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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the year ended December 31, 2003;

OR

[  ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Transition Period from __________ to __________

Commission File Number: 0-22663

THE MIDDLETON DOLL COMPANY
(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (262) 523-4300

Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the Act:

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   [X]    No   [   ]

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   [X]

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

Yes   [   ]    No   [X]

        The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant at March 15, 2004 was $12,943,578.

        The number of shares of common stock outstanding at March 15, 2004 was 3,727,589.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the The Middleton Doll Company Proxy Statement for the 2004 Annual Meeting of Shareholders (to be filed with the Securities and Exchange Commission under Regulation 14A within 120 days after the end of the Registrant’s year) are, upon such filing, to be incorporated by reference into Part III.

THE MIDDLETON DOLL COMPANY

Index to Annual Report on Form 10-K
For the Year Ended December 31, 2003

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Part I

Item 1.    Description of Business

Introduction

        The Middleton Doll Company was incorporated in February, 1980 to provide long-term collateralized loans to small businesses. The Middleton Doll Company and its subsidiaries are referred to herein as the “Company”. At present the Company consists of two business segments, the Financial Services Business and the Consumer Products Business. The Middleton Doll Company, when referred to singularly and not with its subsidiaries is referred to herein as the “Parent”.

        The Financial Services Business segment consists of the Parent and its wholly-owned subsidiary Bando McGlocklin Small Business Lending Corporation (“BMSBLC”). The principal business of the segment is making loans and leasing buildings to small businesses. The segment also participates in loans with third party loan originators. Both the Parent and BMSBLC are operated as a real estate investment trust (“REIT”) pursuant to the provisions of Section 856 of the Internal Revenue Code of 1986, as amended. The REIT does not pay any corporate income taxes because it has a tax exempt status. To achieve the tax exempt status a REIT must be in compliance with tests concerning the nature of the assets of the REIT and the income earned. In addition, a REIT must distribute substantially all of its taxable income each year in dividends to its shareholders.

        The Consumer Products Business segment consists of a 99% interest in Lee Middleton Original Dolls, Inc. (“LMOD”). George R. Schonath, President and Chief Executive Officer, owns the remaining 1% of the stock of LMOD. LMOD is a manufacturer of vinyl collectible dolls and a distributor of vinyl play dolls. LMOD has a wholly-owned subsidiary, License Products, Inc. (“LPI”), that designs, develops and markets a line of proprietary time pieces. Prior to 2002, LMOD owned a 51% interest in LPI. On January 1, 2002, LMOD acquired the remaining outstanding 49% interest in LPI. During 2002, LMOD disposed of its 51% interest in Middleton (HK) Limited (“MHK”), a Hong Kong corporation that provided LMOD with raw material and finished goods from Asia. Neither of these transactions had a material impact upon the financial statements.

        In order to qualify as a REIT under the Internal Revenue Code, the Parent cannot hold more than 10% of the outstanding voting securities of any one issuer except for “Taxable Real Estate Investment Trust Subsidiaries” (“TRSs”). LMOD and LPI became TRSs as of January 1, 2001, which allowed the Company on June 25, 2001, to exchange its non-voting stock in LMOD for voting stock. Both LMOD and LPI are operated as C-Corporations under the Internal Revenue Code and are subject to corporate income tax rates.

        On September 3, 1997, the Company capitalized InvestorsBancorp, Inc., a bank holding company for approximately $6.2 million and then distributed all of the outstanding shares of InvestorsBancorp, Inc. to the Company’s shareholders. The Company and InvestorsBancorp, Inc., together with its wholly-owned subsidiary, InvestorsBank (the “Bank”), share common offices and personnel. Expenses are shared between the two entities in accordance with a Management Services and Allocation of Expenses Agreement (the “Management Agreement”). See “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Overview”.

Financial Services Business

        Loans

        The Company, through its Financial Services Business, (i) manages its loan portfolio comprised primarily of loans to small business entities collateralized by first or second mortgages, (ii) purchases loan participations from banks, including the Bank, and (iii) owns industrial and commercial real estate for lease to small businesses.

        Until the distribution of the shares of InvestorsBancorp, Inc. in September, 1997, the Parent and BMSBLC had engaged in the business of originating loans to small businesses. Concurrent with such distribution, the Parent, BMSBLC, and the Bank agreed in the Management Agreement that neither the Parent nor BMSBLC would originate any loans unless agreed to by the Bank in writing, unless the loans were made to current customers or unless the loans were outside the Bank’s lending limitations. Thus, except for the making of loans to customers who desire to increase their loan amounts with the Parent or BMSBLC and for loans outside the Bank’s lending limitations, neither the Parent nor BMSBLC can solicit any loans.

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        The loan and leased property portfolio is managed by the Bank for an annual fee, payable monthly, equal to 25 basis points of the total dollar amount of loans under management and 6% of the rents from leased properties. Operating expenses are also shared between the Bank and BMSBLC, as well as certain expenses of employees providing accounting, reporting and related services to the Company.

        The loan portfolio is primarily comprised of long-term, variable rate, collateralized loans to small business entities. The loans are primarily collateralized by first mortgages on real estate, although some loans are collateralized by second mortgages. Approximately 87% of loans by dollar volume are loans to borrowers located in the State of Wisconsin. Substantially all of the loan portfolio is held by BMSBLC.

        The borrowers include manufacturers, wholesalers, retailers, professionals and service providers. The Parent and BMSBLC fund their lending operations through their equity capital, bank and institutional borrowings, commercial paper sales and the sale of loan participations.

        The Company’s exposure to loss in the event of nonperformance by the borrower is represented by the outstanding principal amount of loans of $52.29 million at December 31, 2003. Substantially all loans are fully secured by first or second mortgages on commercial real estate. Diversification across industries is a means of managing market risk by decreasing loan concentrations. The following table provides information regarding the outstanding principal amount of loans by industry.

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        The loans are further comprised of fixed rate loans, variable rate loans with fixed cap rates and variable rate loans.

Further detail regarding the fixed rate loans and the variable rate loans with a fixed cap is provided in the following table.

        A loan is considered to be impaired when, based on current information and events, management does not expect to collect all amounts due according to the contractual terms of the loan agreement in the normal course of business. A loan is also impaired when the loan contract is restructured by extending the due date of either principal or interest payments or by reducing the interest rate on the loan. A loan is not impaired during a period of delay in payment if management expects to collect all amounts due including accrued interest at the contractual interest rate for the period of the delay. When the projected cash flow of the business from all sources including capital contributions, conversion of assets to cash and net income plus depreciation are inadequate to make contractual payments as scheduled, then the loan is considered impaired. Impaired loans totaled $0.25 million and $2.01 million at December 31, 2003 and 2002, respectively. Interest income of $0.02 million would have been recorded during 2003 had the impaired loans been current in accordance with their original terms.

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        Real Estate

        At December 31, 2003 BMSBLC owned 22 buildings and had entered into long-term lease agreements on 20 of the properties. During the year BMSBLC completed construction of one property and sold two properties. BMSBLC anticipates that it will continue to construct or purchase additional industrial or commercial properties to lease. The total cost of the BMSBLC’s properties at December 31, 2003, was $33.60 million and the depreciated carrying value was $30.81 million.

        BMSBLC anticipates that its rental properties will either be industrial real estate (i.e. used for manufacturing purposes), or commercial real estate properties, such as office buildings and retail stores and that substantially all of its properties will be located in Wisconsin. The following table sets forth additional information regarding BMSBLC’s leased properties, all of which are located in Wisconsin.

        Competition

        BMSBLC, in managing its loan portfolio, competes primarily with commercial banks and commercial finance companies, many of which have substantially more assets and capital than BMSBLC. Banks, in particular, have been active in seeking to refinance outstanding loans.

        In owning and leasing real estate, BMSBLC competes primarily with other REITs and other investors such as insurance companies and a variety of investment companies which seek to own and lease real estate. In addition, BMSBLC competes with banks and other financial institutions, which seek to lend money to potential tenants of BMSBLC in order to allow the potential tenants to construct and own their own building rather than to lease a building owned by BMSBLC.

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        Employees

        On December 31, 2003, the Company employed only its President and Vice President. All other duties are performed by Bank employees pursuant to the Management Agreement.

        Credit Concentration

        As of December 31, 2003, BMSBLC had seven loans with outstanding balances totaling $10.70 million to one customer and its affiliated companies, which accounted for approximately 20% of the total loans outstanding.

Consumer Products Business

        Lee Middleton Original Dolls, Inc.

        Lee Middleton Original Dolls, Inc. (“LMOD”), headquartered in Westerville, Ohio with its manufacturing facility located in Belpre, Ohio, is a 99% owned subsidiary of the Company, with the President of the Company owning the remaining 1%. LMOD is a manufacturer of artist-designed vinyl collectible dolls and a distributor of vinyl play dolls. LMOD uses a multi-step process to manufacture its vinyl collectible dolls that includes (1) rotational molding to create body parts for dolls, (2) painting, eyeing and wigging each doll, and (3) dressing the dolls in custom designed clothes.

        LMOD distributes its collectible doll lines through a network of independent, specialty retail stores throughout the United States. Distribution is also slowly expanding into Canada, Japan, Mexico and Europe. Competition is with various other doll manufacturers including Adora, Madam Alexander, Ashton Drake, Mattel’s American Girl and a variety of small artist-owned manufacturers. LMOD has two outlet stores and a mall-based retail location showcasing the Newborn Nursery concept that was developed at the factory outlet retail store. LMOD is continuing to focus its efforts on re-emphasizing the name recognition and high product quality of LMOD in the collectible doll market by developing new products for the artist studio collection line of dolls. The emphasis on marketing through the traditional independent doll dealers is being accompanied during this transition period by de-emphasizing the focus on play-dolls in the competitive mass merchandise market. In addition, LMOD is pursuing a limited expansion of its “Newborn Nursery Adoption Centers” that go beyond selling dolls to evoke an emotional experience as children “adopt” their new baby doll.

        License Products, Inc.

        License Products, Inc. (“LPI”) is a wholly-owned subsidiary of LMOD. Prior to January 1, 2002, LMOD owned 51% of LPI. On January 1, 2002, LMOD acquired the remaining 49% of the common stock of LPI. LPI, located in Hartland, Wisconsin, designs, develops and markets a line of proprietary time pieces. LPI’s products are distributed nationwide through major retail account channels.

        Employees

        The Consumer Products Business segment employs approximately 120 persons. At LMOD, approximately 50 employees are subject to a collective bargaining agreement which expires on April 30, 2004.

        Large Customers

        Two customers at LPI with total sales of $4.87 million and one customer at LMOD with total sales of $0.86 million accounted for approximately 33% of the Consumer Products Business’ total revenues for 2003.

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        Backlog

        The backlog of the Consumer Products Business was approximately $0.58 million as of December 31, 2003, all of which should be filled during 2004.

Revenues of Principal Product Groups

        The following table sets forth (in thousands of dollars), for each of the last three years, revenues attributable to the Company’s principal product groups:

Segment Information

        Financial information concerning the Company’s business segments is incorporated by reference from the consolidated financial statements on pages 25 to 28 herein.

Executive Officers

        George R. Schonath, 63, has served as Chief Executive Officer of the Company since 1983, as President since July, 1997, and as a director since May, 2001. Mr. Schonath has also served as President and Chief Executive Officer of InvestorsBancorp, Inc. and the Bank since they were established in 1997. From 1983 until July, 1997, he served as Chairman of the Board of the Company.

        Jon McGlocklin, 60, has served as a Vice President of the Company since November, 2001. From July, 1997, through November, 2001, he served as a Senior Vice President. Mr. McGlocklin has served as a director of InvestorsBancorp, Inc. since 1997. Until February 2001, Mr. McGlocklin had also served as Senior Vice President of InvestorsBancorp, Inc. and Senior Vice President of the Bank since they were established in 1997. He has also served as President of Healy Manufacturing, Inc., Menomonee Falls, Wisconsin, since 1997, and as an announcer for the Milwaukee Bucks, an NBA basketball team, since 1976. From 1980 through July, 1997, he served as a director of the Company and as President from 1991 through July, 1997.

        Susan J. Hauke, 38, has been the Company’s Chief Financial Officer since 2002 and Vice President – Finance, Secretary and Treasurer since 1997. In 2002, Ms. Hauke was also appointed Chief Financial Officer of InvestorsBancorp. She is also the Vice President – Finance and Secretary of InvestorsBancorp, Inc. and Controller, Vice President-Finance, and Treasurer of the Bank. From 1991 until 1997, Ms. Hauke served as Controller for the Company and was a senior accountant at PricewaterhouseCoopers LLP before joining the Company.

Item 2.    Properties

        In October, 2002, the Company sold the building located at W239 N1700 Busse Road, Pewaukee, Wisconsin, to the Bank for $2.4 million, which represented its fair market value at the time of the sale as determined by an independent appraiser. The Company now leases 4,000 square feet of the building from the Bank.

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        LMOD owns an approximately 51,000 square foot building that serves as its manufacturing facility located at 1301 Washington Boulevard, Belpre, Ohio. The one-story building also contains retail and warehouse space. During 1999, an additional leased retail outlet store was opened in West Virginia. A new 44,100 square foot facility in Columbus, Ohio, was leased beginning in June of 2000 which is used for distribution and to store raw materials and finished goods. In September, 2000, LMOD entered into a five year office lease for 18,800 square feet in Westerville, Ohio, which is LMOD’s headquarters.

        LPI leases approximately 62,000 square feet of office and warehouse space in a building owned by BMSBLC and located at 1050 Walnut Ridge Drive, Hartland, Wisconsin. During 2002, LPI added approximately 35,000 square feet of additional warehouse space to the building in order to accommodate future growth.

Item 3.    Legal Proceedings

        As of the date of this filing, neither the Parent nor any of its subsidiaries is a party to any legal proceedings, the adverse outcome of which, in management’s opinion, would have a material effect on the Company’s consolidated financial statements.

Item 4.    Submission of Matters to a Vote of Security Holders

        No matters were submitted to a vote of security holders during the quarter ended December 31, 2003.

Part II

Item 5.    Market for Common Equity and Related Shareholder Matters

        The common stock of the Company is traded on the Nasdaq Stock Market under the symbol DOLL. The table below represents the high and low sales price for the Company’s common stock as reported on the Nasdaq Stock Market and the cash dividends paid per share for 2003 and 2002.

        As of March 15, 2004, there were approximately 850 shareholders of record of the Company’s common stock.

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Item 6.    Selected Financial Data (In thousands, except per share data)

        The following table sets forth certain Selected Consolidated Financial Data for the periods and as of the dates indicated:

(1)     Restated for 10% stock dividend as of December 31, 1999 record date.

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

        Amounts presented as of December 31, 2003, 2002 and 2001 include the consolidation of two segments. The financial services segment includes The Middleton Doll Company (the “Parent”) and Bando McGlocklin Small Business Lending Corporation (“BMSBLC”), a 100% owned subsidiary of the Parent. The consumer products segment includes Lee Middleton Original Dolls, Inc. (“LMOD”), a 99% owned subsidiary of the Parent and License Products, Inc. (“LPI”), a 100% owned subsidiary of LMOD. In 2002, Middleton (HK) Limited, a former subsidiary of LMOD, was liquidated.

        The loan and real estate portfolios of the Parent and BMSBLC are administered and managed by InvestorsBank (the “Bank”), a wholly-owned subsidiary of InvestorsBancorp, Inc. under a “Second Amended and Restated Management and Services and Allocation of Expenses Agreement” dated January 1, 2004, (the “Management Agreement”). In addition, the Bank provides certain management services to LMOD. George R. Schonath, President and Chief Executive Officer of the Parent and BMSBLC, is also President and Chief Executive Officer of the Bank and InvestorsBancorp, Inc. George Schonath and members of his family own all of the outstanding stock of InvestorsBancorp, Inc.

        For the loan and real estate management services provided under the Management Agreement, the Bank receives an annual fee, payable monthly, equal to 0.25% (1/4 of 1%) of the total amount of loans under management and 6% of the rents from the real estate portfolio. The Management Agreement provides for the sharing of operating expenses between the Bank and BMSBLC, as well as certain expenses of employees of the Bank who provide accounting, reporting and related services to the Parent and BMSBLC. Additionally, for its services in providing ongoing credit analysis, loan and lease monitoring, workout services, and management services to LMOD, the Bank receives an annual fee of $365,000, payable monthly. The Parent and BMSBLC currently have only one paid employee, a Vice President of the Company and BMSBLC. George Schonath, the President and Chief Executive Officer, provides services to the Parent, BMSBLC and LMOD under the Management Agreement and is not separately compensated by any of those entities.

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        During the past four years there has been a significant decrease in net sales of the consumer products segment. This decrease is primarily attributable to intense pricing competition from dolls produced in China and is also due to a downturn in consumer discretionary spending as a result of the recent “soft” economy. To deal with these concerns, LMOD is pursuing legal action to prevent the sale of certain dolls that management believes infringe on Lee Middleton’s copyrights. LMOD is also focusing efforts on reemphasizing the name recognition and high product quality of LMOD in the collectible doll market as well as developing new products for the artist studio collection line of dolls. Operating expenses, particularly in the sales and marketing area, have been reduced during the last two years. However, general and administrative expenses have not decreased primarily due to long-term leases in effect until 2006 for its headquarters location in Westerville, Ohio, and its warehouse facilities in Columbus, Ohio.

        During the past four years there has also been a significant decrease in the loan portfolio of the financial products segment resulting in a corresponding decrease in interest income on loans. The financial services segment is at a lending disadvantage with other institutions such as banks, due to its higher cost of funds. Also, the existing management agreement with InvestorsBank prevents it from making new loans to other than existing customers without the prior consent of InvestorsBank. Because of this restriction, it is anticipated that the majority of any new loans will consist of loan participations with InvestorsBank. These two factors, in addition to the recent difficult business economy, has resulted in BMSBLC’s inability to maintain the size of its loan portfolio. If this trend continues, it may result in the Company not being able to maintain its current level of dividend payments.

Results of Operations

For the years ended December 31, 2003 and December 31, 2002

        The Company’s total net (loss) income available for common shareholders for the year ended December 31, 2003 equaled ($0.66) million or ($0.18) per common share (diluted) as compared to $3.20 million or $0.86 per common share (diluted) for the year ended December 31, 2002.

        The consumer products segment decrease in income was primarily due to lower sales as a result of the soft economy, pricing pressure from collectible dolls produced in China and lower margins due to price reductions. The financial services segment decrease was due to a decrease in both rental and loan income and smaller gains from the termination of interest rate swaps and from the sale of leased properties.

Consumer Products

        Net sales from consumer products for the year ended December 31, 2003, decreased 25% to $17.60 million from $23.46 million for the year ended December 31, 2002. This was due to decreased sales of $5.24 million at LMOD and decreased sales of $0.62 million at LPI. At LMOD, sales of artist-designed collectible dolls have been materially and adversely affected by foreign produced dolls which have been selling at a substantial discount from LMOD’s dolls. To meet this challenge, LMOD lowered prices in June, 2003 on its line of artist-designed collectible dolls in order to stimulate sales. Since the price reduction, unit sales have increased 17% over the comparable period one year ago. Although this pricing strategy has had a short-term impact on performance, management believes it has the potential to generate improvement over the long term. LMOD is also continuing to pursue legal action to prevent the sale of certain dolls that management believes infringe on LMOD’s copyrights and other intellectual property. LMOD has settled with several defendants and is continuing to pursue remedies in all pending lawsuits.

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        LMOD is focusing its efforts on reemphasizing the name recognition and high product quality of LMOD in the collectible doll market as well as continuing to develop new products for the artist studio collection line of dolls. At the American International Toy Fair in New York City in 2004, LMOD introduced “Breath of Life Babies”. In addition, LMOD is pursuing a limited expansion of its “Newborn Nursery Adoption Centers” that provide customers with the experience of “adopting” their new baby doll. Both of these new lines are featured on the LMOD website. To improve LMOD’s competitive position in the marketplace, LMOD is evaluating other new products and additional strategies to reduce costs.

        Reflecting the decline in net sales, cost of goods sold decreased 18% to $11.45 million for the year ended December 31, 2003, compared to $13.91 million for the year ended December 31, 2002. LMOD’s cost of goods sold decreased to $7.84 million from $9.84 million while LPI’s cost of goods sold decreased to $3.61 million from $4.07 million. Total gross profit margin decreased to 35% from 41% in the prior year. LMOD’s gross profit margin decreased to 34% from 42% due mainly to price reductions on the line of artist-designed collectible dolls. LMOD lowered prices an average of 31% on its line of artist-designed collectible dolls in order to stimulate sales and to meet the increased competition from offshore dolls. The liquidation of slow-moving inventory also contributed to LMOD’s reduced margin. LPI’s gross profit margin increased to 37% from 36% due to a slightly different product mix.

        Total operating expenses of the consumer products segment for the year ended December 31, 2003, were $8.65 million compared to $9.76 million for the year ended December 31, 2002, an 11% decrease. LMOD’s total operating expenses decreased $1.25 million to $7.09 million for the year ended December 31, 2003. Sales and marketing expense decreased $1.42 million of which staff reductions accounted for $0.30 million, advertising and promotion accounted for $0.31 million, bad debt expense accounted for a reduction of $0.20 million, and licensing fees were reduced $0.33 million due to the expiration of the Lee Middleton licensing agreement. The remaining reduction of $0.28 million was due to decreases in expenses for freight, samples, supplies, travel, commissions and royalties. New product development decreased $0.09 million and general and administrative expenses increased $0.26 million. General and administrative expenses increased due to a $0.09 million increase in legal fees relating to the pending lawsuits and due to $0.08 million in severance pay. LPI’s operating expenses increased $0.14 million primarily due to increased insurance costs.

        Interest expense decreased $0.16 million from December 31, 2002, to December 31, 2003, due to the payoff of debt between LMOD and InvestorsBank. The debt was replaced with intercompany loans from the Company to LMOD and from BMSBLC to LPI. Interest expense on these intercompany loans has been eliminated for consolidation purposes. At December 31, 2003, LMOD owed the Company $6.92 million which consisted of a first mortgage on real estate of $2.12 million, a line of credit of $1.1 million, and an unsecured note of $3.7 million. The interest rate on these notes averaged 4.3% at December 31, 2003. At December 31, 2003, LPI owed BMSBLC $4.50 million composed of a line of credit of $2.0 million and an unsecured note of $2.5 million. The interest rate on these notes was 4.0% at December 31, 2003. Before intercompany eliminations, interest expense to the consumer products segment and interest income to the financial services segment was $0.47 million for the year ended December 31, 2003. Intercompany eliminations also included $0.28 million in rent paid by LPI to BMSBLC and $0.45 million in management fees paid by LMOD to BMSBLC.

        Consumer products’ income tax benefit, based on net losses before intercompany charges, was $0.89 million for the year ended December 31, 2003 and $0.83 million for the year ended December 31, 2002. At December 31, 2003, there were unused net operating loss carryforwards of approximately $5.6 million to be used to offset against future federal taxable income.

Financial Services

        The financial services segment decrease in net income for the year ended December 31, 2003, compared to the year ended December 31, 2002, was due to a decrease in the net interest income on loans of $0.76 million, a decrease in rental income of $0.57 million, a decrease in the net gain from the sale of leased properties of $0.44 million, and a decrease in the gain from termination of interest rate swaps of $0.27 million.

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        Interest income on loans decreased 33% to $3.26 million for the year ended December 31, 2003, as compared to $4.85 million for the year ended December 31, 2002. This decrease was primarily due to a $22.51 million decrease in the average total loans outstanding when comparing the year ended December 31, 2003, to the year ended December 31, 2002. In addition, interest income from variable rate loans decreased due to the decrease in the average prime rate when comparing 2003 to 2002. The average prime rate was 4.16% for the year ended December 31, 2003, compared to 4.68% for the year ended December 31, 2002. In the present competitive interest rate environment, BMSBLC is at a lending disadvantage with other institutions such as banks, due to its higher cost of funds. During 2003, competitive pressures resulted in a reduction of $16.6 million in loans due to pay-offs, and the recent difficult economy resulted in $5.0 million of loans being paid off due to business closings, with the remaining decrease in loans due to normal principal reductions. During 2003, $6.95 million of new loans and $2.17 million of intercompany loans were added to the loan portfolio. The Parent’s and BMSBLC’s management agreement with InvestorsBank prevents it from making new loans to other than existing customers without the prior consent of InvestorsBank. Because of this restriction, it is anticipated that the majority of new loans will consist of loan participations with InvestorsBank. Participations with InvestorsBank comprised approximately 48% of the loan portfolio at December 31, 2003. These two factors, in addition to the difficult business economy in 2003, resulted in BMSBLC’s inability to maintain the size of its loan portfolio.

        Rental income decreased 16% to $3.07 million for the year ended December 31, 2003, as compared to $3.64 million for the year ended December 31, 2002. Rental income decreased $0.51 million due to the sale of two leased properties during 2002 and two leased properties during 2003. One property under construction at December 31, 2002, was completed and placed in service in May, 2003, resulting in $0.17 million in new rental income for 2003 and scheduled rent increases added $0.01 million. During 2003, one tenant was placed on non-accrual resulting in $0.24 million of rental income which would have been recorded in 2003 had the tenant been current in accordance with the lease.

        Net interest margin is determined by dividing the total of interest income on loans and rental income less interest expense by the total of average loans and leased properties. The interest margin for the year ended December 31, 2003 was 3.65% compared to 3.99% for the year ended December 31, 2002. During 2003, average loans outstanding (net of intercompany loans) of $62.80 million generated $3.26 million in interest income and average leased properties (net of intercompany properties) of $30.83 million generated $3.07 million in rental income. The average gross return in 2003 on rental properties was approximately 10% while the average gross return on loans was approximately 5%. During 2002, average loans outstanding (net of intercompany loans) of $85.31 million generated $4.85 million in interest income and average leased properties (net of intercompany properties) of $33.15 million generated $3.64 million in rental income. The average gross return in 2002 on rental properties was approximately 11% while the average gross return on loans was approximately 5.5%.

        During the year ended December 31, 2003, two leased properties were sold, resulting in a net gain of $0.34 million (net of income taxes). During the year ended December 31, 2002, the net gain from the sale of two leased properties (net of income taxes) was $0.78 million. At December 31, 2003, BMSBLC owned 22 properties with a net carrying value of $30.81 million. One vacant rental property with a net carrying value of $1.40 million was available for lease at December 31, 2003, and two rental properties with a net carrying value of $3.57 million were on non-accrual status.

        The termination of interest rate swaps resulted in income of $0.48 million for the year ended December 31, 2003, and $0.75 million for the year ended December 31, 2002. BMSBLC may periodically use these derivative instruments for purposes of managing interest rate risk. However, there were no interest rate swap agreements in effect at December 31, 2003.

        Interest expense decreased 22% to $2.87 million for the year ended December 31, 2003, as compared to $3.70 million for the year ended December 31, 2002, primarily due to a decrease in the outstanding average debt balance and due to lower interest rates. The average debt balance decreased $21.97 million when comparing 2003 to 2002 as a result of the decrease in loans as explained above. BMSBLC’s cost of funds is based primarily on variable interest rates, which were lower in 2003. BMSBLC was able to reduce certain higher fixed rate debt in 2003 with proceeds from loan payoffs, resulting in an average cost of funds of 3.51% in 2003 as compared to 3.57% during 2002. In 2002, interest rate expense was reduced by $0.54 million in income from interest rate swaps.

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        BMSBLC’s debt facility consists of commercial paper and drawn letters of credit backed by a $65 million line of credit that matures on June 25, 2004. At December 31, 2003, BMSBLC had $10.17 million in lending capability with outstanding unfunded commitments of $1.77 million. During the first quarter of 2004, BMSBLC used this lending capability to add a new loan of $1.65 million and to pay off $5.58 million in long-term debt. BMSBLC expects that the remaining $1.17 million in lending capability will be used to fund other commitments during 2004.

        During 2003, commercial paper which had matured was not able to be replaced by sales of additional commercial paper, requiring BMSBLC to draw upon the back-up bank line of credit which has a higher interest rate than commercial paper. This higher cost of funds lessens BMSBLC’s ability to compete with banks and other financial institutions for loans, resulting in a decreased ability to replace loans that are paid-off. BMSBLC’s future growth rate will depend upon the BMSBLC’s ability to obtain additional sources of acceptable funding at reasonable interest rates. BMSBLC is continually reviewing various funding sources; however, to date, BMSBLC has not found any additional acceptable funding sources. Additionally, the 2008 redemption requirements of $16.9 million of preferred stock requires the Company to focus on asset quality while de-leveraging the balance sheet. For further detail, see “Liquidity and Capital – Financial Services” on page 18 hereof.

        Other income for the year ended December 31, 2003 included $0.11 million in loan prepayment penalties, $0.02 million in late payment fees and $0.05 million in miscellaneous income. For the year ended December 31, 2002, other income included $0.13 million in loan prepayment penalties, $0.02 million in late payment fees and $0.06 million of miscellaneous income.

        Depreciation expense decreased $0.05 million due to the decrease in leased properties when comparing the year ended December 31, 2003 to 2002. Management fees under the management fee agreement with InvestorsBank decreased $0.05 million due to the decrease in loans under management when comparing 2003 to 2002. Other operating expenses increased $0.34 million due to a $0.27 million increase in expenses involving the leased property portfolio and an increase of $0.03 million was due to related legal expenses. Other legal expense increased $0.03 million due to additional professional fees associated with complying with the Sarbanes-Oxley Act of 2002. Due to the prepayment of certain loans, $0.02 million in debt issue costs also were expensed in 2003.

        The Parent and its qualified REIT subsidiary, BMSBLC, qualify as a real estate investment trust under the Internal Revenue Code. Accordingly, they are not subject to income tax on taxable income that is distributed to common shareholders. During 2003 and 2002, the Parent took advantage of a provision in the tax law that allows a REIT to retain any capital gains on the sale of real estate properties by paying income tax on the gains. The Parent retained $0.52 million in capital gains and paid $0.18 million in taxes as of December 31, 2003, and retained $1.19 million in capital gains and paid $0.41 million in taxes as of December 31, 2002.

        At December 31, 2003, LMOD owed the Parent and BMSBLC $6.92 million, which consisted of a first mortgage on real estate of $2.12 million, a line of credit of $1.1 million, and an unsecured note of $3.7 million. The interest rate on these notes averaged 4.3% at December 31, 2003. At December 31, 2003, LPI owed BMSBLC $4.50 million composed of a line of credit of $2.0 million and an unsecured note of $2.5 million. The interest rate on these notes was 4.0% at December 31, 2003. Before intercompany eliminations, the financial services segment included $0.47 million of interest income, $0.28 million of rental income from LPI to BMSBLC and $0.45 million in management fees paid by LMOD to BMSBLC. As of November 12, 2003, the Parent extended a guarantee to a supplier of LMOD in which the Parent has agreed to unconditionally guarantee all obligations of LMOD to the supplier. It is anticipated that the maximum amount of the guarantee will not exceed $0.60 million, however, the amount of the guarantee is unlimited and the amount of the obligation may increase in the future.

For the years ended December 31, 2002 and December 31, 2001

        The Company’s total net income available for common shareholders for the year ended December 31, 2002 equaled $3.20 million or $0.86 per share (diluted) as compared to $1.64 million or $0.44 per share (diluted) for the year ended December 31, 2001, a 95% increase. The improved earnings were due to the consumer products segment recognizing a net operating loss carryforward from LPI which resulted in an income tax benefit of $0.83 million and the financial services segment selling two leased properties resulting in income net of related taxes of $0.78 million and terminating two interest rate swap agreements resulting in income of $0.75 million.

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Consumer Products

        Net income (loss) for the consumer products segment before intercompany charges and after income taxes and minority interest for the year ended December 31, 2002 was $0.41 million compared to ($0.07) million for the year ended December 31, 2001.

        Net sales from consumer products for the year ended December 31, 2002 decreased 14% to $23.46 million from $27.23 million for the year ended December 31, 2001. This was due to decreased sales of $5.93 million at LMOD offset by increased sales of $2.16 million at LPI. The decrease in sales at LMOD was primarily due to a $6 million decrease in the artist studio collection sales resulting from the soft economy and an increase in competition in the collectible doll market. Sales decreased due to a net loss of over 130 dealers and the remaining dealers have been ordering conservatively, approximately 20% below the previous year’s levels. If the difficult economic conditions in the marketplace continue to result in sales decreases, then personnel reductions and/or periodic plan shut-downs in 2003 might be required in order to further reduce costs. Cost of sales decreased 7% to $13.91 million for the year ended December 31, 2002 compared to $14.97 million for the year ended December 31, 2001. LMOD’s cost of sales decreased to $9.84 million from $12.07 million, an 18% decrease. LPI’s cost of sales increased to $4.07million from $2.90 million, a 40% increase. Total gross profit margin decreased to 41% from 45% in the prior year. LMOD’s gross profit margin decreased to 42% from 48% while LPI’s increased to 36% from 31% during 2002. The decrease in the gross profit margin at LMOD was primarily due to the liquidation of $1.0 million of slow moving inventory, including the remaining 2001 artist studio collection dolls. Obsolete inventory from the Small Wonder play doll line and the nursery bear line was also liquidated. The increase in the gross profit margin at LPI was due to a change in suppliers which decreased product costs and a decrease in sales to a less profitable customer, which improved the product mix.

        Total operating expenses of consumer products for the year ended December 31, 2002 were $9.76 million compared to $11.98 million for the year ended December 31, 2001, a 19% decrease. Total operating expenses as a percent of net sales was 42% in 2002 compared to 44% in 2001. Sales and marketing expense decreased 21% to $4.98 million, with LMOD’s expense decreasing $1.48 million and LPI’s increasing $0.14 million. The increase at LPI was due to an increase in customer store allowances and promotions for customers’ new store openings. Expense reduction at LMOD was accomplished by decreasing advertising, catalog printing, and packaging costs. Due to the decrease in sales, cost reductions in commissions, freight and merchant fees contributed to the overall decrease in sales and marketing expenses. Reduced participation in trade shows and the associated reduction in travel expenses also contributed to the decrease. New product development costs decreased $0.26 million at LMOD due to the reclassification of quality administration costs. LPI’s new product development costs increased $0.14 million due to an increase in sample prototypes being developed for customer approval. General and administrative expenses were $3.91 million for the year ended December 31, 2002 compared to $4.66 million for the year ended December 31, 2001. General and administrative expenses at LMOD decreased $1 million and LPI’s increased $0.25 million. LPI’s increase was due to increased shipping costs associated with the increase in sales and higher costs associated with improved data processing capabilities. Expense reduction at LMOD was accomplished through personnel reduction and a decrease in royalty payments due to the decrease in sales.

        Other income, net decreased $0.10 million when compared to the same period a year ago due to a decrease in interest expense. The minority interest in earnings of subsidiaries decreased the consolidated net income of consumer products by $0.08 million for the year ended December 31, 2002 and $0.10 million for the prior year. Consumer products’ income tax expense, based on net income before intercompany charges, was ($0.83) million for the year ended December 31, 2002 and $0.03 million for the year ended December 31, 2001. For the year ended December 31, 2002, LMOD and LPI were allowed to file consolidated income tax returns due to the change in stock ownership at LPI. The $0.83 million of income tax benefit for the year ended December 31, 2002, was primarily due to the recognition of a net operating loss carryforward of $0.72 million from LPI.

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Financial Services

        Net income from financial services for the year ended December 31, 2002 was $3.89 million compared to $2.64 million for the year ended December 31, 2001, a 47% increase. The increase resulted from the sale of two leased properties, which resulted in income net of related taxes, of $0.78 million and from the termination of two interest rate swap agreements totaling $0.75 million. In January, 2003, all remaining interest rate swap agreements were terminated resulting in $0.48 million of income for 2003. Neither the Parent or BMSBLC anticipates any further income from the termination of interest rate swap contracts.

        The net interest margin for 2002 was 3.98% compared to 3.23% for 2001. Net interest margin is determined by dividing the total of interest income on loans and rental income less interest expenses by the total of average loans and leased properties. The increase is the result of BMSBLC’s cost of funds falling faster than the rates charged by BMSBLC to borrowers and to tenants of leased properties.

        Total revenues were $10.63 million for the year ended December 31, 2002 compared to $12.37 million for the year ended December 31, 2001, a 14% decrease. Interest on loans decreased 39% to $4.85 million for the year ended December 31, 2002 compared to $7.89 million for the year ended December 31, 2001. The large decrease in interest income from loans was primarily due to the 32% decrease in the prime rate. The average prime rate was 4.68% for the year ended December 31, 2002 compared to 6.92% for the year ended December 31, 2001. Average loans under management decreased $19.73 million from a year ago. The decrease was primarily due to maturing loans and the inability to replace them with BMSBLC’s current funding sources. BMSBLC’s ability to make additional loans and to maintain its earnings depends on the ability of the Company to obtain additional sources of funding.

        Rental income was $3.64 million for the year ended December 31, 2002 compared to $3.89 million for the year ended December 31, 2001, a 6% decrease. The sale of two leased properties resulted in a reduction of $0.22 million in rents and the transfer of $0.05 million to nonaccrual status further reduced rental income. Leased properties, net of accumulated depreciation, decreased to $32.37 million as of December 31, 2002, compared to $34.88 million as of December 31, 2001. One new property is under construction and improvements to existing properties totaled $1.64 million during 2002.

        Other income for the year ended December 31, 2002, included a gain of $1.19 million from the sale of leased properties, $0.75 million from the termination of two interest rate swap agreements, $0.13 million in loan prepayment penalties and $0.08 million of miscellaneous income. For the year ended December 31, 2001, other income included a gain of $0.15 million from the sale of leased property, $0.25 million from the termination of two interest rate swap agreements, $0.08 million of fees from letters of credit and $0.11 million of miscellaneous income.

        Interest expense decreased 47% to $3.70 million from $7.03 million for the year ended December 31, 2002 as compared with the year ended December 31, 2001 primarily due to lower rates for the Company’s cost of funds and a decrease in the outstanding average debt balance. BMSBLC’s debt cost is based primarily on variable interest rates which were significantly lower due to the decrease in interest rates set by the Federal Reserve. The average prime rate decreased 224 basis points during 2002. The average debt balance also decreased $22.82 million during 2002 as a result of the decrease in loans as explained above. As a result of interest rate swaps, the Parent and BMSBLC recognized a reduction in interest expense of $0.54 million for the year ended December 31, 2002, and $0.69 million for the year ended December 31, 2001.

        Depreciation expense decreased $0.04 million for the year ended December 31, 2002 as compared to the year ended December 31, 2001, due to the decrease in leased properties. Management fees did not change significantly between the years. Other operating expenses increased to $0.82 million for the year ended December 31, 2002 compared to $0.78 million for the year ended December 31, 2001. Legal expenses of $0.03 million were incurred to obtain a loan recovery of $0.47 million, additional debt issue costs of $0.02 million were expensed due to the prepayment of a real estate loan, and leased property expenses increased $0.03 million due to insurance and real estate tax expenses incurred with regard to two leased properties.

16

        The Parent and its qualified REIT subsidiary, BMSBLC, qualify as a real estate investment trust under the Internal Revenue Code. Accordingly, they are not subject to income tax on taxable income that is distributed to shareholders. During 2002 and 2001, the Parent took advantage of a provision in the tax law that allows a REIT to retain any capital gains on the sale of real estate properties by paying income tax on the gains. The Parent retained $1.19 million in capital gains and paid $0.41 million in taxes as of December 31, 2002, and retained $0.15 million in capital gains and paid $0.06 million in taxes as of December 31, 2001. Tax basis income for financial services (before the preferred stock dividend) was approximately $4.98 million of $1.33 per share (diluted) for the year ended December 31, 2002. Book income for financial services (before the preferred stock dividend) was $3.89 million or $1.04 per share (diluted) due to the elimination of intercompany revenue and expenses from the consumer products segment and normal book/tax adjustments. For the year ended December 31, 2001, tax basis income for financial services (before the preferred stock dividend) was approximately $3.99 million or $1.07 per share (diluted) and book income (before the preferred stock dividend) was $2.64 million or $0.71 per share (diluted) due to the elimination of intercompany revenue and expenses from the consumer products segment and normal book/tax adjustments.

Liquidity and Capital

Consumer Products

        During 2003, the consumer products segment’s net loss after intercompany transactions was $2.28 million. Intercompany transactions financed $1.15 million of the loss and depreciation financed $1.05 million of the loss. Based on projections for 2004, the consumer products segment is expected to be able to meet its cash flow needs internally from operating cash flows and by using its current line of credit facilities.

        Total assets of consumer products were $15.62 million as of December 31, 2003, and $17.07 million as of December 31, 2002, an 8% decrease. Cash increased to $0.70 million at December 31, 2003, from $0.50 million at December 31, 2002.

        Primarily due to lower fourth quarter sales, accounts receivable, net of the allowance for doubtful accounts, decreased to $2.17 million at December 31, 2003, from $3.23 million at December 31, 2002. LPI’s receivables decreased $0.60 million and LMOD’s receivables decreased $0.46 million. At December 31, 2003, LMOD had an outstanding receivable of $0.27 million from FAO, Inc. FAO, Inc. has filed for bankruptcy and LMOD has provided for 88% of the receivable in its December 31, 2003, allowance for doubtful accounts. Also due to lower sales, inventory, net of the allowance, decreased to $5.56 million at December 31, 2003, compared to $6.35 million at December 31, 2002. LMOD’s inventory decreased $0.66 million and LPI’s inventory decreased $0.13 million. Inventories are valued at the lower of cost or market using the first-in, first-out (FIFO) method.

        Property and equipment, net of accumulated depreciation, decreased by $0.32 million as of December 31, 2003, compared to December 31, 2002. Property and equipment increased by $0.56 million while accumulated depreciation increased by $0.88 million.

        Prepaid corporate taxes decreased $0.64 million from the prior year due to the refund in 2003 of estimated income tax payments. The deferred income tax asset increased by $1.37 million between December 31, 2003 and 2002 due to the recognition of the tax benefits related to net operating loss carryforwards generated in 2003. At December 31, 2003, the consumer products segment had unused federal net operating loss carryforwards of approximately $5.6 million. Other prepaid expenses decreased $0.04 million between 2003 and 2002.

        A licensing agreement, with an original cost of $2.5 million, gave LMOD the right to produce certain dolls until April 28, 2003, and an additional twelve months to sell any remaining inventory. It was treated as an intangible asset with a definite five year life and was fully amortized at December 31, 2003. Sales of dolls designed under the licensing agreement have decreased during the past few years and represented less than five percent of LMOD’s sales during the year.

17

        Goodwill was recorded when the Company purchased the remaining interest in the stock from the estate of Lee Middleton, the founder of LMOD, on April 30, 1998. The purchase price exceeded the carrying value by $0.62 million. As of December 31, 2003 and 2002, the balance of the goodwill, net of previous accumulated amortization, was $0.51 million. For the years ended December 31, 2003 and 2002, no impairment was recorded.

        LMOD decreased its short-term borrowings on a line of credit with InvestorsBank by $1.24 million during the year ended December 31, 2003. The debt was replaced with intercompany loans of $3.10 million which are collateralized by LMOD’s and LPI’s accounts receivable and inventory. Accounts payable and other liabilities decreased $0.30 million between 2003 and 2002.

Financial Services

        During 2003, the financial products segment’s net income after intercompany transactions was $2.79 million. Dividends of $1.17 million were paid to preferred stockholders and dividends of $1.49 million were paid to common stockholders.

        Total assets of financial services were $86.59 million as of December 31, 2003 and $108.47 million as of December 31, 2002. Cash increased to $0.65 million at December 31, 2003 from $0.43 million at December 31, 2002.

        Interest and rent receivable decreased to $0.36 million as of December 31, 2003, from $0.52 million at December 31, 2002. The rent receivable is shown net of an allowance for doubtful accounts of $150,000 at both periods. At December 31, 2003, four non-performing loans totaling $0.45 million in principal were on non-accrual, resulting in $0.02 million of interest income which would have been recorded for the year had the non-accruing loans been current in accordance with their original terms. Two tenants were also on non-accrual resulting in $0.45 million of rental income which would have been recorded for the year had the tenants been current in accordance with their leases.

        Property and equipment and other assets, including prepaid amounts, increased by $0.93 million. Property and equipment decreased by $0.06 million due to depreciation. Interest rate swap contracts decreased by $0.51 million due to the termination of those contracts in 2003. BMSBLC’s other assets increased by $1.50 million due to a receivable from the sale of a leased property on December 31, 2003. This receivable was collected in January, 2004.

        Total loans (excluding intercompany loans) decreased by $21.31 million, or 29%, to $52.29 million at December 31, 2003, from $73.60 million at December 31, 2002, with a corresponding decrease in liabilities. As of December 31, 2003 and 2002, management did not provide an allowance for loan losses due to management’s belief that the collateral which secured nonperforming loans was adequate to fully secure the debtors’ obligation to BMSBLC.

        Leased properties, net of accumulated depreciation, decreased to $30.81 million as of December 31, 2003, compared to $32.37 million as of December 31, 2002. One property that was under construction was completed in 2003 and two leased properties were sold during 2003. A foreclosed loan of $1.75 million was added to the leased property portfolio during the second quarter of 2003. This property was then sold on December 31, 2003, for $1.59 million. The decrease in the property value and other related foreclosure costs totaling $0.33 million were expensed in 2003.

        The financial services’ total consolidated indebtedness at December 31, 2003 decreased $18.58 million, primarily as the result of the reduction of the loan portfolio.

18

        BMSBLC’s short-term debt facility consists of commercial paper and drawn letters of credit backed by a $65 million line of credit that matures on June 25, 2004. At December 31, 2003, the outstanding commercial paper balance was $34.0 million. BMSBLC also had drawn $18.2 million against its bank line of credit to replace outstanding commercial paper that had matured and was unable to be replaced by sales of additional commercial paper. The bank line of credit has a higher interest rate of approximately 40 basis points than that paid on commercial paper which resulted in a reduction of net income for 2003. The Parent also has a line of credit agreement with InvestorsBank providing for a line of credit of $1.41 million bearing interest at the prime rate. The outstanding balance on the line at December 31, 2003, was $1.03 million.

        Long-term debt consists primarily of fixed rate debt. In 2004, BMSBLC paid off long-term debt of $5.58 million and replaced it with short-term debt from the bank line of credit at a lower interest rate.

        Accrued liabilities decreased to $1.13 million at December 31, 2003, as compared to $1.66 million at December 31, 2002, due to the decrease in loan participations.

        The Parent has outstanding preferred stock of $16.85 million which is required to be redeemed no later than July 1, 2008.

Critical Accounting Policies

        In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following areas require management to make estimates that are susceptible to significant change in the near term.

Consumer Products

        Allowance for doubtful accounts. LMOD and LPI provide an allowance for doubtful accounts based on management’s estimate of uncollectible amounts. The estimate is based on historical collection experience and a review of the current status of trade accounts receivable.

        Inventory valuation. Inventories are valued at lower of cost or market using the first-in, first-out (FIFO) method.

        Allowance for obsolete inventory. LMOD and LPI provide an allowance for obsolete inventory items based on management’s estimate. The estimate is based on items which are slow-moving or obsolete and for which management feels that full value cannot be realized.

        Amortization of goodwill. The Financial Accounting Standards Board issued Statement 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001 (i.e., January 1, 2002 for calendar year companies). This statement provides that goodwill and indefinite lived intangible assets are no longer amortized against income but are reviewed at least annually for impairment. An impairment review is designed to determine whether the fair value, and the related recorded goodwill, of a reporting unit is below its carrying value. In the year of adoption, any impairment loss will be recorded as a cumulative effect of a change in accounting principle. Thereafter, goodwill impairment losses will be charged to operations.

        Deferred income tax assets. Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred income tax assets and liabilities are adjusted through the provision for income taxes. The differences relate principally to different methods used for depreciation for income tax purposes, vacation accruals, health insurance, deferred revenue, net operating losses, capitalization requirements of the Internal Revenue Code, allowances for doubtful accounts and obsolete inventory and charitable contribution carryforwards. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount expected to be realized.

19

Financial Services

        Accrual of interest income. Interest income is accrued on the unpaid principal balance of loans. The accrual of interest income on loans is discontinued when, in the opinion of management, there is reasonable doubt as to whether the collateral securing the borrower’s obligation is sufficient to pay all principal, accrued interest and other expenses. Loans are returned to accrual status when the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

        Accrual of rental income. Rent is accrued on a monthly basis based on lease agreements. If it is determined by management that the lessee will not be able to make rent payments as required by the lease agreement, the accrual of rent is discontinued until management determines the rent to be collectible.

        Allowance for loan losses. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the amount of unpaid principal, reduced by the allowance for loan losses. Management reviews the value of the collateral securing each loan to determine if an allowance for loan losses is necessary. In this review, management takes into account the projected cash flow of the business from all sources including capital contributions, conversion of collateral to cash, and net income plus depreciation.

        Leased properties. Leased properties are recorded at cost and are depreciated using the straight-line method. The costs of normal repairs and maintenance are charged to expense as incurred.

        Nonperforming loans. A loan is considered nonperforming when the scheduled principal and/or interest payments are more than ninety days past due. Nonperforming loans are not automatically placed on non-accrual status. For a discussion of when loans are placed on non-accrual status, see “Accrual of interest income” above.

        Unfunded commitments. Unfunded commitments are recorded in the financial statements when they are funded or when related fees are incurred or received.

        Derivative Instruments. The Company designates all derivative instruments as either fair value hedges or cash flow hedges and to record the hedge on the balance sheet at its fair market value. The net gain/loss on instruments classified as cash flow hedges are reported as changes in other comprehensive income. The net gain/loss on instruments classified as fair value hedges are reported as increases/decreases in current year earnings. All derivatives are marked to market on the balance sheet.

        Fair Value of Financial Instruments. Financial Accounting Standards Board Statement No. 107, “Disclosures About Fair Value of Financial Instruments”, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement No. 107 excludes certain financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company (See Note 21 to the consolidated financial statements).

Off Balance Sheet Arrangements

        BMSBLC, in its ordinary course of business, had undisbursed loan commitments and lines of credit totaling $1.77 million and $1.28 million at December 31, 2003 and 2002, respectively. There were no letters of credit outstanding as of December 31, 2003.

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Contractual Obligations

        The Company has obligations and commitments to make future payments under debt and operating leases. The following schedule details these obligations at December 31, 2003.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

        This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identifiable by use of the words “may”, “will”, “could”, “believe”, “expect”, “intend”, “anticipate”, “estimate”, “project”, or similar expressions. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company and the subsidiaries include, but are not limited to, changes in: interest rates, general economic conditions, including the condition of the local real estate market, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or real estate portfolios, demand for loan products, competition, demand for financial services in the Company’s market area, the accessibility of funding sources at competitive rates, demand for the Company’s consumer products, the degree of success of the Company’s strategy to reduce prices on its collectible dolls and reduce expenses, payment when due of principal and interest on loans made by the Company, payment of rent by lessees on Company properties and the necessity to make additions to the Company’s loan loss reserve. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

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Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

        The Parent and BMSBLC assume interest rate risk (the risk that general interest rate levels will change) as a normal component of its operations. As a result, fair values of the Parent’s and BMSBLC’s financial instruments will change when interest rate levels fluctuate and that change may be either favorable or unfavorable to the Company.

        The Parent and BMSBLC’s debt structure and interest rate risk are managed through the use of fixed and variable rate debt. Management attempts to match variable rate loans with variable rate debt and fixed rate loans with fixed rate debt to the extent believed necessary to minimize interest rate risk. The Parent and BMSBLC’s fixed rate loans are matched with fixed rate debt, which reduces market rate risk. Variable rate loans are also matched against variable rate debt.

        BMSBLC’s $30.81 million of carrying value of leased properties are considered a fixed rate earning asset which is matched against $16.85 million of fixed rate preferred stock and $8.24 million of variable rate debt with the remaining $5.72 million funded with common equity. In the present low interest rate environment the mismatch of $8.24 million variable rate debt against fixed rate earning assets has been favorable to BMSBLC. In a rising interest rate environment the margin of difference becomes smaller and less favorable to BMSBLC. For example, an increase in the interest rate paid on the variable debt of 1%, would decrease Company pre-tax profits in an amount approximating $80,000.

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Item 8.    Financial Statements and Supplementary Data

The Middleton Doll Company

Consolidated Financial Statements

Contents

Financial Statement Schedules

23

INDEPENDENT AUDITOR’S REPORT

Board of Directors and Shareholders
The Middleton Doll Company and Subsidiaries
Waukesha, Wisconsin

We have audited the accompanying consolidated balance sheets of The Middleton Doll Company and Subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for the years ended December 31, 2003, 2002 and 2001. We have also audited the financial statement schedules listed in Item 8. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Middleton Doll Company and Subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years ended December 31, 2003, 2002 and 2001, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedules listed in Item 8, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

Milwaukee, Wisconsin
January 28, 2004

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THE MIDDLETON DOLL COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002

ASSETS

See accompanying notes to consolidated financial statements.

25

THE MIDDLETON DOLL COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Continued)
December 31, 2003 and 2002

LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY

See accompanying notes to consolidated financial statements.

26

THE MIDDLETON DOLL COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2003, 2002 and 2001

See accompanying notes to consolidated financial statements.

27

THE MIDDLETON DOLL COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Continued)
Years Ended December 31, 2003, 2002 and 2001

See accompanying notes to consolidated financial statements.

28

THE MIDDLETON DOLL COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years Ended December 31, 2003, 2002 and 2001

See accompanying notes to consolidated financial statements.

29

THE MIDDLETON DOLL COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2003, 2002 and 2001