The Company, through its operating subsidiaries, is one of the world’s leading manufacturers of musical instruments. Effective September 15, 2000, the Company completed the acquisition of United Musical Instruments Holdings, Inc. (“UMI”) through its wholly owned subsidiary, Selmer. The acquisition of UMI was accounted for as a purchase for financial reporting purposes. The aggregate purchase price approximated $84.0 million. The financial statements of the Company as of and for the three months and six months ended June 30, 2001 include the effects of the acquisition and the results of operations for UMI.
Certain statements contained in the following Discussion and Analysis of Financial Condition and Results of Operations 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 the Company’s present expectations or beliefs concerning future events. The Company cautions that such statements are necessarily based on certain assumptions which are subject to risks and uncertainties, including, but not limited to, changes in general economic conditions, increased competition, exchange rate fluctuations, and the availability of production capacity and qualified workers which could cause actual results to differ materially from those indicated herein. Further information on these risk factors is included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2000 and its Final Prospectus filed in August 1996.
Operating Expenses – Overall operating expenses increased by $2.7 million (19%) to $17.0 million in the second quarter. Excluding $2.8 million of UMI operating expense in the current year period, expenses decreased slightly to $14.1 million as compared to $14.3 million in the second quarter of 2000 as a result of increased fiscal control over sales and marketing expenses.
Other Expense, net -Other expenses, primarily interest expense, increased by $1.2 million (40%) to $4.3 million. Higher average outstanding debt balances resulting from increased inventory levels and the additional debt associated with the acquisition of UMI contributed to the increased expense.
Income Taxes – The Company’s effective tax rate decreased from 40.5% in 2000 to 36.2% in 2001 primarily as a result of the decrease in the German tax rate.
Six Months Ended June 30, 2001 Compared to Six Months Ended July 1, 2000
Net Sales –Net sales increased $19.6 million (12%) to $185.2 million in the first six months of 2001 primarily due to the UMI acquisition. Band and orchestral instrument sales increased $24.3 million (31%) to $101.8 million, and units increased 30% compared to the prior period. As an offset, piano sales decreased $4.7 million (5%) in 2001 on unit decreases of 6% for Steinway pianos and 41% for Boston pianos, due to ongoing economic softness in the United States, particularly in the mid-priced piano market, as well as slower sales at the retail level.
Gross Profit –Gross profit increased by $7.2 million (14%) to $58.8 million in the first six months of 2001. Gross margins improved to 31.7% from 31.1% when compared to the prior period. Piano margins improved from 34.5% in 2000 to 37% in 2001 primarily as a result of the higher proportion of Steinway units sold. Gross margins for band instruments remained relatively consistent, increasing slightly from 27.3% in 2000 to 27.4% in 2001.
Operating Expenses –Operating expenses increased by $6.7 million to $ 35.6 million in the current year period, primarily due to the acquisition of UMI, which reported operating expenses of $6.1 million in the current period.
Other Expense, Net –Other expenses increased by $2.4 million (38%) to $8.7 million in the current year period. Higher average outstanding debt balances due to increased inventory levels and the additional debt associated with the acquisition of UMI generated an increase in net interest expense of $2.1 million. A slight increase in foreign currency exchange loss of $0.3 million also contributed to the increase in other expenses in the current period.
Income Taxes –The Company’s effective tax rate decreased from 40.5% to 38.6% in 2001. This decrease was primarily due to the decrease in the German tax rate.
Liquidity and Capital Resources
The Company has relied primarily upon cash provided by operations, supplemented as necessary by seasonal borrowings under its working capital line, to finance its operations, repay long-term indebtedness and fund capital expenditures.
Cash used in operations in the first six months of 2001 was $28.7 million, compared to cash used in operations of $12.9 million in 2000. This change is due primarily to the acquisition of UMI, payments made on accounts payable, and an increase in inventory balances in the current period. A decline in Boston piano shipments and certain band products has led to a buildup in inventories in the current period.
Capital expenditures of $4.2 million and $3.0 million in the first six months of 2000 and 2001, respectively, were used primarily for the purchase of new machinery, building improvements and certain EPA compliance projects. The Company expects to maintain this level of capital spending in the future as it continues to modernize its equipment and renovate its facilities in order to improve its production efficiency.
The Company’s domestic seasonal borrowing requirements are accommodated through a committed, revolving credit facility with a domestic lender (the “Credit Facility”). The Credit Facility, which was amended and restated to accommodate both the acquisition of UMI and the $150.0 million bond offering completed in the current period, provides the Company with a potential borrowing capacity, on a revolving basis, of up to $85.0 million, based on eligible accounts receivable and inventory balances. The Credit Facility bears interest at average 30-day LIBOR plus 1.75% and expires on September 14, 2008. As of June 30, 2001, revolving credit loans outstanding were $44.0 million and additional availability was approximately $41.0 million. Open account loans with foreign banks also provide for borrowings by Steinway’s foreign subsidiaries of up to 39 million Deutsche marks ($17.0 million at the June 30, 2001 exchange rate).
On April 19, 2001, the Company completed a $150.0 million 8.75% senior note offering. The proceeds of this offering were used to redeem $110.0 million of previously outstanding Senior Subordinated Notes, with the balance used to pay down the Credit Facility. The early retirement of the Notes, which were redeemed on June 1, 2001 at 102.75% of the principal amount, generated an extraordinary charge of approximately $4.0 million, net of tax of $2.7 million. The Company’s current long-term financing includes the $150.0 million senior notes and $63.3 million of term loans outstanding under the Credit Facility. The Company’s debt agreements contain restrictive covenants that place certain restrictions on the Company, including restrictions on the Company’s ability to incur additional indebtedness, to make investments in other entities, or to pay cash dividends.
Management believes that cash on hand, together with cash flows anticipated from operations and available borrowings under the Credit Facility, will be adequate to meet existing debt service requirements, fund continuing capital requirements and satisfy working capital and general corporate needs through 2001.
New Accounting Pronouncements
On January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), which establishes accounting and reporting standards for derivative instruments. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income and are recognized in the income statement when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings.
The Company uses derivative instruments to manage exposures to foreign exchange rate fluctuations. The Company’s objectives for holding derivatives are to minimize the risks using the most effective methods to eliminate or reduce the impacts of these exposures. The Company monitors its foreign currency exposures daily to maximize the overall effectiveness of its foreign currency hedge positions. Principal currencies hedged include the Euro, British pound and Japanese yen. Options and forwards used to hedge a portion of forecasted international intercompany revenue for up to one year in the future are designated as cash flow hedging instruments. Forwards and options not designated as hedging instruments under SFAS 133 are also used to hedge the impact of the variability in exchange rates on accounts receivable and payable balances.
For options designated as cash flow hedges, changes in the time value are excluded from the assessment of hedge effectiveness. Hedge ineffectiveness, determined in accordance with SFAS 133, had no impact on earnings for the three months and six months ended June 30, 2001 as the Company did not have any qualifying hedged transactions. For the three months and six months ended June 30, 2001, other income included a net foreign currency loss of $11 and gain of $13, respectively, for forward contracts not designated as hedging instruments.
In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 141 (“SFAS 141”), “Business Combinations.” SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The Company does not believe that the adoption of SFAS 141 will have a significant impact on its financial statements.
In July 2001 the FASB issued Statement of Financial Accounting Standards No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets”, which is effective January 1, 2002. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently assessing but has not yet determined the impact of SFAS 142 on its financial position and results of operations.
| ITEM 3 | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The Company is subject to market risk associated with changes in foreign currency exchange rates and interest rates. The Company mitigates its foreign currency exchange rate risk by maintaining foreign currency cash balances and holding forward foreign currency contracts. These contracts are used as a hedge against intercompany transactions and are not used for trading or speculative purposes. The fair value of the 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2000.
The Company’s revolving loans and term loans bear interest at rates that fluctuate with changes in the Libor rate. Substantially all of the Company’s long-term debt, except the term loans referred to above, is at fixed interest rates. Accordingly, the Company’s interest expense on its revolving loans and term loans and the fair value of its fixed long-term debt is sensitive to changes in market interest rates. The effect of an adverse change in market interest rates on the Company’s interest expense and the fair value of its long-term debt would not be materially different than that disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2000.
PART II OTHER INFORMATION
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company’s Annual Meeting of Shareholders held on May 4, 2001, the Board of Directors was re-elected in its entirety. The votes cast for each nominee were as follows:
| | For | | Against | |
| Kyle Kirkland | 51,693,788 | | 295,999 | |
| Dana D. Messina | 51,693,788 | | 295,999 | |
| Thomas T. Burzycki | 51,857,583 | | 132,204 | |
| Bruce A. Stevens | 51,857,770 | | 132,017 | |
| A. Clinton Allen | 51,905,843 | | 83,944 | |
| Peter McMillan | 51,905,843 | | 83,944 | |
The proposal to ratify Deloitte & Touche LLP to serve as the Company’s independent auditors for the fiscal year ending December 31, 2001 was approved with 51,925,887 votes cast for, 38,350 votes against, and 25,550 abstentions.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
| (a) | Exhibits
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| | | 4.1 Second Amendment to the Second Amended and Restated Credit Agreement dated as of April 19, 2001 among Selmer Company, Inc., Steinway, Inc. and United Musical Instruments USA, Inc., as borrowers; certain wholly owned subsidiaries of the borrowers (as may be amended from time to time), as guarantors; the several lenders from time to time parties thereto; and GMAC Commercial Credit LLC, as Administrative Agent |
| | | | |
| (b) | Reports on Form 8-K |
| | |
| | The Company did not file any reports on Form 8-K during the quarter ended June 30, 2001. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized.
| | STEINWAY MUSICAL INSTRUMENTS, INC.
|
| | /s/ Dana D. Messina |
| |
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| | Dana D. Messina |
| | Director, President and Chief Executive Officer
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| | /s/ Dennis M. Hanson |
| |
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| | Dennis M. Hanson |
| | Senior Executive Vice President and |
| | Chief Financial Officer |
Date: August 14, 2001
