UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended July 31, 2003

 

Commission file number 0-4479

 

THE OHIO ART COMPANY

(Exact name of registrant as specified in its charter)

 

 

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

 

Yes   ý      No   o

 

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

 

Yes  o      No   ý

 

At August 31, 2003 there were 886,784 shares outstanding of the Company’s Common Stock, $1.00 par value.

 

 

PART I - FINANCIAL INFORMATION

 

Item 1.  Financial statements

 

THE OHIO ART COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(amounts in thousands, except per share amounts)

(unaudited)

 

		Three Months Ended						Six Months Ended
		July 31 2003			July 31 2002			July 31 2003			July 31 2002
Net sales		$	6,237		$	10,406		$	13,169		$	16,521
Other income		128			326			427			603
		6,365			10,732			13,596			17,124
Costs and expenses:
Cost of products sold		4,511			6,923			9,723			11,931
Selling, administrative and general		2,458			2,932			4,964			5,208
Interest		30			95			79			176
		6,999			9,950			14,766			17,315
Income (loss) before income taxes		(634		)	782			(1,170		)	(191		)
Provision for (Benefit from) income taxes		(340		)	279			(340		)	(52		)
Net income (loss)		$	(294	)	$	503		$	(830	)	$	(139	)
Net income(loss) per share(Note 3)		$	(.34	)	$	.58		$	(.95	)	$	(.16	)
Average shares outstanding (Note 3)		874			873			874			873

 

See notes to condensed consolidated financial statements.

 

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THE OHIO ART COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET

(amounts in thousands, except share amounts)

 

		July 31 2003			January 31 2003
		(unaudited)
Assets
Current assets
Cash		$	1,944		$	2,184
Marketable Securities					1,506
Accounts receivable less allowance (July - $462; January - $520)		2,917			4,222
Inventories (Note 2)
Finished products		3,261			2,825
Products in process		58			58
Raw materials		1,241			1,026
		4,560			3,909
Deferred income taxes		926			586
Prepaid expenses		66			295
Total current assets		10,413			12,702
Property, plant and equipment, net		7,085			7,355
Other assets (Note 6)		367			399
Total assets		$	17,865		$	20,456
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	2,338		$	2,731
Other current liabilities		1,866			1,904
Long-term debt due within one year (Note 5)		870			2,249
Total current liabilities		5,074			6,884
Long-term obligations, less current maturities (Note 5)		4,683			4,528
Deferred federal income tax		267			267
Stockholders’ equity (Note 3)
Common stock, par value $1.00 per share: Authorized: 1,935,552 shares Outstanding: 886,784 shares for both periods		887			887
Additional paid-in capital		197			197
Accumulated other comprehensive loss, net of tax		(1,531		)	(1,531		)
Retained earnings		8,571			9,507
Reduction for ESOP loan		(283		)	(283		)
Total stockholders’ equity		7,841			8,777
Total liabilities and stockholders’ equity		$	17,865		$	20,456

 

See notes to condensed consolidated financial statements.

 

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THE OHIO ART COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(amounts in thousands)

(unaudited)

 

		Six Months Ended
		July 31 2003			July 31 2002
Cash flows from operating activities
Net loss		$	(830	)	$	(139	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for depreciation and amortization		817			793
Changes in assets and liabilities		2,396			(585		)
Deferred federal income tax		(340		)	(52		)
Net cash provided by operating activities		2,043			17
Cash flows from investing activities
Purchase of plant and equipment, less net book value of disposals		(547		)	(284		)
Cash flows from financing activities
Payments of debt		(1,630		)	(522		)
Dividends		(106		)	(158		)
Net cash used in financing activities		(1,736		)	(680		)
Cash
Decrease during period		(240		)	(947		)
Beginning of period		2,184			2,199
End of period		$	1,944		$	1,252

 

See notes to condensed consolidated financial statements.

 

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THE OHIO ART COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands)

 

Note 1 - Basis of Presentation

 

The accompanying condensed consolidated financial statements are unaudited and reflect adjustments (consisting solely of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the interim periods presented.  This report includes information in a condensed format and should be read in conjunction with The Ohio Art Company’s (the Company) audited consolidated financial statements included in the Annual Report filed on Form 10-K for the year ended January 31, 2003.

 

Due to the seasonal nature of the toy business in which the Company is engaged and the factors set forth in Management’s Discussion and Analysis, the results of interim periods are not necessarily indicative of the full calendar year or any other interim period.

 

Note 2 - Inventories

 

The Company takes a physical inventory annually at each location.  The amounts shown in the quarterly financial statements have been determined using the Company’s standard cost perpetual inventory accounting system.  An estimate, based on past experience, of the adjustment which may result from the next physical inventory has been included in the financial statements.  Inventories are priced at the lower of cost or market under the first-in, first-out (FIFO) cost method.

 

Note 3 - Average Shares Outstanding

 

Unallocated ESOP shares are deducted from outstanding shares of Common Stock to arrive at average shares outstanding.  There are no dilutive securities included in the calculation of earnings (loss) per share, accordingly basic and diluted earnings (loss) per share are the same.

 

Note 4 - Industry Segments

 

The Company has four reportable segments: domestic toy, international toy, Ohio Art diversified products, and Strydel diversified products.  The domestic toy segment manufactures and distributes toys through major retailers in the United States while the international toy segment manufactures and utilizes foreign toy companies and sales agents to distribute their products throughout the world.  Ohio Art diversified products manufactures and sells custom lithographed products to consumer goods companies.  The Strydel diversified products segment manufactures and sells plastic injection molded parts to other manufacturers, including Ohio Art.

 

The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.

 

Intersegment sales are recorded at cost, therefore, there is no intercompany profit or loss on intersegment sales or transfers.

 

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The Company’s reportable segments offer either different products in the case of the diversified products segments, or utilize different distribution channels in the case of the two toy segments.

 

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Financial information relating to reportable segments is as follows:

 

		Domestic Toy			International Toy			Ohio Art Diversified			Strydel Diversified			Total
Three months ended July 31, 2003
Revenues from external customers		$	2,827		$	74		$	2,352		$	984		$	6,237
Intersegment revenues		6			0			0			0			6
Segment income (loss)		(137		)	(250		)	213			(120		)	(294		)
Three months ended July 31, 2002
Revenues from external customers		$	4,101		$	2,953		$	2,128		$	1,224		$	10,406
Intersegment revenues		23			0			0			0			23
Segment income		115			335			37			16			503
Six months ended July 31, 2003
Revenues from external customers		$	5,400		$	666		$	4,682		$	2,421		$	13,169
Intersegment revenues		20			0			0			0			20
Segment income(loss)		(535		)	(435		)	216			(76		)	(830		)
Six months ended July 31, 2002
Revenues from external customers		$	6,488		$	4,293		$	3,336		$	2,404		$	16,521
Intersegment revenues		30			0			0			0			30
Segment income(loss)		(102		)	304			(350		)	9			(139		)

 

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Note 5 - Debt

 

The Company executed a $2,500 term loan in August 2002, to refinance its existing term loan on real estate.  The new term loan is payable in monthly installments of $47 including interest at the prime rate (4.00% effective rate at July 31, 2003).  The outstanding balance on the loan as of July 31, 2003 was $2,038.  The loan is collateralized by all real and personal property of the company.

 

The term loan contains a financial covenant common to similar agreements that requires maintenance of a minimum debt service coverage.  As of July 31, 2003, the Company was in compliance with this financial covenant.

 

In addition, in May 2003, the Company executed a commercial security agreement that provides for borrowings up to $5,000 for one year under the terms of a demand line of credit.  Interest is payable monthly at prime minus 1.00% (3.00% effective rate at July 31, 2003).  The amount available under the agreement as of July 31, 2003 was approximately $4,600.  The security agreement is collateralized by all real and personal property of the Company

 

Note 6 - Intangible Assets

 

		Original Cost			Accumulated Amortization			Net Book Value
Trademarks		$	987		$	754		$	233

 

Amortization expenses for the six months and three months ended July 31, 2003 were $48 and $24 respectively.  Estimated amortization expense for the next five years is:

 

 

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Item 2.  Management’s discussion and analysis of financial condition and results of operations

 

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

(amounts in thousands)

 

Results of operations

 

Net sales for the six months ended July 31, 2003 decreased approximately 20% to $13,169 from $16,521 for the comparable period of 2002.  For the three-month period ended July 31, 2003, net sales decreased approximately 40% to $6,237 from $10,406 for the quarter ended July 31, 2002.  Please refer to Note 4 to the condensed consolidated financial statements for a breakdown of sales by segment.  For the six months ended July 31, 2003, the domestic and international toy segments accounted for approximately $1,100 and $3,600 of the sales decrease respectively.

 

The diversified products segments reported a combined increase of approximately $1,400 primarily due to a strong performance by the Ohio Art Lithography segment.  Sales by the Strydel diversified products segment were flat in comparison to the six-month period ended July 31, 2002.  All toy categories except seasonal products recorded lower sales volume during the six-month period primarily due to weak shipments of the Betty Spaghetty^® fashion doll in the domestic and European markets.

 

The sales decrease in the second quarter was mainly due to a decline in Betty Spaghetty^® sales compared to the prior year and was partially offset by an increase in shipments of seasonal toys.  An increase of approximately $200 in the Ohio Art diversified products shipments was offset by a drop of approximately $200 in the Strydel division.

 

The Company’s business is seasonal, with approximately 55% to 60% of its sales being made in the last six months of the calendar year in recent years.  Because of the seasonality of the Company’s business, the dollar order backlog at the most recent period end, August 31, 2003, is not necessarily indicative of expectations of sales for the full year.  Subject to industry practice and comments as detailed in the Company’s report on form 10-K for the year ended January 31, 2003, order backlog as of August 31 is approximately $6,400 versus $13,400 at the same date in 2002.

 

Other income for the six-month period ending July 31, 2003 dropped $176 from $603 for the comparable period of 2002.  For the three-month period ending July 31, 2003, other income decreased $198 from $326 for the comparable period of 2002.  The decreases in both the six-month and three-month periods are primarily due to lower royalties paid by international partners.

 

Gross profit margin (percentage) for the six-month period ending July 31, 2003 (26.1%) fell from the six months ended July 31, 2002 (27.7%).  The decline was due primarily to lower margins in the domestic toy segment resulting from sales of overstocked inventory and an overall reduction in

 

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shipments.  The Strydel diversified products division also experienced gross margin erosion as weak market conditions have required adjustments to product pricing to maintain sales levels.

 

Gross profit margin (percentage) for the three-month period ending July 31, 2003 (27.6%) decreased from the three months ended July 31, 2002 (33.4%).  The decline was largely due to the same factors affecting year-to-date gross margins.

 

Selling, administrative, and general expenses for the six months ended July 31, 2003 decreased to approximately $5,000 from approximately $5,200 for the comparable period of 2002 and decreased to approximately $2,500 for the three months ended July 31, 2003 from approximately $2,900 for the comparable period of 2002.  The key line items contibuting to the reductions in both periods include advertising expense, commissions, royalties and salary expense.  These were partially offset by higher pension expense.

 

Interest expense decreased to $79 for the six months ended July 31, 2003 from $176 for the comparable period of 2002 and decreased to $30 for the three months ended July 31, 2003 from $95 for the comparable period of 2002.  The lower interest expense is primarily due to a reduction in long-term debt of approximately $2,400 and to the lowering of the bank prime lending rate.

 

An income tax benefit of approximately $340 was recorded for the six month and three month period ended July 31, 2003.  An income tax benefit of $52 and an income tax expense of $279 were recorded for the six-month and three-month periods ended July 31, 2002 respectively.  Income taxes are based upon estimates of the full fiscal year effective tax rate.

 

Liquidity and Capital Resources

 

Cash provided by operations for the six month period ended July 31, 2003 was $2,043 versus cash provided by operations of $17 for the comparable period of 2002.  A net loss of $830 was more than offset by positive changes in working capital items, principally accounts receivable.

 

Cash used in investing activities for the six month period ended July 31, 2003 was $547 compared to a cash usage of $284 in the comparable period of 2002.  The increase in capital expenditures in the six month period of 2003 is due to the timing of planned expenditures.

 

Cash used in financing activities for the six month period ended July 31, 2003 was $1,736 compared to cash used in the comparable period of 2002 of $680.  The cash used in the 2003 period is primarily attributable to a reduction of borrowings under the Company’s line of credit facility and dividends paid of $1,630 and $106 respectively.

 

10

 

Effective August 2, 2002, the Company executed a five year $2,500 term loan to replace its existing term loan. The outstanding balance on the loan as of July 31, 2003 was $2,038.  Effective May 21, 2003, the Company entered into a one year demand line of credit agreement that provides for unrestricted borrowings of up to $5,000. The amount available under the agreement as of July 31, 2003 was approximately $4,600. The line of credit facility and term loan are collateralized by the assets of the Company.

 

The Company was in compliance with the covenants included in its loan agreements at July 31, 2003 and July 31, 2002.

 

Certain of the matters discussed in Management’s Discussion and Analysis contain certain forward-looking statements concerning the Company’s operations, economic performance, and financial condition.  These statements are based on the Company’s expectations and are subject to various risks and uncertainties.  Actual results could differ materially from those anticipated due to various factors, including those discussed herein.

 

Critical accounting policies

 

Principles of consolidation

 

The consolidated financial statements include the accounts of The Ohio Art Company and its subsidiaries (the Company) after elimination of significant intercompany accounts, transactions and profits.

 

Use of estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 amount of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

The Company has established a reserve for customer returns and defective merchandise based on our past experience.  As of July 31, 2003, the accrual rate was 2.5% of gross sales and the account balance was $613.

 

Marketable Securities

 

Management determines the appropriate classification of marketable securities at the time of purchase and reevaluates such designation as of each balance sheet date.  All securities held at January 31, 2003 are classified as trading securities and are stated at fair value as determined by the most recently traded price of each security at the balance sheet date.  The net unrealized gains or losses on trading securities are reported in earnings.

 

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Accounts receivable

 

Accounts receivable are stated at net invoice amounts.  An allowance for doubtful accounts is established based on a specific assessment of all invoices that remain unpaid following normal customer payment periods.  In addition, a general valuation allowance is established for other accounts receivable based on historical loss experience.  All amounts deemed to be uncollectible are charged against the allowance for doubtful accounts in the period that the determination is made.

 

Property, plant and equipment

 

Property, plant and equipment are recorded at cost.  Depreciation and amortization are computed by the straight-line method over the estimated useful life of the respective assets.

 

Revenue recognition

 

Revenue for all segments is recognized when products are shipped to customers.  Royalty income is recognized as earned.  Shipments are based on customer orders.  Revenue is recognized at the time of shipment and is not dependent on customer acceptance.  The Company’s Diversified Products segments manufacture to customer specifications.

 

Product development costs

 

Costs related to the development of new products and changes to existing products are charged to operations as incurred.

 

Advertising and sales promotions

 

Advertising and sales promotion expenditures are charged to operations in the year incurred.

 

Income taxes

 

The Company accounts for income taxes under the asset and liability method.  Deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the estimated future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax basis.  Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.  When appropriate, a valuation allowance is recorded to reduce the carrying amounts of deferred tax assets to an amount that is more likely than not to be realized.  In this connection, the Company considers the scheduled reversal of existing taxable temporary differences, projected future taxable income and tax planning strategies to determine the valuation allowance, if any, to be recognized for net deferred tax assets.

 

12

 

Net income (loss) per share

 

Net income (loss) per share is computed based upon the average number of shares outstanding during the year after giving effect to unallocated shares held by the Company’s Employee Stock Ownership Plan and shares released during the year.  The Company has no potential dilutive securities.

 

Financial instruments

 

The carrying amounts for cash, accounts receivable and short and long term debt approximate fair market value.  The carrying value of debt approximates market based on current borrowing rates.

 

Inventory valuation

 

Inventories are carried at the lower of cost or market, cost being determined using the first-in, first-out (FIFO) method.

 

Other comprehensive income (loss)

 

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income.  Certain changes in assets and liabilities, however, such as unrealized gains and losses on available-for-sale securities and minimum pension liability adjustments required by generally accepted accounting principles, are reported as a direct adjustment to the equity section of the balance sheet.  Such items, along with net income, are considered components of comprehensive income.  Accumulated other comprehensive income (loss) consists solely of the minimum pension liability adjustment, net of tax benefit of approximately ($1,531) as of July 31, 2003.

 

Item 3.                                     Qualitative and quantitative disclosures about market risk

 

The Company’s earnings and cash flow are not directly affected by foreign currency exchange since nearly all purchases and sales are made in U.S. currency.  However, the Company could be affected indirectly, either positively or negatively, since the majority of its toy products are manufactured by unrelated vendors overseas and the price of the products is influenced by the foreign exchange rate.

 

The Company’s interest expense is sensitive to the level of the U.S. prime rate as described in Note 5 to the condensed consolidated financial statements.  The Company is not a party to any material derivative financial instruments.

 

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Item 4.                                    Controls and procedures

 

Our Chief Executive Officer and our Chief Financial Officer have concluded, based on their evaluation, as of the end of the period covered by this report that our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(d) and 15d-15(e)) are effective to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

 

PART II - OTHER INFORMATION

 

Item 6.                                    Exhibits and reports on Form 8-K

 

The Company did not file any reports on Form 8-K during the three months ended July 31, 2003.

 

a.                                       Exhibit

 

31.1                           Certification of William C. Killgallon pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2                           Certification of Jerry D. Kneipp pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32                                    Certification of William C. Killgallon and Jerry D. Kneipp pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

The information called for in Items 1, 2, 3, 4, and 5 are not applicable.

 

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SIGNATURES

 

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

 

		THE OHIO ART COMPANY
		(Registrant)
Date:	September 12, 2003	/s/ William C. Killgallon
				William C. Killgallon
				Chairman of the Board
Date:	September 12, 2003		/s/ M. L. Killgallon II
					M. L. Killgallon II
					President
Date:	September 12, 2003					/s/ Jerry D. Kneipp
							Jerry D. Kneipp
						Chief Financial Officer

 

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