UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| FOR THE QUARTERLY PERIOD ENDED JUNE 28, 2003 |
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| 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 |
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800 South Street, Suite 305 |
| 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 ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).Yes ý No o
Number of shares of Common Stock issued and outstanding as of August 1, 2003: |
| Class A |
| 477,953 |
|
| Ordinary |
| 8,428,285 |
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| Total |
| 8,906,238 |
STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
2
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In Thousands Except Share and Per Share Amounts)
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| Three Months Ended |
| Six Months Ended |
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| June 29, |
| June 28, |
| June 29, |
| June 28, |
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Net sales |
| $ | 78,349 |
| $ | 78,035 |
| $ | 166,408 |
| $ | 160,544 |
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Cost of sales |
| 53,964 |
| 55,322 |
| 116,660 |
| 116,999 |
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Gross Profit |
| 24,385 |
| 22,713 |
| 49,748 |
| 43,545 |
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Operating expenses: |
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Sales and marketing |
| 9,949 |
| 10,944 |
| 20,630 |
| 21,957 |
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General and administrative |
| 5,362 |
| 5,535 |
| 10,929 |
| 11,489 |
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Amortization |
| 289 |
| 288 |
| 578 |
| 577 |
| ||||
Other operating expense |
| 250 |
| 136 |
| 407 |
| 308 |
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Total operating expenses |
| 15,850 |
| 16,903 |
| 32,544 |
| 34,331 |
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Income from operations |
| 8,535 |
| 5,810 |
| 17,204 |
| 9,214 |
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Interest expense, net |
| 3,489 |
| 3,007 |
| 6,790 |
| 5,979 |
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Other income, net |
| (1,238 | ) | (712 | ) | (1,543 | ) | (1,333 | ) | ||||
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Income before income taxes |
| 6,284 |
| 3,515 |
| 11,957 |
| 4,568 |
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Provision for income taxes |
| 2,200 |
| 1,355 |
| 4,190 |
| 1,725 |
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Net income |
| $ | 4,084 |
| $ | 2,160 |
| $ | 7,767 |
| $ | 2,843 |
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Earnings per share: |
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Basic |
| $ | 0.46 |
| $ | 0.24 |
| $ | 0.88 |
| $ | 0.32 |
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Diluted |
| $ | 0.46 |
| $ | 0.24 |
| $ | 0.87 |
| $ | 0.32 |
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Weighted average shares: |
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Basic |
| 8,860,834 |
| 8,906,238 |
| 8,854,103 |
| 8,906,238 |
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Diluted |
| 8,915,071 |
| 8,906,238 |
| 8,891,756 |
| 8,906,252 |
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See notes to condensed consolidated financial statements.
3
STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
|
| December 31, |
| June 28, |
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ASSETS: |
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Current assets: |
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Cash |
| $ | 19,099 |
| $ | 7,727 |
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Accounts, notes and leases receivable, net of allowance for bad debts of $11,389 and $11,418 in 2002 and 2003, respectively |
| 77,421 |
| 89,339 |
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Inventories |
| 163,090 |
| 167,561 |
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Prepaid expenses and other current assets |
| 5,227 |
| 4,367 |
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Deferred tax assets |
| 7,012 |
| 7,683 |
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Total current assets |
| 271,849 |
| 276,677 |
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Property, plant and equipment, net of accumulated depreciation of $55,151 and $60,547 in 2002 and 2003, respectively |
| 102,567 |
| 101,269 |
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Trademarks |
| 9,651 |
| 9,949 |
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Goodwill |
| 29,539 |
| 30,490 |
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Other intangibles, net |
| 6,936 |
| 6,394 |
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Other assets |
| 7,692 |
| 7,667 |
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TOTAL ASSETS |
| $ | 428,234 |
| $ | 432,446 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY |
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Current liabilities: |
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Current portion of long-term debt |
| $ | 8,055 |
| $ | 8,307 |
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Accounts payable |
| 9,888 |
| 7,741 |
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Other current liabilities |
| 35,264 |
| 36,051 |
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Total current liabilities |
| 53,207 |
| 52,099 |
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Long-term debt |
| 192,581 |
| 189,311 |
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Deferred tax liabilities |
| 22,709 |
| 23,577 |
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Other non-current liabilities |
| 23,931 |
| 25,925 |
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Total liabilities |
| 292,428 |
| 290,912 |
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Commitments and contingent liabilities |
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Stockholders’ equity: |
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Common stock |
| 9 |
| 9 |
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Additional paid-in capital |
| 73,172 |
| 73,172 |
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Retained earnings |
| 91,620 |
| 94,463 |
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Accumulated other comprehensive loss |
| (13,142 | ) | (10,257 | ) | ||
Treasury stock, at cost |
| (15,853 | ) | (15,853 | ) | ||
Total stockholders’ equity |
| 135,806 |
| 141,534 |
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TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |
| $ | 428,234 |
| $ | 432,446 |
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See notes to condensed consolidated financial statements.
4
STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
|
| Six Months Ended |
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| June 29, |
| June 28, |
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Cash flows from operating activities: |
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Net income |
| $ | 7,767 |
| $ | 2,843 |
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Adjustments to reconcile net income to cash flows from operating activities: |
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Depreciation and amortization |
| 5,580 |
| 5,546 |
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Deferred tax benefit |
| (212 | ) | (252 | ) | ||
Other |
| 235 |
| 179 |
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Changes in operating assets and liabilities: |
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Accounts, notes and leases receivable |
| (14,334 | ) | (11,393 | ) | ||
Inventories |
| (1,221 | ) | (3,463 | ) | ||
Prepaid expenses and other current assets |
| (191 | ) | 1,060 |
| ||
Accounts payable |
| (2 | ) | (2,382 | ) | ||
Other current liabilities |
| 553 |
| 657 |
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Cash flows from operating activities |
| (1,825 | ) | (7,205 | ) | ||
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Cash flows from investing activities: |
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Capital expenditures |
| (2,341 | ) | (1,675 | ) | ||
Changes in other assets |
| 1,135 |
| 416 |
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Cash flows from investing activities |
| (1,206 | ) | (1,259 | ) | ||
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Cash flows from financing activities: |
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Gross borrowings under lines of credit |
| 18,755 |
| 6,365 |
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Gross repayments under lines of credit |
| (14,286 | ) | (6,121 | ) | ||
Repayments of long-term debt |
| (3,166 | ) | (3,240 | ) | ||
Proceeds from issuance of stock |
| 406 |
| — |
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Cash flows from financing activities |
| 1,709 |
| (2,996 | ) | ||
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Effect of foreign exchange rate changes on cash |
| (9 | ) | 88 |
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Decrease in cash |
| (1,331 | ) | (11,372 | ) | ||
Cash, beginning of period |
| 5,545 |
| 19,099 |
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Cash, end of period |
| $ | 4,214 |
| $ | 7,727 |
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Supplemental Cash Flow Information |
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Interest paid |
| $ | 7,652 |
| $ | 7,344 |
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Taxes paid |
| $ | 3,767 |
| $ | 4,179 |
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See notes to condensed consolidated financial statements.
5
STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 28, 2003
(Tabular Amounts In Thousands Except Share and Per Share Data)
(1) Basis of Presentation
The accompanying condensed consolidated financial statements of Steinway Musical Instruments, Inc. and subsidiaries (the “Company”) for the three months and six months ended June 29, 2002 and June 28, 2003 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, 2002, 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 period. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002 filed with the Securities and Exchange Commission. The results of operations for the three months and six months ended June 28, 2003 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. Effective January 1, 2003, we combined the operations of The Selmer Company, Inc. (“Selmer”) and United Musical Instruments, Inc. (“UMI”) into Conn-Selmer, Inc. (“Conn-Selmer”). References to Selmer and UMI occur in connection with events or circumstances prior to the merger.
(2) Summary of Significant Accounting Policies
Principles of Consolidation - Our consolidated financial statements include the accounts of our direct and indirect wholly owned subsidiaries, including The Steinway Piano Company, Inc. (“Steinway”) and Conn-Selmer. Significant intercompany balances have been eliminated in consolidation.
Stock-based Compensation - - We have an employee stock purchase plan (“Purchase Plan”) and a stock plan (“Stock Plan”). As permitted under accounting principles generally accepted in the United States of America, we have elected to continue to follow the intrinsic value method in accounting for our stock-based employee compensation arrangement.
6
The following table illustrates the effect on net income and earnings per share if we had applied the fair value method to measure stock-based employee compensation.
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| Three Months Ended |
| Six Months Ended |
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| June 29, |
| June 28, |
| June 29, |
| June 28, |
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Net income, as reported |
| $ | 4,084 |
| $ | 2,160 |
| $ | 7,767 |
| $ | 2,843 |
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Deduct: Total stock-based employee compensation expense determined under fair-value based method for all awards, net of related tax effects |
| (102 | ) | (217 | ) | (205 | ) | (437 | ) | ||||
Pro forma net income |
| $ | 3,982 |
| $ | 1,943 |
| $ | 7,562 |
| $ | 2,406 |
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Earnings per share: |
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As reported Basic |
| $ | 0.46 |
| $ | 0.24 |
| $ | 0.88 |
| $ | 0.32 |
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As reported Diluted |
| $ | 0.46 |
| $ | 0.24 |
| $ | 0.87 |
| $ | 0.32 |
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Pro forma Basic and Diluted |
| $ | 0.45 |
| $ | 0.22 |
| $ | 0.85 |
| $ | 0.27 |
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The fair value of options on their grant date, including the valuation of the option feature implicit in our Purchase Plan, was measured using the Black-Scholes option-pricing model. Key assumptions used to apply this pricing model are as follows:
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| Three Months Ended |
| Six Months Ended |
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| June 29, |
| June 28, |
| June 29, |
| June 28, |
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Range of risk-free interest rates |
| 3.57% |
| 1.86% |
| 3.57% |
| 1.86 - 3.12% |
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Range of expected life of option grants (in years) |
| 1 to 6 |
| 1 to 6 |
| 1 to 6 |
| 1 to 6 |
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Expected volatility of underlying stock |
| 25.7% |
| 26.5% |
| 25.7% |
| 26.5% |
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The weighted average fair value of options on their grant date is as follows:
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| Three Months Ended |
| Six Months Ended |
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| June 29, |
| June 28, |
| June 29, |
| June 28, |
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Stock Plan |
| $ | — |
| $ | — |
| $ | — |
| $ | 4.77 |
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Purchase Plan |
| $ | 4.48 |
| $ | 4.78 |
| $ | 4.48 |
| $ | 4.78 |
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It should be noted that the Black-Scholes option-pricing model was designed to value readily tradable options with relatively short lives and no vesting restrictions. In addition, option valuation models require the input of highly subjective assumptions including the expected price volatility. Because the options granted are not tradable and have contractual lives of up to ten years, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not provide a reliable measure of the fair value of the options issued under either the Stock Plan or Purchase Plan.
Income per Common Share – Basic income per share is computed using the weighted average number of common shares outstanding during each period. Diluted income per common share reflects the effect of our outstanding options using the treasury stock method, except when such items would be antidilutive.
7
A reconciliation of the weighted average shares used for the basic and diluted computations is as follows:
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| Three months ended |
| Six Months Ended |
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| June 29, |
| June 28, |
| June 29, |
| June 28, |
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Weighted average shares: |
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For basic income per share |
| 8,860,834 |
| 8,906,238 |
| 8,854,103 |
| 8,906,238 |
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Dilutive effect of stock options |
| 54,237 |
| — |
| 37,653 |
| 14 |
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For diluted income per share |
| 8,915,071 |
| 8,906,238 |
| 8,891,756 |
| 8,906,252 |
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Options to purchase 29,500 shares of common stock at a price of $21.94 per share and options to purchase 1,058,400 shares of common stock at prices ranging from $18.55 to $21.94 per share were outstanding during the periods ended June 29, 2002 and June 28, 2003, respectively, but were not included in the computation of diluted net income per share because the options’ exercise prices were greater than the average market price of the common shares.
Comprehensive Income – Other comprehensive income is comprised of foreign currency translation adjustments, additional minimum pension liabilities, and unrealized gains and losses on certain long-term assets. Total comprehensive income is as follows:
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| Three months ended |
| Six Months Ended |
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| June 29, |
| June 28, |
| June 29, |
| June 28, |
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Net income |
| $ | 4,084 |
| $ | 2,160 |
| $ | 7,767 |
| $ | 2,843 |
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Other comprehensive income, net |
| 4,180 |
| 2,186 |
| 3,500 |
| 2,885 |
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Total comprehensive income |
| $ | 8,264 |
| $ | 4,346 |
| $ | 11,267 |
| $ | 5,728 |
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New Accounting Pronouncements – In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS 149 amends SFAS 133 to conform and incorporate derivative implementation issues and subsequently issued accounting guidance. SFAS 149 clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, and clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS 149 also amends other existing pronouncements, resulting in more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant special accounting. SFAS 149 is effective for contracts entered into or modified after June 30, 2003, and should be applied prospectively. However, certain SFAS 133 implementation issues that were effective for all fiscal quarters prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. We are required to adopt SFAS 149 effective July 1, 2003. We do not believe that the adoption of SFAS 149 will have a material effect on our financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 establishes standards for how an issuer classifies and measures certain freestanding financial instruments with characteristics of both liabilities and equity. SFAS 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or asset in some circumstances). We are required to adopt SFAS 150 effective June 29, 2003.
8
We do not believe that the adoption of SFAS 150 will have a material effect on our financial position, results of operations or cash flows.
In May 2003, the Emerging Issues Task Force (“EITF”) reached consensus in EITF 03-04, “Determining the Classification and Benefit Attribution Method for a ‘Cash Balance’ Pension Plan,” to specifically address the accounting for certain cash balance pension plans. The consensus reached in EITF 03-04 requires certain cash balance pension plans to be accounted for as defined benefit plans. For cash balance plans described in the consensus, the consensus also requires the use of the traditional unit credit method for purposes of measuring the benefit obligation and annual cost of benefits earned as opposed to the projected unit credit method. We do not believe that the adoption of EITF 03-04 will have a material effect on our financial position, results of operations or cash flows.
In May 2003, the EITF reached consensus in EITF 01-08, “Determining Whether an Arrangement Contains a Lease,” to clarify the requirements on identifying whether an arrangement should be accounted for as a lease at its inception. The guidance in the consensus is designed to mandate reporting revenue as rental or leasing income that otherwise would be reported as part of product sales or service revenue. EITF 01-08 requires both parties to an arrangement to determine whether a service contract or similar arrangement is or includes a lease within the scope of SFAS No. 13, “Accounting For Leases.” The consensus is to be applied prospectively to arrangements agreed to, modified, or acquired in business combinations in fiscal periods beginning after May 28, 2003. We do not believe the adoption of EITF 01-08 will have a material effect on our financial position, results of operations or cash flows.
Reclassifications – Certain prior year amounts have been reclassified to conform to the current year presentation.
(3) Inventories
Inventories consist of the following:
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| December 31, |
| June 28, |
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Raw materials |
| $ | 21,568 |
| $ | 20,671 |
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Work in process |
| 56,019 |
| 60,033 |
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Finished goods |
| 85,503 |
| 86,857 |
| ||
Total |
| $ | 163,090 |
| $ | 167,561 |
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9
(4) Intangible Assets
Amortizable intangible assets consist of the following:
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| December 31, |
| June 28, |
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Gross deferred financing costs |
| $ | 10,751 |
| $ | 10,753 |
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Accumulated amortization |
| (3,951 | ) | (4,505 | ) | ||
Deferred financing costs, net |
| $ | 6,800 |
| $ | 6,248 |
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Gross covenants not to compete |
| $ | 750 |
| $ | 805 |
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Accumulated amortization |
| (614 | ) | (659 | ) | ||
Covenants not to compete, net |
| $ | 136 |
| $ | 146 |
|
The weighted average amortization period for deferred financing costs is 8.75 years, and the weighted average amortization period of covenants not to compete is 8.5 years. Total amortization expense is as follows:
|
| Three months ended |
| Six months ended |
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| June 29, |
| June 28, |
| June 29, |
| June 28, |
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Amortization expense |
| $ | 289 |
| $ | 288 |
| $ | 578 |
| $ | 577 |
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The following table shows the estimated amortization expense for the remainder of 2003 and the next five succeeding fiscal years:
Estimated amortization expense:
2003 |
| $ | 577 |
|
2004 |
| 1,043 |
| |
2005 |
| 987 |
| |
2006 |
| 952 |
| |
2007 |
| 952 |
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2008 |
| 952 |
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10
(5) Other Current Liabilities
|
| December 31, |
| June 28, |
| ||
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Accrued payroll and related benefits |
| $ | 15,287 |
| $ | 17,074 |
|
Current portion of pension liability |
| 4,111 |
| 3,317 |
| ||
Accrued warranty expense |
| 2,357 |
| 2,479 |
| ||
Accrued interest |
| 2,720 |
| 2,704 |
| ||
Deferred income |
| 3,536 |
| 4,005 |
| ||
Other accrued expenses |
| 7,253 |
| 6,472 |
| ||
Total |
| $ | 35,264 |
| $ | 36,051 |
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Accrued warranty expense is generally recorded at the time of sale for instruments which have a warranty period ranging from five to ten years. The accrued expense recorded is based on a percentage of sales and is adjusted periodically following an analysis of warranty activity. Accrued warranty expense for instruments that have a warranty period of one year is recorded based on warranty return trends. The accrued warranty expense activity for the year ended December 31, 2002 and six months ended June 28, 2003 is as follows:
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| Period Ended |
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| December 31, |
| June 28, |
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Accrued warranty expense: |
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Beginning balance |
| $ | 2,221 |
| $ | 2,357 |
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Additions |
| 950 |
| 611 |
| ||
Claims and reversals |
| (814 | ) | (489 | ) | ||
Ending balance |
| $ | 2,357 |
| $ | 2,479 |
|
(6) Stockholders’ Equity
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. Class A common stock shall automatically convert to Ordinary common stock if, at any time, the Class A common stock is not owned by an original Class A holder. The Chairman and Chief Executive Officer own 100% of the Class A common shares, representing approximately 85% of the combined voting power of the Class A common stock and Ordinary common stock.
11
(7) Other Income, Net
Other income, net consists of the following:
|
| Three months ended |
| Six months ended |
| ||||||||
|
| June 29, |
| June 28, |
| June 29, |
| June 28, |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
West 57th Building income |
| $ | (1,164 | ) | $ | (1,163 | ) | $ | (2,327 | ) | $ | (2,326 | ) |
West 57th building expenses |
| 810 |
| 814 |
| 1,624 |
| 1,628 |
| ||||
Foreign exchange gain, net |
| (584 | ) | (286 | ) | (474 | ) | (390 | ) | ||||
Miscellaneous |
| (300 | ) | (77 | ) | (366 | ) | (245 | ) | ||||
Other income, net |
| $ | (1,238 | ) | $ | (712 | ) | $ | (1,543 | ) | $ | (1,333 | ) |
(8) 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, or results of operations or projects.
We operate manufacturing facilities at certain locations where hazardous substances (including chlorinated solvents) were used. We believe that an entity that formerly operated one such facility may have released hazardous substances at such location, which we leased through July 2001. We did not contribute to such release. Further, we have a contractual indemnity from certain stockholders of such entity. This facility is not the subject of a legal proceeding that involves us, nor, to our knowledge, is the facility subject to investigation. However, no assurance can be given that legal proceedings will not arise in the future and that such indemnitors would make the payments described in the indemnity.
We operate other manufacturing facilities, which were previously owned by Philips Electronics North America Corporation (“Philips”). Philips agreed to indemnify us for any and all losses, damages, liabilities and claims relating to environmental matters resulting from certain activities of Philips occurring prior to December 29, 1988 (the “Environmental Indemnity Agreement”). Philips has fully performed its obligations under the Environmental Indemnity Agreement, which terminates on December 29, 2008. Four matters covered by the Environmental Indemnity Agreement are currently pending. Philips has entered into Consent Orders with the Environmental Protection Agency (“EPA”) for one site and the North Carolina Department of Environment, Health and Natural Resources for a second site, whereby Philips has agreed to pay required response costs. For the third site, the EPA has notified us it intends to carry out the final remediation itself. The EPA estimates that this remedy has a present net cost of approximately $14.5 million. Over 40 persons or entities have been named by the EPA as potentially responsible parties at this site. This matter has been tendered to Philips pursuant to the Environmental Indemnity Agreement. On October 22, 1998, we were joined as defendant in an action involving a site formerly occupied by a business we acquired in Illinois. Philips has accepted the defense of this action pursuant to the terms of the Environmental Indemnity Agreement. Our potential liability at any of these sites is affected by several factors including, but not limited to, the method of remediation,
12
our portion of the materials in the site relative to the other named parties, the number of parties participating, and the financial capabilities of the other potentially responsible parties once the relative share has been determined. No assurance can be given, however, that additional environmental issues will not require additional, currently unanticipated investigation, assessment or remediation expenditures or that Philips will make payments that it is obligated to make under the Environmental Indemnity Agreement.
We are also continuing existing environmental remediation programs at facilities acquired in 2000. We currently estimate that this project will take eighteen years to complete, at a total cost of approximately $1.0 million. We have accrued approximately $0.6 million for the estimated remaining cost of these remediation programs, which represents the present value total cost using a discount rate of 4.75%. A summary of expected payments associated with this project is as follows:
|
| Environmental |
| |
2003 |
| $ | 101 |
|
2004 |
| 72 |
| |
2005 |
| 72 |
| |
2006 |
| 72 |
| |
2007 |
| 51 |
| |
Thereafter |
| 656 |
| |
Total |
| $ | 1,024 |
|
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 competitive position. However, some risk of environmental liability is inherent in the nature of our current and former businesses and we might, in the future, incur material costs to meet current or more stringent compliance, cleanup or other obligations pursuant to environmental laws.
(9) Segment Information
We have identified two distinct and reportable segments: the piano segment and the band and orchestral instrument segment. These segments were selected based upon the way in which management oversees and evaluates the results of each operation. Management and the chief operating decision maker utilize 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” include those corporate costs that were not allocated to the reportable segments and the remaining intercompany profit elimination.
13
The following tables present information about our operating segments for the three month and six month periods ended June 29, 2002 and June 28, 2003:
Three months ended 2002 |
| Piano Segment |
| Band and Orchestral Segment |
| Other & |
| Consol |
| |||||||||||||||||||
|
| U.S. |
| Germany |
| Other |
| Total |
| U.S. |
| Other |
| Total |
|
|
| |||||||||||
Net sales to external customers |
| $ | 24,984 |
| $ | 8,534 |
| $ | 4,780 |
| $ | 38,298 |
| $ | 39,137 |
| $ | 914 |
| $ | 40,051 |
| $ | — |
| $ | 78,349 |
|
Income from operations |
| 3,576 |
| 890 |
| 707 |
| 5,173 |
| 3,926 |
| 27 |
| 3,953 |
| (591 | ) | 8,535 |
| |||||||||
Three months ended 2003 |
| Piano Segment |
| Band and Orchestral Segment |
| Other & |
| Consol |
| |||||||||||||||||||
|
| U.S. |
| Germany |
| Other |
| Total |
| U.S. |
| Other |
| Total |
|
|
| |||||||||||
Net sales to external customers |
| $ | 25,971 |
| $ | 12,271 |
| $ | 3,068 |
| $ | 41,310 |
| $ | 35,782 |
| $ | 943 |
| $ | 36,725 |
| $ | — |
| $ | 78,035 |
|
Income from operations |
| 2,145 |
| 631 |
| 456 |
| 3,232 |
| 3,053 |
| (16 | ) | 3,037 |
| (459 | ) | 5,810 |
| |||||||||
Six months ended 2002 |
| Piano Segment |
| Band and Orchestral Segment |
| Other & |
| Consol |
| |||||||||||||||||||
|
| U.S. |
| Germany |
| Other |
| Total |
| U.S. |
| Other |
| Total |
|
|
| |||||||||||
Net sales to external customers |
| $ | 48,482 |
| $ | 16,584 |
| $ | 9,652 |
| $ | 74,718 |
| $ | 89,807 |
| $ | 1,883 |
| $ | 91,690 |
| $ | — |
| $ | 166,408 |
|
Income from operations |
| 6,184 |
| 1,889 |
| 1,456 |
| 9,529 |
| 8,758 |
| 53 |
| 8,811 |
| (1,136 | ) | 17,204 |
| |||||||||
Six months ended 2003 |
| Piano Segment |
| Band and Orchestral Segment |
| Other & |
| Consol |
| |||||||||||||||||||
|
| U.S. |
| Germany |
| Other |
| Total |
| U.S. |
| Other |
| Total |
|
|
| |||||||||||
Net sales to external customers |
| $ | 46,385 |
| $ | 25,003 |
| $ | 5,857 |
| $ | 77,245 |
| $ | 81,240 |
| $ | 2,059 |
| $ | 83,299 |
| $ | — |
| $ | 160,544 |
|
Income from operations |
| 2,418 |
| 1,962 |
| 1,250 |
| 5,630 |
| 4,582 |
| 47 |
| 4,629 |
| (1,045 | ) | 9,214 |
| |||||||||
(10) Summary of Guarantees
During 2001, we completed a $150.0 million 8.75% Senior Note offering. At the end of 2002, we repurchased $4.7 million of these Senior Notes.
Our payment obligations under the 8.75% Senior Notes are fully and unconditionally guaranteed on a joint and several basis by Conn-Selmer, Steinway, and certain other of our direct and indirect wholly-owned subsidiaries, each a Guarantor (the “Guarantor Subsidiaries”). These subsidiaries represent all of our (the “Issuer”) operations conducted in the United States. The remaining subsidiaries, which do not guarantee the 8.75% Senior Notes, represent non-U.S. operations (the “Non Guarantor Subsidiaries”).
The following condensed consolidating supplementary data presents the financial position, results of operations, and cash flows of the Guarantor Subsidiaries and the Non Guarantor Subsidiaries. Separate complete financial statements of the respective Guarantors would not provide additional material information that would be useful in assessing the financial composition of the Guarantor Subsidiaries. No single Guarantor Subsidiary has any significant legal restrictions on the ability of investors or creditors to obtain access to its assets in event of default on the guarantee other than its subordination to senior indebtedness.
Investments in subsidiaries are recorded on the cost method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are therefore not reflected in the parent company’s investment accounts and earnings. The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions.
14
STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
SIX MONTHS ENDED JUNE 28, 2003
(In Thousands)
|
| Issuer |
| Guarantor |
| Non |
| Reclass/ |
| Consolidated |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net sales |
| $ | — |
| $ | 132,267 |
| $ | 34,223 |
| $ | (5,946 | ) | $ | 160,544 |
|
Cost of sales |
| — |
| 100,761 |
| 22,071 |
| (5,833 | ) | 116,999 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Gross profit |
| — |
| 31,506 |
| 12,152 |
| (113 | ) | 43,545 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
| |||||
Sales and marketing |
| — |
| 16,058 |
| 5,947 |
| (48 | ) | 21,957 |
| |||||
General and administrative |
| 2,287 |
| 6,683 |
| 2,519 |
| — |
| 11,489 |
| |||||
Amortization |
| 226 |
| 349 |
| 2 |
| — |
| 577 |
| |||||
Other operating (income) expense |
| (1,600 | ) | 1,435 |
| 425 |
| 48 |
| 308 |
| |||||
Total operating expenses |
| 913 |
| 24,525 |
| 8,893 |
| — |
| 34,331 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Income (loss) from operations |
| (913 | ) | 6,981 |
| 3,259 |
| (113 | ) | 9,214 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Interest (income) expense, net |
| (753 | ) | 6,613 |
| 119 |
| — |
| 5,979 |
| |||||
Other income, net |
| — |
| (1,197 | ) | (136 | ) | — |
| (1,333 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Income (loss) before income taxes |
| (160 | ) | 1,565 |
| 3,276 |
| (113 | ) | 4,568 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Provision for (benefit of) income taxes |
| (56 | ) | 1,371 |
| 456 |
| (46 | ) | 1,725 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net income (loss) |
| $ | (104 | ) | $ | 194 |
| $ | 2,820 |
| $ | (67 | ) | $ | 2,843 |
|
15
STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
JUNE 28, 2003
(In Thousands)
|
| Issuer |
| Guarantor |
| Non |
| Reclass/ |
| Consolidated |
| |||||
ASSETS |
|
|
|
|
|
|
|
|
|
|
| |||||
Current assets: |
|
|
|
|
|
|
|
|
|
|
| |||||
Cash |
| $ | — |
| $ | 426 |
| $ | 2,072 |
| $ | 5,229 |
| $ | 7,727 |
|
Accounts, notes and leases receivable, net |
| — |
| 77,282 |
| 12,015 |
| 42 |
| 89,339 |
| |||||
Inventories |
| — |
| 133,237 |
| 35,418 |
| (1,094 | ) | 167,561 |
| |||||
Prepaid expenses and other current assets |
| 329 |
| 2,860 |
| 1,178 |
| — |
| 4,367 |
| |||||
Deferred tax assets |
| — |
| 6,155 |
| 5,242 |
| (3,714 | ) | 7,683 |
| |||||
Total current assets |
| 329 |
| 219,960 |
| 55,925 |
| 463 |
| 276,677 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Property, plant and equipment, net |
| 153 |
| 85,585 |
| 15,531 |
| — |
| 101,269 |
| |||||
Investment in subsidiaries |
| 71,143 |
| 261,129 |
| — |
| (332,272 | ) | — |
| |||||
Trademarks |
| — |
| 6,280 |
| 3,669 |
| — |
| 9,949 |
| |||||
Goodwill |
| — |
| 18,795 |
| 11,695 |
| — |
| 30,490 |
| |||||
Other intangibles, net |
| 3,523 |
| 2,863 |
| 8 |
| — |
| 6,394 |
| |||||
Other assets |
| 1,052 |
| 6,103 |
| 512 |
| — |
| 7,667 |
| |||||
TOTAL ASSETS |
| $ | 76,200 |
| $ | 600,715 |
| $ | 87,340 |
| $ | (331,809 | ) | $ | 432,446 |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
|
|
|
|
|
|
| |||||
Current liabilities: |
|
|
|
|
|
|
|
|
|
|
| |||||
Current portion of long-term debt |
| $ | — |
| $ | 6,484 |
| $ | 1,823 |
| $ | — |
| $ | 8,307 |
|
Accounts payable |
| 109 |
| 4,744 |
| 2,888 |
| — |
| 7,741 |
| |||||
Other current liabilities |
| (14,029 | ) | 39,659 |
| 14,420 |
| (3,999 | ) | 36,051 |
| |||||
Total current liabilities |
| (13,920 | ) | 50,887 |
| 19,131 |
| (3,999 | ) | 52,099 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Long-term debt |
| 145,395 |
| 38,687 |
| — |
| 5,229 |
| 189,311 |
| |||||
Intercompany |
| (110,504 | ) | 106,291 |
| 4,171 |
| 42 |
| — |
| |||||
Deferred tax liabilities |
| — |
| 16,533 |
| 7,044 |
| — |
| 23,577 |
| |||||
Other non-current liabilities |
| 439 |
| 9,714 |
| 15,772 |
| — |
| 25,925 |
| |||||
Total liabilities |
| 21,410 |
| 222,112 |
| 46,118 |
| 1,272 |
| 290,912 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Stockholders’ equity |
| 54,790 |
| 378,603 |
| 41,222 |
| (333,081 | ) | 141,534 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |
| $ | 76,200 |
| $ | 600,715 |
| $ | 87,340 |
| $ | (331,809 | ) | $ | 432,446 |
|
16
STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 28, 2003
(In Thousands)
|
| Issuer |
| Guarantor |
| Non |
| Reclass/ |
| Consolidated |
| |||||
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
| |||||
Net income (loss) |
| $ | (104 | ) | $ | 194 |
| $ | 2,820 |
| $ | (67 | ) | $ | 2,843 |
|
Adjustments to reconcile net income (loss) to cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
| |||||
Depreciation and amortization |
| 255 |
| 4,503 |
| 788 |
| — |
| 5,546 |
| |||||
Deferred tax benefit |
| — |
| (130 | ) | (122 | ) | — |
| (252 | ) | |||||
Other |
| — |
| 90 |
| 89 |
| — |
| 179 |
| |||||
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
|
|
| |||||
Accounts, notes and leases receivable |
| — |
| (11,682 | ) | 409 |
| (120 | ) | (11,393 | ) | |||||
Inventories |
| — |
| (550 | ) | (3,026 | ) | 113 |
| (3,463 | ) | |||||
Prepaid expenses and other current assets |
| 127 |
| 1,180 |
| (247 | ) | — |
| 1,060 |
| |||||
Accounts payable |
| 11 |
| (2,189 | ) | (282 | ) | 78 |
| (2,382 | ) | |||||
Other current liabilities |
| 353 |
| (154 | ) | 504 |
| (46 | ) | 657 |
| |||||
Cash flows from operating activities |
| 642 |
| (8,738 | ) | 933 |
| (42 | ) | (7,205 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
|
|
| |||||
Capital expenditures |
| (23 | ) | (1,100 | ) | (552 | ) | — |
| (1,675 | ) | |||||
Capital contribution to subsidiary |
| — |
| (513 | ) | 513 |
| — |
| — |
| |||||
Changes in other assets |
| 58 |
| 358 |
| — |
| — |
| 416 |
| |||||
Cash flows from investing activities |
| 35 |
| (1,255 | ) | (39 | ) | — |
| (1,259 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
|
|
| |||||
Gross borrowings under lines of credit |
| — |
| 5,119 |
| 1,246 |
| — |
| 6,365 |
| |||||
Gross repayments under lines of credit |
| (3 | ) | (5,119 | ) | (1,002 | ) | 3 |
| (6,121 | ) | |||||
Repayment of long-term debt |
| — |
| (3,240 | ) | — |
| — |
| (3,240 | ) | |||||
Intercompany transactions |
| (674 | ) | 5,817 |
| (5,185 | ) | 42 |
| — |
| |||||
Cash flows from financing activities |
| (677 | ) | 2,577 |
| (4,941 | ) | 45 |
| (2,996 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Effect of exchange rate changes on cash |
| — |
| — |
| 88 |
| — |
| 88 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Decrease in cash |
| — |
| (7,416 | ) | (3,959 | ) | 3 |
| (11,372 | ) | |||||
Cash, beginning of period |
| — |
| 1,166 |
| 6,736 |
| 11,197 |
| 19,099 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Cash, end of period |
| $ | — |
| $ | (6,250 | ) | $ | 2,777 |
| $ | 11,200 |
| $ | 7,727 |
|
17
(11) Subsequent Events
On August 7, 2003, we announced that we will be closing our manufacturing facility in Nogales, Arizona, which has been operating at reduced capacity for several quarters. Manufacturing operations will cease in the fourth quarter and the final plant closing will be early in 2004. This closure will eliminate approximately 90 positions.
We expect to take charges of approximately $6.3 million during the second half of 2003 related to this closing, approximately $0.7 million of which will be severance payments. The remainder of the charge will consist primarily of inventory write-downs and asset impairment costs.
18
ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
We, through our operating subsidiaries, 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. Moreover, we are the largest domestic producer of band and orchestral instruments and offer a complete line of brasswind, woodwind, percussion and stringed instruments and related accessories with well known brand names such as Bach, C.G. Conn, 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
The nature of our business - the production and sale of musical instruments - is such that it rarely involves application of highly complex or subjective accounting principles. The accounting policies that are subject to significant management estimates are those normally found in traditional businesses and include inventory reserves, accounts receivable reserves, reserves on notes receivable, and warranty reserves. We have significant experience and data on which to base these estimates. Historical information is adjusted for specific uncertainties, such as new product introductions, and contemporaneous information, such as price fluctuations. Management regularly performs assessments of the underlying assumptions and believes that they provide a reasonable basis for the estimates contained in our 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 herein. These risk factors include, but are not limited to, changes in general economic conditions, geopolitical events, increased competition, work stoppages and slowdowns, exchange rate fluctuations, variations in the mix of products sold, fluctuations in effective tax rates resulting from shifts in sources of income, and the ability to successfully integrate and operate acquired businesses. Further information on these risk factors is included in our Annual Report on Form 10-K for the year ended December 31, 2002, our Final Prospectus filed in August 1996, and Registration Statement No. 333-62790 filed in June 2001, particularly in the sections entitled “Risk Factors.” 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.
19
Results of Operations
Three Months Ended June 28, 2003 Compared to Three Months Ended June 29, 2002
Net Sales - Net sales remained stable at $78.0 million. Piano sales increased $3.0 million (8%) to $41.3 million in the current period, despite a 4% decrease in Steinway unit shipments and a 13% decrease in Boston product line unit shipments. The increase was primarily attributable to the positive foreign exchange impact of $2.5 million. Band and orchestral instrument sales decreased $3.3 million (8%) on an overall unit decrease of 9%. Less background brass shipments, resulting from the strike (settled on May 5, 2003) at our Eastlake, Ohio brass instrument factory, and less tuned percussion shipments due to the residual impact of the strike at our LaGrange, Illinois facility (settled on March 31, 2003) were the primary causes of the decrease, although continued competition from foreign imports was also a factor.
Gross Profit - - Gross profit decreased by $1.7 million (7%) to $22.7 million on a gross margin decrease from 31.1% to 29.1%. Piano margins decreased from 35.9% in 2002 to 33.1% in 2003 due to fewer production days at our domestic manufacturing facility, resulting in underabsorption of overhead. Unfavorable exchange rates on our Boston piano purchases also contributed to the decrease. Band and orchestral instrument margins decreased from 26.5% in 2002 to 24.6% in 2003. This decrease was primarily due to unabsorbed overhead resulting from reduced production levels at certain facilities and the work stoppage at our brass instrument factory. Increased pension expense also contributed to the gross profit decrease.
Operating Expenses - - Overall operating expenses increased by $1.1 million (7%) to $16.9 million in the second quarter. Excluding the foreign exchange impact of $0.7 million, the increase was less than 3%.
Other Expense, Net - Other expenses remained flat at $2.3 million. Net interest expense decreased $0.5 million as a result of lower interest rates, lower borrowings on our line of credit, and interest savings of $0.1 million associated with our debt buyback of $4.7 million in December 2002. This was offset by a decrease in miscellaneous income and $0.3 million less foreign exchange gains in the current period.
Income Taxes – Our effective tax rate increased from 35.0% to 38.5% primarily due to the unfavorable shift in the ratio of foreign source income to domestic income and the resultant decrease in use of foreign tax credits in 2003.
Six Months Ended June 28, 2003 Compared to Six Months Ended June 29, 2002
Net Sales - Net sales decreased $5.9 million (4%) to $160.5 million in the first half of 2003. Piano sales increased $2.5 million (3%) despite an overall unit shipment decrease of 10%. This decrease, which resulted from the economic slowdown, was more than offset by a positive foreign exchange impact of $5.0 million in the current period. Band and orchestral instrument sales decreased $8.4 million (9%) on an overall unit decrease of 11%. Lower priced products imported from Asia continued to negatively impact our student instrument shipments. The sales decline was also attributed to the delay in availability of product resulting from the union strikes at our LaGrange, Illinois and Eastlake, Ohio plants, which were settled in March and May, respectively.
Gross Profit - - Gross profit decreased by $6.2 million (13%) to $43.5 million on a gross margin decrease from 29.9% to 27.1%. Piano margins decreased from 35.8% in 2002 to 33.0% in 2003 as a result of lower production levels and underabsorption of overhead at our domestic manufacturing facility,
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compounded by a shift in mix to the lower-margin Boston products. Band and orchestral instrument margins decreased from 25.1% in 2002 to 21.6% in 2003. This decrease was due to costs of $1.9 million paid to employees in accordance with the terms of labor contracts which expired and $1.3 million in unabsorbed overhead and lost profit resulting from the work stoppages at two of our plants.
Operating Expenses – Overall operating expenses increased by $1.8 million (6%) to $34.3 million in the first half of 2003. Approximately $1.3 million of the increase is attributable to foreign exchange. The remainder is due to the costs associated with the 150th anniversary celebration of our piano division.
Other Expense, net - Other expenses decreased by $0.6 million (13%) to $4.6 million, primarily as a result of lower net interest expense of $0.8 million. Lower interest rates, limited borrowings on our lines of credit, and our debt buyback of $4.7 million in December 2002 contributed $0.5 million to the decrease. Increased interest income of $0.3 million, resulting from our internal financing of notes receivable that had historically been sold to a third party also contributed to the net decrease.
Income Taxes – Our effective tax rate increased from 35.0% to 37.8% as a result of the proportion of foreign source income to domestic income and our ability to effectively utilize foreign tax credits in 2003.
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.
Cash used in operations in the first six months of 2002 was $1.8 million, compared to cash used in operations in the first six months of 2003 of $7.2 million. This change is primarily due to lower income, as well as the change in working capital balances period over period and payments made on accounts payable. Prior to August 2002, we sold notes receivable generated by our band division to third-party financing companies. This practice, which generated $2.6 million in cash in the first half of 2002, was not employed in the current period. Additionally, inventory increased in the current period due to the sales slowdown and larger volume of pianos needed for music festival season.
Capital expenditures of $2.3 million and $1.7 million in the second quarter of 2002 and 2003, respectively, were used primarily for the purchase of new machinery and equipment and production and retail facility improvements. In 2003, we expect to spend approximately $5.0 million for capital projects, consisting mainly of retail facility build-outs, machinery and process improvements, and equipment replacement.
Borrowing Availability and Activities
Our real estate term loan, acquisition term loan and domestic seasonal borrowing requirements are accommodated through a committed credit facility with a syndicate of domestic lenders (the “Credit Facility”). The Credit Facility provides us with a potential borrowing capacity of up to $85.0 million in revolving credit loans, based on eligible accounts receivable and inventory balances. The acquisition term loan and revolving credit loan portions of the Credit Facility bear interest at average 30-day LIBOR plus 1.75%, and the real estate term loan bears interest at average 30-day LIBOR plus 1.5%. The Credit facility expires on September 14, 2008. As of June 28, 2003, there were no revolving credit loans outstanding and availability based on eligible accounts receivable and inventory balances, net of letter of credit deductions of $4.5 million, was approximately $80.5 million. Open account loans with foreign
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banks also provide for borrowings by Steinway’s foreign subsidiaries of up to €17.6 million ($20.1 million at the June 28, 2003 exchange rate). We had $1.8 million in foreign loans outstanding as of June 28, 2003.
Our long-term financing consists primarily of $145.3 million of 8.75% Senior Notes and $50.5 million of term loans outstanding under the Credit Facility. Our debt agreements contain covenants that place certain restrictions on us, including our ability to incur additional indebtedness, to make investments in other entities and to pay cash dividends. We were in compliance with all such covenants as of June 28, 2003.
We expect to continue to focus on working capital management, repaying debt, maintaining and expanding market share, and improving production efficiency. We also intend to focus on scaling back the number of band division production facilities in the next twelve to eighteen months. We do not expect the cash impact of our facility rationalization project to materially impact our liquidity. We are not aware of any other trends, demands, commitments, or costs of resources that are expected to materially impact liquidity or capital resources. Therefore, 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 existing debt service requirements, fund continuing capital requirements and satisfy working capital and general corporate needs for the next twelve months.
We have reserved 721,750 shares of our existing treasury stock to be utilized for the exercise of stock options our Amended and Restated 1996 Stock Plan. These options will have no impact on our cash flow or the number of shares outstanding unless and until the options are exercised.
Contractual Obligations
The following table provides a summary of our contractual obligations at June 28, 2003.
|
| Payments due by period (amounts in 000s) |
| |||||||||||||
Contractual Obligations |
| Total |
| Less than |
| 1 - 3 years |
| 3 - 5 years |
| More than |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Long-term debt (1) |
| $ | 197,618 |
| $ | 8,307 |
| $ | 14,500 |
| $ | 16,628 |
| $ | 158,183 |
|
Operating leases (2) |
| 276,737 |
| 4,709 |
| 8,511 |
| 6,545 |
| 256,972 |
| |||||
Purchase obligations (3) |
| 3,208 |
| 2,788 |
| 210 |
| 210 |
| — |
| |||||
Other long-term liabilities (4) |
| 31,189 |
| 4,138 |
| 6,426 |
| 8,216 |
| 12,409 |
| |||||
Total |
| $ | 508,752 |
| $ | 19,942 |
| $ | 29,647 |
| $ | 31,599 |
| $ | 427,564 |
|
Notes to Contractual Obligations:
(1) The nature of our long-term debt obligations is described more fully in the “Borrowing Availability and Activities” section of “Liquidity and Capital Resources.”
(2) Approximately $260.8 million of our operating lease obligations are attributable to the ninety-nine year land lease associated with the purchase of Steinway Hall; the remainder is attributable to the leasing of other facilities and equipment.
(3) Purchase obligations consist of firm purchase commitments for raw materials and equipment.
(4) Our other long-term liabilities consist primarily of pension obligations and employment agreement obligations.
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New Accounting Pronouncements
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS 149 amends SFAS 133 to conform and incorporate derivative implementation issues and subsequently issued accounting guidance. SFAS 149 clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, and clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS 149 also amends other existing pronouncements, resulting in more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant special accounting. SFAS 149 is effective for contracts entered into or modified after June 30, 2003, and should be applied prospectively. However, certain SFAS 133 implementation issues that were effective for all fiscal quarters prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. We are required to adopt SFAS 149 effective July 1, 2003. We do not believe that the adoption of SFAS 149 will have a material effect on our financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 establishes standards for how an issuer classifies and measures certain freestanding financial instruments with characteristics of both liabilities and equity. SFAS 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or asset in some circumstances). We are required to adopt SFAS 150 effective June 29, 2003. We do not believe that the adoption of SFAS 150 will have a material effect on our financial position, results of operations or cash flows.
In May 2003, the Emerging Issues Task Force (“EITF”) reached consensus in EITF 03-04, “Determining the Classification and Benefit Attribution Method for a ‘Cash Balance’ Pension Plan,” to specifically address the accounting for certain cash balance pension plans. The consensus reached in EITF 03-04 requires certain cash balance pension plans to be accounted for as defined benefit plans. For cash balance plans described in the consensus, the consensus also requires the use of the traditional unit credit method for purposes of measuring the benefit obligation and annual cost of benefits earned as opposed to the projected unit credit method. We do not believe that the adoption of EITF 03-04 will have a material effect on our financial position, results of operations or cash flows.
In May 2003, the EITF reached consensus in EITF 01-08, “Determining Whether an Arrangement Contains a Lease,” to clarify the requirements on identifying whether an arrangement should be accounted for as a lease at its inception. The guidance in the consensus is designed to mandate reporting revenue as rental or leasing income that otherwise would be reported as part of product sales or service revenue. EITF 01-08 requires both parties to an arrangement to determine whether a service contract or similar arrangement is or includes a lease within the scope of SFAS No. 13, “Accounting For Leases.” The consensus is to be applied prospectively to arrangements agreed to, modified, or acquired in business combinations in fiscal periods beginning after May 28, 2003. We do not believe the adoption of EITF 01-08 will have a material effect on our financial position, results of operations or cash flows.
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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 our 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 our Annual Report on Form 10-K for the year ended December 31, 2002.
Although the majority of our long-term debt is at a fixed interest rate, our revolving loans and term loans bear interest at rates that fluctuate with changes in LIBOR. As such, our interest expense on our revolving loans and term loans and the fair value of its 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 and the fair value of our long-term debt would not be materially different than that disclosed in our Annual Report on Form 10-K for the year ended December 31, 2002.
ITEM 4 CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Our disclosure controls and procedures are the controls and other procedures that we designed to ensure that we record, process, summarize and report in a timely manner the information we must disclose in reports that we file with or submit to the SEC. Mr. Messina, our President and Chief Executive Officer, and Mr. Hanson, our Senior Executive Vice President and Chief Financial Officer, reviewed and participated in this evaluation. Based on this evaluation, Messrs. Messina and Hanson concluded that, as of the Evaluation Date, our disclosure controls were effective. As of the end of the period covered by this report, there have not been any significant changes in our internal accounting controls or in other factors that could significantly affect those controls.
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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 2, 2003, the Board of Directors was re-elected in its entirety. The votes cast for each nominee were as follows:
|
| For |
| Withheld |
|
|
|
|
|
Kyle Kirkland |
| 52,014,880 |
| 2,000,590 |
Dana D. Messina |
| 52,014,687 |
| 2,000,783 |
John M. Stoner, Jr. |
| 52,016,499 |
| 1,998,971 |
Bruce A. Stevens |
| 52,015,790 |
| 1,999,680 |
A. Clinton Allen |
| 53,965,586 |
| 49,884 |
Rudolph K. Kluiber |
| 53,965,585 |
| 49,885 |
Peter McMillan |
| 53,965,586 |
| 49,884 |
The proposal to ratify Deloitte & Touche to serve as the Company’s independent auditors for the fiscal year ending December 31, 2003 was approved with 53,986,184 votes cast for, 29,165 votes against, and 121 abstentions.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Working Agreement between Conn-Selmer, Inc. and United Automobile, Aerospace and Agriculture Implement Workers of America, Local No. 612
10.2 Working Agreement between Vincent Bach Division of Conn-Selmer, Inc. and United Automobile, Aerospace and Agricultural Implement Workers of America Local No. 364
10.3 Agreement between Conn-Selmer, Inc. and U.A.W. Local 2359
31.1 Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted 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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(b) Reports on Form 8-K
During the quarter ended June 28, 2003, we filed or furnished the following reports on Form 8-K:
(i) On March 31, 2003, the Company filed a Current Report on Form 8-K that included a press release issued on the same day announcing that approximately 500 employees of its Elkhart, Indiana plants approved new three-year union contracts. The Company also announced that Steinway Musical Instruments, Inc. ‘BB’ corporate credit and ‘BB-’ senior unsecured ratings were put on CreditWatch with negative implications by Standard and Poor’s Rating Services.
(ii) On April 30, 2003, the Company filed a Current Report on Form 8-K that included a press release issued on the same day announcing its results for the first quarter ended March 29, 2003.
(iii) On May 6, 2003, the Company filed a Current Report on Form 8-K that included a press release issued on the same day announcing that employees of its Eastlake, Ohio plant approved a new two-year union contract.
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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 |
| |
| Dana D. Messina | ||
| Director, President and Chief Executive Officer | ||
|
| ||
| /s/ Dennis M. Hanson |
| |
| Dennis M. Hanson | ||
| Senior Executive Vice President and | ||
|
| ||
|
| ||
Date: | August 11, 2003 |
| |
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