
television commercials to promote both the Rosie(R) and Pattie(TM) dolls. The
Company intends to continue to utilize a promotional strategy whereby the
Company will advertise certain of its proprietary products. The Company
believes that television advertising, properly utilized, has a positive effect
on sales. Although a majority of the Company's advertising budget is allocated
to television, the Company continues to expend a portion of its advertising
budget to promote its products through retail catalogs, advertisement in trade
magazines, and cooperative promotional efforts of retailers. The Company has
begun utilizing in-store radio promotions at Toys "R" Us to promote certain of
its products. The Company's Director of Marketing helps coordinate the
advertising efforts of the Company.

MANUFACTURING

The Company annually contracts with approximately 40 independent
manufacturers located principally in the PRC within a 200-mile radius of Hong
Kong for the manufacturing of its products. The Company may use more than one
manufacturer to produce a single product. The only manufacturers that
accounted for more than 10% of the Company's purchases of products during
fiscal 1996 were GMT Industrial Ltd. (26.1%), which manufactured walkie-talkie
and musical toys products for the Company, Ocean Dragon Industrial Co. Ltd.
(15.6%), which manufactured Rosie(R) and Pattie(TM) dolls and Loyal Technology
Co. Ltd. (14.4%), which manufactured certain walkie-talkies and radios.
Manufacturing commitments are made on a purchase order basis. The Company does
not have long-term contractual arrangements with its manufacturers.

Decisions related to the choice of manufacturer for non-proprietary products
generally are based on reliability, quality of merchandise, price and the
ability of the manufacturer to meet the Company's or its customers' timing
requirements for delivery. Proprietary products designed by the Company are
placed with a specific manufacturer whose expertise is in that type of toy.
The Company currently has its tooling placed in several different
manufacturing facilities and generally receives 60 to 90 day delivery after
its orders are booked.

The Company believes that its presence in Hong Kong through its subsidiary
DSI(HK) has enhanced the Company's relationships with manufacturers in the PRC
and has allowed the Company to closely monitor manufacturing operations,
including quality control, production scheduling and order fulfillment.
DSI(HK) utilizes a quality control staff of five degreed engineers, a quality
assurance staff of two engineers, and nine full-time inspectors who rotate
among the various plants at which the Company's products are being
manufactured.

The principal materials used in the production of the Company's products are
plastics, integrated circuits, batteries, corrugated paper (used in packaging
and packing material) and acrylic textiles. The Company believes that an
adequate supply of materials used in the manufacture and packaging of its
products is readily available from existing and alternative sources at
reasonable prices.

DISTRIBUTION

The Company's distribution strategy focuses on distributing its products
either through FOB Asia sales or through direct sales made from inventory
maintained at its Houston facility. For FOB Asia sales, the customer places
its order and shipping instructions, and the toys are then manufactured and
shipped directly to the customer or its freight consolidator from the factory.
Following the October 1993 acquisition by DSI(HK) of

certain assets of its Hong Kong distributor, the Company has used its Hong
Kong personnel to conduct the FOB Asia business. The Company believes that its
Hong Kong presence has contributed to the success of its FOB Asia business
because the Company does not have to utilize independent agents, who may have
conflicting interests.

Basic, continuous stock toys that are offered by retailers on a year-round
basis generally are shipped to customers by the Company from its inventory in
Houston. In addition, certain faster-selling toys are often shipped directly
to major customers for seasonal selling as well as stocked by the Company in
Houston for peak season back-up and continuous supply. The Company also
maintains inventory which is committed to specific customers for peak holiday
season support as well as some inventory which is available for smaller
retailers and for opportunistic selling strategies. The Company's television-
promoted proprietary products generally are shipped to customers from the
Company's inventory in Houston.

Most of the Company's larger customers have instituted electronic data
interchange ("EDI") programs to reduce the retailers' inventory carrying
requirements and place more inventory risk on the supplier. When selling toys
out of its Houston inventory, the Company participates in the EDI programs of
most of its customers who have established an EDI program, including Kmart,
Wal-Mart, Toys "R" Us, Target and Kay-Bee Toy & Hobby. Although these programs
require the Company to bear some inventory risk, the Company believes the
programs can be utilized to monitor store inventory levels, schedule
production to meet anticipated reorders and maintain sufficient inventory
levels to both serve its customers and better manage its own inventory.

COMPETITION

The toy industry is highly competitive. Dun & Bradstreet categorizes over
1,000 companies, including the Company, as toy manufacturers. Competitive
factors include product appeal, new product development, price and order
fulfillment. The Company competes with many companies that have greater
financial resources and advertising budgets than the Company. The largest
United States toy companies are Mattel, Inc., Hasbro, Inc. and Tyco Toys, Inc.
(which has agreed to merge with Mattel, Inc.), and the Company considers YES!
Entertainment Corporation, Toy Biz, Inc., Galoob Toys, Inc., Kidd Designs,
Inc. (a division of SDI Technologies Inc.) and Alaron, Inc. to be among its
other competitors. In addition, due to the low barriers to entry into the toy
business, the Company competes with many smaller toy companies, some of which
market single products.

SEASONAL PATTERNS

The toy industry is very seasonal with the holiday selling season
representing over two-thirds of annual sales at retail. To accommodate this
peak selling season, holiday toy lines are introduced early in the first
quarter at toy shows in Hong Kong, Dallas and New York. Generally, retailers
commit to their holiday season purchases during the first two calendar
quarters and those orders are shipped from Asia to the retailers' distribution
centers on a scheduled basis from May through September. During the last two
full fiscal years, an average of approximately 87% of the Company's annual
Hong Kong-based sales have occurred between the months of May through October.
Sales from Houston historically have tended to occur closer to the holiday
season to provide peak holiday season inventory to certain large retailers and
to ship to smaller retailers that have not chosen to purchase products FOB
Asia. During the last two fiscal years, an average of approximately 66% of the
Company's annual Houston-based sales have occurred during the months of August
through November.

GOVERNMENT AND INDUSTRY REGULATION

The Company is subject to the provisions of the Federal Hazardous Substances
Act and the Federal Consumer Product Safety Act. Such Acts empower the United
States Consumer Products Safety Commission (the "CPSC") to protect the public
from hazardous goods. The CPSC has the authority to exclude from the market
goods that are found to be hazardous and require a manufacturer to repurchase
such goods under certain circumstances. The Company sends samples of all of
its marketed products to independent laboratories to test for compliance with
the CPSC's rules and regulations, as well as with the product standards of the
TMA. The

Company is not required to comply with the product standards of the TMA, but
voluntarily does so. Similar consumer protection laws exist in state and local
jurisdictions within the United States as well as certain foreign countries.
The Company designs its products to exceed the highest safety standards
imposed or recommended either by government or industry regulatory
authorities. To date, the Company has not been found to be in material
violation of any governmental product standard with respect to the Company's
products.

TARIFFS AND DUTIES

In December 1994, the United States approved a trade agreement pursuant to
which import duties on toys, games, dolls and other specified items were
eliminated effective January 1, 1995 from products manufactured in all MFN
countries (including the PRC). Increases in quotas, duties, tariffs or other
changes or trade restrictions which may be imposed in the future would have a
material adverse effect on the Company's financial condition, operating
results or ability to import products. In particular, the Company's costs
would be increased if the PRC's MFN status is revoked. The loss of MFN status
for the PRC would result in substantial duties on the cost of toy products
manufactured in the PRC and imported into the United States.

In 1996, the United States government proposed retaliatory trade sanctions
against the PRC, which would have included increased duties on selected
products, but would not have included the Company's products originating in
the PRC. The United States and PRC eventually agreed on settlement terms
avoiding these sanctions. Any future imposition of trade sanctions by the
United States and subsequent retaliatory actions by the Chinese government
could result in supply disruptions and higher merchandise costs to the
Company. The Company could attempt to mitigate the effects of an increase in
duties by shifting its manufacturing to other countries, but there can be no
assurance that the Company would be successful in this regard.

INTELLECTUAL PROPERTY

The Company has been utilizing the mark "DSI" since 1991 and believes it has
common law trademark rights to the mark. The Company applied for a registered
trademark for "DSI Toys" in the United States in January 1996 and will seek to
register the trademark in other countries where the Company markets and
distributes its products. The Company believes it has the rights to use the
mark in the manner in which it is currently used.

The Company has the following United States registered trademarks for
various products and product categories currently being marketed: Cool
Keys(R), Desert Shield(R), Escort(R), Handyman Jr.(R), Hydro Blaster(R), Hydro
Shield(R), Jam Stand(R), Ka-Splash(R), LA Rock(R), Magic Steering Wheel(R),
Mega Blaster(R), Mountain King Express(R), Music Maker(R), My Music Maker(R),
Police Escort(R), Pop 'N Score(R), Real Tech(R), Rosie(R), Sabre Blaster(R),
Secret Service(R), Star Hunter(R), Trak Champs(R), Ultimatron(R), Vrooom(R),
Wave Weapon(R), and Wheels of Prey(R). The Company believes it has the rights
to use these marks for the product lines on which they are currently used.

The Company believes it has trademark rights with respect to certain
additional products and product lines, including Air Guitar(TM), Big Bam
Boom(TM), Baby Pick Me Up(TM), Build-A-Lot(TM), Country Chords(TM), Dreamie
Sweets(TM), Hoppin' Poppin' Spaceballs(TM), Mad World(TM), Pattie(TM), Rosie's
Best Friend, Pattie(TM), and Tracker(TM) in the United States. The Company has
applied for trademark protection for the mark Rosie(R) in all countries in
which the Rosie(R) doll has been sold. The Company believes it has the rights
to use these marks for the product lines on which they are, or will be, used.

EMPLOYEES

As of January 31, 1997, the Company had a total of 70 employees, of whom 44
are employees of DSI(HK) and are based in Hong Kong, and 26 are employees of
DSI and are based in Houston. Of the Houston based employees, 5 are engaged in
sales and marketing, 4 are involved in design and development, 4 are involved
in warehousing and distribution and 13 are involved in finance and
administration. Of the Hong Kong based

employees, 8 are engaged in sales and merchandising, 14 are engaged in
engineering, including product quality assurance and quality control, 12 are
involved in finance and administration and 10 are involved in shipping and
distribution. None of the Company's employees is subject to a collective
bargaining agreement. The Company has experienced no work stoppages and
believes that its labor relations are satisfactory.

FACILITIES

The Company's principal executive offices and showroom and principal
warehouse are located in Houston, Texas, where the Company occupies
approximately 14,000 square feet of office and showroom space and 32,000
square feet of dock-high warehouse space. The Company leases this space from
Tommy Moss Family Partnership, Ltd. pursuant to a lease that commenced on June
2, 1992 and terminates on August 31, 2002. The base rental for this lease is
$16,100 per month ($4.20 per square foot on an annual basis). The lease
provides for an annual increase in rent based on projected cost of living and
tax escalation adjustments. See "Certain Transactions."

The Company leases a 2,200 square foot showroom in the Toy Center building
in New York at 200 Fifth Avenue. This lease commenced on January 1, 1993 and
will terminate on April 30, 2003. The base rental for this lease is $6,026 per
month ($32.87 per square foot on an annual basis), subject to cost of living
and tax escalations. The facility is staffed only during toy shows and
specially scheduled customer showings.

The Company leases 7,178 square feet of office and showroom space in Hong
Kong under a lease that commenced on January 1, 1995 and terminates in March,
1998. The base rental for the lease term is $32,514 per month based on current
currency exchange rates ($54.35 per square foot on an annual basis).

The Company is leasing 1,080 square feet of showroom space in the World
Trade Center Building in Dallas, Texas for a three-year term that began on
June 1, 1996. The base rental for this lease is currently $925 per month
($10.28 per square foot on an annual basis).

The Company leases a small storage facility in Hong Kong and a small office
in Bentonville, Arkansas. From time to time, the Company rents excess
warehouse facilities in Houston to accommodate peak seasonal needs.

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.

The Company has determined that payments aggregating approximately $1.0
million which were made by DSI(HK) (or its predecessor) from fiscal 1988
through fiscal 1994 were misclassified as sales commissions. An independent
investigator determined that such payments principally were made at the
direction of the Company's former sole shareholder and should have been
classified as compensation expense and consulting fees. In the event the
Company incurs any tax liability relating to such payments, the Company
intends to pursue a claim for indemnification against the Estate of Tommy Moss
under the indemnity agreement entered into among Mr. Moss, RAC and the Company
in connection with the Recapitalization which the Company believes covers any
such tax liabilities.

On February 27, 1997, a former independent sales representative for the
Company sued the Company and the Estate of Tommy Moss for additional royalties
and sales commissions in Probate Court No. 3 of Harris County, Texas. The
representative also is seeking to recover exemplary damages, interest, costs
and attorneys fees. Although the Company believes that it has fulfilled its
obligations to this representative and intends to defend against the claims,
there can be no assurance as to the outcome of this lawsuit.

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The executive officers and directors of the Company are as follows:

NAME AGE POSITION
---- --- --------

M. D. Davis............. 62 Chairman of the Board and Chief Executive Officer
Richard R. Neitz........ 48 President, Chief Operating Officer and Director
Tommy Yau............... 48 Managing Director--DSI(HK)
J. Russell Denson....... 46 Executive Vice President and Chief Financial Officer
Dale Y. Chen............ 45 Vice President and Controller
Thomas V. Yarnell....... 43 Administrative Vice President, General Counsel and Secretary
Barry B. Conrad......... 56 Director
Jack R. Crosby.......... 70 Director
Joseph N. Matlock....... 48 Director
Douglas A. Smith........ 45 Director

- --------

Set forth below is a description of the backgrounds of each of the directors
and executive officers of the Company.

M. D. Davis has served as the Chairman of the Board and Chief Executive
Officer since December 1995. Prior to joining the Company, Mr. Davis spent
eighteen years with Ernst & Whinney in Houston, where, as a partner, he headed
the healthcare practice. He left Ernst & Whinney in 1981 when he purchased
Southwest Medical Packaging, Inc. This company was sold to Cooper Vision, Inc.
(now Cooper Company, Inc.) in 1985 and later to Alcon Laboratories, Inc. in
1989. During this time, Mr. Davis maintained senior management positions at
both companies. In 1990, Mr. Davis and another employee acquired Southwest
Medical Packaging, Inc. from Alcon Laboratories. In June 1994, this company
was sold to Maxxim Medical, Inc. From June 1994 until December 1995, Mr. Davis
was engaged in personal investment activities.

Richard R. Neitz has served as President of the Company since March 1992 and
Vice President, Marketing and Product Development from March 1990 to March
1992. He has served as Chief Operating Officer and director since December
1995. Prior to joining the Company in 1990, Mr. Neitz served in various
management and marketing positions with Main Street Ltd., Joseph Markovits,
Inc., Toys "R" Us and McCrory Stores. Mr. Neitz has approximately 17 years of
experience in the toy industry and related businesses.

Tommy Yau has served as Managing Director of DSI(HK) since October 1993.
From January 1991 until January 1993 he served as Managing Director of Arco
Toys Ltd. (a Mattel company), and from January 1987 until December 1990, he
served as Vice President of Operations for that company. From April 1986 to
December 1986, he served as Vice President of Operations for Arco Industries
Ltd. Mr. Yau has approximately 28 years of experience in the toy industry.

J. Russell Denson has served as Executive Vice President and Chief Financial
Officer of the Company since March 1997. From February 1992 to February 1997,
Mr. Denson served as President, Chief Financial Officer and a director of
Houston Biotechnology Incorporated, a publicly held biopharmaceutical company,
until it was merged with Medarex, Inc. Mr. Denson will continue to provide
transition services to Medarex, Inc. up to May 31, 1997. From 1987 to 1992,
Mr. Denson was the Managing Partner of The Denson Publishing Group in Houston,
Texas. From 1981 to 1987, Mr. Denson was the Executive Vice President of HEI
Corporation, a publicly held hospital management company, and he served as its
Chief Financial Officer during its initial public offering in 1983. Mr. Denson
is a certified public accountant.

Dale Y. Chen has served as Controller of the Company since August 1992 and
as Vice President of the Company since April 1995. From 1986 to June 1992, Mr.
Chen served as Accounting Manager for SIGMA

Management Company. Prior to 1986, he served as Vice President and Assistant
Treasurer of Ben Milam Savings and Loan Association.

Thomas V. Yarnell has served as Vice President of the Company since October
1989, General Counsel since February 1990 and Secretary since April 1991.
Prior to joining the Company in 1989, Mr. Yarnell worked as an attorney for
Texaco, Inc., Houston Division, and practiced law for a general practice law
firm.

Barry B. Conrad has served as a director of the Company since December 1995.
Mr. Conrad is a co-founder and Managing Partner of Conrad/Collins Merchant
Banking Group Ltd., a Dallas, Texas-based merchant bank formed in 1988 that is
active in leveraged buyouts of middle-market companies in the southwestern
United States. Mr. Conrad has extensive investment banking experience.

Jack R. Crosby has served as a director of the Company since December 1995.
Mr. Crosby is the founder and Chairman of Rust Capital, Ltd., a small business
investment partnership headquartered in Texas. Mr. Crosby has co-founded
and/or financed two private venture capital funds and has been one of the co-
founders of eight multiple system cable companies. He is the founder,
President and CEO of Tescorp, Inc., a publicly traded company which owns and
operates cable television systems in Argentina. He serves on the board of
directors of Tescorp, Inc., Battle Mountain Gold Company and National Dentex
Corporation.

Joseph N. Matlock has served as a director of the Company since December
1995. Mr. Matlock has spent the majority of his career in the financial
services industry. From January 1986 to September 1988, Mr. Matlock served as
Chairman, Chief Executive Officer and President of Franklin Savings
Association in Austin, Texas; and from September 1988 through September 1994,
he served as Chief Executive Officer, President and a director of Franklin
Federal. From September 1994 to January 1996, he was engaged in the merchant
banking and consulting business. From September 1995 to the present, he has
served as President (and was the founder) of AffordAmerica, Inc. which
provides housing for low income families. From January 1996 to the present, he
has served as Director of Business and Community Relations for Bank of
America.

Douglas A. Smith has served as a director of the Company since March 1996.
Since 1983, Mr. Smith has been President of Vanguard Investment Company, which
has been active in leveraged buy-outs of middle market companies. Since July
1996, Mr. Smith has also served as a principal of Wingate Partners, a private
equity group based in Dallas, Texas.

Directors are elected at the annual meeting of shareholders to serve during
the following year and until a successor is duly elected and qualified.
Officers are elected by and serve at the discretion of the Board of Directors.
There are no family relationships between any of the directors or officers of
the Company.

COMPENSATION OF DIRECTORS; COMMITTEES

Directors of the Company who are not full-time employees or retained by the
Company as consultants are paid a retainer of $5,000 per fiscal quarter plus
reasonable out-of-pocket expenses incurred in attending Board of Directors
meetings. In addition, pursuant to the Company's 1997 Stock Option Plan, each
of the current non-employee directors are eligible to receive grants of
options to purchase shares of Common Stock. See "--1997 Stock Option Plan."

The Board of Directors recently has established standing audit and
compensation committees. The audit committee, whose members are Messrs.
Matlock, Davis and Conrad, reviews the scope and results of the audit and
other services provided by the Company's independent accountants. The members
of the compensation committee are Messrs. Conrad, Matlock and Crosby, all of
whom are independent directors. The compensation committee sets the
compensation levels and employment benefits of all officers of the Company.
The compensation committee administers the 1997 Stock Option Plan and makes
awards under such plan. The Board of Directors does not have a nominating
committee. The selection of nominees for the Board of Directors is made by the
entire Board of Directors.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

In connection with services rendered by Mr. Matlock in connection with the
Recapitalization, the Company agreed to pay Mr. Matlock the sum of $240,000 in
three equal payments due on January 1, 1996, 1997 and 1998. Mr. Matlock is a
member of the compensation committee of the Board of Directors of the Company.

The Company has agreed to pay MBG a fee of $100,000 upon the consummation of
this Offering as compensation for financial advisory services rendered by MBG
to the Company. The general partner of MBG is Conrad/Collins, Inc., of which
Mr. Conrad is an officer and director and in which Mr. Conrad owns a
controlling interest. Mr. Conrad is a member of the compensation committee of
the Board of Directors of the Company.

No member of the Board of Directors of the Company, its current compensation
committee or the compensation committee that served during the fiscal year
ended January 31, 1997 serves as a member of the Board of Directors or
compensation committee of an entity that has one or more executive officers
serving as a member of the Company's Board of Directors or compensation
committee.

EXECUTIVE COMPENSATION

The following table sets forth certain information with respect to
compensation paid for fiscal 1996 to the Company's Chief Executive Officer and
the other executive officers of the Company who received compensation in
excess of $100,000 (the "Named Officers").

SUMMARY COMPENSATION TABLE

ANNUAL COMPENSATION
------------------------
ALL OTHER
NAME AND PRINCIPAL POSITION SALARY BONUS(1) COMPENSATION(2)
- --------------------------- ---------- ---------- ---------------

M. D. Davis...................... $ 150,000 500 $ 9,500
Chairman of the Board and Chief
Executive Officer
Richard R. Neitz................. $ 225,000 500 $ 9,500
President, Chief Operating Offi-
cer and Director
Tommy Yau........................ $ 180,000(3) $ 9,500(3)(4) --
Managing Director--DSI(HK)
Dale Y. Chen..................... $ 100,000 $ 6,000 $ 9,500
Vice President and Controller
Thomas V. Yarnell................ $ 90,000 $ 5,300 $ 7,263
Administrative Vice President,
General Counsel and Secretary

- --------
(1) No individual named above received perquisites or non-cash compensation
during fiscal 1996 exceeding the lesser of $50,000 or an amount equal to
10% of such person's annual salary and bonus.

(2) Consists of Company contributions to a defined contribution plan.

(3) Based on currency exchange rates at January 31, 1997. Mr. Yau's salary is
paid by DSI(HK) in Hong Kong dollars.

(4) Amount represents a discretionary bonus paid to Tommy Yau.

EMPLOYMENT AGREEMENTS

Effective January 2, 1996, M. D. Davis entered into an employment agreement
with the Company, pursuant to which he will be employed as Chairman of the
Board and Chief Executive Officer of the Company until

December 31, 1998 and will be paid an annual salary of $150,000 (which salary
may be raised at the discretion of the Board of Directors). The agreement
contains non-competition and non-solicitation provisions applicable during the
term of employment under the agreement and until one year after termination of
employment. Upon termination of Mr. Davis's employment without cause, the
Company must continue to pay Mr. Davis his salary for a period of six months
(or one year if the non-competition provision is enforced) following
termination.

Effective December 11, 1995, Richard R. Neitz entered into an employment
agreement with the Company. Pursuant to this agreement, Mr. Neitz will be
employed as President and Chief Operating Officer until January 31, 2000 and
will be paid an annual salary of $225,000. Beginning with fiscal 1996, Mr.
Neitz is entitled to a fiscal year-end performance bonus equal to 2% of the
Company's total pre-tax income, provided that such pre-tax income exceeds $5.8
million. The agreement contains non-competition and non-solicitation
provisions applicable during the term of employment under the agreement and
until one year after termination of employment. Upon termination of Mr.
Neitz's employment without cause the Company must continue to pay Mr. Neitz
his salary for a period of six months (or one year if the non-competition
provision is enforced) following termination and must pay a pro-rated
performance bonus.

Effective December 11, 1995, Tommy Yau entered into an employment agreement
with DSI(HK), pursuant to which he will be employed as Managing Director of
DSI(HK) until January 31, 2000 and will be paid a monthly salary of HK
$116,000 (approximately $15,000 based on currency exchange rates as of January
31, 1997). Beginning with fiscal 1996, Mr. Yau is entitled to a fiscal year-
end performance bonus equal to 1.5% of the Company's total pre-tax income,
provided that such pre-tax income exceeds $5.8 million. The agreement contains
non-competition and non-solicitation provisions applicable during the term of
employment under the agreement and until one year after termination of
employment. Upon termination of Mr. Yau's employment without cause, the
Company must continue to pay Mr. Yau his salary for a period of six months (or
one year if the non-competition provision is enforced) following termination
and must pay a pro-rated performance bonus.

Effective March 16, 1997, J. Russell Denson entered into an employment
agreement with the Company, pursuant to which he will be employed as Executive
Vice President and Chief Financial Officer until March 15, 2000. He will be
paid an annual salary of $90,000 through May 31, 1997 and $180,000 thereafter
(which salary is subject to increase at the discretion of the Board of
Directors). Prior to May 31, 1997, Mr. Denson is permitted to spend a
reasonable amount of time, not in excess of one-half, during normal business
hours on transition matters for Medarex, Inc. Mr. Denson is entitled to a
performance bonus based upon the Company's total pre-tax income for fiscal
1997 and increases in earnings per share for subsequent fiscal years. Upon
completion of this Offering, the Company will grant Mr. Denson options under
the Stock Option Plan for the purchase of 90,000 shares of Common Stock
expiring 10 years from date of grant with an exercise price equal to the
initial public offering price. These options will vest as follows: 25% upon
completion of this Offering and 25% on each of March 16, 1999, March 16, 2000
and March 16, 2001, so long as Mr. Denson is still employed by the Company.

Also effective December 11, 1995, Dale Y. Chen and Thomas V. Yarnell entered
into employment agreements with the Company for terms of one year, which terms
were extended for one year on December 11, 1996. Mr. Chen's employment
agreement provides that he will serve as Controller and will receive an annual
salary of at least $100,000. Mr. Yarnell's employment agreement provides that
he will serve as Administrative Vice President and General Counsel and will
receive an annual salary of at least $70,000.

1997 STOCK OPTION PLAN

On May 1, 1997, the Board of Directors and the shareholders of the Company
approved the DSI Toys, Inc. 1997 Stock Option Plan (the "Stock Option Plan")
which permits the Company to grant incentive and non-qualified stock options
to purchase an aggregate of up to 600,000 shares of Common Stock. The purpose
of the Stock Option Plan is to foster and promote the financial success of the
Company by, among other things, enabling key employees to participate in the
long-term growth and financial success of the Company. The Stock

Option Plan is administered by the Company's compensation committee, which is
composed of three non-employee directors. Any employee or director of the
Company is eligible to receive grants of stock options under the Stock Option
Plan.

All stock options granted under the Stock Option Plan will have an exercise
price per share to be determined by the compensation committee, provided that
the exercise price per share under each stock option shall not be less than
the fair market value of the Common Stock at the time the stock option is
granted (110% of such fair market value in the case of incentive stock options
granted to a shareholder who owns 10% or more of the Company's Common Stock).
The maximum term for all stock options granted under the Stock Option Plan is
10 years (5 years in the case of an incentive stock option granted to a
shareholder who owns 10% or more of the Company's Common Stock). Stock options
granted to the non-employee directors are not intended to qualify as
"incentive stock options" within the meaning of Section 422A of the Internal
Revenue Code of 1986, as amended.

The Board of Directors may at any time terminate, amend or modify the Stock
Option Plan; provided, however, that no such action of the Board of Directors,
without the approval of the shareholders of the Company, may increase the
total number of shares of Common Stock which may be issued under the Stock
Option Plan, decrease the minimum incentive stock option exercise price,
extend the period during which options may be granted pursuant to the Stock
Option Plan, or change the class of individuals eligible to be granted
options. No amendment to the Stock Option Plan shall, without the consent of
an optionee, affect such optionee's rights under an option previously granted.

BONUSES

Prior to the Recapitalization, a significant part of the Company's profits
was distributed as a bonus to the Company's former sole shareholder. The
Company will not distribute profits in this manner in the future. The Company
has entered into employment agreements with three executive officers, pursuant
to which the Company will pay performance bonuses based on the Company's
profitability if the Company's operations generate a specified level of
income. See "--Employment Agreements." Management of the Company may from time
to time in the future grant discretionary bonuses based in part on the
Company's profitability, subject to compensation committee approval.

401(K) PLAN

Effective May 1, 1994, the Company adopted its 401(k) plan (the "401(k)
Plan") that covers all employees of the Company in the United States. Under
the 401(k) plan, an employee may elect to defer, in the form of pre-tax
contributions to the 401(k) Plan, up to 15% of the total compensation that
would otherwise be paid to the employee, currently not to exceed $9,500.00 per
calendar year (adjusted for cost-of-living increases). Participants are
entitled to direct the investment of their accounts among various investment
funds. The 401(k) Plan is intended to qualify under Sections 401(a) and 401(k)
of the Internal Revenue Code so that salary deferral contributions are not
currently taxable to participants until distributed from the 401(k) Plan upon
termination of employment, and contributions to the 401(k) Plan are currently
deductible by the Company. The contributions made by employees are fully
vested and nonforfeitable at all times. The Company may, in its discretion,
provide matching funds to the 401(k) Plan.

INDEMNIFICATION ARRANGEMENTS

The Company's Articles of Incorporation and Bylaws provide that the Company
shall indemnify all directors and officers of the Company to the fullest
extent permitted by the Texas Business Corporation Act. Under such provisions,
any director or officer, who in his capacity as such, is made or threatened to
be made, a party to any suit or proceeding, shall be indemnified if it is
determined that such director or officer acted in good faith and in a manner
he reasonably believed to be in, or not opposed to, the best interests of the
Company.

CERTAIN TRANSACTIONS

RECAPITALIZATION TRANSACTIONS

In connection with the Recapitalization, the Company entered into a
consulting agreement with Mr. Moss, pursuant to which Mr. Moss was to serve as
a consultant to the Company for three years, and was to be compensated in the
amount of $300,000 per year. The consulting agreement also required the
Company to maintain health and disability insurance policies for the benefit
of Mr. Moss for the term of his life. Pursuant to the consulting agreement,
the Company agreed to maintain Mr. Moss's office space for his use for the
term of the consulting agreement and to provide to Mr. Moss for 180 days the
services of certain Company employees for his outside business, provided that
such services did not exceed 30% of the time of each of such employees. This
agreement terminated upon Mr. Moss's death on November 19, 1996.

FORMER SOLE SHAREHOLDER BONUS

In fiscal 1995, the Company agreed to pay Mr. Moss a $1.0 million bonus
pursuant to the Moss Bonus Note.

OFFICE/WAREHOUSE LEASE

The Company currently leases its office/warehouse space in Houston from the
Tommy Moss Family Partnership, Ltd. The aggregate amount of lease payments
made by the Company under this lease was approximately $193,200 for fiscal
1995 and $193,200 for fiscal 1996. Management believes that the terms of lease
represent a fair market rate. See "Business--Facilities."

MOSS LIFE INSURANCE

Prior to the Recapitalization, the Company entered into split-dollar life
insurance arrangements with the Tommy Moss Family Trusts (the "Family Trusts")
and with the Tommy and JoBeth Moss Joint Life Insurance Trusts (the "Life
Insurance Trusts") which obligated the Company to pay premiums on life
insurance policies owned by the Family Trusts and the Life Insurance Trusts.
The Family Trusts own policies payable on the death of Mr. Moss and the Life
Insurance Trusts own policies payable on the last to die of Mr. Moss and Mrs.
Moss. The trusts were obligated to pay to the Company a specified portion of
the premiums for the underlying policies. At the death of Mr. Moss, the
Company was entitled to be reimbursed its premium payments out of insurance
proceeds payable to the Family Trusts. Under the Recapitalization agreements,
Mr. Moss agreed to cause the underlying trust agreements to be amended to
provide that the Company would receive interest, at a 7% rate, on the premiums
paid by the Company.

Subsequent to the death of Mr. Moss, the trustees of the Family Trusts and
the Company disagreed over the amount of premiums owed by the Family Trusts to
the Company and the amount of and liability for the interest payable with
respect to unpaid premiums and prior premium payments. The trustees and the
Company subsequently agreed the Company will receive an amount from the life
insurance proceeds equal to the total premiums paid by the Company with
respect to policies held by the Family Trusts plus an amount representing a
compromise settlement for interest and unpaid premiums. These amounts will be
recognized as income or credited against the insurance receivable from the
Family Trusts which will not have a material effect on the results of
operations of the Company. The Company has continued to make premium payments
on the policies held by the Life Insurance Trusts. During fiscal 1996, the
Company paid approximately $62,000 and $265,000 of premiums on the policies
held by the Family Trusts and the Life Insurance Trusts, respectively.

FINANCIAL ADVISORY FEE

The Company has agreed to pay MBG a fee of $100,000 upon the consummation of
this Offering as compensation for financial advisory services rendered by MBG
to the Company. The general partner of MBG is Conrad/Collins, Inc., a Texas
corporation of which Mr. Conrad is an officer and director and in which
Mr. Conrad owns a controlling interest. Mr. Conrad is a director of the
Company.

PRINCIPAL AND SELLING SHAREHOLDERS

The following table sets forth certain information as of January 31, 1997
and after giving effect to the Offering made hereby regarding the beneficial
ownership of Common Stock by (i) each of the directors and each Named Officer
individually, (ii) all directors and executive officers of the Company as a
group, (iii) each person known by the Company to be the beneficial owner of 5%
or more of the Common Stock and (iv) the Selling Shareholder. Additionally,
this table reflects the number of shares of Common Stock to be sold by the
Selling Shareholder in this Offering.

SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR OWNED AFTER
TO OFFERING(2)(3) COMMON OFFERING(2)(5)
----------------------- STOCK -----------------------
NAME AND ADDRESS OF BENEFICIAL OWNER (1) NUMBER PERCENT OFFERED(4) NUMBER PERCENT
- ---------------------------------------- ------------ ---------- ---------- ------------ ----------

Directors and Named Offi-
cers
M. D. Davis.............. 456,845 13.1% -- 456,845 7.6%
Richard R. Neitz......... 170,000 4.9% -- 170,000 2.8%
Tommy Yau................ 80,000 2.3% -- 80,000 1.3%
Dale Y. Chen (6)......... 21,622 * -- 21,622 *
Thomas V. Yarnell (7).... 18,920 * -- 18,920 *
Barry B. Conrad (8)...... 253,581 7.2% -- 253,581 4.2%
North Tower, Suite 1910
Plaza of the Americas
700 North Pearl Street,
LB-321
Dallas, Texas 75201
Jack R. Crosby (9)....... 427,115 12.2% -- 427,115 7.1%
327 Congress Avenue
Suite 200
Austin, Texas 78701
Joseph N. Matlock (10)... 481,250 13.8% -- 481,250 8.0%
515 Congress Avenue
Suite 2626
Austin, Texas 78701
Douglas A. Smith......... 262,173 7.5% -- 262,173 4.4%
750 North St. Paul,
Suite 1200
Dallas, Texas 75201
All directors and execu-
tive officers as a
group................... 2,171,506 62.0% -- 2,171,506 36.2%
(9 persons)
Beneficial owners of 5%
or more
(excluding persons named
above)
The Tommy Moss Living
Trust................... 781,000 22.3% 500,000 281,000 4.7%
1001 Fannin
Suite 3700
Houston, Texas 77002-
6797
Attn: M. M. Sheinfeld,
Trustee
Hibernia Corporation
(11).................... 388,888 10.0% -- 388,888 6.1%
313 Carondelet Street
New Orleans, Louisiana
70130
Conrad/Collins Merchant
Banking Group Ltd. (8)... 224,376 6.4% -- 224,376 3.7%
North Tower, Suite 1910
Plaza of the Americas
700 North Pearl Street,
LB-321
Dallas, Texas 75201
Rust Capital, Ltd. (9)... 427,115 12.2% -- 427,115 7.1%
327 Congress Avenue,
Suite 200
Austin, Texas 78701

- --------
* Less than 1%.
(footnotes on following page)

(1) Unless otherwise indicated, the business address of all officers and
directors is 1100 West Sam Houston Parkway (North), Suite A, Houston,
Texas 77043.

(2) Assumes that RAC has been dissolved and that the Common Stock held by it
has been distributed to the members thereof.

(3) Excludes 388,888 shares of Common Stock issuable upon exercise of
currently exercisable warrants, except with respect to Hibernia
Corporation.

(4) In the event that the Underwriters' over-allotment option is exercised in
full, The Tommy Moss Living Trust and Hibernia Corporation will sell an
aggregate of 781,000 and 150,000 shares, respectively, in this Offering.
See "Underwriting."

(5) Excludes 388,888 shares of Common Stock issuable upon exercise of
currently exercisable warrants, except with respect to Hibernia
Corporation. In the event that the Underwriters' over-allotment option is
exercised in full, The Tommy Moss Living Trust and Hibernia Corporation
will beneficially own no shares and 238,000 shares (3.7%), respectively,
after the Offering.

(6) Includes 1,760 shares held in an Individual Retirement Account ("IRA") in
the name of Mr. Chen's wife and 5,081 shares held in an IRA in Mr. Chen's
name.

(7) Includes 8,110 shares held in an IRA in Mr. Yarnell's name.

(8) Includes 129,730 shares owned of record by Conrad/Collins Merchant Banking
Fund, Ltd., a Texas limited partnership, of which MBG is the general
partner. The general partner of MBG is Conrad/Collins, Inc., a Texas
corporation of which Mr. Conrad is an officer and director and owns a
controlling interest. Also includes 94,646 shares owned of record by MBG.

(9) Consists of 427,115 shares owned of record by Rust Capital, Ltd., as to
which Mr. Crosby is founder and Chairman.

(10) Includes 106,000 shares owned of record by the M.H. Partnership, a
general partnership of which Mr. Matlock is the managing partner and
213,000 shares owned of record by the M.D. Partnership, a general
partnership of which Mr. Matlock is the managing partner.

(11) Consists of 388,888 shares issuable upon exercise of warrants issued to
Hibernia Corporation, all of which are currently exercisable. In the
event that the Underwriters' over-allotment option is exercised in full,
Hibernia Corporation will exercise warrants for 150,000 shares, which
shares will be sold by Hibernia Corporation in the Offering. See
"Underwriting."

DESCRIPTION OF CAPITAL STOCK

GENERAL

The Company is authorized to issue 20,000,000 shares of Common Stock, par
value $0.01 per share, and 5,000,000 shares of Preferred Stock, par value
$0.01 per share ("Preferred Stock"). As of January 31, 1997, there were
outstanding 3,500,000 shares of Common Stock, held of record by two
shareholders (72 shareholders assuming dissolution of RAC and distribution of
the shares of Common Stock held by RAC), and no shares of Preferred Stock. In
addition, as of such date there was an outstanding warrant entitling the
holder thereof to purchase an aggregate of 388,888 shares of Common Stock.

The following summary description of the Company's capital stock is
qualified in its entirety by reference to the Company's Amended and Restated
Articles of Incorporation (the "Articles of Incorporation") and the Company's
Amended and Restated Bylaws, as amended (the "Bylaws"), copies of which are
included as exhibits to the Registration Statement of which this Prospectus is
a part.

COMMON STOCK

The holders of shares of Common Stock are entitled to one vote for each
share held of record on all matters to be voted on by shareholders. There is
no cumulative voting with respect to the election of directors. Accordingly,
the holders of a majority of the shares of Common Stock entitled to vote in
any election of directors may elect all of the directors. The holders of
shares of Common Stock are entitled to receive dividends when, as and if
declared by the Board of Directors out of funds legally available therefor.
See "Dividend Policy." In the event of a liquidation, dissolution or winding
up of the Company, the holders of shares of Common Stock are entitled to share
ratably in all assets remaining available for distribution to them after
payment of liabilities and after provision has been made for each class of
stock, if any, having preference over the shares of Common Stock. Holders of
shares of Common Stock, as such, have no conversion, preemptive or other
subscription rights, and there are no redemption provisions applicable to the
shares of Common Stock. All of the outstanding shares of Common Stock are, and
the shares of Common Stock to be issued in this Offering will be when issued
and paid for, fully paid and nonassessable.

PREFERRED STOCK

The Board of Directors has the authority, without shareholder approval, to
issue Preferred Stock with dividend, liquidation, conversion, voting or other
rights that could adversely affect the voting power or other rights of the
holders of shares of Common Stock. The Preferred Stock could be utilized,
under certain circumstances, as a method of discouraging, delaying or
preventing a change in control or an acquisition of the Company. Although the
Company has no plans as of the date of this Prospectus to issue any shares of
Preferred Stock, there can be no assurance that the Company will not do so in
the future.

The issuance of shares of Preferred Stock, or the issuance of rights to
purchase such shares, could adversely affect the voting power of the Common
Stock, discourage an unsolicited acquisition proposal or make it more
difficult for a third party to gain control of the Company. For instance, the
issuance of a series of Preferred Stock might impede a business combination by
including class voting rights that would enable the holder to block such a
transaction, or facilitate a business combination by including voting rights
that would provide a required percentage vote of the shareholders. In
addition, under certain circumstances, the issuance of Preferred Stock could
adversely affect the voting power of the holders of the Common Stock. Although
the Board of Directors is required to make any determination to issue such
stock based on its judgment as to the best interests of the shareholders of
the Company, the Board of Directors could act in a manner that would
discourage an acquisition attempt or other transaction that some, or a
majority, of the shareholders might believe to be in their best interests or
in which shareholders might receive a premium for their stock over the then
market price of such stock. The Board of Directors does not at present intend
to seek shareholder approval prior to any issuance of currently authorized
stock, unless otherwise required by law.

WARRANTS

In connection with the Recapitalization, the Company issued to Hibernia
Corporation a warrant (the "Hibernia Warrant") to purchase 388,888 shares of
Common Stock exercisable at a price of $2.00 per share. The Hibernia Warrant
is exercisable at any time during the ten-year period beginning December 11,
1995. At Hibernia's option, the exercise price may be paid by off-setting an
equivalent amount of principal payments owed by the Company under the Hibernia
Loan. The Hibernia Warrant contains anti-dilution provisions providing for
adjustment of the exercise price and/or the number of shares of Common Stock
issuable upon exercise of the Hibernia Warrant upon the occurrence of certain
events, including the issuance of shares of Common Stock (or other securities
convertible into or exercisable for shares of Common Stock) at a price per
share less than the exercise price of the Hibernia Warrant, or less than the
market price of the shares of Common Stock, or in the event of any
recapitalization, reorganization, reclassification, stock dividend, stock
split, stock combination or similar transaction. Pursuant to an Option to Sell
Agreement between the Company and Hibernia, Hibernia has the right to sell the
Hibernia Warrant or the underlying shares of Common Stock to the Company after
January 31, 2001, under certain circumstances.

LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS

As authorized by the Texas Business Corporation Act ("TBCA"), the Company's
Articles of Incorporation provide that to the fullest extent permitted by
Texas law, as the same exists or may hereafter be amended, directors of the
Company shall not be liable to the Company or its shareholders for monetary
damages for an act or omission that breaches a director's fiduciary duty.
Texas law does not currently authorize the elimination or limitation of the
liability of a director to the extent the director is found liable for (i) any
breach of the director's duty of loyalty to the Company or its shareholders,
(ii) acts or omissions not in good faith that constitute a breach of duty of
the director of the Company or that involve intentional misconduct or a
knowing violation of law, (iii) transactions from which the director received
an improper benefit, whether or not the benefit resulted from action taken
within the scope of the director's office, or (iv) acts or omissions for which
the liability of a director is expressly provided by law. If the TBCA is
amended to authorize further elimination or limitation of directors'
liability, then the liability of directors of the Company shall automatically
be limited to the fullest extent provided by law. The Bylaws of the Company
also contain provisions to indemnify the directors, officers, employees or
other agents to the fullest extent permitted by the TBCA. These provisions may
have the practical effect in certain cases of eliminating the ability of
shareholders to collect monetary damages from directors.

CERTAIN PROVISIONS OF THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS

Subject to any additional voting rights that may be granted to holders of
future classes or series of stock, the Company's Articles of Incorporation
require the affirmative vote of holders of a majority of the outstanding
shares entitled to vote thereon to approve any merger, consolidation or share
exchange, sale of all or substantially all of the assets of the Company,
dissolution of the Company or amendment to the Articles of Incorporation for
which a vote is required by the TBCA.

Approval of any matter not described above that is submitted to the
shareholders also requires the affirmative vote of the holders of a majority
of the shares of Common Stock represented at the meeting. The holders of a
majority of the shares entitled to vote will constitute a quorum at meetings
of shareholders. Only the Chairman of the Board of Directors, the President,
the Board of Directors or holders of not less than 50% of the outstanding
shares of stock entitled to vote at a proposed special meeting of shareholders
of the Company may call such a meeting.

The Company's Bylaws provide that the Board of Directors can increase the
number of directors and fill (but only until the next annual meeting of
shareholders) vacancies on the Board of Directors resulting from an increase
in the number of directors constituting the entire Board. Further, any vacancy
on the Board of Directors resulting from the death, resignation or removal of
a director, or other cause, may be filled (for the remainder of

the full term) only by the affirmative vote of a majority of the remaining
director(s) then in office. Additionally, no decrease in the number of
directors constituting the Board of Directors may shorten the term of any
incumbent director. Unless otherwise stated in an amendment to the Company's
Articles of Incorporation, both the Board of Directors and the shareholders
have the authority to alter, amend, adopt or repeal the Bylaws of the Company.
The Company's Bylaws also provide that the directors of the Company are to be
divided into three classes of directors of as equal size as possible, with the
term of each class expiring in consecutive years so that only one class is
elected in any given year. This results in directors serving staggered three-
year terms, except that the terms of the current directors of the Company will
expire at the 1998, 1999 or 2000 annual meeting of shareholders, depending
upon the particular class in which each such director is placed. These
provisions could increase the likelihood that, in the event of a change in
control of the Company, incumbent directors would retain their positions and,
consequently, could have the effect of discouraging, delaying or preventing
such a change in control.

REGISTRATION RIGHTS

The Company has agreed that, upon the request of Hibernia Corporation, on up
to two occasions, the Company will register under the Securities Act and
applicable state securities laws the sale of the 388,888 shares of Common
Stock underlying the Hibernia Warrant. If the Underwriters' over-allotment
option is exercised in full, Hibernia Corporation will sell 150,000 of such
shares in this Offering. See "Underwriting." The Company is also obligated to
offer to the holder of the Hibernia Warrant the opportunity to include shares
of Common Stock underlying the Hibernia Warrant in certain registration
statements filed by the Company. Hibernia Corporation has agreed to waive its
registration rights in connection with this Offering (except as otherwise
provided in this Prospectus). The Company's obligations are subject to certain
limitations regarding the timing of registrations and certain other matters.
The Company has agreed to bear certain expenses associated with such
registrations.

The Company has granted to Mr. Moss, and his successors, certain demand and
piggyback registration rights with respect to the 781,000 shares of Common
Stock held by him or his successors. The Company is registering, and The Tommy
Moss Living Trust (successor to Mr. Moss) is selling, 500,000 of the shares of
Common Stock held by The Tommy Moss Living Trust in this Offering. If the
Underwriters' over-allotment option is exercised in full, The Tommy Moss
Living Trust will sell, its remaining 281,000 shares in this Offering. See
"Underwriting." The Company has agreed to bear certain expenses associated
with the registration of shares of Common Stock held by The Tommy Moss Living
Trust.

MARKET INFORMATION

Prior to this Offering, there has been no established public trading market
for the Common Stock. The Common Stock has been approved for listing in the
Nasdaq National Market under the symbol "DSIT," subject to official notice of
issuance.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the shares of Common Stock is American
Stock Transfer & Trust Company, New York, New York.

SHARES ELIGIBLE FOR FUTURE SALE

Prior to this Offering, there has been no market for the Common Stock.
Therefore, future sales of substantial amounts of Common Stock in the public
market could adversely affect market prices prevailing from time to time.
Furthermore, because only a limited number of shares will be available for
sale shortly after this offering due to certain contractual and legal
restrictions on resale (as described below), sales of substantial amounts of
Common Stock of the Company in the public market after the restrictions lapse
could adversely affect the prevailing market price and the ability of the
Company to raise equity capital in the future.

Upon completion of this Offering, the Company will have a total of 6,000,000
shares of Common Stock outstanding (6,169,000 shares if the Underwriters'
over-allotment option is exercised in full). Of such shares, the 3,000,000
shares sold in the Offering will be freely tradeable without restriction or
registration under the

Securities Act, except for any shares purchased by an "affiliate" (as defined
in the Securities Act) of the Company. The remaining 3,000,000 shares (the
"Restricted Shares") are deemed to be "restricted securities" within the
meaning of the Securities Act and may be publicly sold only if registered
under the Securities Act or sold in accordance with an available exemption
from registration, such as that provided by Rule 144 promulgated under the
Securities Act. Upon the completion of this Offering and subject to compliance
with any lock-up agreements between certain shareholders and the Underwriters,
all of such shares will be freely tradeable in the public market upon
compliance with Rule 144.

In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) is entitled to sell Restricted Shares if at least
one year has passed since the later of the time such shares were acquired from
the Company or an affiliate of the Company. Rule 144 provides, however, that
within any three-month period such person may only sell up to the greater of
(i) one percent of the then outstanding shares of Common Stock (60,000 shares
upon completion of this Offering) or (ii) the average weekly trading volume in
the Common Stock during the four calendar weeks immediately preceding the date
on which notice of the sale is filed with the Securities and Exchange
Commission (the "Commission"). Under Rule 144(k), any person who has not been
an affiliate of the Company for a period of three months preceding a sale of
Restricted Shares is entitled to sell such shares without regard to such
volume limitations if at least two years have passed since the later of the
time such shares were acquired from the Company or an affiliate of the
Company. Shares held by persons who are deemed to be affiliates of the Company
are subject to such volume limitations regardless of how long they have been
owned or how they were acquired. The Company is unable to estimate the number
of Restricted Shares that may be sold from time to time under Rule 144, since
such number will depend on the market price and trading volume for the Common
Stock, the personal circumstances of the sellers and other factors.

The Company and its officers, directors and certain shareholders (including
the Selling Shareholder), who in the aggregate will hold approximately
2,822,803 shares upon the completion of the Offering, have agreed that they
will not, directly or indirectly, offer, sell, offer to sell, contract to
sell, grant any option to purchase or otherwise sell or dispose (or announce
any offer, sale, offer of sale, contract of sale, grant of any option to
purchase or other sale or disposition) of any shares of Common Stock or any
securities convertible into, or exercisable or exchangeable for, any shares of
Common Stock without the prior written consent of Tucker Anthony Incorporated,
on behalf of the Underwriters, for a period of 180 days from the date of this
Prospectus, with certain limited exceptions for the grant of options and other
rights by the Company pursuant to the Stock Option Plan. In addition, the
Selling Shareholder has agreed to sell no more than 2,000 shares per day, up
to a maximum of 20,000 shares per month, for an additional 180 days.

Upon completion of this Offering, the Company will have outstanding warrants
entitling the holders thereof to acquire an aggregate of 638,888 shares of
Common Stock, of which warrants covering 388,888 shares currently are
exercisable. The holder of the Hibernia Warrant has entered into a lock-up
agreement similar to that entered into by the Company, except with respect to
any shares that may be sold upon exercise of the Underwriters' over-allotment
option. See "Underwriting".

An aggregate of 600,000 shares of Common Stock are reserved for issuance
upon the exercise of options that may be granted under the Stock Option Plan,
of which options to purchase 90,000 shares will be granted or are outstanding
following this Offering. See "Capitalization." The Company anticipates filing
a registration statement on Form S-8 under the Securities Act to register all
of the shares of Common Stock reserved for future issuance under the Stock
Option Plan. Shares purchased upon exercise of the options granted pursuant to
the Stock Option Plan generally will be available for resale in the public
market to the extent the stock transfer restriction agreements with the
Underwriters have expired, except that any such shares issued to affiliates
will be subject to the volume limitations and certain other restrictions of
Rule 144. It is contemplated that, upon completion of the Offering, the Board
of Directors will consider the granting of additional stock options to various
employees of the Company, the amount, terms and timing of which have not yet
been determined.

Various holders of Common Stock and warrants have certain "piggyback" and
demand registration rights to register such Common Stock and shares issuable
upon exercise of such warrants for public sale under the Securities Act. See
"Description of Capital Stock--Registration Rights." The Company is
contractually prohibited, without the prior written consent of Tucker Anthony
Incorporated, on behalf of the Underwriters, from filing such registration
statement for a period of 180 days from the date of this Prospectus. The
preparation and filing of any registration statements filed in connection with
the exercise of such registration rights will be at the expense of the
Company.

The Company can make no prediction as to the effect, if any, that sales of
shares of Common Stock or the availability of shares for sale will have on the
market price of Common Stock. Nevertheless, sales of significant amounts of
Common Stock could adversely affect the prevailing market price of Common
Stock, as well as impair the ability of the Company to raise capital through
the issuance of additional equity securities. Prior to this Offering, there
has been no established public trading market for the Common Stock. The
Company anticipates that the trading market in the Common Stock, if any, will
be very limited based upon the number of shares currently outstanding and
anticipated to be sold in this Offering.

UNDERWRITING

The Underwriters named below, acting through Tucker Anthony Incorporated and
Sutro & Co. Incorporated, as Representatives, have severally agreed, subject
to the terms and conditions of the Underwriting Agreement, to purchase from
the Company and the Selling Shareholder, and the Company and the Selling
Shareholder has agreed to sell to the Underwriters, the number of shares of
Common Stock set forth opposite their names below:

NUMBER
NAME OF SHARES
---- ---------

Tucker Anthony Incorporated........................................
Sutro & Co. Incorporated...........................................
---------
Total............................................................ 3,000,000
=========

The Underwriters will purchase all shares of Common Stock offered hereby,
other than over-allotment shares, if any of such shares are purchased. The
Underwriting Agreement provides that the obligations of the several
Underwriters are subject to conditions precedent specified therein. In the
event of a default by an Underwriter, the commitment set forth above of the
non-defaulting Underwriters may be increased or the Underwriting Agreement may
be terminated.

The Company and the Selling Shareholder have been advised by the
Representatives that the Underwriters propose to offer the shares of Common
Stock to the public at the offering price set forth on the cover page of this
Prospectus and to certain dealers at such price less a concession not in
excess of $ per share. Such dealers may reallow a concession of not in
excess of $ per share to certain other dealers. After the public offering,
the offering price, concession and reallowance to dealers may be changed by
the Underwriters.

The Company, the Selling Shareholder and Hibernia Corporation have granted
to the Underwriters an option, exercisable by the Underwriters not later than
45 days after the effective date of this Prospectus, to purchase up to 450,000
additional shares of Common Stock at the public offering price, less the
underwriting discount set forth on the cover page of this Prospectus. The
Underwriters may exercise such option, in whole or in part, only to cover
over-allotments made in connection with the sale of the shares of Common Stock
offered hereby. To the extent that the Underwriters exercise such option, each
Underwriter will become obligated, subject to certain conditions, to purchase
approximately the same percentage thereof that the number of shares of Common
Stock to be purchased by it shown in the above table bears to the total shown,
first from the Selling Shareholder (up to 281,000 shares) and Hibernia
Corporation (up to 150,000 shares) on a pro rata basis in proportion to the
number of shares subject to such option, and then from the Company (up to
19,000 shares). The Selling Shareholder, Hibernia Corporation and the Company
will be obligated, pursuant to the option, to sell such shares to the
Underwriters.

In connection with the Offering made hereby, the Company has agreed to sell
to the Representatives, for nominal consideration, warrants to purchase
250,000 shares of Common Stock from the Company (10% of the number of shares
issued by the Company in the Offering) (the "Representatives' Warrants"). The
Representatives' Warrants are exercisable, in whole or in part, at an exercise
price of 120% of the price to public set forth on the cover page of this
Prospectus at any time during the four-year period commencing one year after
the effective date of the Registration Statement of which this Prospectus is a
part. The warrant agreement pursuant to which the Representatives' Warrants
will be issued will contain provisions providing for adjustment of the
exercise price and the number and type of securities issuable upon exercise of
the Representatives' Warrants should any one or more of certain specified
events occur. The Representatives' Warrants grant to the holders thereof
certain rights of registration for the securities issuable upon exercise of
the Representatives' Warrants. In addition, the Company has agreed to pay to
MBG a $100,000 fee for financial advisory services in connection with the
Offering.

The Company, the Selling Shareholder and Hibernia Corporation have agreed to
indemnify the Underwriters against certain liabilities, including liabilities
under the Securities Act, and to contribute to certain payments that the
Underwriters may be required to make.

Without the prior written consent of Tucker Anthony Incorporated, the
Company has agreed that it will not for a period of 180 days from the date of
this Prospectus, offer, sell or otherwise dispose of any of the Company's
equity securities (except that the Company may grant options to purchase
shares of Common Stock under the Stock Option Plan). The Company's directors,
officers and existing shareholders and the holder of the Hibernia Warrant have
agreed that they will not, for a period of 180 days (subject to certain
further restrictions with respect to the Selling Shareholder for an additional
180 days) from the date of this Prospectus, offer, sell or otherwise dispose
of any of the Company's equity securities that they beneficially own or
control.

Prior to the Offering, there has been no public market for the Common Stock.
Consequently, the initial public offering price for the Common Stock has been
determined by negotiations between the Company and by the Representatives.
Factors considered in determining such price were prevailing market
conditions, the state of the Company's development, recent financial results
of the Company, the future prospects of the Company and its industry, market
valuations of the securities of companies engaged in activities deemed by the
Representatives to be similar to those of the Company and other factors deemed
relevant.

The Underwriters do not intend to confirm sales to accounts over which they
exercise discretionary authority.

The Representatives, on behalf of the Underwriters, may engage in over-
allotment, stabilizing transactions, syndicate covering transactions and
penalty bids in accordance with Regulation M under the Securities Exchange Act
of 1934, as amended (the "Exchange Act"). Over-allotment involves syndicate
sales in excess of the offering size, which creates a syndicate short
position. Stabilizing transactions permit bids to purchase the underlying
security so long as the stabilizing bids do not exceed a specific maximum.
Syndicate covering transactions involve purchases of Common Stock in the open
market after the distribution has been completed in order to cover syndicate
short positions. Penalty bids permit the Representatives to reclaim a selling
concession from a syndicate member when the shares of Common Stock originally
sold by such syndicate member are purchased in a syndicate covering
transaction to cover syndicate short positions. Such stabilizing transactions,
syndicate covering transactions and penalty bids may cause the price of the
Common Stock to be higher than it would otherwise be in the absence of such
transactions. These transactions may be effected on the Nasdaq National Market
or otherwise and, if commenced, may be discontinued at any time.

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Company by Thompson & Knight, P.C., Dallas, Texas. Certain matters will be
passed upon for the Underwriters by Stroock & Stroock & Lavan LLP, Los
Angeles, California.

EXPERTS

The financial statements as of January 31, 1996 and January 31, 1997 and for
each of the three years in the period ended January 31, 1997 included in this
Prospectus have been so included in reliance on the report of Price Waterhouse
LLP, independent accountants, given on the authority of said firm as experts
in auditing and accounting.

ADDITIONAL INFORMATION

The Company has filed with the Commission a Registration Statement on Form
S-1 (as amended and together with all exhibits thereto, the "Registration
Statement") under the Securities Act, with respect to the

shares of Common Stock offered hereby. This Prospectus constitutes a part of
the Registration Statement and does not contain all of the information set
forth in the Registration Statement, certain parts of which are omitted from
this Prospectus as permitted by the rules and regulations of the Commission.
Statements contained in this Prospectus as to the contents of any contract,
agreement or other document referred to herein are not necessarily complete
and, where such agreement or other document is an exhibit to the Registration
Statement, each such statement is qualified in all respects by the provisions
of such exhibit, to which reference is hereby made for a full statement of the
provisions thereof. For further information with respect to the Company and
the Common Stock, reference is hereby made to the Registration Statement and
to the schedules and exhibits thereto.

The Registration Statement may by inspected, without charge, and copies may
be obtained, at prescribed rates, at the public reference facilities of the
Commission maintained at Judiciary Plaza, 450 Fifth Street, N.W.,
Room 1024, Washington, D.C. 20549. Copies of the Registration Statement may
also be inspected, without charge, at the Commission's regional offices at 7
World Trade Center, Suite 1300, New York, New York 10048 and 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. In addition, copies of the
Registration Statement may be obtained by mail at prescribed rates, from the
Public Reference Branch of the Commission at 450 Fifth Street, N.W.,
Washington D.C. 20549.

As a result of this Offering, the Company will become subject to the
information and periodic reporting requirements of the Exchange Act and, in
accordance therewith, will file periodic reports, proxy statements and other
information with the Commission. Such periodic reports, proxy statements and
other information will be available for inspection and copying at the public
reference facilities and regional offices referred to above. The Commission
maintains a Web site that contains reports, proxy statements and other
information regarding registrants that file electronically with the
Commission. The address of such Web site is http://www.sec.gov.

The Company intends to furnish its shareholders with annual reports
containing consolidated financial statements certified by its independent
auditors and with quarterly reports for each of the first three quarters of
each fiscal year containing unaudited financial information.

DSI TOYS, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

PAGE
----

Report of Independent Accountants........................................ F-2
Consolidated Balance Sheet at January 31, 1996 and 1997.................. F-3
Consolidated Statement of Income for fiscal years 1994, 1995 and 1996.... F-4
Consolidated Statement of Cash Flows for fiscal years 1994, 1995 and
1996.................................................................... F-5
Consolidated Statement of Shareholders' Equity (Deficit) for fiscal years
1994, 1995 and 1996..................................................... F-6
Notes to Consolidated Financial Statements............................... F-7

F-1

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders of DSI Toys, Inc.

In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, cash flows and shareholders' equity
(deficit) present fairly, in all material respects, the financial position of
DSI Toys, Inc. and its subsidiary at January 31, 1996 and 1997, and the
results of their operations and their cash flows for each of the three years
in the period ended January 31, 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.

Price Waterhouse LLP

Houston, Texas
March 21, 1997, except as to
Note 12 which is as of
May 1, 1997.

F-2

DSI TOYS, INC.

CONSOLIDATED BALANCE SHEET

JANUARY 31,
--------------------------
1996 1997
------------ ------------

ASSETS
------
Current assets:
Cash............................................. $ 2,660,455 $ 1,501,992
Restricted cash.................................. 150,000 150,000
Accounts receivable, net of allowance for
doubtful accounts of $68,477 and $104,781....... 5,223,446 4,219,942
Due from shareholder............................. 819,283 151,667
Shareholder insurance proceeds receivable........ 511,765
Inventories...................................... 3,409,962 4,615,087
Prepaid expenses................................. 1,130,006 1,462,189
Deferred income taxes............................ 351,000 362,000
------------ ------------
Total current assets........................... 13,744,152 12,974,642
Property and equipment, net........................ 1,514,096 1,190,498
Shareholder insurance proceeds receivable.......... 1,143,076 920,987
Deferred debt issuance costs....................... 842,963 679,906
Other assets....................................... 145,316 537,868
------------ ------------
$ 17,389,603 $ 16,303,901
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable and accrued liabilities......... $ 6,480,485 $ 7,247,254
Current portion of long-term debt ............... 3,359,210 2,755,789
Income taxes payable............................. 314,874 193,211
Deferred income taxes............................ 79,408 158,000
------------ ------------
Total current liabilities...................... 10,233,977 10,354,254
Long-term debt..................................... 11,187,702 8,203,108
Notes payable--shareholder......................... 7,000,000 6,000,000
Deferred income taxes.............................. 549,987 1,169,000
------------ ------------
Total liabilities.............................. 28,971,666 25,726,362
------------ ------------
Shareholders' equity (deficit):
Preferred stock, $0.01 par value, 5,000,000
shares authorized, none issued or outstanding...
Common stock, $0.0001 and $0.01 par value,
respectively, 20,000,00 shares authorized,
6,219,000 shares issued......................... 622 62,190
Additional paid-in capital....................... 3,504,661 3,443,093
Common stock warrants............................ 100,000 100,000
Retained earnings................................ 7,472,077 9,623,350
Cumulative translation adjustment................ 1,169 9,498
------------ ------------
11,078,529 13,238,131
Less-treasury stock, 2,719,000 shares, at cost... (22,660,592) (22,660,592)
------------ ------------
(11,582,063) (9,422,461)
------------ ------------
Commitments and contingencies (Note 9)
------------ ------------
$ 17,389,603 $ 16,303,901
============ ============

The accompanying notes are an integral part of this statement.

F-3

DSI TOYS, INC.

CONSOLIDATED STATEMENT OF INCOME

FISCAL YEAR
-------------------------------------
1994 1995 1996
----------- ----------- -----------

Net sales.............................. $45,219,277 $63,146,080 $63,219,212
Costs of goods sold.................... 33,614,394 43,428,075 42,023,044
----------- ----------- -----------
Gross profit........................... 11,604,883 19,718,005 21,196,168
Selling, general and administrative
expenses.............................. 7,910,192 14,624,519 15,569,422
Former sole shareholder bonus.......... 2,000,000 1,000,000 --
----------- ----------- -----------
Operating income....................... 1,694,691 4,093,486 5,626,746
Interest expense....................... 332,660 700,986 2,599,942
Other income........................... (110,651) (383,801) (344,469)
----------- ----------- -----------
Income before income taxes............. 1,472,682 3,776,301 3,371,273
Provision for income taxes............. 504,011 1,449,677 1,220,000
----------- ----------- -----------
Net income............................. $ 968,671 $ 2,326,624 $ 2,151,273
=========== =========== ===========
Earnings per share..................... $ 0.28 $ 0.66 $ 0.58
=========== =========== ===========
Weighted average shares outstanding.... 3,500,000 3,500,000 3,739,146
=========== =========== ===========

The accompanying notes are an integral part of this statement.

F-4

DSI TOYS, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

FISCAL YEAR
--------------------------------------
1994 1995 1996
----------- ------------ -----------

Cash flows from operating activities:
Net income........................... $ 968,671 $ 2,326,624 $ 2,151,273
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization...... 734,947 830,667 596,332
Amortization of debt discount and
issuance costs.................... 38,998 163,057
Provision for doubtful accounts.... 45,927 88,012 62,160
Gain on sale of equipment.......... (12,511)
Deferred income taxes.............. (36,880) 162,275 686,605
Changes in assets and liabilities:
Accounts receivable.............. (1,764,514) (2,196,971) 941,344
Due from shareholder............. 674,184 (613,367) 667,616
Inventories...................... (885,052) (1,544,972) (1,205,125)
Prepaid expenses................. (259,900) (208,762) (332,183)
Accounts payable and accrued
liabilities..................... 1,517,127 3,176,595 766,769
Income taxes payable............. 148,071 (96,722) (121,663)
----------- ------------ -----------
Net cash provided by operating
activities.................... 1,142,581 1,962,377 4,363,674
----------- ------------ -----------
Cash flows from investing activities:
Capital expenditures................. (801,685) (383,446) (284,260)
Proceeds from sale of equipment...... 24,037
Increase in insurance receivable from
shareholder......................... (348,459) (369,441) (289,676)
(Increase) decrease in other assets.. (2,944) 10,065 (392,552)
----------- ------------ -----------
Net cash used by investing
activities.................... (1,153,088) (742,822) (942,451)
----------- ------------ -----------
Cash flows from financing activities:
Net borrowings (repayments) under
revolving lines of credit........... 409,805 5,183,399 (2,088,225)
Proceeds from long-term debt......... 950,000 10,000,000
Payments on long-term debt........... (1,293,186) (522,280) (2,499,790)
Net proceeds from issuance of common
stock............................... 3,502,783
Purchase of treasury shares.......... (16,208,742)
Debt and stock issue costs........... (879,259)
----------- ------------ -----------
Net cash provided (used) by
financing activities.......... 66,619 1,075,901 (4,588,015)
----------- ------------ -----------
Effect of exchange rate changes on
cash.................................. (577) 1,746 8,329
----------- ------------ -----------
Net increase (decrease) in cash........ 55,535 2,297,202 (1,158,463)
Cash and cash equivalents:
Beginning of year.................... 307,718 363,253 2,660,455
----------- ------------ -----------
End of year.......................... $ 363,253 $ 2,660,455 $ 1,501,992
=========== ============ ===========

The accompanying notes are an integral part of this statement.

F-5

DSI TOYS, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)

COMMON STOCK ADDITIONAL CUMULATIVE
------------------ PAID-IN RETAINED TRANSLATION TREASURY
SHARES AMOUNT CAPITAL WARRANTS EARNINGS ADJUSTMENT STOCK TOTAL
--------- -------- ---------- -------- ---------- ----------- ------------ -----------

Balance, February 1,
1994................... 3,500,000 $ 350 $ 2,150 $4,176,782 $ 4,179,282
Net income............. 968,671 968,671
Change in cumulative
translation
adjustment............ $ (577) (577)
--------- -------- ---------- ---------- ------ -----------
Balance, January 31,
1995................... 3,500,000 350 2,150 5,145,453 (577) 5,147,376
Purchase of 2,719,000
shares of treasury
stock................. $(22,151,850) (22,151,850)
Stock purchase costs... (508,742) (508,742)
Issuance of common
stock................. 2,719,000 272 3,799,728 3,800,000
Stock issuance costs... (297,217) (297,217)
Warrants issued........ $100,000 100,000
Net income............. 2,326,624 2,326,624
Change in cumulative
translation
adjustment............ 1,746 1,746
--------- -------- ---------- -------- ---------- ------ ------------ -----------
Balance, January 31,
1996................... 6,219,000 622 3,504,661 100,000 7,472,077 1,169 (22,660,592) (11,582,063)
Net income............. 2,151,273 2,151,273
Change in cumulative
translation
adjustment............ 8,329 8,329
Change in par value of
common stock (Note
12)................... 61,568 (61,568) --
--------- -------- ---------- -------- ---------- ------ ------------ -----------
Balance, January 31,
1997................... 6,219,000 $ 62,190 $3,443,093 $100,000 $9,623,350 $9,498 $(22,660,592) $(9,422,461)
========= ======== ========== ======== ========== ====== ============ ===========

The accompanying notes are an integral part of this statement.

F-6

DSI TOYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--ORGANIZATION:

DSI Toys, Inc. (formerly Diversified Specialists, Inc.) was incorporated
under the laws of the state of Texas in November 1970. The Company markets and
distributes a variety of toys and children's consumer electronics both within
the United States and internationally, primarily to retailers. The Company's
products are manufactured in China and various other Asian countries.

In December 1995, the Company sold newly issued common stock representing
77.7% of its common stock to a group of new investors through Rosie
Acquisition, L.L.C. ("RAC") pursuant to a recapitalization transaction (the
"Recapitalization"). In connection with the Recapitalization, the Company
issued 2,719,000 new shares of common stock to RAC in exchange for $3.8
million in cash. Also in connection therewith, the Company purchased 2,719,000
shares of the common stock of the Company from the previous sole shareholder
for approximately $22.2 million. The previous sole shareholder died on
November 19, 1996. Any references to the previous sole shareholder includes
references to his estate. The purchase price was funded through (a) cash paid
from borrowing of $10.6 million from banks pursuant to a five-year bank note,
a six-year subordinated note and a bank revolving line of credit; (b) the
issuance to the previous sole shareholder of a $6 million subordinated note
and a $1.3 million promissory note, including the grant of a warrant to
purchase 700,000,000 shares of common stock of the Company at $0.001 per share
exercisable in the event of default (see Note 9); (c) the transfer of land to
the previous sole shareholder with a cost of approximately $452,000; and (d)
approximately $3.8 million in cash obtained from the sale of common stock to
RAC. The subordinated bank note carries warrants to purchase 388,888 shares of
common stock of the Company at an exercise price of $2.00 per share. In
connection with the purchase of treasury stock, the Company incurred
approximately $509,000 in costs and fees, which were included as the cost of
the stock, and approximately $879,000 in debt issuance costs. The Company also
incurred approximately $297,000 in costs related to the sale of shares to RAC.
The Company has agreed to bear certain expenses of a public offering of the
781,000 shares retained by the former sole shareholder.

In January 1996, the Company received a note from the previous sole
shareholder of approximately $1.3 million in satisfaction of the balance
receivable from the previous sole shareholder. Such note was offset against
the aforementioned $1.3 million note issued to the previous sole shareholder
in connection with the Recapitalization.

The Company has agreed to keep life insurance policies in place for the
previous sole shareholder and has issued him a three-year consulting contract.
The Company has also granted a $1 million bonus to the previous sole
shareholder, payable in a $1 million subordinated note issued in January 1996.

NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Basis of presentation

The accompanying consolidated financial statements include the accounts of
DSI (HK) Ltd., a wholly-owned subsidiary formed in February 1992. All
significant intercompany transactions have been eliminated in consolidation.

These financial statements reflect the historical basis of the Company's
assets and liabilities. No adjustments have been made to reflect an allocation
of the purchase price paid by RAC for its 77.7% interest in the Company.

Fiscal Year

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).

F-7

DSI TOYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Cash equivalents

The Company considers all highly liquid investments with original maturities
of three months or less to be cash equivalents. Restricted cash held as a
compensating balance under the revolving loan supported by letters of credit
is not considered a cash equivalent.

Revenue recognition

Revenues are recognized upon shipment of product by the Company or, in the
case of FOB Asia sales, by the manufacturer, and, at that point, legal
responsibility and title pass to the buyer. The Company provides an allowance
for doubtful accounts and accrues for returns and discounts using a percentage
of gross sales based on historical experience. Provision is made currently for
estimated returns of defective and slow-moving merchandise, price protection
and customer allowances.

Inventories

Inventories consist of finished goods and supplies and are stated at the
lower of cost or market, with cost determined on a first-in, first-out basis.

Property and equipment

Property and equipment are recorded at cost. Depreciation is recorded over
the estimated useful lives of the related assets using the straight-line
method for molds and leasehold improvements and an accelerated method for all
other assets.

Debt issuance costs and debt discount

Debt issuance costs of $879,000 and debt discount of $100,000 incurred in
connection with the Recapitalization are amortized over the terms of the
related debt.

Advertising

The cost of producing media advertising is capitalized as incurred and
expensed in the period in which the advertisement is first shown. During
interim periods, media communication costs are accrued in relation to sales
when the advertising is clearly implicit in the related sales arrangement. In
any event, all media communication costs are expensed in the fiscal year
incurred. All other advertising costs are expensed in the period incurred.
Television advertising expense totaled $3.1 million and $6.0 million during
fiscal 1995 and 1996 and was not significant prior to that time. At January
31, 1996 and 1997, prepaid television advertising production costs of $119,000
and $451,000 are included in prepaid expenses.

Income taxes

The Company accounts for deferred income taxes using the liability method
which provides for the recognition of deferred tax assets and liabilities
based upon temporary differences between the tax basis of assets and
liabilities and their carrying value for financial reporting purposes.
Deferred tax expense or benefit is the result of changes in deferred tax
assets and liabilities during the period. In estimating future tax
consequences, all expected future events are considered other than enactments
of changes in the tax law or rates.

Deferred income taxes are provided on the undistributed earnings of DSI (HK)
Ltd.

Foreign currency translations

During fiscal 1994, the Company changed the functional currency for its
foreign subsidiary from the U.S. dollar to the local currency, as cash flows
and financing activities of this entity were increasingly denominated in the
local currency. The impact of this change was not material to the Company's
financial statements. As a result of this change, assets and liabilities at
the balance sheet date are translated into U.S. dollars at the exchange

F-8

DSI TOYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

rate in effect on the balance sheet date and translation adjustments are
accumulated as a separate component of shareholders' equity. Revenue and
expense accounts are translated at prevailing rates throughout the year.

Recent accounting pronouncement

Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
(SFAS 121), was issued by the Financial Accounting Standards Board in March
1995. SFAS 121 establishes accounting standards for the impairment of long-
lived assets, certain identifiable intangibles, and goodwill related to those
assets to be held and used and for long-lived assets and certain identifiable
intangibles to be disposed of. Adoption of the provisions of SFAS 121 at the
beginning of fiscal 1995 did not have a material impact on the Company's
financial statements. The Company reviews the carrying value of its long-lived
and identifiable assets for possible impairment whenever events or changes in
circumstances indicate that the carrying amount of assets may not be
recoverable.

Concentration of credit risk and export sales

Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of trade receivables. The
Company sells its products principally to retail discount stores and toy
stores. Concentrations of credit risk with respect to trade receivables are
limited due to the large number of customers comprising the Company's customer
base and their geographic dispersion. The Company performs ongoing credit
evaluations of its customers to minimize credit risk, and for the majority of
its FOB Asia sales, the Company obtains letters of credit from its customers
supporting the accounts receivable.

Sales to major customers that exceeded 10% of total net sales consist of the
following:

FISCAL YEAR
----------------
1994 1995 1996
---- ---- ----

Customer A................................................... 17% 19%
Customer B................................................... 11% 13% 14%
Customer C................................................... 12%
Customer D................................................... 10%

Approximately 19%, 17% and 19% of the Company's sales were exports to
foreign countries during fiscal 1994, 1995 and 1996, respectively. Such sales
were made principally in Canada, the U.K. and Australia.

Use of estimates

The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
period. Because of the inherent uncertainties in their process, actual
results could differ from such estimates. Management believes that the
estimates are reasonable.

Earnings per share

Earnings per share is computed based on the weighted average number of
common and dilutive common equivalent shares outstanding. Earnings per share
during fiscal 1995 does not include the assumed exercise of common stock
equivalents, as such inclusion would be anti-dilutive.

F-9

DSI TOYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 3--PROPERTY AND EQUIPMENT:

Property and equipment consist of the following:

JANUARY 31,
---------------------
ESTIMATED USEFUL LIVES 1996 1997
---------------------- ---------- ----------

Molds......................... 3 years $1,688,104 $1,749,229
Equipment, furniture and
fixtures..................... 5-7 years 1,206,600 1,350,189
Leasehold improvements........ 10 years or lease term 790,102 848,079
Automobiles................... 3-5 years 84,258 84,258
---------- ----------
3,769,064 4,031,755
Less-accumulated depreciation
and amortization............. 2,254,968 2,841,257
---------- ----------
$1,514,096 $1,190,498
========== ==========

NOTE 4--ACCOUNTS PAYABLE AND ACCRUED LIABILITIES:

Accounts payable and accrued liabilities consist of the following:

JANUARY 31,
---------------------
1996 1997
---------- ----------

Trade payables........................................ $3,231,035 $3,221,563
Accrued royalties..................................... 438,435 301,442
Accrued compensation and commissions.................. 984,665 765,277
Accrued returns and discounts......................... 987,781 988,153
Accrued television advertising........................ 375,000 1,345,087
Other................................................. 463,569 625,732
---------- ----------
$6,480,485 $7,247,254
========== ==========

F-10

DSI TOYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 5--NOTES PAYABLE:

Indebtedness consists of the following:

JANUARY 31,
-----------------------
1996 1997
----------- -----------

Bank revolving line of credit for $6 million se-
cured by all of the Company's U.S. accounts re-
ceivable, inventory, intangibles, equipment, fix-
tures and 65% of the common stock of DSI (HK)
Ltd.; guaranteed by RAC; principal due on May 31,
1998; interest at prime plus 0.75%............... $ 4,785,000 $ 3,055,000
Subordinated bank note due January 31, 2002, se-
cured by all of the Company's U.S. accounts re-
ceivable, inventory, intangibles, equipment, fix-
tures, and 65% of the common stock of DSI (HK)
Ltd.; guaranteed by RAC; interest at 13%; princi-
pal of $75,000 payable quarterly; net of related
unamortized debt discount of $97,298 and
$81,082.......................................... 2,902,702 1,418,918
Bank note, secured by all of the Company's U.S.
accounts receivable, inventory, intangibles,
equipment, fixtures and 65% of the common stock
of DSI (HK) Ltd. and 2,719,000 shares of the
Company's common stock; guaranteed by RAC;
interest at prime plus 1% not to exceed 18%;
principal due in quarterly installments of
$250,000......................................... 6,000,000 5,000,000
Subordinated note payable to shareholder; interest
at 10% until March 31, 1996, thereafter, interest
at 12%, payable in full no later than the third
business day following the completion and closing
of an initial public offering of the Company; if
the closing does not occur, unpaid principal due
in $1,000,000 annual installments beginning March
31, 1998 through March 31, 2001 with additional
$1,000,000 installments due December 31, 2000 and
March 31, 2001; secured by 2,719,000 shares of
common stock of the Company; guaranteed by RAC;
and subordinated to all senior debt.............. 6,000,000 6,000,000
Subordinated note payable to shareholder, interest
at 10% until March 31, 1996, thereafter, interest
at 12%, payable in full no later than the third
business day following the completion and closing
of an initial public offering of the Company; if
the closing does not occur, unpaid principal and
interest due May 31, 1997, secured by 2,719,000
shares of common stock of the Company, guaranteed
by RAC and subordinated to all senior debt....... 1,000,000 1,000,000
Revolving bank loan, drawn against a line of
credit, secured by a customer's letter of credit
and $150,000 cash, interest at prime............. 843,204 484,979
Other............................................. 16,006
----------- -----------
21,546,912 16,958,897
Less-current portion.............................. 3,359,210 2,755,789
----------- -----------
$18,187,702 $14,203,108
=========== ===========

F-11

DSI TOYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The Company has a $5 million revolving bank loan available for negotiating
and collecting export sales and for opening back-to-back letters of credit
secured by letters of credit from its customers. Amounts of $843,204 and
$484,979 were borrowed against this line of credit as of January 31, 1996 and
1997. The Company has pledged $150,000 in cash as security for the credit
facility at January 31, 1996 and 1997.

Certain of the Company's loan agreements require the maintenance of
financial covenants, including minimum current ratio, net worth and debt
service coverage and restrict the payment of dividends.

The aggregate amount of maturities for all indebtedness for each of the next
five years are as follows:

FISCAL YEAR AMOUNT
----------- ----------

1997.............................................................. $2,755,789
1998.............................................................. 5,332,297
1999.............................................................. 2,283,784
2000.............................................................. 3,290,270
2001.............................................................. 3,296,757

Based on borrowing rates currently available, management believes the
carrying amounts of notes payable at January 31, 1996 and January 31, 1997
approximate fair values.

NOTE 6--INCOME TAXES:

The components of income before provision for income taxes were as follows:

FISCAL YEAR
----------------------------------
1994 1995 1996
----------- ---------- ----------

Domestic................................. $(1,172,783) $ 613,724 $ (898,344)
Foreign.................................. 2,645,465 3,162,577 4,269,617
----------- ---------- ----------
$ 1,472,682 $3,776,301 $3,371,273
=========== ========== ==========

F-12

DSI TOYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The provision for income taxes consists of the following:

FISCAL YEAR
--------------------------------
1994 1995 1996
-------- ---------- ----------

Current:
Federal.................................. $ 86,923 $ 630,000 $ (185,605)
State.................................... (12,000) 72,000 (14,000)
Foreign.................................. 465,968 585,402 733,000
-------- ---------- ----------
540,891 1,287,402 533,395
-------- ---------- ----------
Deferred:
Federal.................................. (30,000) 208,000 657,605
State.................................... (11,000)
Foreign.................................. (6,880) (45,725) 40,000
-------- ---------- ----------
(36,880) 162,275 686,605
-------- ---------- ----------
$504,011 $1,449,677 $1,220,000
======== ========== ==========

The difference between taxes at the statutory federal and the effective
income tax rates is as follows:

FISCAL YEAR
-------------------------------
1994 1995 1996
-------- ---------- ----------

Taxes computed at
statutory rate......... $500,711 $1,283,942 $1,146,000
State income taxes net
of federal benefit..... (8,000) 47,000 (16,000)
Nondeductible items..... 21,000 54,000 13,000
Other, net.............. (9,700) 64,735 77,000
-------- ---------- ----------
$504,011 $1,449,677 $1,220,000
======== ========== ==========

Deferred tax assets (liabilities) are comprised of the following:

JANUARY 31,
----------------------
1996 1997
--------- -----------

Allowance for doubtful accounts..................... $ 23,000 $ 37,000
Inventory valuation adjustments..................... 28,000 20,000
Depreciation........................................ 19,000 63,000
Reserve for lease cancellation...................... 51,000 52,000
Accrued liabilities................................. 311,000 97,000
Accruals for inventory returns and markdowns........ 132,000 92,000
Foreign and alternative minimum tax credits......... 45,000
Net operating loss carryforward..................... 4,000
Other............................................... 19,000 19,000
--------- -----------
Gross deferred tax assets......................... 587,000 425,000
--------- -----------
Unremitted earnings of foreign subsidiary........... (740,000) (1,225,000)
Prepaid expenses.................................... (79,408) (158,000)
Depreciation........................................ (45,987) (7,000)
--------- -----------
Gross deferred tax liabilities.................... (865,395) (1,390,000)
--------- -----------
Net deferred tax liabilities........................ $(278,395) $ (965,000)
========= ===========

The Company has approximately $24,000 in alternative minimum tax credits and
approximately $50,000 in foreign tax credits. These credits do not expire.

NOTE 7--EMPLOYEE BENEFIT PLAN:

The Company maintains a 401(k) Plan (the Plan) for the benefit of its
employees. The Company may, at its discretion, provide funds to match employee
contributions to the Plan. The Company matched employee contributions of
$105,000 in fiscal 1996. There were no such matching contributions to the Plan
for fiscal 1994 and fiscal 1995.

F-13

DSI TOYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 8--RELATED PARTY TRANSACTIONS:

Prior to the Recapitalization, the Company periodically advanced cash and
made payments on behalf of the shareholder of the Company and related
entities. At January 31, 1996 and 1997, the outstanding balance receivable
from the shareholder was $819,283 and $151,667, respectively. The Company
recorded interest income of $43,000, $114,000 and $12,000 for fiscal 1994,
1995 and 1996, respectively, related to such receivable.

The Company recorded bonuses to the former sole shareholder of $2,000,000
and $1,000,000 for fiscal 1994 and 1995, respectively.

The Company entered into a consulting agreement with the shareholder to
serve as a consultant to the Company for three years for annual compensation
of $300,000. The consulting agreement also requires the Company to maintain
health and disability insurance policies for the benefit of the shareholder
for the term of his life. Pursuant to the agreement, the Company agreed to
maintain the shareholder's office space for his use for the term of the
agreement and to provide for 180 days the services of certain Company
employees for his outside business, provided that such services shall not
exceed 30% of the time of each of such employees. This agreement terminated
upon the shareholder's death on November 19, 1996.

As compensation for consulting services rendered in connection with the
Recapitalization, the Company agreed to pay the Vice Chairman of the Board the
sum of $240,000, payable January 1, 1996, 1997 and 1998.

The Company paid a fee and out-of-pocket expenses aggregating $415,000 to a
consulting firm for services related to the Recapitalization. A Director of
the Company is the co-founder and managing partner of the consulting firm.

The Company has agreed to pay a fee of $100,000 upon completion of a public
offering to a partnership controlled by a director of the Company.

The Company leases its office and warehouse from an entity owned by the
previous sole shareholder of the Company. Rent expense on these leases was
$217,000 each year for fiscal 1994, 1995 and 1996. Management believes that
the rental rates approximate fair market value.

The Company pays insurance premiums for certain single life and last to die
life insurance policies owned by the previous sole shareholder and his wife
and is a beneficiary on these policies to the extent of premiums paid. The
receivables related to these policies as of January 31, 1996 and 1997 amounted
to $1,143,076 and $1,432,752, respectively, and are collateralized by the
related insurance policies. The shareholder is restricted from borrowing
against the policies until the receivable is satisfied in full. The balance of
shareholder insurance proceeds receivable bears interest at 7%.

The Company purchased office furniture from the previous sole shareholder of
the Company for $300,000 during fiscal 1994. Management of the Company
believes that such purchase price represents the approximate fair market value
of the furniture purchased.

Additional related party transactions are described in Notes 1, 5 and 9.

NOTE 9--COMMITMENTS AND CONTINGENCIES:

In the normal course of business, the Company is involved in product and
intellectual property issues which sometimes result in litigation. It is the
opinion of management that the ultimate resolution of such matters will not
have a material adverse effect on the Company's financial position or results
of operations taken as a whole.

F-14

DSI TOYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The Company has granted its previous sole shareholder a warrant to purchase
700,000,000 shares of common stock of the Company at $0.001 per share, subject
to adjustment. Such warrant is exercisable only upon default of the notes
issued by the Company to such shareholder or RAC's guaranty thereof. The
warrant expires upon the fulfillment in the entirety of the Company's and
RAC's obligations with respect to such notes. The Company does not expect such
warrant to be exercised and, accordingly, has not included the shares issuable
upon exercise of the warrant in the calculation of earnings per share.

The Company has reserved 388,888 common shares for issuance upon exercise of
warrants issued to a bank. Such warrants are exercisable immediately at an
initial purchase price of $2 per share (subject to adjustment) and expire upon
the earlier of December 11, 2005 or simultaneously with the exercise of the
warrants held by the previous sole shareholder. The Company is obligated to
bear certain expenses associated with the public registration of the common
stock underlying the warrants. The Company has granted the warrantholder a
right to sell the warrant shares to the Company under certain terms and
conditions if the Company's common stock is not publicly traded by January 31,
2001. The bank warrants were valued by the Company at $100,000.

Upon completion of a public offering of its common shares, the Company has
agreed to grant options to purchase 90,000 shares of its common shares
expiring ten years from date of grant at an exercise price equal to the
initial public offering price to a new officer of the Company.

The Company leases its facilities under various operating leases which
expire from 1998 to 2003. Rent expense, including amounts paid to a related
party for fiscal 1994, 1995 and 1996, amounted to $483,000, $695,000 and
$687,000, respectively. Aggregate minimum rental commitments under
noncancelable leases are as follows:

FISCAL YEAR
-----------

1997.............................................................. $ 675,463
1998.............................................................. 361,792
1999.............................................................. 301,680
2000.............................................................. 312,743
2001.............................................................. 332,945
Thereafter........................................................ 248,457
----------
$2,233,080
==========

Royalty expense under licensing agreements aggregated $729,000, $1,439,000
and $1,578,000 in fiscal 1994, 1995 and 1996, respectively. At January 31,
1997, minimum guaranteed royalties payable under these agreements in fiscal
1997 and thereafter of $52,000 and $180,000 are included in accrued royalties
payable and prepaid expenses.

F-15

DSI TOYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 10--SEGMENT INFORMATION:

Financial information for fiscal 1996, 1995 and 1994 by geographic area is as
follows:

ADJUSTMENTS
AND
UNITED STATES HONG KONG ELIMINATIONS CONSOLIDATED
------------- ----------- ------------ ------------

FISCAL 1994
Sales to customers...... $ 11,088,585 $34,130,692 $45,219,277
Intercompany transfers.. 2,466,097 762,049 $(3,228,146)
------------ ----------- ----------- ------------
Net sales............... 13,554,682 34,892,741 (3,228,146) 45,219,277
Gross profit............ 4,934,699 9,258,714 (2,588,530) 11,604,883
Selling, general and
administrative
expenses............... (6,100,751) (6,225,275) 2,415,834 (9,910,192)
Interest expense........ (61,304) (271,356) (332,660)
Other income............ 1,347,314 56,078 (1,292,741) 110,651
Income before income
taxes.................. 119,958 2,818,161 (1,465,437) 1,472,682
Identifiable assets at
fiscal year end........ 6,822,717 3,802,922 (236,566) 10,389,073
FISCAL 1995
Sales to customers...... $ 27,724,986 $35,421,094 $63,146,080
Intercompany transfers.. 2,561,937 2,006,794 $(4,568,731)
------------ ----------- ----------- ------------
Net sales............... 30,286,923 37,427,888 (4,568,731) 63,146,080
Gross profit............ 12,463,968 9,716,928 (2,462,891) 19,718,005
Selling, general and
administrative
expenses............... (11,814,995) (6,433,503) 2,623,979 (15,624,519)
Interest expense........ (398,649) (302,337) (700,986)
Other income............ 363,400 15,425 4,976 383,801
Income before income
taxes.................. 613,724 2,996,513 166,064 3,776,301
Identifiable assets at
fiscal year end........ 10,016,623 7,443,482 (70,502) 17,389,603
FISCAL 1996
Sales to customers...... $ 27,970,378 $35,248,834 $ 63,219,212
Intercompany transfers.. 2,543,768 1,998,736 $(4,542,504)
------------ ----------- ----------- ------------
Net sales............... 30,514,146 37,247,570 (4,542,504) 63,219,212
Gross profit............ 12,857,158 10,907,350 (2,568,340) 21,196,168
Selling, general and
administrative
expenses............... (11,791,909) (6,315,544) 2,538,031 (15,569,422)
Interest expense........ (2,251,709) (348,233) (2,599,942)
Other income............ 288,116 50,616 5,737 344,469
Income (loss) before
income taxes........... (898,344) 4,294,189 (24,572) 3,371,273
Identifiable assets at
fiscal year end........ 6,455,459 9,943,516 (95,074) 16,303,901

F-16

DSI TOYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 11--SUPPLEMENTAL CASH FLOW INFORMATION:

FISCAL YEAR
------------------------------
1994 1995 1996
-------- ---------- ----------

Cash paid for:
Interest.................................. $328,911 $ 656,117 $2,360,538
Income taxes.............................. 393,000 1,851,890 655,058
Noncash activities included the following:
Accounts receivable write-off............. $ 5,588 $ 145,995 $ 31,188
Purchase of treasury stock from former
sole shareholder in exchange for land.... 451,850
Purchase of treasury stock from former
sole shareholder in exchange for notes
payable.................................. 7,300,000
Cancellation of note payable and note
receivable from former sole shareholder.. 1,300,000

NOTE 12--SUBSEQUENT EVENTS:

Effective May 1, 1997, the Company's Articles of Incorporation were amended
to (i) authorize the issuance of 5,000,000 shares of $0.01 par value preferred
stock, (ii) change the par value of common stock to $0.01, and (iii) reduce
the authorized shares of common stock to 20,000,000 shares.

On May 1, 1997, the Board of Directors (i) authorized the issuance of
warrants to purchase 250,000 shares of common stock for an exercise price
equal to 120% of the price of common stock sold by the Company in an initial
public offering of common stock, (ii) adopted the 1997 Stock Option Plan and
(iii) reserved 600,000 shares of common stock for issuance under such plan and
250,000 shares of common stock issuable upon exercise of such warrants. No
options have been issued under the plan.

F-17

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

TABLE OF CONTENTS

PAGE
----

Prospectus Summary....................................................... 3
Risk Factors............................................................. 6
The Recapitalization..................................................... 11
Use of Proceeds.......................................................... 12
Dividend Policy.......................................................... 13
Dilution................................................................. 14
Capitalization........................................................... 15
Selected Consolidated Financial Data..................................... 16
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 17
Business................................................................. 23
Management............................................................... 33
Certain Transactions..................................................... 38
Principal and Selling Shareholders....................................... 39
Description of Capital Stock............................................. 41
Shares Eligible for Future Sale.......................................... 43
Underwriting............................................................. 46
Legal Matters............................................................ 47
Experts.................................................................. 47
Additional Information................................................... 47
Index to Consolidated Financial Statements............................... F-1

---------------

NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY IN-
FORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHO-
RIZED BY THE COMPANY, THE SELLING SHAREHOLDER OR THE UNDERWRITERS. THIS PRO-
SPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO
BUY, COMMON STOCK IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PRO-
SPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY
IMPLICATION THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS
PROSPECTUS OR THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.

UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EF-
FECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY REQUIRE-
MENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENT OR
SUBSCRIPTIONS.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

3,000,000 Shares

LOGO

[LOGO OF DSI TOYS, INC. APPEARS HERE]

Common Stock

---------------

PROSPECTUS

---------------

, 1997

Tucker Anthony
Incorporated

Sutro & Co. Incorporated

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, incurred or to be incurred in
connection with the sale of the Common Stock being registered (all amounts are
estimated except the SEC Registration Fee, the NASD Filing Fee and the Nasdaq
Listing Fees), all of which will be paid by the Registrant:

SEC Registration Fee........................................... $ 12,500.72
NASD Filing Fee................................................ 4,625.25
Nasdaq National Market Listing Fees............................ 32,500.00
Blue Sky Fees and Expenses..................................... 5,000.00
Accounting Fees and Expenses................................... 100,000.00
Legal Fees and Expenses........................................ 180,000.00
Transfer Agent and Registrar Fees.............................. 2,000.00
Printing and Engraving Expenses................................ 125,000.00
Financial Advisory Fees........................................ 145,000.00
Miscellaneous.................................................. 13,374.03
------------
Total........................................................ $ 620,000.00
============

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

DSI Toys, Inc. (the "Registrant") is incorporated in Texas. Under Section
2.02 of the Business Corporation Act of the State of Texas ("TBCA"), a Texas
corporation has the power, under specified circumstances, to indemnify its
directors, officers, employees and agents in connection with actions, suits or
proceedings brought against them by a third party or in the right of the
corporation, by reason of the fact that they were or are such directors,
officers, employees or agents, against expenses incurred in any action, suit
or proceedings. The Bylaws of the Registrant provide for indemnification of
directors and officers to the fullest extent permitted by the TBCA. Reference
is made to the Bylaws, as amended, of the Registrant, filed as Exhibits 3.2
and 3.3 hereto.

The Registrant currently does not have directors' and officers' liability
insurance covering certain liabilities incurred by the Registrant's directors
and officers in connection with the performance of their duties and does not
anticipate obtaining such liability insurance coverage.

The Underwriting Agreement filed as Exhibit 1 contains provisions by which
the Underwriter agrees to indemnify the Registrant, any person controlling the
Registrant within the meaning of Section 15 of the Securities Act of 1933 (the
"Act") or Section 20 of the Securities Exchange Act of 1934, each director of
the Registrant, and each officer of the Registrant who signs this Registration
Statement with respect to information relating to such Underwriter furnished
in writing to the Company by or on behalf of such Underwriter expressly for
use in the Registration Statement.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.

The securities sold by the Registrant within the past three years have not
been registered under the Act pursuant to an exemption from registration under
Section 4(2) of the Act. All securities sold within the past three years were
shares of Common Stock or warrants to purchase shares thereof. There were no
underwriters employed in connection with any of these transactions. The
recipients of such securities in each such transaction represents their
intention to acquire the securities for investment only and not with a view
to, or for sale in

II-1

connection with, any distribution thereof. Appropriate legends were affixed to
the share certificates and other instruments issued in such transactions. All
recipients either received adequate information about the Registrant or had
access through employment or other relationships, to such information. The
following sets forth the original terms of such sales of securities by the
Registrant within the past three years:

On December 11, 1995, the Registrant sold 2,719,000 newly-issued shares of
Common Stock to Rosie Acquisition, L.L.C., a Texas limited liability company
("RAC"), in connection with the recapitalization of the Registrant. In
consideration of these shares, RAC paid the Registrant $3.8 million.

On December 11, 1995, in connection with the recapitalization of the
Registrant, the Registrant issued to Hibernia Corporation warrants to purchase
388,888 shares of Common Stock at a price of $2.00 per share. These warrants
are exercisable at any time during the ten year period beginning December 11,
1995.

On December 11, 1995, in connection with the recapitalization of the
Registrant, the Registrant issued to Tommy Moss, the former sole shareholder
of the Registrant, a warrant to purchase 700,000,000 shares of Common Stock in
the event of default by the Registrant on certain indebtedness to Mr. Moss.
Such warrant will terminate upon repayment of the indebtedness, which will
occur upon application of the net proceeds of the Offering contemplated by
this Registration Statement.

II-2

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) Exhibits:

EXHIBIT
NUMBER DESCRIPTION
------- -----------

1 Form of Underwriting Agreement.**
3.1 Amended and Restated Articles of Incorporation.***
3.2 Amended and Restated Bylaws.***
3.3 Amendment to Bylaws.***
4.1 Form of Common Stock Certificate.**
4.2 Form of Warrant Agreement among the Company and the Representatives to
purchase 250,000 shares of Common Stock.**
4.3 Common Stock Purchase Warrant No. A-1 dated December 11, 1995, issued
to Hibernia Corporation to purchase 388,888 shares of Common
Stock.***
4.4 Registration Rights Agreement by and between the Company and Hibernia
Corporation.***
4.5 Registration Rights Agreement by and between the Registrant and Tommy
Moss.***
5 Opinion of Thompson & Knight, P.C.***
10.1 1997 Stock Option Plan.**+
10.2 Agreement for Sale of Stock between Rosie Acquisition, L.L.C. and DSI
Acquisition, Inc. and Diversified Specialists, Inc. and Tommy Moss,
dated December 11, 1995.***
10.3 Employment Agreement dated December 11, 1995 by and between the
Company and M.D. Davis.***
10.4 Employment Agreement dated December 11, 1995 by and between the
Company and Richard R. Neitz.***
10.5 Employment Agreement dated December 11, 1995 by and between the
Company and Yau Wing Kong.***
10.6 Employment Agreement dated December 11, 1995 by and between the
Company and Dale Y. Chen.***
10.7 Employment Agreement dated December 11, 1995 by and between the
Company and Thomas V. Yarnell.***
10.8 Employment Agreement dated March 16, 1997 by and between the Company
and J. Russell Denson.***
10.9 Letter Loan Agreement between the Company and Bank One, Texas, N.A.,
dated December 11, 1995, evidencing a revolving line of credit and a
term note (the "Bank One Letter Loan Agreement").***
10.10 First Amendment to Bank One Letter Loan Agreement, dated January 31,
1996.***
10.11 Second Amendment to Bank One Letter Loan Agreement, dated August 1,
1996.***
10.12 Third Amendment to Bank One Letter Loan Agreement, dated November 14,
1996.***
10.13 Fourth Amendment to Bank One Letter Loan Agreement, dated January 31,
1997.***
10.14 Fifth Amendment to Bank One Letter Loan Agreement, dated January 31,
1997.***
10.15 Line of Credit Facility with State Street Bank and Trust Company, Hong
Kong Branch, dated April 1, 1997, evidencing a $5,000,000 line of
credit.***
11 Calculation of Earnings Per Share.***
21 Subsidiaries.***
23.1 Consent of Thompson & Knight, P.C. (included in its opinion filed as
Exhibit 5 hereto).***
23.2 Consent of Price Waterhouse LLP.**
24 Powers of Attorney.***
27 Financial Data Schedule.***

II-3

- --------
+ Management contract or compensatory plan.

** Filed herewith.
*** Previously filed.

(b) Financial Statement Schedules:

Schedule II--Valuation and Qualifying Accounts for fiscal years 1994, 1995
and 1996

ITEM 17. UNDERTAKINGS

(a) The undersigned registrant hereby undertakes to provide to the
underwriter at the closing specified in the underwriting agreements,
certificates in such denominations and registered in such names as required by
the underwriter to permit prompt delivery to each purchaser.

(b) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.

(1) For purposes of determining any liability under the Act, the
information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Act, each
post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.

II-4

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS DULY CAUSED THIS AMENDMENT NO. 2 TO THE REGISTRATION STATEMENT TO BE
SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE
CITY OF HOUSTON, STATE OF TEXAS, ON MAY 21, 1997.

DSI Toys, Inc.

By: /s/ M. D. Davis
-----------------------------------
M. D. DAVIS CHAIRMAN OF THE BOARD
OF DIRECTORS AND CHIEF EXECUTIVE
OFFICER

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
NO. 1 TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS
IN THE CAPACITIES AND ON THE DATES INDICATED.

SIGNATURE TITLE DATE

Chairman of the
/s/ M. D. Davis Board,and Chief
- ------------------------------------- Executive Officer May 21, 1997
M. D. DAVIS (principal
executive officer)

* President, Chief
- ------------------------------------- Operating Officer May 21, 1997
RICHARD R. NEITZ and Director

* Executive Vice
- ------------------------------------- Presidentand Chief May 21, 1997
J. RUSSELL DENSON Financial Officer
(principal
financial officer)

* Vice President and
- ------------------------------------- Controller May 21, 1997
DALE YUNG CHEN (principal
accounting officer)

* Director
- ------------------------------------- May 21, 1997
BARRY B. CONRAD

* Director
- ------------------------------------- May 21, 1997
JACK R. CROSBY

* Director
- ------------------------------------- May 21, 1997
J. N. MATLOCK

* Director
- ------------------------------------- May 21, 1997
DOUGLAS A. SMITH

*By: /s/ M. D. Davis
---------------------------
M. D. DAVIS
ATTORNEY-IN-FACT

II-5

DSI TOYS, INC.

SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS

ADDITIONS RECOVERY OF
BALANCE CHARGED TO AMOUNTS BALANCE
AT BEGINNING COSTS AND PREVIOUSLY AT END
OF PERIOD EXPENSES WRITTEN OFF DEDUCTIONS OF PERIOD
------------ ---------- ----------- ---------- ---------

Allowance for doubtful
accounts:
Fiscal year 1994...... $ 90,000 $45,927 $3,283 $ (11,490) $ 127,720
Fiscal year 1995...... 127,720 88,012 -- (147,255) 68,477
Fiscal year 1996...... 68,477 62,160 5,332 (31,188) 104,781

INDEX TO EXHIBITS

EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION NUMBERED PAGE
------- ----------- -------------

1 Form of Underwriting Agreement.**
3.1 Amended and Restated Articles of Incorporation.***
3.2 Amended and Restated Bylaws.***
3.3 Amendment to Bylaws.***
4.1 Form of Common Stock Certificate.**
4.2 Form of Warrant Agreement among the Company and the
Representatives to purchase 250,000 shares of Common
Stock.**
4.3 Common Stock Purchase Warrant No. A-1 dated December
11, 1995, issued to Hibernia Corporation to purchase
388,888 shares of Common Stock.***
4.4 Registration Rights Agreement by and between the
Company and Hibernia Corporation.***
4.5 Registration Rights Agreement by and between the
Registrant and Tommy Moss.***
5 Opinion of Thompson & Knight, P.C.***
10.1 1997 Stock Option Plan.**+
10.2 Agreement for Sale of Stock between Rosie Acquisition,
L.L.C. and DSI Acquisition, Inc. and Diversified
Specialists, Inc. and Tommy Moss, dated December 11,
1995.***
10.3 Employment Agreement dated December 11, 1995 by and
between the Company and M.D. Davis.***
10.4 Employment Agreement dated December 11, 1995 by and
between the Company and Richard R. Neitz.***
10.5 Employment Agreement dated December 11, 1995 by and
between the Company and Yau Wing Kong.***
10.6 Employment Agreement dated December 11, 1995 by and
between the Company and Dale Y. Chen.***
10.7 Employment Agreement dated December 11, 1995 by and
between the Company and Thomas V. Yarnell.***
10.8 Employment Agreement dated March 16, 1997 by and
between the Company and J. Russell Denson.***
10.9 Letter Loan Agreement between the Company and Bank
One, Texas, N.A., dated December 11, 1995, evidencing
a revolving line of credit and a term note (the "Bank
One Letter Loan Agreement").***
10.10 First Amendment to Bank One Letter Loan Agreement,
dated January 31, 1996.***
10.11 Second Amendment to Bank One Letter Loan Agreement,
dated August 1, 1996.***
10.12 Third Amendment to Bank One Letter Loan Agreement,
dated November 14, 1996.***
10.13 Fourth Amendment to Bank One Letter Loan Agreement,
dated January 31, 1997.***
10.14 Fifth Amendment to Bank One Letter Loan Agreement,
dated January 31, 1997.***
10.15 Line of Credit Facility with State Street Bank and
Trust Company, Hong Kong Branch, dated April 1, 1997,
evidencing a $5,000,000 line of credit.***
11 Calculation of Earnings Per Share.***
21 Subsidiaries.***
23.1 Consent of Thompson & Knight, P.C. (included in its
opinion filed as Exhibit 5 hereto).***
23.2 Consent of Price Waterhouse LLP.**
24 Powers of Attorney.***
27 Financial Data Schedule.***

- --------
+ Management contract or compensatory plan.

** Filed herewith.
*** Previously filed.