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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011

 

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

 

COMMISSION FILE NUMBER 001-11911

 

STEINWAY MUSICAL INSTRUMENTS, INC.

(Exact name of registrant as specified in its charter)

 

DELAWARE

 

35-1910745

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification No.)

 

 

 

800 South Street, Suite 305

 

 

Waltham, Massachusetts

 

02453

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number including area code:  (781) 894-9770

 

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 during the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Number of shares of Common Stock issued and outstanding as of May 6, 2011:

 

Class A

 

477,952

 

 

Ordinary

 

11,621,560

 

 

Total

 

12,099,512

 

 

 



Table of Contents

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

 

PART I

FINANCIAL STATEMENTS

 

 

 

 

Item 1.

Condensed Consolidated Financial Statements:

 

 

 

 

 

Condensed Consolidated Statements of Operations Three months ended March 31, 2011 and 2010

3

 

 

 

 

Condensed Consolidated Balance Sheets March 31, 2011 and December 31, 2010

4

 

 

 

 

Condensed Consolidated Statements of Cash Flows Three months ended March 31, 2011 and 2010

5

 

 

 

 

Condensed Consolidated Statement of Stockholders’ Equity Three months ended March 31, 2011

6

 

 

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

24

 

 

 

Item 4.

Controls and Procedures

25

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 6.

Exhibits

25

 

 

 

 

Signatures

26

 

2



Table of Contents

 

PART I                                                       FINANCIAL STATEMENTS

 

ITEM 1                                                        CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

(In Thousands Except Share and Per Share Amounts)

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Net sales

 

$

72,931

 

$

68,543

 

Cost of sales

 

50,534

 

47,219

 

 

 

 

 

 

 

Gross profit

 

22,397

 

21,324

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Sales and marketing

 

10,181

 

10,137

 

General and administrative

 

8,383

 

7,425

 

Other

 

161

 

39

 

Total operating expenses

 

18,725

 

17,601

 

 

 

 

 

 

 

Income from operations

 

3,672

 

3,723

 

 

 

 

 

 

 

Other expense (income), net

 

488

 

(1,467

)

Interest income

 

(368

)

(457

)

Interest expense

 

2,724

 

2,816

 

Total non-operating expenses

 

2,844

 

892

 

 

 

 

 

 

 

Income before income taxes

 

828

 

2,831

 

 

 

 

 

 

 

Income tax provision

 

323

 

1,031

 

 

 

 

 

 

 

Net income

 

$

505

 

$

1,800

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

Basic

 

$

0.04

 

$

0.17

 

Diluted

 

$

0.04

 

$

0.17

 

 

 

 

 

 

 

Weighted average shares:

 

 

 

 

 

Basic

 

12,087,950

 

10,433,830

 

Diluted

 

12,190,035

 

10,482,704

 

 

See notes to condensed consolidated financial statements.

 

3



Table of Contents

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

Unaudited

(In Thousands)

 

 

 

March 31,

 

December 31,

 

 

 

2011

 

2010

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash

 

$

107,069

 

$

119,811

 

Accounts, notes, and other receivables, net of allowances of
$12,235 and $12,265 in 2011 and 2010, respectively

 

41,693

 

42,385

 

Inventories

 

152,930

 

144,500

 

Prepaid expenses and other current assets

 

12,050

 

10,513

 

Deferred tax assets

 

11,511

 

11,419

 

Total current assets

 

$

325,253

 

$

328,628

 

 

 

 

 

 

 

Property, plant and equipment, net of accumulated depreciation of
$113,514 and $110,983 in 2011 and 2010, respectively

 

87,207

 

86,404

 

Trademarks

 

15,238

 

14,981

 

Goodwill

 

26,846

 

26,023

 

Other intangibles, net

 

3,470

 

4,028

 

Other assets

 

17,594

 

16,144

 

Long-term deferred tax assets

 

8,679

 

8,886

 

 

 

 

 

 

 

Total assets

 

$

484,287

 

$

485,094

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Debt

 

$

87,169

 

$

2,462

 

Accounts payable

 

11,150

 

12,141

 

Other current liabilities

 

33,395

 

39,181

 

Total current liabilities

 

131,714

 

53,784

 

 

 

 

 

 

 

Long-term debt

 

67,319

 

152,048

 

Deferred tax liabilities

 

3,762

 

3,761

 

Pension and other postretirement benefit liabilities

 

40,189

 

38,366

 

Other non-current liabilities

 

8,405

 

8,511

 

Total liabilities

 

251,389

 

256,470

 

 

 

 

 

 

 

Commitments and contingent liabilities

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock

 

14

 

14

 

Additional paid-in capital

 

154,857

 

154,404

 

Retained earnings

 

134,714

 

134,209

 

Accumulated other comprehensive loss

 

(9,619

)

(12,935

)

Treasury stock, at cost

 

(47,068

)

(47,068

)

Total stockholders’ equity

 

232,898

 

228,624

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

484,287

 

$

485,094

 

 

See notes to condensed consolidated financial statements.

 

4



Table of Contents

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(In Thousands)

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

505

 

$

1,800

 

Adjustments to reconcile net income to cash flows from operating activities:

 

 

 

 

 

Depreciation and amortization

 

2,198

 

2,686

 

Stock-based compensation expense

 

406

 

366

 

(Excess benefit) tax deficiency from stock-based awards

 

(7

)

64

 

Tax benefit from stock option exercises

 

7

 

4

 

Deferred tax benefit

 

(115

)

(121

)

(Recovery of) provision for doubtful accounts

 

(257

)

250

 

Other

 

182

 

47

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts, notes and other receivables

 

686

 

(935

)

Inventories

 

(7,238

)

(3,287

)

Prepaid expenses and other assets

 

(2,283

)

(1,122

)

Accounts payable

 

(1,046

)

1,435

 

Other liabilities

 

(3,367

)

(1,480

)

Cash flows from operating activities

 

(10,329

)

(293

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(1,170

)

(519

)

Payment of contingent consideration for previous acquisition

 

(2,727

)

 

Other

 

41

 

5

 

Cash flows from investing activities

 

(3,856

)

(514

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Borrowings under lines of credit

 

669

 

218

 

Repayments under lines of credit

 

(668

)

(218

)

Proceeds from issuance of common stock

 

40

 

27,647

 

Excess benefit (tax deficiency) from stock-based awards

 

7

 

(64

)

Cash flows from financing activities

 

48

 

27,583

 

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash

 

1,395

 

(1,363

)

(Decrease) increase in cash

 

(12,742

)

25,413

 

Cash, beginning of period

 

119,811

 

65,873

 

Cash, end of period

 

$

107,069

 

$

91,286

 

 

 

 

 

 

 

Supplemental Cash Flow Information:

 

 

 

 

 

Interest paid

 

$

5,345

 

$

6,132

 

Income taxes paid

 

$

1,598

 

$

3,838

 

 

See notes to condensed consolidated financial statements.

 

5



Table of Contents

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Unaudited

(In Thousands Except Option and Share Data)

 

 

 

Common
Stock

 

Additional
Paid-In
Capital

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Loss

 

Treasury
Stock

 

Total
Stockholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2011

 

$

14

 

$

154,404

 

$

134,209

 

$

(12,935

)

$

(47,068

)

$

228,624

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

505

 

 

 

 

 

505

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

3,316

 

 

 

3,316

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

3,821

 

Exercise of 3,600 options for shares of common stock

 

 

40

 

 

 

 

 

 

 

40

 

Tax benefit of options exercised

 

 

 

7

 

 

 

 

 

 

 

7

 

Stock-based compensation

 

 

 

406

 

 

 

 

 

 

 

406

 

Balance, March 31, 2011

 

$

14

 

$

154,857

 

$

134,714

 

$

(9,619

)

$

(47,068

)

$

232,898

 

 

See notes to condensed consolidated financial statements.

 

6



Table of Contents

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS

MARCH 31, 2011

Unaudited

(Tabular Amounts In Thousands Except Share, Per Share, Option, and Per Option Data)

 

(1)           Basis of Presentation

 

The accompanying condensed consolidated financial statements of Steinway Musical Instruments, Inc. and subsidiaries (the “Company”) for the three months ended March 31, 2011 and 2010 are unaudited. In the opinion of management, these statements have been prepared on the same basis as the audited consolidated financial statements as of and for the year ended December 31, 2010, and include all adjustments which are of a normal and recurring nature, necessary for the fair presentation of financial position, results of operations and cash flows for the interim periods. We encourage you to read the condensed consolidated financial statements in conjunction with the risk factors, consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the entire year.

 

Throughout this report “we,” “us,” and “our” refer to Steinway Musical Instruments, Inc. and subsidiaries taken as a whole.

 

(2)           Summary of Significant Accounting Policies

 

Our significant accounting policies were described in Note 2 to our audited Consolidated Financial Statements included in our 2010 Annual Report on Form 10-K for the fiscal year ended December 31, 2010. There have been no significant changes in our accounting policies for the first quarter of fiscal year 2011.

 

Recent Accounting Pronouncements There have been no recent accounting pronouncements not yet adopted by the Company which would have a material impact on our financial statements.

 

(3)           Earnings per Common Share

 

We compute earnings per share using the weighted-average number of common shares outstanding during each period. Diluted earnings per common share reflects the dilutive impact of shares subscribed under the Employee Stock Purchase Plan (“Purchase Plan”) and effect of our outstanding options and restricted stock using the treasury stock method, except when such items would be antidilutive.

 

The following table presents the calculation of basic and diluted earnings per share:

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Numerator:

 

 

 

 

 

Net income

 

$

505

 

$

1,800

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted-average common shares outstanding - basic

 

12,087,950

 

10,433,830

 

Dilutive effect of stock-based compensation plans

 

102,085

 

48,874

 

Weighted-average common shares outstanding - diluted

 

12,190,035

 

10,482,704

 

 

 

 

 

 

 

Net income per share - basic

 

$

0.04

 

$

0.17

 

Net income per share - diluted

 

$

0.04

 

$

0.17

 

 

7



Table of Contents

 

We did not include 534,100 or 735,876 of the outstanding options to purchase shares of common stock in the computation of diluted earnings per share for the three months ended March 31, 2011 and 2010, respectively, because generally their exercise prices were more than the average market price of our common shares, and therefore antidilutive. We did not include any of the 40,000 shares of restricted stock outstanding in the computation of diluted earnings per share for the three months ended March 31, 2011 because they were antidilutive.

 

(4)           Accumulated Other Comprehensive Income (Loss) - Accumulated other comprehensive loss is comprised of foreign currency translation adjustments and pension and other postretirement benefits. The components of accumulated other comprehensive loss are as follows:

 

 

 

March 31,

 

December 31,

 

 

 

2011

 

2010

 

Accumulated other comprehensive loss:

 

 

 

 

 

Foreign currency translation adjustment

 

$

7,056

 

$

3,740

 

Pension and other postretirement benefits

 

(16,675

)

(16,675

)

Total accumulated other comprehensive loss

 

$

(9,619

)

$

(12,935

)

 

The components of comprehensive income (loss) are as follows:

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Comprehensive income:

 

 

 

 

 

Net income

 

$

505

 

$

1,800

 

Foreign currency translation adjustment

 

3,316

 

(3,990

)

Total comprehensive income (loss)

 

$

3,821

 

$

(2,190

)

 

(5)           Inventories

 

 

 

March 31,

 

December 31,

 

 

 

2011

 

2010

 

Raw materials

 

$

18,224

 

$

18,091

 

Work-in-process

 

37,027

 

34,493

 

Finished goods

 

97,679

 

91,916

 

Total inventory

 

$

152,930

 

$

144,500

 

 

8



Table of Contents

 

(6)           Goodwill, Trademarks, and Other Intangible Assets

 

Intangible assets other than goodwill and indefinite-lived trademarks are amortized on a straight-line basis over their estimated useful lives. Deferred financing costs are amortized over the repayment periods of the underlying debt. We performed our annual goodwill and intangible asset impairment test as of July 31, 2010 given the timing of our fall budgeting and planning process, which provides multi-year cash flows used to conduct our annual impairment testing of intangible assets. Our analyses of band division trademarks and piano division goodwill and trademarks did not indicate any impairment; therefore, no charge was taken against those assets. No other events or circumstances occurred subsequent to our annual impairment test which would have indicated that these assets may be impaired.

 

The changes in carrying amounts of goodwill and trademarks are as follows:

 

 

 

Piano

 

Band

 

Total

 

Goodwill:

 

 

 

 

 

 

 

Balance, January 1, 2011

 

$

25,823

 

$

200

 

$

26,023

 

Foreign currency translation impact

 

823

 

 

823

 

Balance, March 31, 2011

 

$

26,646

 

$

200

 

$

26,846

 

 

 

 

 

 

 

 

 

Trademarks:

 

 

 

 

 

 

 

Balance, January 1, 2011

 

$

9,157

 

$

5,824

 

$

14,981

 

Foreign currency translation impact

 

257

 

 

257

 

Balance, March 31, 2011

 

$

9,414

 

$

5,824

 

$

15,238

 

 

We have previously recorded cumulative impairment losses of $8.6 million associated with band division goodwill and $1.0 million associated with online music business trademarks.

 

We also carry certain intangible assets that are amortized. Once fully amortized, these assets are removed from both the gross and accumulated amortization balances. These assets consist of the following:

 

 

 

March 31,
2011

 

December 31,
2010

 

Gross deferred financing costs

 

$

5,912

 

$

6,170

 

Accumulated amortization

 

(3,705

)

(3,542

)

Deferred financing costs, net

 

$

2,207

 

$

2,628

 

 

 

 

 

 

 

Gross non-compete agreements

 

$

250

 

$

250

 

Accumulated amortization

 

(144

)

(131

)

Non-compete agreements, net

 

$

106

 

$

119

 

 

 

 

 

 

 

Gross customer relationships

 

$

477

 

$

524

 

Accumulated amortization

 

(252

)

(283

)

Customer relationships, net

 

$

225

 

$

241

 

 

 

 

 

 

 

Gross website and developed technology

 

$

2,176

 

$

2,176

 

Accumulated amortization

 

(1,244

)

(1,136

)

Website and developed technology, net

 

$

932

 

$

1,040

 

 

 

 

 

 

 

Total gross other intangibles

 

$

8,815

 

$

9,120

 

Accumulated amortization

 

(5,345

)

(5,092

)

Other intangibles, net

 

$

3,470

 

$

4,028

 

 

9



Table of Contents

 

We wrote off $0.3 million of deferred financing costs during the period. The weighted-average amortization period for deferred financing costs is seven years, and the weighted-average amortization period for all other amortizable intangibles is approximately five years. Total amortization expense, which includes amortization of deferred financing costs, is as follows:

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Amortization expense

 

$

310

 

$

306

 

 

The following table shows the total estimated amortization expense for the remainder of 2011 and beyond:

 

Remainder of 2011

 

$

922

 

2012

 

1,228

 

2013

 

878

 

2014

 

283

 

2015

 

159

 

Total

 

$

3,470

 

 

(7)           Other Current Liabilities

 

Our other current liabilities consist of the following:

 

 

 

March 31,
2011

 

December 31,
2010

 

Accrued payroll and related benefits

 

$

13,020

 

$

11,428

 

Current portion of pension and other postretirement benefit liabilities

 

1,364

 

1,306

 

Accrued warranty expense

 

1,402

 

1,510

 

Accrued interest

 

884

 

3,549

 

Deferred income

 

10,532

 

9,652

 

Income and other taxes payable

 

311

 

358

 

Other accrued expenses

 

5,882

 

11,378

 

Total

 

$

33,395

 

$

39,181

 

 

Accrued warranty expense is recorded at the time of sale for instruments that have a warranty period ranging from one to ten years. The accrued expense recorded is generally calculated on a ratio of warranty costs to sales based on our warranty history and is adjusted periodically following an analysis of actual warranty claims. The accrued warranty expense activity for the three months ended March 31, 2011 and 2010, and the year ended December 31, 2010 is as follows:

 

 

 

March 31,
2011

 

March 31,
2010

 

December 31,
2010

 

Beginning balance

 

$

1,510

 

$

1,553

 

$

1,553

 

Additions

 

332

 

140

 

894

 

Claims and reversals

 

(484

)

(241

)

(896

)

Foreign currency translation impact

 

44

 

(41

)

(41

)

Ending balance

 

$

1,402

 

$

1,411

 

$

1,510

 

 

10


 


Table of Contents

 

(8)           Debt

 

Our outstanding debt consists of the following:

 

 

 

March 31,
2011

 

December 31,
2010

 

Senior Notes

 

$

152,506

 

$

152,506

 

Unamortized bond discount

 

(422

)

(458

)

Overseas lines of credit

 

2,404

 

2,462

 

Total

 

154,488

 

154,510

 

Less: current portion

 

87,169

 

2,462

 

Long-term debt

 

$

67,319

 

$

152,048

 

 

Scheduled repayments of outstanding debt as of March 31, 2011 are as follows:

 

Remainder of 2011

 

$

87,404

 

2011

 

 

2012

 

 

2013

 

 

2014

 

67,506

 

Total

 

$

154,910

 

 

On April 1, 2011 we announced the call of $85.0 million in outstanding principal of our bonds, which were redeemed on May 2, 2011. The table above includes the $85.0 million of called bonds as payable within the remainder of 2011. This transaction is discussed more fully in Note 16.

 

(9)           Facility Rationalization Charges — Band Segment

 

By the fourth quarter of 2011, we intend to close our tuned percussion instrument manufacturing facility located in LaGrange, Illinois and consolidate the production into our other percussion facility in Monroe, North Carolina. As a result of this pending closure, we recorded charges of $0.4 million in severance and related expenses during the first quarter of 2011 as a component of cost of goods sold. We currently do not expect to incur any additional severance expenses during the remainder of 2011.

 

The severance liability and related activity associated with this plant closure is as follows:

 

Facility rationalization severance liability:

 

 

 

Balance at January 1, 2011

 

$

 

Additions charged to cost of sales

 

417

 

Payments

 

 

Balance, March 31, 2011

 

$

417

 

 

Although we are still in the process of quantifying the impact of this plant closure, we do not expect impairment charges or equipment relocation costs, if any, to be material.

 

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(10)         Fair Values of Financial Instruments

 

Our financial instruments, which are recorded at fair value, consist primarily of foreign currency contracts and marketable equity securities. We assess the inputs used to measure fair value using the following three-tier hierarchy, which indicates the extent to which inputs used are observable in the market.

 

Level 1                                Valuation is based upon unadjusted quoted prices for identical instruments traded in active markets.

 

Level 2                                Valuation is based upon quoted prices for identical or similar instruments such as interest rates, foreign currency exchange rates, commodity rates and yield curves, and model-based valuation techniques for which all significant assumptions are observable in the market.

 

Level 3                                Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions include management’s own judgments about the assumptions market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques. (We do not have any assets or liabilities carried at Level 3 fair value.)

 

We value our foreign currency contracts using internal models with observable inputs, including currency forward and spot prices. Estimated fair value has been determined as the difference between the current forward rate and the contract rate, multiplied by the notional amount of the contract, or upon the estimated fair value of purchased option contracts.

 

The following table presents information about our assets and liabilities measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010 and the fair value hierarchy of the valuation techniques we utilized.

 

 

 

March 31,
2011

 

December 31,
2010

 

Financial assets:

 

 

 

 

 

Trading securities(1) - Level 1

 

$

1,864

 

$

1,758

 

Foreign currency contracts(2) - Level 2

 

329

 

216

 

 

 

$

2,193

 

$

1,974

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

Foreign currency contracts(2) - Level 2

 

$

176

 

$

447

 

 


(1)          Our trading securities pertain to the Supplemental Executive Retirement Plan (“SERP”) and are held in a Rabbi Trust. We record a corresponding liability for the same amount in our financial statements, which represents our obligation to SERP participants.

 

(2)          Our foreign currency contracts pertain to obligations or potential obligations to purchase or sell euros, pounds, U.S. dollars, and yen under various forward contracts.

 

We base the estimated fair value of our debt on institutional quotes currently available to us. The historical cost, net carrying value, and estimated fair value are as follows:

 

 

 

March 31, 2011

 

December 31, 2010

 

 

 

Net Carrying
Value

 

Estimated
Fair Value

 

Net Carrying
Value

 

Estimated
Fair Value

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Debt

 

$

154,488

 

$

152,528

 

$

154,510

 

$

156,208

 

 

The carrying values of accounts, notes and other receivables, and accounts payable approximate fair value.

 

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Table of Contents

 

(11)         Stockholders’ Equity and Stock-based Compensation Arrangements

 

Our common stock is comprised of two classes: Class A and Ordinary. With the exception of disparate voting power, both classes are substantially identical. Each share of Class A common stock entitles the holder to 98 votes. Holders of Ordinary common stock are entitled to one vote per share. Each share of Class A common stock shall automatically convert to Ordinary common stock if, at any time, that share of Class A common stock is not owned by an original Class A holder. As of March 31, 2011 our Chairman and our Chief Executive Officer collectively owned 100% of the Class A common shares, representing approximately 80% of the combined voting power of the Class A common stock and Ordinary common stock.

 

Employee Stock Purchase Plan - We have an employee stock purchase plan under which substantially all employees may purchase Ordinary common stock through payroll deductions at a purchase price equal to 85% of the lower of the fair market values as of the beginning or end of each twelve-month offering period. Stock purchases under the Purchase Plan are limited to 5% of an employee’s annual base earnings. We have reserved 400,000 shares of common stock for issuance under this plan.

 

Stock Plans - The 2006 Stock Plan provides for the granting of 1,000,000 stock options (including incentive stock options and non-qualified stock options), stock appreciation rights, restricted shares and other stock awards to certain key employees, consultants and advisors. Our stock options generally have five-year vesting terms and ten-year option terms. Our restricted shares have three-year vesting terms, except upon a change in control, when they would vest immediately.

 

Our 1996 Stock Plan has expired but still has vested options outstanding. We reached our registered share limitation in early 2007, and had previously reserved 721,750 treasury stock shares to issue under this plan. We have since issued 122,674 shares of treasury stock to cover options exercised, with 330,876 remaining options outstanding. Since in most instances the average cost of the treasury stock exceeded the price of the options exercised, the difference between the proceeds received and the average cost of the treasury stock issued resulted in a reduction of retained earnings. There was no reduction to retained earnings associated with options exercised during the three months ended March 31, 2011. This reduction was $0.1 million for the three months ended March 31, 2010.

 

The compensation cost and the income tax benefit recognized for these plans is as follows:

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Compensation cost included in:

 

 

 

 

 

Basic income per share

 

$

0.03

 

$

0.03

 

Diluted income per share

 

$

0.03

 

$

0.03

 

Stock-based compensation expense

 

406

 

366

 

Income tax benefit

 

82

 

67

 

 

We measured the fair value of options on their grant date, including the valuation of the option feature implicit in our Purchase Plan, using the Black-Scholes option-pricing model. The risk-free interest rate is based on the weighted-average of U.S. Treasury rates over the expected life of the stock option or the contractual life of the option feature in the Purchase Plan. The expected life of a stock option is based on historical data of similar option holders. We have segregated our employees into two groups based on historical exercise and termination behavior. The expected life of the option feature in the Purchase Plan is the same as its contractual life. Expected volatility is based on historical volatility of our stock over the expected life of the option, as our options are not readily tradable.

 

There were no options granted during the three months ended March 31, 2011 or 2010. During the three months ended March 31, 2011, we granted 40,000 restricted shares with a fair value of $19.89 per share and an associated unrecognized compensation cost of $0.7 million as of March 31, 2011. The restriction on these shares amortize over a three-year period.

 

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The following table sets forth information regarding the Stock Plans:

 

 

 

Number of
Options

 

Weighted-
Average
Exercise
Price

 

Weighted-
Average
Remaining
Contract
Life
(in years)

 

Aggregate
Intrinsic
Value

 

Outstanding, January 1, 2011

 

1,086,886

 

$

20.60

 

 

 

 

 

Granted

 

 

 

 

 

 

 

Exercised

 

(3,600

)

11.20

 

 

 

 

 

Forfeited

 

(12,760

)

26.12

 

 

 

 

 

Outstanding, March 31, 2011

 

1,070,526

 

$

20.57

 

5.9

 

$

4,376

 

 

 

 

 

 

 

 

 

 

 

Exercisable, March 31, 2011

 

598,566

 

$

22.69

 

4.3

 

$

1,330

 

 

The total intrinsic value of the options exercised during the three month periods ended March 31, 2011 and 2010 was nominal. As of March 31, 2011, there was $2.6 million of unrecognized compensation cost related to nonvested share-based compensation arrangements, exclusive of restricted stock. As of March 31, 2011 this compensation cost was expected to be recognized over a weighted-average period of 2.8 years. However, this timeframe may be accelerated based on the transaction described in Note 16. Cash received from option exercises under the Stock Plans for the three month period ended March 31, 2011 was less than $0.1 million.

 

The following tables set forth information regarding the Purchase Plan:

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Risk-free interest rate

 

0.3%

 

0.5%

 

Weighted-average expected life of option feature (in years)

 

1.0

 

1.0

 

Expected volatility of underlying stock

 

28.3%

 

27.9%

 

Expected dividends

 

n/a

 

n/a

 

Weighted-average fair value of option feature

 

$4.81

 

$2.79

 

 

 

 

Number of
Options

 

Weighted-
Average
Exercise
Price

 

Remaining
Contract
Life
(in years)

 

Aggregate
Intrinsic
Value

 

Outstanding, January 1, 2011

 

15,709

 

$

16.58

 

 

 

 

 

Granted

 

8,419

 

16.58

 

 

 

 

 

Exercised

 

 

 

 

 

 

 

Forfeited

 

(397

)

16.58

 

 

 

 

 

Outstanding, March 31, 2011

 

23,731

 

$

16.58

 

0.3

 

$

131

 

 

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Table of Contents

 

(12)                          Other Expense (Income), Net

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

West 57th Street building income

 

$

(665

)

$

(2,432

)

West 57th Street building expense

 

1,788

 

1,772

 

Foreign exchange gain, net

 

(661

)

(496

)

Miscellaneous, net

 

26

 

(311

)

Other expense (income), net

 

$

488

 

$

(1,467

)

 

Our building on West 57th Street in New York City is managed by an outside company. West 57th Street building income includes all rent and other income attributable to the property; West 57th Street building expense includes the land lease, real estate taxes, depreciation, and other building costs. Since we utilize a portion of the leasable space for our own retail store, we have allocated a ratable portion of the building expenses to sales and marketing expenses.

 

(13)         Commitments and Contingent Liabilities

 

We are involved in certain legal proceedings regarding environmental matters, which are described below. Further, in the ordinary course of business, we are party to various legal actions that we believe are routine in nature and incidental to the operation of our business. While the outcome of such actions cannot be predicted with certainty, we believe that, based on our experience in dealing with these matters, their ultimate resolution will not have a material adverse impact on our business, financial condition, results of operations or prospects.

 

Certain environmental laws, such as the Comprehensive Environmental Response, Compensation, and Liability Act, as amended (“CERCLA”), impose strict, retroactive, joint and several liability upon persons responsible for releases of hazardous substances, which liability is broadly construed. Under CERCLA and other laws, we may have liability for investigation and cleanup costs and other damages relating to our current or former properties, or third-party sites to which we sent wastes for disposal. Our potential liability at any of these sites is affected by many factors including, but not limited to, the method of remediation, our portion of the hazardous substances at the site relative to that of other parties, the number of responsible parties, the financial capabilities of other parties, and contractual rights and obligations.

 

We are continuing an existing environmental remediation plan at a facility we acquired in 2000 and subsequently sold. We expect to pay these costs, which approximate $0.6 million, over a ten-year period. We have accrued approximately $0.4 million for the remaining cost of this remediation program, which represents the present value total cost using a discount rate of 4.54%. A summary of expected payments associated with this project is as follows:

 

 

 

Environmental
Payments

 

Remainder of 2011

 

$

7

 

2012

 

61

 

2013

 

61

 

2014

 

61

 

2015

 

61

 

Thereafter

 

303

 

Total

 

$

554

 

 

In 2004, we acquired two manufacturing facilities from G. Leblanc Corporation, now Grenadilla, Inc. (“Grenadilla”), for which environmental remediation plans had already been established. In connection with the acquisition, we assumed the existing accrued liability of approximately $0.8 million for the cost of these remediation activities. Based on a review of past and ongoing investigatory and remedial work by our environmental consultants, and discussions with state regulatory officials, as well as periodic sampling, we estimate the remaining costs of such remedial plans to be $2.3 million. Pursuant to the purchase and sale agreement, we have sought indemnification from Grenadilla for anticipated costs above the original estimate. We filed a claim against the escrow and recorded a corresponding receivable for this amount in prepaid expenses and other assets in our condensed consolidated balance sheet. Based on the current estimated costs of remediation, this receivable totaled

 

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Table of Contents

 

$2.0 million as of March 31, 2011. We have reached an agreement with Grenadilla whereby certain environmental costs are paid directly out of the escrow. Currently, the escrow balance exceeds our receivable balance. Accordingly, Grenadilla has recently expressed an interest in engaging in non-binding mediation in order to close out the escrow arrangement so that the cash can be distributed to the respective parties in accordance with the purchase agreement. Due to the nature of mediation, the impact, if any, on our financial condition or results of operations cannot be determined at this time.

 

Based on our past experience and currently available information, the matters described above and our other liabilities and compliance costs arising under environmental laws are not expected to have a material impact on our capital expenditures, earnings or financial position in an individual year. However, some risk of environmental liability is inherent in the nature of our current and former businesses and we may, in the future, incur material costs to meet current or more stringent compliance, cleanup, or other obligations pursuant to environmental laws.

 

(14)         Retirement Plans

 

We have defined benefit pension plans covering many of our employees, including certain employees in Germany and the U.K. The components of net periodic pension cost for these plans are as follows:

 

 

 

Domestic Plan

 

Foreign Plans

 

 

 

Three Months Ended March 31,

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

2011

 

2010

 

Service cost

 

$

88

 

$

93

 

$

157

 

$

171

 

Interest cost

 

864

 

844

 

434

 

453

 

Expected return on plan assets

 

(1,049

)

(1,050

)

(105

)

(95

)

Amortization of prior service cost (credit)

 

28

 

28

 

(13

)

 

Amortization of net loss

 

489

 

492

 

29

 

34

 

Net periodic pension cost

 

$

420

 

$

407

 

$

502

 

$

563

 

 

Based on federal laws and regulations, we are not required to make a contribution to our domestic pension plan in 2011. We have not made any payments to this plan during the period and are currently evaluating what amount, if any, we will contribute to this plan in 2011. Our anticipated contributions to the pension plan of our U.K. subsidiary approximate $0.9 million for the current year. As of March 31, 2011, we have made contributions of $0.2 million to this plan. The pension plans of our German entities do not hold any assets and use operating cash to pay participant benefits as they become due. Expected 2011 benefit payments under these plans are $1.3 million, of which $0.3 million was paid through March 2011.

 

We provide postretirement life insurance benefits to a limited number of certain eligible hourly retirees and their dependents. The activity in this plan is not material to the condensed consolidated financial statements.

 

(15)         Segment Information

 

We have identified two reportable segments: the piano segment and the band & orchestral instrument segment. We consider these two segments reportable as they are managed separately and the operating results of each segment are separately reviewed and evaluated by our senior management on a regular basis. We have included the results of our online music division within the “U.S. Piano Segment” as we believe its results are not material and its products and customer base are most correlated with piano operations. Management and the chief operating decision maker use income from operations as a meaningful measurement of profit or loss for the segments. Income from operations for the reportable segments includes certain corporate costs allocated to the segments based primarily on revenue, as well as intercompany profit. Amounts reported as “Other & Elim” contain corporate costs that were not allocated to the reportable segments, and the remaining intercompany profit elimination.

 

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Table of Contents

 

The following tables present information about our operating segments for the three months ended March 31, 2011 and 2010:

 

 

 

Three Months Ended 2011

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

 

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

Net sales to external customers

 

$

20,350

 

$

11,626

 

$

11,613

 

$

43,589

 

$

28,267

 

$

1,075

 

$

29,342

 

$

 

$

72,931

 

Income (loss) from operations

 

709

 

1,395

 

1,428

 

3,532

 

931

 

94

 

1,025

 

(885

)

3,672

 

 

 

 

Three Months Ended 2010

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

 

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

Net sales to external customers

 

$

18,840

 

$

9,722

 

$

10,614

 

$

39,176

 

$

28,280

 

$

1,087

 

$

29,367

 

$

 

$

68,543

 

Income (loss) from operations

 

356

 

720

 

974

 

2,050

 

2,511

 

90

 

2,601

 

(928

)

3,723

 

 

(16)         Subsequent Events

 

On April 29, 2011 the shareholders of our Class A common stock, the Chairman and Chief Executive Officer, agreed to sell all of the Class A shares to two other shareholders. This transaction cannot close until regulatory approval is obtained, which is expected to occur late in the second quarter of 2011. Once the Class A stock is no longer held by its current shareholders, it will convert to Ordinary common stock. This will eliminate the 80% voting power currently held by our Chairman and Chief Executive Officer. Since this is a shareholder to shareholder transaction, it has no direct impact on our financial statements or results of operations. However, in conjunction with the completion of the transaction, vesting of most of the unvested stock options and restricted shares under our Stock Plan will accelerate. Accordingly, we expect to incur approximately $1.7 million of stock-based compensation expense, net of taxes, when the transaction is completed. This includes $0.6 million which would have been incurred in 2011 absent this transaction.

 

On May 2, 2011 we redeemed $85.0 million of our Senior Notes at 101.75% of principal plus accrued interest pursuant to a call we issued on April 1, 2011. We will record a net loss on extinguishment of debt of $2.4 million during the second quarter of 2011. This net loss consists of the following:

 

Premiums paid pursuant to the call

 

1,488

 

Deferred financing costs write-off

 

706

 

Bond discount write-off

 

228

 

Total net loss on extinguishment of debt

 

$

2,422

 

 

As a result of this debt extinguishment, we expect to reduce our bond interest expense by approximately $4.0 million in 2011 and $6.0 million on an annual basis.

 

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Table of Contents

 

ITEM 2                  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Tabular Amounts in Thousands Except Percentages, Share and Per Share Data)

 

Introduction

 

We are a world leader in the design, manufacture, marketing, and distribution of high quality musical instruments. Our piano division concentrates on the high-end grand piano segment of the industry, handcrafting Steinway pianos in New York and Germany. We also offer upright pianos and two mid-priced lines of pianos under the Boston and Essex brand names. We are also an online retailer of classical music. Through our band division, we are the largest domestic producer of band and orchestral instruments and offer a complete line of brass, woodwind, percussion and string instruments and related accessories with well-known brand names such as Bach, Selmer, C.G. Conn, Leblanc, King, and Ludwig. We sell our products through dealers and distributors worldwide. Our piano customer base consists of professional artists, amateur pianists, and institutions such as concert halls, universities, and music schools. Our band and orchestral instrument customer base consists primarily of middle school and high school students, but also includes adult amateur and professional musicians.

 

Critical Accounting Policies and Estimates

 

The Securities and Exchange Commission (“SEC”) has issued disclosure guidance for “critical accounting policies and estimates.” The SEC defines “critical accounting policies and estimates” as those that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.

 

Management is required to make certain estimates and assumptions during the preparation of the condensed consolidated financial statements. These estimates and assumptions impact the reported amount of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Actual results could differ from those estimates.

 

The significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements included in the Company’s 2010 Annual Report on Form 10-K. Not all of these significant accounting policies require management to make difficult, subjective or complex judgments or estimates. However, management considers the following to be critical accounting policies and estimates based on the definition above.

 

Accounts Receivable

 

We establish reserves for accounts receivable and notes receivable. We review overall collectibility trends and customer characteristics such as debt leverage, solvency, and outstanding balances in order to develop our reserve estimates. Historically, a large portion of our sales at both our piano and band divisions has been generated by our top fifteen customers. As a result, we experience some inherent concentration of credit risk in our accounts receivable due to its composition and the relative proportion of large customer receivables to the total. This is especially true at our band division, which characteristically has a majority of our consolidated accounts receivable balance. We consider the credit health and solvency of our customers when developing our receivable reserve estimates.

 

Inventory

 

We establish inventory reserves for items such as lower-of-cost-or-market and obsolescence. We review inventory levels on a detailed basis, concentrating on the age and amounts of raw materials, work-in-process, and finished goods, as well as recent usage and sales dates and quantities to help develop our estimates. Ongoing changes in our business strategy, including a shift from batch processing to single piece production flow, coupled with increased offshore sourcing, could affect our ability to realize the current cost of our inventory, and are considered by management when developing our estimates. We also establish reserves for anticipated book-to-physical adjustments based upon our historical level of adjustments from our annual physical inventories. We account for our inventory using standard costs. Accordingly, variances between actual and standard costs that are not abnormal in nature are capitalized into inventory and released based on calculated inventory turns. Abnormal costs are expensed in the period in which they occur.

 

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Table of Contents

 

Workers’ Compensation and Self-Insured Health Claims

 

We establish self-insured workers’ compensation and health claims reserves based on our trend analysis of data provided by third-party administrators regarding historical claims and anticipated future claims.

 

Long-lived Assets

 

We review long-lived assets, such as property, plant, and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. We measure recoverability by comparing the carrying amount of the asset or asset group to the estimated future cash flows the asset or asset group is expected to generate.

 

We establish long-lived intangible assets based on estimated fair values, and amortize finite-lived intangibles over their estimated useful lives. We test our goodwill and indefinite-lived trademark assets for impairment annually or on an interim basis if events or circumstances indicate that the fair value of an asset may have decreased below its carrying value. We determine our reporting units by first identifying our operating segments, and then assess whether any components of these segments constitute a business for which discrete financial information is available and where segment management regularly reviews the operating results of that component. We aggregate components within a reporting unit that have similar economic characteristics.

 

Our assessment is based on a comparison of net book value to estimated fair values using an income and market approach. For purposes of the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. We make assumptions about the amount and timing of future expected cash flows, terminal value growth rates and appropriate discount rates. The amount and timing of future cash flows within our discounted cash flow analysis is based on our most recent operational budgets, long range strategic plans and other estimates. The terminal value growth rate is used to calculate the value of cash flows beyond the last projected period in our analysis and reflects our best estimates for stable, perpetual growth of our reporting units. We use estimates of market participant weighted average costs of capital as a basis for determining the discount rates to apply to our reporting units’ future expected cash flows, adjusted for the risks and uncertainty inherent in our industry generally and in our internally developed forecasts.

 

Pensions and Other Postretirement Benefit Costs

 

We make certain assumptions when calculating our benefit obligations and expenses. We base our selection of assumptions, such as discount rates and long-term rates of return, on information provided by our actuaries, investment advisors, investment committee, current rate trends, and historical trends for our pension asset portfolio. Our benefit obligations and expenses can fluctuate significantly based on the assumptions management selects.

 

Income Taxes

 

We record valuation allowances for certain deferred tax assets related to foreign tax credit carryforwards and state net operating loss carryforwards. When assessing the realizability of deferred tax assets, we consider whether it is more likely than not that the deferred tax assets will be fully realized. The ultimate realization of these assets is dependent upon many factors, including the ratio of foreign source income to overall income and generation of sufficient future taxable income in the jurisdictions for which we have loss carryforwards. When establishing or adjusting valuation allowances, we consider these factors, as well as anticipated trends in foreign source income and tax planning strategies which may impact future realizability of these assets.

 

When appropriate, a liability has been recorded for uncertain tax positions. When analyzing these positions, we consider the probability of various outcomes which could result from examination, negotiation, or settlement with various taxing authorities. The final outcome on these positions could differ significantly from our original estimates due to the following: expiring statutes of limitations; availability of detailed historical data; results of audits or examinations conducted by taxing authorities or agents that vary from management’s anticipated results; identification of new tax contingencies; release of applicable administrative tax guidance; management’s decision to settle or appeal assessments; the rendering of court decisions affecting our estimates of tax liabilities; or other factors.

 

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Table of Contents

 

Environmental Liabilities

 

We make certain assumptions when calculating our environmental liabilities. We base our selection of assumptions, such as cost and length of time for remediation, on data provided by our environmental consultants, as well as information provided by regulatory authorities. We also make certain assumptions regarding the indemnifications we have received from others, including whether remediation costs are within the scope of the indemnification, the indemnifier’s ability to perform under the agreement, and whether past claims have been successful. Our environmental obligations and expenses can fluctuate significantly based on management’s assumptions.

 

We believe the assumptions made by management provide a reasonable basis for the estimates reflected in our condensed consolidated financial statements.

 

Forward-Looking Statements

 

Certain statements contained in this document are “forward-looking statements” within the meaning of Section 21E of the Securities and Exchange Act of 1934, as amended. These forward-looking statements represent our present expectations or beliefs concerning future events. We caution that such statements are necessarily based on certain assumptions which are subject to risks and uncertainties which could cause actual results to differ materially from those indicated in this report. These risk factors include, but are not limited to, the following: changes in general economic conditions; reductions in school budgets; increased competition; work stoppages and slowdowns; ability to successfully consolidate band manufacturing; impact of dealer consolidations on orders; ability of dealers to obtain financing; exchange rate fluctuations; variations in the mix of products sold; market acceptance of new products, ability of suppliers to meet demand; concentration of credit risk; ability to lease office space; and fluctuations in effective tax rates resulting from shifts in sources of income. Further information on these risk factors is included in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010. We encourage you to read those descriptions carefully. We caution investors not to place undue reliance on the forward-looking statements contained in this report. These statements, like all statements contained in this report, speak only as of the date of this report (unless another date is indicated) and we undertake no obligation to update or revise the statements except as required by law.

 

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Results of Operations

 

Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010

 

 

 

Three Months Ended March 31,

 

 

 

Change

 

 

 

2011

 

 

 

2010

 

 

 

$

 

%

 

Net sales

 

 

 

 

 

 

 

 

 

 

 

 

 

Band

 

$

29,342

 

 

 

$

29,367

 

 

 

(25

)

(0.1

)

Piano

 

43,589

 

 

 

39,176

 

 

 

4,413

 

11.3

 

Total sales

 

72,931

 

 

 

68,543

 

 

 

4,388

 

6.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

 

 

 

 

 

 

 

 

 

 

 

 

Band

 

22,174

 

 

 

20,912

 

 

 

1,262

 

6.0

 

Piano

 

28,360

 

 

 

26,307

 

 

 

2,053

 

7.8

 

Total cost of sales

 

50,534

 

 

 

47,219

 

 

 

3,315

 

7.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

 

 

 

 

 

 

 

 

 

 

 

Band

 

7,168

 

24.4%

 

8,455

 

28.8%

 

(1,287

)

(15.2

)

Piano

 

15,229

 

34.9%

 

12,869

 

32.8%

 

2,360

 

18.3

 

Total gross profit

 

22,397

 

 

 

21,324

 

 

 

1,073

 

5.0

 

 

 

30.7%

 

 

 

31.1%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

18,725

 

 

 

17,601

 

 

 

1,124

 

6.4

 

Income from operations

 

3,672

 

 

 

3,723

 

 

 

(51

)

(1.4

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other expense (income), net

 

488

 

 

 

(1,467

)

 

 

1,955

 

(133.3

)

Net interest expense

 

2,356

 

 

 

2,359

 

 

 

(3

)

(0.1

)

Non-operating expenses

 

2,844

 

 

 

892

 

 

 

1,952

 

218.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

828

 

 

 

2,831

 

 

 

(2,003

)

(70.8

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax provision

 

323

 

39.0%

 

1,031

 

36.4%

 

(708

)

(68.7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

505

 

 

 

$

1,800

 

 

 

(1,295

)

(71.9

)

 

Overview Piano division revenues and profits improved as a result of improved demand for Steinway grand units. Although band division revenues remained consistent with the year-ago period, profits decreased due largely to production inefficiencies at certain plants, increased costs, and severance associated with a pending plant closure.

 

Net Sales Domestic piano division revenues increased $1.5 million as a result of a 17% increase in Steinway grand unit shipments. Sales of higher priced limited edition units and strong retail sales more than offset the impact of a shift in mix from mid-priced grand unit shipments to mid-priced upright unit shipments. Due to better wholesale demand, overseas piano division revenues increased $2.9 million. Although the overseas piano division had a similar shift in mix at the mid-priced piano level, the impact of this was more than offset by an 18% increase in Steinway grand unit shipments.

 

Despite an 8% decrease in overall unit shipments, band division revenues were flat due to higher revenues from step-up and professional instruments, especially trombones and trumpets.

 

Gross Profit Gross profit increased $1.1 million due to improved sales and margins from the piano division. Gross margins at the band division dropped from 28.8% to 24.4% in the current period. In the prior period, there were no significant production variances which impacted the margin. In the current period, plant variances of $0.9 million, coupled with severance charges associated with a pending plant closure of $0.4 million adversely impacted the margin. Higher overall costs, primarily materials and overhead, were also a factor.

 

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Piano margins improved from 32.8% to 34.9%. Domestic piano margins improved from 30.9% to 33.5% due to increased limited edition and retail sales, which typically generate higher margins. Overseas piano margins improved from 34.6% to 36.2% since production at our overseas piano factory increased, resulting in lower factory variances.

 

Operating Expenses— Operating expenses increased $1.1 million compared to the year-ago period. Marketing, advertising, and promotional expenses increased $0.6 million, but this was partially offset by a shift from bad debt expense to bad debt recovery of $0.5 million. General and administrative costs increased $1.0 million due to increased headcount, wages, benefits, and legal costs. Wages and benefits increased in part due to the reinstatement of salaries and the resumption of annual merit increases.

 

Non-operating Expenses — Non-operating expenses increased $2.0 million primarily due to a shift from net income to net expense of $1.8 million from our West 57th Street building. We expect to incur a temporary loss on this facility in 2011 until we have leased the remaining available space to new tenants. Net interest expense was consistent with the year-ago period as the decrease in interest income associated with customer financed receivables at the band division was offset by lower interest expense due to lower outstanding borrowings.

 

Income Taxes We recorded an income tax expense of $0.3 million, reflecting our anticipated annual effective income tax rate of 38.3% associated with current year income, as well as uncertain tax positions and discrete items. The combination of these items resulted in an effective tax rate of 39.0% for the period. The rate of 36.4% in the year-ago period reflected an anticipated annual effective income tax rate of 37.2% as well as uncertain tax positions and discrete items.

 

Liquidity and Capital Resources

 

We have relied primarily upon cash provided by operations, supplemented as necessary by seasonal borrowings under our working capital line, to finance our operations, repay long-term indebtedness and fund capital expenditures.

 

Our statements of cash flows for the three months ended March 31, 2011 and 2010 are summarized as follows:

 

 

 

2011

 

2010

 

Change

 

Net income:

 

$

505

 

$

1,800

 

$

(1,295

)

Changes in operating assets and liabilities

 

(13,248

)

(5,389

)

(7,859

)

Other adjustments to reconcile net income to cash from operating activities

 

2,414

 

3,296

 

(882

)

Cash flows from operating activities

 

(10,329

)

(293

)

(10,036

)

 

 

 

 

 

 

 

 

Cash flows from investing activities

 

(3,856

)

(514

)

(3,342

)

 

 

 

 

 

 

 

 

Cash flows from financing activities

 

48

 

27,583

 

(27,535

)

 

Cash flows from operating activities decreased $10.0 million from the year-ago period. We used $4.0 million more for inventory in the current period as a result of higher production levels at many plants. We used $4.4 million more for accounts payable and accrued expenses, primarily due to shifts in spending patterns, which have returned to normal levels.

 

Cash flows from investing activities resulted in the use of an additional $3.3 million primarily due to the payment of additional consideration associated with the acquisition of our online music business. Higher capital expenditures of $0.7 million were also a factor as capital expenditures were abnormally low in 2010. In 2011, we expect capital expenditures for the full year to be in the range of $4.0 to $6.0 million, along with $1.0 million to $2.0 million for improvements and renovations at our building in New York City.

 

Cash flows from financing activities decreased by $27.5 million as we generated $27.6 million through stock sales in the first quarter of 2010, compared to less than $0.1 million in the current period.

 

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Borrowing Activities and Availability We have a domestic credit facility with a syndicate of lenders (the “Credit Facility”) with a potential borrowing capacity of $100.0 million in revolving credit loans, which expires on October 5, 2015. It provides for periodic borrowings at either London Interbank Offering Rate (“LIBOR”) plus a range from 1.75% to 2.25%, or as-needed borrowings at an alternate base rate, plus a range from 0.75% to 1.25%; both ranges depend upon borrowing availability at the time of borrowing. The Credit Facility is collateralized by our domestic accounts receivable, inventory, and certain property, plant and equipment. As of March 31, 2011 we had nothing outstanding on this credit facility and $89.6 million of availability, net of borrowing restrictions.

 

We also have certain non-domestic credit facilities originating from two German banks that provide for borrowings by foreign subsidiaries of up to €16.0 million ($22.7 million at the March 31, 2011 exchange rate), net of borrowing restrictions of €1.7 million ($2.4 million at the March 31, 2011 exchange rate) which are payable in April 2012. These borrowings are collateralized by most of the assets of the borrowing subsidiaries. A portion of the loans can be converted into a maximum of £0.9 million ($1.4 million at the March 31, 2011 exchange rate) for use by our U.K. branch and ¥300 million ($3.6 million at the March 31, 2011 exchange rate) for use by our Japanese subsidiary. Our Chinese subsidiary also has the ability to convert the equivalent of up to €2.5 million into U.S. dollars or Chinese yuan ($3.5 million at the March 31, 2011 exchange rate). Euro loans bear interest at rates of Euro Interbank Offered Rate (“EURIBOR”) plus a margin determined at the time of borrowing. Margins fluctuate based on the loan amount and the borrower’s bank rating. The remaining demand borrowings bear interest rates of LIBOR plus 0.8% for British pound loans, LIBOR plus 1.0% for U.S. dollar loans of our Chinese subsidiary, and Tokyo Interbank Offered Rate (“TIBOR”) plus 1.4% for Japanese yen loans. We had nothing outstanding as of March 31, 2011 on these credit facilities.

 

Our Japanese subsidiary also maintains a separate revolving loan agreement that provides additional borrowing capacity of up to ¥500 million ($6.0 million at the March 31, 2011 exchange rate). The revolving loan agreement bears interest at an average 30-day TIBOR rate plus 0.9% (outstanding borrowings at 1.1% at March 31, 2011) and expires on December 21, 2011. As of March 31, 2011, we had $2.4 million outstanding on this revolving loan agreement.

 

At March 31, 2011, our total outstanding indebtedness amounted to $154.9 million, consisting of $152.5 million of our 7.00% Senior Notes due March 1, 2014 and $2.4 million of notes payable to foreign banks. On April 1, 2011 we announced a call of $85.0 million in principal of our Senior Notes, which we redeemed on May 2, 2011 at a price of 101.75% of principal, plus accrued interest, which resulted in a cash payment of $87.5 million. We may consider additional redemptions, repurchases, or restructuring of our remaining Senior Note debt in the future, contingent upon cash availability and the trading and call prices of our Senior Notes.

 

All of our debt agreements contain covenants that place certain restrictions on us, including our ability to incur additional indebtedness, to repurchase Senior Notes, to make investments in other entities, and limitations on cash dividend payments. We were in compliance with all such covenants as of March 31, 2011 and do not anticipate any compliance issues in the future. Our bond indenture contains limitations, based on net income (among other things), on the amount of discretionary repurchases we may make of our Ordinary common stock. Our intent and ability to repurchase additional Ordinary common stock either directly from shareholders or on the open market is directly affected by this limitation. In May 2008 we announced a share repurchase program, which permits us to make discretionary purchases of up to $25.0 million of our Ordinary common stock. To date, we have repurchased 102,127 shares and approximately $22.5 million remains authorized for repurchases under this program. We did not make any repurchases during the three months ended March 31, 2011 or 2010.

 

We experience long production and inventory turnover cycles, which we constantly monitor since fluctuations in demand can have a significant impact on these cycles. In normal economic conditions, we are able to effectively utilize cash flow from operations to fund our debt and capital requirements and pay off borrowings on our domestic line of credit. We intend to manage accounts receivable and credit risk, and control inventory levels by monitoring purchases and production schedules. Our intention is to manage cash outflow and maintain sufficient operating cash on hand to meet short-term requirements.

 

Other than those described above, we do not have any current plans or intentions that will have a material impact on our liquidity in 2011, although we may consider acquisitions that may require funding from operations or from our credit facilities. Other than those described, we are not aware of any trends, demands, commitments, or costs of resources that are expected to materially impact our liquidity or capital resources. Accordingly, we believe that cash on hand, together with cash flows anticipated from operations and available borrowings under the Credit Facility, will be adequate to meet our debt service requirements, fund regular capital requirements and satisfy our working capital and general corporate needs for the next twelve months.

 

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Contractual Obligations - The following table provides a summary of our contractual obligations at March 31, 2011.

 

 

 

Payments due by period

 

 

 

Total

 

Less than
1 year

 

1 - 3 years

 

3 - 5 years

 

More than
5 years

 

Contractual Obligations

 

 

 

 

 

 

 

 

 

 

 

Long-term debt(1)

 

$

169,213

 

$

92,650

 

$

76,563

 

$

 

$

 

Capital leases

 

5

 

5

 

 

 

 

Operating leases(2)

 

255,772

 

6,027

 

9,831

 

8,231

 

231,683

 

Purchase obligations(3)

 

25,842

 

25,579

 

263

 

 

 

Other long-term liabilities(4)

 

45,682

 

4,840

 

4,035

 

3,913

 

32,894

 

Total

 

$

496,514

 

$

129,101

 

$

90,692

 

$

12,144

 

$

264,577

 

 


Notes to Contractual Obligations:

 

(1)    Long-term debt represents long-term debt obligations, the fixed interest on our Notes, and the variable interest on our other loans. We estimated the future variable interest obligation using the applicable March 31, 2011 rates. The nature of our long-term debt obligations, including changes to our long-term debt structure, is described more fully in the “Borrowing Availability and Activities” section of “Liquidity and Capital Resources.”

 

(2)    Approximately $242.7 million of our operating lease obligations are attributable to the land lease associated with the purchase of Steinway Hall, which has eighty-six years remaining. The rest is attributable to the leasing of other facilities and equipment.

 

(3)    Purchase obligations consist of firm purchase commitments for raw materials, finished goods, and service agreements.

 

(4)    Our other long-term liabilities consist primarily of the long-term portion of our pension obligations, which are described in Note 14 in the Notes to Condensed Consolidated Financial Statements included within this filing and obligations under employee and consultant agreements. We have not included $0.3 million of liabilities relating to uncertain tax positions within this schedule due to the uncertainty of the payment date, if any.

 

Recent Accounting Pronouncements

 

There have been no recent accounting pronouncements not yet adopted by the Company which would have a material impact on our financial statements.

 

ITEM 3                                                        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are exposed to market risk associated with changes in foreign currency exchange rates and interest rates. We mitigate a portion of our foreign currency exchange rate risk by maintaining foreign currency cash balances and holding option and forward foreign currency contracts. They are not designated as hedges for accounting purposes. These contracts relate primarily to intercompany transactions and are not used for trading or speculative purposes. The fair value of the option and forward foreign currency exchange contracts is sensitive to changes in foreign currency exchange rates. The impact of an adverse change in foreign currency exchange rates would not be materially different than that disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

Our revolving loans bear interest at rates that fluctuate with changes in the Prime Rate, Federal Funds Rate, LIBOR, TIBOR, and EURIBOR. As such, our interest expense on our revolving loans and the fair value of our fixed long-term debt are sensitive to changes in market interest rates. The effect of an adverse change in market interest rates on our interest expense would not be materially different than that disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

The majority of our long-term debt is at a fixed interest rate. Therefore, the associated interest expense is not sensitive to fluctuations in market interest rates. However, the fair value of our fixed interest debt would be sensitive to market rate changes. Such fair value changes may affect our decision whether to retain, replace, or retire this debt.

 

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ITEM 4                                                        CONTROLS AND PROCEDURES

 

Our principal executive officer and our principal financial officer, after evaluating together with management the design and operation of our disclosure controls and procedures, have concluded that our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) were effective as of March 31, 2011, the end of the period covered by this report. In designing disclosure controls and procedures, management recognizes that any controls, no matter how well designed and operated, can only provide reasonable, not absolute, assurance of achieving the desired control objectives.

 

During the quarter covered by this report, there were no significant changes in our internal controls that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

 

PART II                                                   OTHER INFORMATION

 

ITEM 6                                                        EXHIBITS

 

31.1  Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

31.2  Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

32.1  Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2  Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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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 their behalf by the undersigned, thereunto duly authorized.

 

 

 

STEINWAY MUSICAL INSTRUMENTS, INC.

 

 

 

/s/ Dana D. Messina

 

Dana D. Messina

 

Director, President and Chief Executive Officer

 

 

 

/s/ Dennis M. Hanson

 

Dennis M. Hanson

 

Senior Executive Vice President and

 

Chief Financial Officer

 

 

Date: May 10, 2011

 

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