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 October 31, 1998
Commission file number 0-4479
THE OHIO ART COMPANY
(Exact name of registrant as specified in its charter)
Ohio 34-4319140
(State of Incorporation) (I.R.S. Employer Identification No.)
P.O. Box 111, Bryan, Ohio 43506
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (419) 636-3141
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes __X__ No _____
At November 30, 1998 there were 891,784 shares outstanding of the
Company's Common Stock at $1.00 par value.
Page 1 of 15
FORM 10-Q
PART I - FINANCIAL INFORMATION
THE OHIO ART COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Nine Months Ended Three Months Ended
10/31/98 9/30/97 10/31/98 9/30/97
-------- -------- -------- --------
(In thousands, except per share data)
Net Sales $35,828 $24,351 $17,937 $11,369
Other Income 857 512 301 157
-------- -------- -------- --------
36,685 24,863 18,238 11,526
Costs and Expenses:
Cost of products sold 23,098 20,333 10,981 8,292
Selling, administrative
and general 11,963 8,911 5,749 3,229
Interest 1,268 764 545 367
-------- -------- -------- --------
36,329 30,008 17,275 11,888
-------- -------- -------- --------
INCOME(LOSS) BEFORE INCOME TAXES 356 (5,145) 963 (362)
Income Tax Credit --- (1,286) --- (90)
-------- -------- -------- --------
NET INCOME (LOSS) $ 356 $(3,859) $ 963 $ (272)
======== ======== ======== ========
Net Income(Loss) Per Share $ .41 $ (4.25) $ 1.11 $ (.31)
(Note 3)
Dividends Per Share (Note 3) $ .12 $ .16 $ .04 $ .04
Average Shares Outstanding 870 908 870 902
(Note 3)
<FN>
See notes to condensed consolidated unaudited financial statements.
</FN>
Page 2 of 15
FORM 10-Q
THE OHIO ART COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
October 31 December 31
1998 1997
-------- --------
(Unaudited) (Note)
(Thousands of dollars)
ASSETS
Current Assets
Cash $ 445 $ 1,846
Accounts receivable less allowance
(1998 - $596; 1997 - $415) 13,052 8,295
Inventories (Note 2)
On first-in, first-out cost method:
Finished products 8,643 3,582
Products in process 237 312
Raw materials 2,229 2,357
Less: Adjustment to reduce inventories
to last-in, first-out cost method (2,495) (2,447)
-------- --------
8,614 3,804
Recoverable income taxes 1,071 1,066
Prepaid expenses 1,489 1,524
Deferred federal income taxes 1,435 533
-------- --------
Total Current Assets 26,106 17,068
Property, Plant and Equipment
Cost 37,017 35,978
Less allowances for depreciation 25,350 (23,737)
-------- --------
11,667 12,241
Other Assets 2,360 2,422
-------- --------
$40,133 $31,731
======== ========
<FN>
See notes to condensed consolidated unaudited financial statements.
NOTE: The balance sheet at December 31, 1997 has been derived from the
audited financial statements at that date but does not include all of the
the information and footnotes required by generally accepted accounting
principles for complete financial statements.
</FN>
Page 3 of 15
FORM 10-Q
THE OHIO ART COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
October 31 December 31
1998 1997
-------- --------
(Unaudited) (Note)
(Thousands of dollars)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 5,228 $ 3,437
Other current liabilities 2,309 2,460
-------- --------
Total Current Liabilities 7,537 5,897
Deferred Federal Income Taxes 1,386 533
Long-Term Obligations, less current portion 23,474 16,633
Stockholders' Equity (Note 3)
Common Stock, par value $1.00 per share:
Authorized: 1,935,552 shares
Outstanding: 1998-891,784; 1997-892,271
shares (excluding treasury shares of
67,976 and 67,489 respectively) 892 892
Additional paid-in capital 204 205
Retained earnings 6,640 7,571
-------- --------
7,736 8,668
-------- --------
$40,133 $31,731
======== ========
<FN>
See notes to condensed consolidated unaudited financial statements
NOTE: The balance sheet at December 31, 1997 has been derived from the
audited financial statements at that date but does not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements.
</FN>
Page 4 of 15
FORM 10-Q
THE OHIO ART COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
Nine Months Ended
10/31/98 9/30/97
-------- --------
(Thousands of dollars)
Operating Activities
Net income (loss) $ 356 $(3,859)
Adjustments to reconcile net income(loss) to
net cash used in operating activities:
Provision for depreciation and amortization 1,456 1,301
Changes in accounts receivable, inventories,
prepaid expenses, other assets, accounts
payable, and other liabilities (10,734) (4,597)
-------- --------
NET CASH USED IN OPERATING ACTIVITIES (8,922) (7,155)
Investing Activities
Purchase of plant and equipment, less
net book value of disposals (898) (1,731)
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (898) (1,731)
Financing Activities
Borrowings 8,804 9,690
Repayments (1,209) (600)
Purchase of treasury shares (1) (370)
Cash dividends (107) (144)
-------- --------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 7,487 8,576
-------- --------
Cash
Decrease during period (2,333) (310)
At beginning of period 2,778 1,078
-------- --------
CASH AT END OF PERIOD $ 445 $ 768
======== ========
<FN>
See notes to condensed consolidated unaudited financial statements.
</FN>
Page 5 of 15
FORM 10-Q
THE OHIO ART COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
October 31, 1998
Note 1 - Basis of Presentation
The accompanying condensed consolidated unaudited financial statements
have been prepared in accordance with the instructions to Form 10-Q and
therefore do not include all information and footnotes necessary for a
fair presentation of financial position, results of operations, and cash
flows in conformity with generally accepted accounting principles.
For further information, refer to the consolidated financial statements
and footnotes included in the Company's annual report on Form 10-K for
the year ended December 31, 1997.
All adjustments necessary (consisting of normal adjustments), in the
opinion of management, for a fair statement of results for the periods
indicated have been made.
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 a full fiscal year.
No benefit or expense was recorded for income taxes for the nine month or
three month periods ended October 31, 1998 because of the inability to
carryback any loss generated for the periods. Income taxes are recorded
based upon estimates of the full fiscal year effective income tax rate.
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 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 last-in,
first-out (LIFO) cost method. Since inventories under the LIFO method
can only be determined at the end of each fiscal year based on
quantities and costs at that time, interim inventory valuation must be
based on estimates of quantities and costs at year-end.
Note 3 - Average Shares Outstanding
Unallocated ESOP shares are deducted from outstanding shares of Common
Stock to arrive at average shares outstanding.
Page 6 of 15
FORM 10-Q
THE OHIO ART COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
October 31, 1998
Note 4 - Change in Fiscal Year
The Board of Directors approved a fiscal year-end change from December
31st to January 31st beginning February 1, 1998 through January 31,
1999. The following is condensed information regarding the consolidated
results of operations for the transition period of January 1, 1998 to
January 31, 1998 (in thousands, except per share data):
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS:
Net sales and other income $ 1,442
Costs and expenses:
Cost of products sold 1,590
Selling, administrative and general 825
Interest 111
--------
2,526
--------
Net loss $(1,084)
========
Net loss per share $ (1.25)
Average shares outstanding 870
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOW:
Net cash provided from operating activities $ 1,843
Net cash used in investing activities (141)
Net cash used in financing activities (770)
--------
Net increase in cash 932
Cash at beginning of period 1,846
--------
Cash at end of period $ 2,778
========
Page 7 of 15
FORM 10-Q
THE OHIO ART COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
October 31, 1998
Note 5 - Comprehensive Income
During the year, The Ohio Art Company adopted FASB Statement No. 130,
"Reporting Comprehensive Income". Statement No. 130 requires the reporting
of comprehensive income in addition to net income from operations.
Comprehensive income is a more inclusive financial reporting methodology
that includes disclosure of certain financial information that historically
has not been recognized in the calculation of net income.
At year-end (January 31, 1998), the Company holds securities classified as
available-for-sale, which have unrealized gains. Changes in unrealized gains
are includable in comprehensive income.
Comprehensive income is as follows:
Nine Months Ended Three Months Ended
Oct 31 Sept 30 Oct 31 Sept 30
1998 1997 1998 1997
-------- -------- -------- --------
(In Thousands) (In Thousands)
Net income (loss) $ 356 $(3,859) $ 963 $ (272)
Other comprehensive expense, net of tax:
Unrealized holding losses on
securities arising during period (217) 311 (93) 232
Other comprehensive expense (19) (19) (6) (6)
-------- -------- -------- --------
Comprehensive income (loss) $ 120 $(3,567) $ 864 $ (46)
======== ======== ======== ========
MANAGEMENT'S DISCUSSION AND ANALYSIS
OPERATIONS
- ----------
Net sales for the nine months ended October 31, 1998 increased approximately
47% to $35,828,000 from $24,351,000 for the nine months ended September 30,
1998 and increased to $17,937,000 for the three months ended October 31, 1998
from $11,369,000 for the three months ended September 30, 1997. For the nine
month period, toy segment sales increased approximately $10,200,000 while the
Diversified Products segment increased approximately $1,300,000. New product
introductions for 1998, such as Betty Spaghetty(TM) fashion doll, Water T-Ball
(TM) outdoor water toy, and Bull Frogg(TM) interactive plush accounted for
approximately $11,100,000 of the toy segment increase, while the sports line
(primarily basketball games) decreased approximately $900,000. The
Page 8 of 15
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
Diversified Products increase resulted from an increase in our metal
lithography area of approximately $500,000 and an increase of approximately
$800,000 in injection molding sales. The sales increase of approximately
$6,600,000 for the third quarter was made up of an increase of approximately
$6,300,000 in the toy segment, the result of new product introductions as
noted above, as well as an increase in the Diversified Products segment of
approximately $300,000.
The Company's business is seasonal, with approximately 60-70% of its sales
being made in the last six months of the calendar year in recent years.
Subject to industry practice and comments as detailed in the Registrant's
annual Form 10-K for the year ended December 31, 1997, order backlog as of
November 30th is approximately $5,492,000 versus $6,522,000 at the same date
in 1997 or approximately 16% lower than the prior year. Since sales for the
nine months ending October 31, 1998 approximate sales for the twelve months
ended December 31, 1997, it is known that sales for 1998 will exceed 1997
sales. However, based on the decrease in the order backlog at November 30,
1998, it is anticipated that sales for the fourth quarter will be less than
the fourth quarter of the previous year and that sales for 1998 will be
$8,000,000 to $10,000,000 higher than the previous year, although it is
difficult to predict the final outcome for 1998.
Other income for the nine months ended October 31, 1998 increased to $857,000
from $512,000 for the nine months ended September 30, 1997 and increased to
$301,000 for the three months ended October 31, 1998 from $157,000 for the
three months ended September 30, 1997. The increase in other income is
primarily due to an increase in royalty income from the distribution of the
Company's products outside of the United States.
Gross profit margin percentage for the nine months ended October 31, 1998
increased dramatically to 35.5% from 16.5% for the nine months ended September
30, 1997. Gross profit margin percentage for the three months ended October
31, 1998 increased to 38.8% from 27.1% for the three months ended September
30, 1997. Gross profit margins were especially low for the nine months ended
September 30, 1997 because of the voluntary recall of the Splash-Off Water
Rocket which occurred in the second quarter of 1997. Gross profit margins
also increased in 1998 due to higher lithography production and toy production
at the Bryan, Ohio facility which resulted in a decrease in manufacturing
overhead variances. However, the primary reason for the increase in 1998 is a
major change in sales mix, primarily the three 1998 new product introductions
mentioned above. All three products are being heavily promoted through
advertising programs and demand higher margins to cover these programs.
Selling, administrative, and general expenses for the nine months ended
October 31, 1998 increased to $11,963,000 from $8,911,000 for the nine months
ended September 30, 1997 and increased to $5,749,000 for the three months
ended October 31, 1998 from $3,229,000 for the three months ended September
30, 1997. The primary reason is an increase in advertising expense.
Page 9 of 15
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
Advertising expense is budgeted based upon the level of toy sales, as well as
a specific dollar amount per unit sold for the specific toy items which are
heavily promoted. In addition, it was necessary to accelerate the recognition
of advertising expense in the third quarter of 1998 since the advertising
dollars spent did not generate the level of sales necessary to support the
advertising programs.
Interest expense increased to $1,268,000 for the nine months ended October 31,
1998 from $764,000 for the nine months ended September 30, 1997 and increased
to $545,000 for the three months ended October 31, 1998 from $367,000 for the
three months ended September 30, 1997. The increase for both periods is due
to the higher level of debt, principally incurred in financing lithography
equipment, that was carried over from the end of 1997 and has increased
throughout 1998.
No benefit was recorded for income taxes for the nine month or three month
period ended October 31, 1998 because of the inability to carry-back any loss
generated for 1998. The tax benefit of a $3,000,000 net operating loss
carryforward has been previously recorded in deferred tax assets. Income
taxes are recorded based upon estimates of the full fiscal year effective
income tax rate.
FINANCIAL CONDITION
- -------------------
The seasonal nature of the business generally requires a substantial buildup
of working capital during the second and third calendar quarters to carry
inventory and accounts receivable. Extended payment terms are in general use
in the toy industry. Historically, this was given in order to encourage
earlier shipment of merchandise for selling during the Christmas season.
Customers in the toy industry now accept shipments when inventory is needed,
not early, but the extended payment terms have remained. In addition, it is
now necessary for the Company to carry inventory in order to meet estimates of
fourth quarter customer demand. Borrowings to finance this working capital
requirement are normally repaid during the fourth quarter as these receivables
are collected.
Consistent with this seasonal nature of the business, working capital was
increased during the third quarter of 1998. This buildup was primarily funded
through bank borrowings. The use of bank borrowings, classified as long-term
obligations, has resulted in an increase in the current ratio from 2.9 to 1 at
December 31, 1997 to 3.5 to 1 at October 31, 1998.
IMPACT OF THE YEAR 2000
- -----------------------
The Company's plan to resolve the Year 2000 Issue involves the following four
phases: assessment, remediation, testing, and implementation. Please refer
to the chart at the end of this narrative for the status of progress for the
various phases mentioned above as they relate to the various areas of the
business. The following information is supplied to supplement the chart.
Page 10 of 15
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
1. Mainframe Computer System.
Based on an assessment that was made in 1997, the Company determined that it
would be necessary to upgrade its current version of software used on its
mainframe computer system in order to be Year 2000 compliant. Since only
minor modifications will be made internally to the packaged software,
implementation of the Year 2000 compliant software version should be
relatively straightforward. The Company has upgraded its hardware to handle
the new software. Costs incurred to date, the majority of which relate to the
mainframe computer and software, approximate $160,000, the majority of which
has been financed under an operating lease, will be expensed monthly over the
next two years. Future costs to implement the remaining phases are estimated
to be in the $50,000 to $100,000 range, although it is difficult to predict
what problems the Company will encounter. Previously, the current version of
software was tested by forwarding the dates into the year 2000, and the
software did run, although the year 00 came before the year 99. The major
problems occurring because of this would be in the Accounts Payable and
Accounts Receivable areas. The potential solution would be to double the
staff in each department, from two employees to four employees, to manually
sort the dates for approximately three to four months until the majority of
the 99 dates are eliminated. However, there is the risk, however slight, that
the Company installs the updated software, not performing any testing, and
it does not run at all, virtually shutting down the Company. If this remote
possibility would happen, the Company would revert to the older software
version and hire the additional four people.
2. Personal Computers
The Company has also evaluated the personal computers and related software
used within the Company and, with minor upgrades, it is believed there will be
no problems experienced or if there are, they will be minor and isolated.
Approximately three to six personal computers must upgraded or replaced, at a
cost of $5,000 to $10,000. The Company will back-up all data on each computer
just prior to January 1, 2000, and in the unlikely event that certain
computers will not function properly, the data could be run on another
personal computer.
3. Operating Equipment with Embedded Chips or Software
The Company has completed an assessment of its manufacturing facilities for
potential problems with equipment. The Company has isolated any significant
problems to the four-color lithography line which was installed in 1997. The
manufacturer of the equipment is located in Germany, and they will be at the
Bryan facility during the March - April time frame to test and implement any
changes needed to insure that the equipment will be operational in January of
2000. Since the manufacturer's representatives are scheduled to be at the
Bryan facility to install an additional lithography line, the Company believes
the cost associated with the testing and implementation will be minimal (less
than $5,000). In the unlikely event that the equipment would not function,
the Company believes that most of the work scheduled for this machine could be
run on older equipment which is not programmable, since the lithography
department is not at full capacity in January.
Page 11 of 15
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
4. Products
Based on a review of its product line, the Company has determined that all of
the products it has sold and will continue to sell do not require remediation
to be Year 2000 compliant. Accordingly, the Company does not believe that the
Year 2000 presents any exposure as it relates to the Company's products.
5. Third Party Suppliers
The Company has initiated formal communications with all of its significant
suppliers to determine the extent to which the Company's interface systems are
vulnerable to those third parties' failure to remediate their own Year 2000
Issues. There is no guarantee that the systems of other companies on which
the Company's systems rely will be timely converted and would not have an
adverse effect on the Company's systems. However, the majority of the
Company's products are manufactured overseas, and the Company has sent
representatives to these facilities. These manufacturers do not have
sophisticated computer systems, and generally rely on personal computers. If
these personal computers are not Year 2000 compliant, the manufacturers have
assured the Company that they could still supply the products needed.
However, if they could not supply the product needed, it would have a material
impact on the Company.
6. Third Party Customers
The Company's top six customers account for approximately 70% of sales and the
major interface with these customers is the transmission of orders via E.D.I.
The Company has tested and implementated changes needed and feels confident
that January 2000 will not pose a problem. G.E. Information Systems has
certified that the Company is Year 2000 compliant on E.D.I. Costs incurred to
date approximate $1,000 to $2,000 and were charged to operations. Future
costs are estimated at $1,000 to $2,000 if additional customers request that
their E.D.I. systems be tested.
Page 12 of 15
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
RESOLUTION PHASES
Assessment Remediation Testing Implementation
---------- ----------- ----------- --------------
1. Mainframe Computer System 100% Complete 30% Complete 0% Complete 0% Complete
Expected Expected Expected
Completion Completion Completion
Date Date Date
January 1999 May 1999 July 1999
2. Personal Computers 100% Complete 0% Complete 0% Complete 0% Complete
Expected Expected Expected
Completion Completion Completion
Date Date Date
March 1999 March 1999 March 1999
3. Operating Equipment with
Embedded Chips or Software 100% Complete 0% Complete 0% Complete 0% Complete
Expected Expected Expected
Completion Completion Completion
Date Date Date
April 1999 April 1999 April 1999
4. Products 100% Complete N/A N/A N/A
5. Third Party Suppliers 100% Complete 100% Complete 100% Complete 100% Complete
6. Third Party Customers 100% Complete 100% Complete 100% Complete 100% Complete
Page 13 of 15
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
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.
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 October 31, 1998.
The information called for in Items 1, 2, 3, 4, and 5 are not applicable.
Page 14 of 15
FORM 10-Q
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 14, 1998 /s/ William C. Killgallon
--------------------------
William C. Killgallon
Chairman of the Board
Date: December 14, 1998 /s/ M. L. Killgallon II
------------------------
M. L. Killgallon II
President
Date: December 14, 1998 /s/ Paul R. McCusty
----------------------
Paul R. McCusty
Vice President Finance
Page 15 of 15