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LVB > SEC Filings for LVB > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for STEINWAY MUSICAL INSTRUMENTS INC

Form 10-Q for STEINWAY MUSICAL INSTRUMENTS INC


9-Nov-2012

Quarterly Report


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 Hamburg. We also offer Steinway 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 recordings. 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 2011 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, 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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Workers' Compensation and Self-Insured Health Claims

We establish self-insured workers' compensation and health claims reserves related to employees in the United States 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 primarily using an income 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. We also use a market approach against which we benchmark the results of our income approach to ensure that the results are appropriate.

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 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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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; 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 maximize return on NY real estate; fluctuations in effective tax rates resulting from shifts in sources of income; and distractions and uncertainties associated with the pursuit of strategic alternatives for the Company. 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, 2011. 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 September 30, 2012 Compared to Three Months Ended
September 30, 2011



                           Three Months Ended September 30,                       Change
                            2012                       2011                    $          %
Net sales
Band                    $      38,377                $  38,652                  (275 )     (0.7 )
Piano                          50,945                   51,103                  (158 )     (0.3 )
Total sales                    89,322                   89,755                  (433 )     (0.5 )

Cost of sales
Band                           27,503                   30,795                (3,292 )    (10.7 )
Piano                          32,437                   32,988                  (551 )     (1.7 )
Total cost of sales            59,940                   63,783                (3,843 )     (6.0 )

Gross profit
Band                           10,874    28.3%           7,857   20.3%         3,017       38.4
Piano                          18,508    36.3%          18,115   35.4%           393        2.2
Total gross profit             29,382                   25,972                 3,410       13.1
                                32.9%                    28.9%

Operating expenses             20,493                   19,728                   765        3.9
Impairment charges                400                    5,142                (4,742 )    (92.2 )
Income from
operations                      8,489                    1,102                 7,387      670.3

Other expense, net              1,276                    1,886                  (610 )    (32.3 )
Net interest expense              990                    1,011                   (21 )     (2.1 )
Non-operating
expenses                        2,266                    2,897                  (631 )    (21.8 )

Income (loss) before
income taxes                    6,223                   (1,795 )               8,018     (446.7 )

Income tax provision
(benefit)                       2,050    32.9%            (717 ) 39.9%         2,767     (385.9 )

Net income (loss)       $       4,173                $  (1,078 )               5,251     (487.1 )

Piano division revenue is generated in three sales regions: Americas, Europe and Asia-Pacific. Our Americas region sells Steinway pianos which are manufactured in New York. As such, factory variances are reflected in the gross profit and gross margin figures for the Americas region. Our Europe and Asia-Pacific regions both sell Steinway pianos manufactured in Germany. As such, we analyze gross profit and gross margin for the Europe and Asia-Pacific regions on a combined basis in order to appropriately reflect the impact of factory variances.

Overview - Revenues for both the piano and band divisions were consistent with the year-ago period. Piano division margin improved as a result of the Americas region, which had higher sales prices and consistent product costs as well as a shift toward retail sales. Band division margin improved largely due to factory efficiencies.

Net Sales - Piano division revenue generated by our Americas region of $25.1 million was $0.8 million less than the year-ago period. Although sales to dealers were $2.3 million lower, retail revenue improved $1.3 million. Standard price increases of 4% helped mitigate the impact of a 14% decrease in Steinway grand unit shipments in this region. Piano division revenue of $12.9 million generated by Europe was $1.0 million less than the year-ago period due largely to an unfavorable exchange rate impact of $1.2 million. Standard price increases of 4% more than offset the impact of a 2% decrease in Steinway grand unit shipments. Despite an unfavorable exchange rate impact of $0.2 million, piano division sales of $12.9 million related to the Asia-Pacific region were $1.6 million better than the year-ago period. This improvement is primarily attributable to the 12% increase in Steinway grand unit shipments.

Band division revenue decreased $0.3 million during the period. Revenue from woodwind and brass unit shipments decreased $1.1 million (4%) on an 8% decrease in unit shipments. Average price increases of 4% in this instrument category helped mitigate the revenue loss. Accessories sales increased $1.3 million, which more than offset the $0.3 million decrease in percussion instrument revenue.


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Gross Profit - Gross profit was $3.4 million higher due to better margins at both divisions. Piano division margins generated by the Americas increased from 30.3% to 35.4% during the period, causing a $1.1 million increase in gross profit. Production costs were consistent with the year-ago period, therefore annual price increases directly improved margin. Also, the shift towards retail sales contributed $0.4 million to gross profit. Piano division margins attributable to the Europe and Asia-Pacific regions decreased from 40.7% to 37.3% during the period. Training of additional workers hired to meet anticipated demand has resulted in temporary factory inefficiencies and were the primary cause of unfavorable manufacturing variances of $1.0 million.

Gross margins generated by the band division improved from 20.3% to 28.3% in the current period due to increased production at most manufacturing facilities, which resulted in factory efficiencies and better absorption of overhead costs. In the prior year, we recorded unfavorable production variances, including $0.8 million caused by the strike at our Eastlake, Ohio brass instrument manufacturing facility. Lower inventory reserve charges also contributed $0.4 million to gross profit.

Operating Expenses - Operating expenses increased $0.8 million despite a favorable exchange rate impact of $0.5 million. Sales and marketing costs increased $0.3 million primarily due to new retail stores in California and Germany and promotional programs. General and administrative costs increased $0.3 million due to personnel benefits and legal costs. General and administrative costs in 2012 include $1.2 million in legal and consulting fees related to activities undertaken by our Board of Directors in pursuit of strategic alternatives, whereas 2011 included $1.1 million of severance costs associated with the departure of our former Chairman in July 2011.

Impairment Charges - Impairment charges decreased $4.7 million in 2012. In 2012, we incurred impairment charges related to our band division trademarks of $0.4 million. In 2011, we incurred impairment charges related to our band division and online music division goodwill and trademark intangible assets of $4.0 million. We also incurred impairment charges associated with the long-lived assets at our woodwind instrument manufacturing facility. These charges totaled $1.1 million.

Non-operating Expenses - Non-operating expenses decreased $0.6 million. Foreign exchange losses were $0.3 million lower, and there was a favorable shift in earnings from our Supplemental Executive Retirement Plan assets of $0.4 million. However, we incurred $0.1 million of incremental costs associated with our West 57th Street building than in the year-ago period.

Income Taxes - We recorded income tax expense of $2.1 million, reflecting our anticipated annual effective income tax rate of 34.6% 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 32.9% for the period, since a significant portion of our taxable income is generated in jurisdictions which have lower statutory rates than that of the United States. The rate in the year-ago period reflected an anticipated annual effective income tax rate of 38.9% as well as uncertain tax positions and discrete items, resulting in an overall effective rate of 39.9%. The effective tax rate in the year-ago period was higher due to the greater amount of stock-based compensation expenses which were not deductible for tax purposes.


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Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

                           Nine Months Ended September 30,                        Change
                            2012                       2011                    $          %
Net sales
Band                    $     107,527                $ 102,764                 4,763        4.6
Piano                         145,452                  148,863                (3,411 )     (2.3 )
Total sales                   252,979                  251,627                 1,352        0.5

Cost of sales
Band                           79,567                   79,809                  (242 )     (0.3 )
Piano                          93,518                   96,974                (3,456 )     (3.6 )
Total cost of sales           173,085                  176,783                (3,698 )     (2.1 )

Gross profit
Band                           27,960    26.0%          22,955   22.3%         5,005       21.8
Piano                          51,934    35.7%          51,889   34.9%            45        0.1
Total gross profit             79,894                   74,844                 5,050        6.7
                                31.6%                    29.7%

Operating expenses             62,705                   61,794                   911        1.5
Impairment charges                566                    5,361                (4,795 )    (89.4 )
Income from
operations                     16,623                    7,689                 8,934      116.2

Other expense, net              2,907                    3,132                  (225 )     (7.2 )
Net loss on
extinguishment of
debt                                -                    2,422                (2,422 )   (100.0 )
Net interest expense            2,782                    4,851                (2,069 )    (42.7 )
Non-operating
expenses                        5,689                   10,405                (4,716 )    (45.3 )

Income (loss) before
income taxes                   10,934                   (2,716 )              13,650     (502.6 )

Income tax provision
(benefit)                       3,774    34.5%          (1,096 ) 40.4%         4,870     (444.3 )

Net income (loss)       $       7,160                $  (1,620 )               8,780     (542.0 )

Overview - Piano division revenue decreased primarily as a result of a 4% decrease in Steinway grand unit shipments. However, gross profit remained consistent with the year-ago period. Band division revenues and gross profit improved due to strong demand for certain brass products as well as increased production and improved efficiencies at our brass instrument manufacturing plants.

Net Sales - Piano division revenue generated by our Americas region of $69.6 million was $1.1 million lower than the year-ago period, primarily due to an 8% decrease in Steinway grand unit shipments. Although sales to dealers were $4.4 million lower, this was partially offset by a $2.6 million increase in retail sales, all of which is attributable to our Chicago, IL, Miami, FL and Pasadena, CA stores. Standard price increases of 4% also helped mitigate the decline in sales. Revenue of $40.8 million generated by our division in Europe was $3.4 million less than the year-ago period due to an unfavorable exchange rate impact of the same amount. Standard price increases of 4% and a 2% increase in Steinway grand unit shipments more than offset the 14% decrease in Boston and Essex unit shipments in this region. Sales of $35.1 million in the Asia-Pacific region of the piano division were $1.2 million higher despite flat Steinway grand unit shipments primarily due to shifts in mix of products sold to Steinway grand pianos.

Band division revenue increased $4.8 million during the period. Revenue from accessories improved $3.1 million from the year-ago period. Although woodwind and brass instrument shipments were down 2%, an average selling price increase of 4% caused the $1.4 million increase in revenue.


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Gross Profit - Gross profit was $5.1 million higher primarily due to improved sales and margins at the band division. Piano margins generated by the Americas increased from 32.2% to 33.4% despite unfavorable factory variances in certain departments and a shift in mix to smaller, lower margin Steinway grands in the early part of the year. Standard price increases and higher retail sales caused the margin improvement. Piano margins generated by the Europe and Asia-Pacific regions increased from 37.3% to 37.8% as unfavorable manufacturing variances were offset by favorable shifts in product mix.

Gross margins generated by the band division went from 22.3% to 26.0% in the current period. Margins benefited from increased production and greater efficiency at our brass manufacturing facilities, which offset the adverse impact of materials, overhead, and sourced-product costs increases.

Operating Expenses - Operating expenses were $0.9 million greater than the year-ago period. In 2011, the holders of our Class A common stock sold their shares to other shareholders. In conjunction with this transaction, we incurred an incremental $3.0 million in costs related to the accelerated vesting of most of our stock options and all of our restricted stock and $0.8 million in legal and consulting costs. We also incurred $1.1 million of severance costs associated with the departure of our former Chairman in July 2011.

Excluding these transaction-related charges, sales and marketing costs were $2.1 million higher than the year-ago period. This increase was due to incremental bad debt expense of $1.1 million as well as costs associated with our retail expansion. Our general and administrative costs increased $2.9 million as 2012 includes $3.9 million of legal and consulting fees related to activities undertaken by our Board of Directors in pursuit of strategic alternatives. A favorable exchange rate impact of $1.0 million partially offset these costs.

Impairment Charges - Impairment charges are $4.8 million lower than the year-ago period. In 2012, we incurred impairment charges related to our band division trademarks of $0.4 million and assets held for sale of $0.2 million. In 2011, we incurred impairment charges related to our band division and online music division goodwill and trademark intangible assets of $4.0 million. We also incurred impairment charges of $1.1 million associated with the long-lived assets at one of our manufacturing facilities as well as a $0.2 million impairment charge related to assets held for sale.

Non-operating Expenses - Non-operating expenses were $4.7 million less than the year-ago period. In 2011, we extinguished $85.0 million of our 7.00% Senior Notes, which resulted in a loss on extinguishment of debt of $2.4 million. As a result of the debt extinguishment, our net interest expense was $2.1 million lower in the current period. Although we incurred incremental costs associated with our West 57th Street building of $0.4 million, these were more than offset by a favorable shift in earnings on our Supplemental Executive Retirement Plan assets of $0.4 million.

Income Taxes - We recorded income tax expense of $3.8 million, reflecting our anticipated annual effective income tax rate of 34.6% 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 34.5% for the period, since a significant portion of our taxable income is generated in jurisdictions which have lower statutory rates than that of the United States. The rate of 40.4% in the year-ago period reflected an anticipated annual . . .

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