UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

 

FORM 10-Q

 

 

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 November 30, 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						Nine Months Ended
		Oct 31 2003			Oct 31 2002			Oct 31 2003			Oct 31 2002
Net sales		$	8,564		$	12,016		$	21,734		$	28,537
Other income		156			427			582			1,030
		8,720			12,443			22,316			29,567
Costs and expenses:
Cost of products sold		5,814			7,679			15,537			19,610
Selling, administrative and general		2,552			3,106			7,516			8,314
Interest		21			81			100			257
		8,387			10,866			23,153			28,181
Income (loss) before income taxes		333			1,577			(837		)	1,386
Provision for (Benefit from) income taxes		52			547			(288		)	495
Net income (loss)		$	281		$	1,030		$	(549	)	$	891
Net income (loss) per share (Note 3)		$	.32		$	1.18		$	(.63	)	$	1.02
Average shares outstanding (Note 3)		874			873			874			873

 

See notes to condensed consolidated financial statements.

 

2

 

THE OHIO ART COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEET

(amounts in thousands, except share and per share amounts)

 

		October 31 2003			January 31 2003
		(unaudited)
Assets
Current assets
Cash		$	389		$	2,184
Marketable Securities					1,506
Accounts receivable less allowance (Oct - $408; January - $520)		4,809			4,222
Inventories (Note 2)
Finished products		3,096			2,825
Products in process		58			58
Raw materials		875			1,026
		4,029			3,909
Deferred income taxes		874			586
Prepaid expenses		316			295
Total current assets		10,417			12,702
Property, plant and equipment, net		6,818			7,355
Other assets (Note 6)		567			399
Total assets		$	17,802		$	20,456
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	2,420		$	2,731
Other current liabilities		1,754			1,904
Long-term debt due within one year (Note 5)		659			2,249
Total current liabilities		4,833			6,884
Long-term obligations, less current maturities (Note 5)		4,647			4,528
Deferred federal income tax		235			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		8,817			9,507
Reduction for ESOP loan		(283		)	(283		)
Total stockholders’ equity		8,087			8,777
Total liabilities and stockholders’ equity		$	17,802		$	20,456

 

See notes to condensed consolidated financial statements.

 

3

 

THE OHIO ART COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(amounts in thousands)

(unaudited)

 

		Nine Months Ended
		Oct 31 2003			Oct 31 2002
Cash flows from operating activities
Net income (loss)		$	(549	)	$	891
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for depreciation and amortization		1,226			1,189
Sale of marketable securities		1,506
Changes in assets and liabilities		(819		)	175
Deferred federal income tax		(321		)	495
Net cash provided by operating activities		1,043			2,750
Cash flows from investing activities
Purchase of plant and equipment, less net book value of disposals		(689		)	(542		)
Cash flows from financing activities
Payments of debt		(2,007		)	(1,085		)
Dividends		(142		)	(213		)
Net cash used in financing activities		(2,149		)	(1,298		)
Cash
Increase (decrease) during period		(1,795		)	910
Beginning of period		2,184			2,199
End of period		$	389		$	3,109

 

See notes to condensed consolidated financial statements.

 

4

 

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.

 

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.

 

5

 

Financial information relating to reportable segments is as follows:

 

		Domestic Toy			International Toy			Ohio Art Diversified			Strydel Diversified			Total
Three months ended October 31, 2003
Revenues from external customers		$	4,499		$	229		$	2,801		$	1,035		$	8,564
Intersegment revenues		4			0			0			0			4
Segment income (loss)		198			(197		)	339			(59		)	281
Three months ended October 31, 2002
Revenues from external customers		$	5,472		$	2,293		$	3,006		$	1,245		$	12,016
Intersegment revenues		15			0			0			85			100
Segment income		388			81			554			7			1,030
Nine months ended October 31, 2003
Revenues from external customers		$	9,899		$	896		$	7,483		$	3,456		$	21,734
Intersegment revenues		23			0			0			0			23
Segment income (loss)		(337		)	(632		)	555			(135		)	(549		)
Nine months ended October 31, 2002
Revenues from external customers		$	11,960		$	6,586		$	6,342		$	3,649		$	28,537
Intersegment revenues		45			0			0			85			130
Segment income		286			385			204			16			891

 

6

 

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 October 31, 2003).  The outstanding balance on the loan as of October 31, 2003 was $1,918.  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 October 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 October 31, 2003).  The amount available under the agreement as of October 31, 2003 was approximately $4,800.  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 nine months and three months ended October 31, 2003 were $72 and $24 respectively.  Estimated amortization expense for the next five years is:

 

 

7

 

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 decreased approximately 24% from $28,537 for the nine months ended October 31, 2002 to $21,734 for the comparable period of 2003.  For the three-month period ended October 31, 2003, net sales decreased approximately 29% to $8,564 from $12,016 for the quarter ended October 31, 2002.  Please refer to Note 4 to the condensed consolidated financial statements for a breakdown of sales by segment.

 

For the nine months ended October 31, 2003, the domestic and international toy segments reported sales declines of approximately $7,800, while the diversified products segments provided sales increases of approximately $900.  The Ohio Art diversified products segment was the only division to report an increase for the nine-month period.  Sales of seasonal toys improved by $1,600 over the comparable period in 2002, while sales of the Betty Spaghetty® fashion doll and Etch A Sketch® products decreased approximately $8,600 and $500, respectively, during the period.  All other toy categories recorded decreases as well.

 

The improvement in the shipment of Ohio Art diversified products was mainly due to sales to new customers.  Strydel diversified products sales fell $200 during the nine-month period due to a slowdown in shipments to automotive customers.

 

The sales decrease in the third quarter was the result of declines in toy and diversified products shipments of approximately $3,000 and $400 respectively.

 

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, November 30, 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 November 30 is approximately $4,400 versus $6,700 at the same date in 2002.

 

Other income for the nine-month period ending October 31, 2003 decreased to $582 from $1,030 for the comparable period of 2002.  For the three-month period ending October 31, 2003, other income decreased to $156 from $427 for the comparable period of 2002.  The decreases in both the nine-month and three-month periods were primarily due to lower royalties paid by international partners and licensees.

 

Gross profit margin (percentage) for the nine-month period ending October 31, 2002 (31.2%) decreased to (28.5%) for the nine months ended October 31, 2003.  The decline was due primarily to lower margins in the domestic toy segment resulting from sales of overstocked inventory and an overall reduction in shipments.

 

8

 

Gross profit margin (percentage) for the three-month period ending October 31, 2002 (36.1%) fell to (32.1%) for the comparable period of 2003.  The decrease is largely due to the same factors affecting the nine-month period.

 

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

 

Selling, administrative, and general expenses for the nine months ended October 31, 2003 decreased to approximately $7,500 from approximately $8,300 for the comparable period of 2002 and fell to approximately $2,600 for the three months ended October 31, 2003 from approximately $3,100 for the comparable period of 2002.  The key expense areas affected for both periods include advertising, royalties, and sales commissions, all of which declined.

 

Interest expense decreased to $100 for the nine months ended October 31, 2003 from $257 for the comparable period of 2002 and decreased to $21 for the three months ended October 31, 2003 from $81 for the comparable period of 2002.  The lower interest expense is due primarily to a reduction in long-term debt of approximately $1,200.

 

An income tax benefit of $288 was recorded for the nine-month period ended October 31, 2003 compared to an expense of $495 for the similar period of 2002.  An expense of $52 was recorded for the three-month period ended October 31, 2003 compared to an expense of $547 for the three-month period ended October 31, 2002.  Income taxes are based upon estimates of the full fiscal year effective tax rate.

 

Liquidity and Capital Resources

 

Cash provided by operations for the nine-month period ended October 31, 2003 was $1,043 versus cash provided by operations of $2,750 for the comparable period of 2002.  The decrease was primarily the result of a net loss of $549 in the current nine-month period compared to net income of $891 in the comparable period of 2002.  Also, positive changes in marketable securities and accounts receivable were more than offset by decreases in accounts payable, accrued expenses, the short-term portion of long-term debt and deferred federal income taxes.

 

Cash used in investing activities for the nine month period ended October 31, 2003 was $689 compared to a cash usage of $542 in the comparable period of 2002.  The increase in capital expenditures in the nine-month period of 2003 was the result of the timing of planned expenditures.

 

Cash used in financing activities for the nine month period ended October 31, 2003 was $2,149 compared to cash used in the comparable period of 2002 of $1,298.  The increase in cash used in the 2003 period was primarily attributable to a reduction of borrowings under the Company’s line of credit facility and dividends paid of $2,007 and $142, respectively.

 

9

 

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 October 31, 2003 was $1,918.  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 October 31, 2003 was approximately $4,800. 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 October 31, 2003 and October 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 October 31, 2003, the accrual rate was 2.5% of gross sales and the account balance was $542.

 

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.

 

10

 

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.

 

11

 

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 October 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.

 

12

 

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.

 

There were no changes in our internal controls over financial reporting during the quarter ended October 31, 2003 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 6.            Exhibits and reports on Form 8-K

 

a.          Exhibits

 

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.

 

b.         A current report on Form 8-K dated May 21, 2003 was filed to announce the refinancing of the Company’s existing revolving credit facility with the CIT Group/Business Credit Inc. with a demand line of credit facility with Key Bank.  The Commercial Security Agreement, dated May 21, 2003, with Key Bank was also filed.

 

For Items 1, 2, 3, 4, and 5 there is no responsive information.

 

13

 

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:                    December 12, 2003		/s/ William C. Killgallon
		William C. Killgallon
		Chairman of the Board
		and Chief Executive Officer
Date:                    December 12, 2003				/s/ M. L. Killgallon II
				M. L. Killgallon II
				President
Date:                    December 12, 2003			/s/ Jerry D. Kneipp
			Jerry D. Kneipp
			Treasurer and
			Chief Financial Officer

 

14