=============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 001-11911 STEINWAY MUSICAL INSTRUMENTS, INC. ------------------------------------------------------ (Exact Name of Registrant as Specified in its Charter) DELAWARE 35-1910745 ------------------------------- ------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 800 South Street, Suite 425 Waltham, Massachusetts 02453 ---------------------------------------- ------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number including area code: (781) 894-9770 and THE SELMER COMPANY, INC. ------------------------------------------------------ (Exact Name of Registrant as Specified in its Charter) DELAWARE 95-4432228 ------------------------------- ------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 600 Industrial Parkway, Elkhart, Indiana 46516 - ---------------------------------------- ------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number including area code: (219) 522-1675 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements during the past 90 days. Yes [X] No [ ] Number of shares of Common Stock issued and outstanding as of October 31, 2000: Class A 477,953 Ordinary 8,453,547 ---------- Total 8,931,500 ============================================================================== STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES FORM 10Q INDEX PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS: Condensed Consolidated Balance Sheets December 31, 1999 and September 30, 2000.....................................................3 Condensed Consolidated Statements of Operations Three months and nine months ended October 2, 1999 and September 30, 2000....................4 Condensed Consolidated Statements of Cash Flows Nine months ended October 2, 1999 and September 30, 2000.....................................5 Notes to Condensed Consolidated Financial Statements............................................6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...................................................................14 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.....................................17 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...............................................................18 SIGNATURES.....................................................................................19 2 STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) (UNAUDITED) DECEMBER 31, SEPTEMBER 30, 1999 2000 --------------- --------------- ASSETS Current assets: Cash $ 4,664 $ 3,740 Accounts, notes and leases receivable, net of allowance for bad debts of $6,765 and $10,872 in 1999 and 2000, respectively 56,510 119,238 Inventories 102,116 149,694 Prepaid expenses and other current assets 2,605 3,341 Deferred tax assets 6,059 2,289 --------------- --------------- Total current assets 171,954 278,302 Property, plant and equipment, net of accumulated depreciation of $32,602 and $34,227 in 1999 and 2000, respectively 89,510 106,857 Other assets, net 17,308 22,082 Cost in excess of fair value of net assets acquired, net of accumulated amortization of $4,449 and $4,923 in 1999 and 2000, respectively 30,869 28,875 --------------- --------------- TOTAL ASSETS $ 309,641 $ 436,116 =============== =============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable and current portion of long-term debt $ 7,286 $ 14,815 Accounts payable 6,920 9,783 Other current liabilities 30,753 38,863 --------------- --------------- Total current liabilities 44,959 63,461 Long-term debt 132,794 228,666 Deferred tax liabilities 21,569 24,986 Non-current pension liability 12,117 11,601 --------------- --------------- Total liabilities 211,439 328,714 --------------- --------------- Commitments and contingent liabilities Stockholders' equity: Common stock 9 9 Additional paid in capital 71,031 71,724 Retained earnings 48,488 61,008 Accumulated other comprehensive income (7,857) (11,387) Treasury stock, at cost (13,469) (13,952) --------------- --------------- Total stockholders' equity 98,202 107,402 --------------- --------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 309,641 $ 436,116 =============== =============== See notes to condensed consolidated financial statements. 3 STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS) (UNAUDITED) Three Months Ended Nine Months Ended ------------------------------ ------------------------------ October 2, September 30, October 2, September 30, 1999 2000 1999 2000 -------------- -------------- -------------- -------------- Net sales $ 72,707 $ 75,702 $ 232,001 $ 241,301 Cost of sales 50,648 52,260 157,797 166,321 -------------- -------------- -------------- -------------- Gross profit 22,059 23,442 74,204 74,980 Operating expenses: Sales and marketing 8,360 8,555 27,470 26,326 General and administrative 4,201 4,798 12,716 13,886 Amortization 987 938 2,944 2,762 Other operating expense 105 118 185 342 Non-recurring charges 1,490 1,490 ------------- -------------- -------------- -------------- Total operating expenses 13,653 15,899 43,315 44,806 -------------- -------------- -------------- -------------- Income from operations 8,406 7,543 30,889 30,174 Interest expense, net 3,676 4,236 9,989 11,203 Other (income) expense, net (776) (328) (1,138) (1,004) -------------- -------------- -------------- -------------- Income before income taxes 5,506 3,635 22,038 19,975 Provision for income taxes 2,037 835 8,815 7,455 -------------- -------------- -------------- -------------- Net income $ 3,469 $ 2,800 $ 13,223 $ 12,520 ============== ============== ============== ============== Net income per share: Basic $ .38 $ .31 $ 1.43 $ 1.40 ============== ============== ============== ============== Diluted $ .37 $ .31 $ 1.42 $ 1.40 ============== ============== ============== ============== Weighted average shares: Basic 9,241,350 8,921,724 9,247,882 8,917,621 ============== ============== ============== ============== Diluted 9,323,630 8,921,724 9,332,767 8,917,634 ============== ============== ============== ============== See notes to condensed consolidated financial statements. 4 STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) Nine Months Ended ----------------------------- October 2, September 30, 1999 2000 -------------- -------------- Cash flows from operating activities: Net income $ 13,223 $ 12,520 Adjustments to reconcile net income to cash flows from operating activities: Depreciation and amortization 8,638 8,769 Deferred tax benefit (1,451) (2,019) Other 133 155 Changes in operating assets and liabilities: Accounts, notes and leases receivable (32,489) (21,767) Inventories (1,911) (10,523) Prepaid expenses and other current assets (357) (666) Accounts payable (739) (356) Other current liabilities 4,162 4,269 -------------- -------------- Cash flows from operating activities (10,791) (9,618) Cash flows from investing activities: Capital expenditures (33,888) (6,193) Proceeds from disposals of fixed assets 138 122 Business acquisitions, net of cash acquired (32,484) Changes in other assets (631) 114 -------------- -------------- Cash flows from investing activities (34,381) (38,441) Cash flows from financing activities: Net borrowings under lines of credit 16,406 47,676 Proceeds from long-term debt 22,500 Repayments of long-term debt (994) (920) Proceeds from issuance of stock 786 693 Purchase of treasury stock (1,906) (483) -------------- -------------- Cash flows from financing activities 36,792 46,966 Effect of foreign exchange rate changes on cash (152) 169 -------------- -------------- Decrease in cash (8,532) (924) Cash, beginning of period 12,460 4,664 -------------- -------------- Cash, end of period $ 3,928 $ 3,740 ============== ============== Supplemental Cash Flow Information Interest paid $ 7,475 $ 8,469 ============== ============== Taxes paid $ 10,684 $ 12,237 ============== ============== See notes to condensed consolidated financial statements. 5 STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2000 (IN THOUSANDS EXCEPT SHARE DATA) (UNAUDITED) (1) BASIS OF PRESENTATION The accompanying condensed consolidated financial statements of Steinway Musical Instruments, Inc. and subsidiaries (the "Company") for the three month and nine month periods ended October 2, 1999 and September 30, 2000 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, 1999, 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, 1999 and Reports on Form 8-K filed with the Securities and Exchange Commission during 2000. The results of operations for the three months and nine months ended September 30, 2000 are not necessarily indicative of the results that may be expected for the entire year. On September 15, 2000, the Company completed the acquisition of United Musical Instruments Holdings, Inc. ("UMI") pursuant to a Stock Purchase Agreement dated as of July 20, 2000. The acquisition of UMI, as more fully discussed in Note 3, was accounted for as a purchase. The total purchase price has been allocated to UMI's assets and liabilities based on preliminary valuations of their relative fair values as of the closing date. These valuations include estimates and are subject to further review and adjustments. The financial statements of the Company for the nine months ended September 30, 2000 include the effects of the acquisition and the results of operations for UMI for the period September 15 to September 30, 2000. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION - The consolidated financial statements of the Company include the accounts of all of its direct and indirect wholly owned subsidiaries, including The Selmer Company, Inc. ("Selmer"), The Steinway Piano Company, Inc. ("Steinway") and UMI. Significant intercompany balances have been eliminated in consolidation. INCOME PER SHARE - Basic income per share is computed using the weighted average number of shares outstanding during each period. Diluted income per share reflects the effect of the Company's outstanding options using the treasury stock method. A reconciliation of the weighted average shares used for the basic and diluted computations for the three month and nine month periods ended October 2, 1999 and September 30, 2000 is as follows: THREE MONTHS ENDED NINE MONTHS ENDED ------------------------- ------------------------- 1999 2000 1999 2000 ---------- --------- --------- --------- Weighted average shares: For basic income per share 9,241,350 8,921,724 9,247,882 8,917,621 Dilutive effect of stock options 82,280 - 84,885 13 ---------- --------- --------- --------- For diluted income per share 9,323,630 8,921,724 9,332,767 8,917,634 ========== ========= ========= ========= 6 COMPREHENSIVE INCOME - Other comprehensive income (loss) is comprised of foreign currency translation adjustments. Total comprehensive income for the three month and nine month periods ended October 2, 1999 and September 30, 2000 is as follows: THREE MONTHS ENDED NINE MONTHS ENDED ------------------ ----------------- 1999 2000 1999 2000 ---- ---- ---- ---- Net income $ 3,469 $ 2,800 $ 13,223 $ 12,520 Other comprehensive income (loss) 1,642 (1,902) (2,237) (3,530) ---------- ---------- ----------- ----------- Total comprehensive income $ 5,111 $ 898 $ 10,986 $ 8,990 ========== ========== ========== ========== RECLASSIFICATIONS - Certain reclassifications of 1999 amounts have been made to conform to the 2000 financial statement presentation. (3) SUMMARY OF ACQUISITIONS In January 2000, the Company's subsidiary, Steinway & Sons, acquired Pianohaus Karl Lang, located in Munich, Germany, for approximately $2.3 million. On September 15, 2000, the Company completed the acquisition of United Musical Instruments Holdings, Inc. ("UMI") pursuant to a Stock Purchase Agreement dated as of July 20, 2000. The Company's existing lender funded the total purchase price of $84 million, including the assumption of approximately $57 million of debt, through an amended and restated credit agreement that expires on September 14, 2008. The amended agreement provided a $45 million term loan and increased the Company's potential borrowing capacity for its domestic seasonal borrowing requirements from $60 million to $120 million in revolving credit loans. The term loan is repayable in monthly installments of $417 for the first five years and monthly installments of $556 in years six through eight. The term loan and revolving credit loans bear interest at the average 30-day Libor rate plus 1.75%. Cash flow information with respect to the acquisition of UMI is as follows: Fair value of assets acquired $106,280 Liabilities assumed 76,136 Cash paid 30,144 7 (4) INVENTORIES Inventories consist of the following: December 31, September 30, 1999 2000 --------------- --------------- Raw materials $ 15,791 $ 20,813 Work in process 37,921 58,661 Finished goods 48,404 70,220 --------------- ------------- Total $ 102,116 $ 149,694 =============== ============== (5) OTHER (INCOME) EXPENSE, NET Other (income) expense, net consists of the following: Three months ended Nine months ended ------------------------------ ------------------------------ October 2, September 30, October 2, September 30, 1999 2000 1999 2000 ------------- --------------- ------------- ------------- West 57th Building income $ (1,164) $ (1,164) $ (2,353) $ (3,491) West 57th Building expenses 814 814 1,640 2,441 Foreign exchange (gain) loss, net (319) 206 (117) 454 Miscellaneous (107) (184) (308) (408) ------------- --------------- ------------- ------------- Other (income) expense, net $ (776) $ (328) $ (1,138) $ (1,004) ============= =============== ============= ============= (6) COMMITMENTS AND CONTINGENT LIABILITIES Certain environmental matters are pending against a subsidiary of the Company, which might result in monetary damages, the amount of which, if any, cannot be determined at the present time. Philips Electronics, a previous owner of a subsidiary of the Company, has agreed to hold the Company harmless from any financial liability arising from these environmental matters which were pending as of December 29, 1988. Management believes that these matters will not have a material adverse impact on the Company's results of operations or financial condition. 8 (7) SUMMARIZED FINANCIAL INFORMATION The Company is a holding company whose only material asset consists of its investment in its wholly owned subsidiary, Selmer. Summarized financial information for Selmer and its subsidiaries is as follows: Nine Months Ended December 31, September 30, October 2, September 30, 1999 2000 1999 2000 --------------- --------------- --------------- --------------- Current assets $ 169,295 $ 275,081 Total assets 306,516 432,437 Current liabilities 58,569 80,302 Stockholder's equity 110,811 120,922 Total revenues $ 229,878 $ 239,134 Gross profit 73,593 74,532 Net income 13,355 13,641 (8) SEGMENT INFORMATION The Company has 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. The following tables present information about the Company's operating segments for the three month and nine month periods ended October 2, 1999 and September 30, 2000: THREE MONTHS ENDED 1999 Piano Segment Band and Orchestral Segment ------------------------------------ ------------------------------ Other & Consol U.S. Germany Other Total U.S. Other Total Elim Total ---- ------- ----- ----- --- ----- ----- ---- ------ Revenues from external customers $28,384 $8,279 $3,979 $40,642 $30,594 $1,471 $32,065 $ - $72,707 Net income (loss) 1,058 126 290 1,474 (808) 31 (777) 2,772 3,469 THREE MONTHS ENDED 2000 Piano Segment Band and Orchestral Segment ------------------------------------ ------------------------------Other & Consol U.S. Germany Other Total U.S. Other Total Elim Total ---- ------- ----- ----- --- ----- ----- ---- ------ Revenues from external customers $28,394 $7,752 $5,193 $41,339 $32,898 $1,465 $34,363 $ - $75,702 Net income (loss) 742 1,017 583 2,342 (1,592) 6 (1,586) 2,044 2,800 NINE MONTHS ENDED 1999 Piano Segment Band and Orchestral Segment ------------------------------------ ------------------------------Other & Consol U.S. Germany Other Total U.S. Other Total Elim Total ---- ------- ----- ----- --- ----- ----- ---- ------ Revenues from external customers $83,553 $26,154 $12,835 $122,542 $106,253 $3,206 $109,459 $ - $232,001 Net income 3,143 730 1,007 4,880 226 46 272 8,071 13,223 NINE MONTHS ENDED 2000 Piano Segment Band and Orchestral Segment ------------------------------------ ------------------------------Other & Consol U.S. Germany Other Total U.S. Other Total Elim Total ---- ------- ----- ----- --- ----- ----- ---- ------ Revenues from external customers $89,642 $25,299 $14,539 $129,480 $108,315 $3,506 $111,821 $ - $241,301 Net income (loss) 2,603 1,499 1,275 5,377 (560) (26) (586) 7,729 12,520 9 (9) SUMMARY OF GUARANTEES The acquisition of Steinway in May 1995 was funded by Selmer's issuance of $105 million of 11% Senior Subordinated Notes (the "Notes") due 2005 and available cash balances of the Company. Selmer's payment obligations under the Notes are fully and unconditionally guaranteed on a joint and several basis by the Company as Parent (the "Guarantor Parent"), and by Steinway, UMI and certain direct and indirect wholly-owned subsidiaries of the Company, each a "Guarantor" (the "Guarantor Subsidiaries"). These subsidiaries, together with the operating divisions of Selmer, represent all of the operations of the Company conducted in the United States. The remaining subsidiaries, which do not guarantee the Notes, represent foreign operations (the "Non Guarantor Subsidiaries"). The following condensed consolidating supplementary data illustrates the composition of the combined Guarantors. Separate complete financial statements of the respective Guarantors would not provide additional material information which would be useful in assessing the financial composition of the Guarantors. No single Guarantor 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 accounted for by the parent on the cost method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are therefore not reflected in the parent's investment accounts and earnings. The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions. 10 STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATING BALANCE SHEETS SEPTEMBER 30, 2000 (IN THOUSANDS) (UNAUDITED) Non Guarantor Issuer Guarantor Guarantor Parent Of Notes Subsidiaries Subsidiaries Eliminations Consolidated ----------- --------- ----------- ------------ ------------ ------------ ASSETS Current assets: Cash $ -- $ 443 $ 1,392 $ 1,905 $ - $ 3,740 Accounts, notes and leases receivable, net 58,212 51,122 9,904 119,238 Inventories 38,628 85,838 26,356 (1,128) 149,694 Prepaid expenses and other current assets 232 2,013 406 690 3,341 Deferred tax assets 560 2,741 3,432 (4,444) 2,289 --------- --------- --------- --------- --------- --------- Total current assets 232 99,856 141,499 42,287 (5,572) 278,302 Property, plant and equipment, net 101 12,909 80,243 13,604 106,857 Investment in subsidiaries 71,143 195,887 56,147 (323,177) - Other assets, net 613 734 17,073 4,272 (610) 22,082 Cost in excess of fair value of net assets acquired, net 8,893 10,623 9,359 28,875 --------- --------- --------- --------- --------- --------- TOTAL ASSETS $ 72,089 $ 318,279 $ 305,585 $ 69,522 $(329,359) $ 436,116 ========= ========= ========= ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable and current portion of long-term debt $ - $ - $ 5,218 $ 9,597 $ - $ 14,815 Accounts payable 176 2,413 5,488 1,706 9,783 Other current liabilities (16,643) 7,526 44,984 8,322 (5,326) 38,863 --------- --------- --------- --------- --------- --------- Total current liabilities (16,467) 9,939 55,690 19,625 (5,326) 63,461 Long-term debt 155 145,104 83,407 228,666 Intercompany 32,178 77,617 (114,951) 5,156 - Deferred tax liabilities 2,440 15,203 7,343 24,986 Non-current pension liability 492 11,109 11,601 --------- --------- --------- --------- --------- --------- Total liabilities 15,866 235,100 39,841 43,233 (5,326) 328,714 Stockholders' equity 56,223 83,179 265,744 26,289 (324,033) 107,402 --------- --------- --------- --------- --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 72,089 $ 318,279 $ 305,585 $ 69,522 $(329,359) $ 436,116 ========= ========= ========= ========= ========= ========= 11 STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2000 (IN THOUSANDS) (UNAUDITED) Non Guarantor Issuer Guarantor Guarantor Parent of Notes Subsidiaries Subsidiaries Eliminations Consolidated ---------- --------- ------------ ------------ ------------ ----------- Net sales $ - $ 103,556 $ 100,747 $ 46,421 $ (9,423) $ 241,301 Cost of sales 75,858 69,309 30,459 (9,305) 166,321 --------- --------- --------- --------- --------- --------- Gross profit - 27,698 31,438 15,962 (118) 74,980 Operating expenses: Sales and marketing 8,073 11,299 7,020 (66) 26,326 General and administrative 2,468 3,983 4,120 3,315 13,886 Amortization 206 1,708 848 2,762 Other operating (income) expense (1,954) (183) 1,598 815 66 342 Non-recurring charges 1,290 200 1,490 --------- --------- --------- --------- --------- ---------- Total operating expenses 1,804 12,079 18,925 11,998 -- 44,806 --------- --------- --------- --------- --------- --------- Income (loss) from operations (1,804) 15,619 12,513 3,964 (118) 30,174 Interest (income) expense, net 15,273 (4,547) 477 11,203 Other (income) expense, net (864) (140) (1,004) --------- --------- --------- --------- --------- --------- Income (loss) before income taxes (1,804) 346 17,924 3,627 (118) 19,975 Provision for (benefit of) income taxes (830) 884 6,736 760 (95) 7,455 --------- --------- --------- --------- --------- --------- Net income (loss) $ (974) $ (538) $ 11,188 $ 2,867 $ (23) $ 12,520 ========= ========= ========= ========= ========= ========= 12 STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2000 (IN THOUSANDS) (UNAUDITED) Non Guarantor Issuer Guarantor Guarantor Parent Of Notes Subsidiaries Subsidiaries Eliminations Consolidated ---------- ----------- ------------ ------------ ------------ ------------ Cash flows from operating activities: Net income (loss) $ (974) $ (538) $ 11,188 $ 2,867 $ (23) $ 12,520 Adjustments to reconcile net income (loss) to cash flows from operating activities: Depreciation and amortization 35 2,105 4,709 1,920 8,769 Deferred tax benefit (546) (1,473) (2,019) Other 194 11 (50) 155 Changes in operating assets and liabilities: Accounts, notes and leases receivable (17,300) (4,273) (194) (21,767) Inventories 2,915 (10,132) (3,424) 118 (10,523) Prepaid expenses and other current assets 255 (549) (25) (347) (666) Accounts payable (12) (137) (818) 611 (356) Other current liabilities (3,342) (351) 7,952 105 (95) 4,269 -------- -------- -------- -------- -------- -------- Cash flows from operating activities (4,038) (13,661) 8,066 15 - (9,618) Cash flows from investing activities: Capital expenditures (33) (1,952) (3,260) (948) (6,193) Proceeds from disposals of fixed assets 1 121 122 Business acquisitions, net of cash acquired (26,500) (3,644) (2,340) (32,484) Changes in other assets 136 (22) 114 -------- -------- -------- -------- -------- --------- Cash flows from investing activities (33) (28,315) (6,904) (3,189) - (38,441) Cash flows from financing activities: Net borrowings (repayments) under lines of credit (49) 35,104 7,534 4,133 954 47,676 Repayments of long-term debt (368) (552) (920) Proceeds from issuance of stock 693 693 Purchase of treasury stock (483) (483) Intercompany transactions 3,910 5,440 (9,527) 177 - -------- -------- -------- -------- -------- --------- Cash flows from financing activities 4,071 40,544 (2,361) 3,758 954 46,966 Effect of exchange rate changes on cash 169 169 -------- -------- -------- -------- -------- -------- Increase (decrease) in cash - (1,432) (1,199) 753 954 (924) Cash, beginning of period 1,875 2,591 1,152 (954) 4,664 -------- -------- -------- -------- -------- -------- Cash, end of period $ - $ 443 $ 1,392 $ 1,905 $ - $ 3,740 ======== ======== ======== ======== ======== ========= 13 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS) INTRODUCTION The Company, through its Steinway and Selmer 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, including the assumption of approximately $57.0 million of debt. The purchase price has been allocated to UMI's assets and liabilities based on their relative fair values as of the closing date. These valuations include estimates and are subject to further review and adjustments. The financial statements of the Company for the nine months ended September 30, 2000 include the effects of the acquisition and the results of operations for UMI for the period September 15 to September 30, 2000. 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, 1999 and its Final Prospectus filed in August 1996. RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE MONTHS ENDED OCTOBER 2, 1999 NET SALES - Net sales increased $3.0 million (4%) to $75.7 million in the third quarter of 2000. Piano sales increased $0.7 million (2%) despite a $1.5 million negative foreign currency translation impact. Increased foreign demand drove Steinway & Sons piano unit shipments up 19% while domestic units increased 6%. Yen driven cost increases have forced the Company to increase prices on its Boston piano line twice during the last twelve months. Together with increased competition, these price increases slowed the Boston business considerably, particularly in the U.S. where unit shipments declined 28%. Band and orchestral instrument sales increased $2.3 million (7%) on an overall unit sales increase of 10%. GROSS PROFIT - Gross profit increased by $1.4 million (6%) to $23.4 million. Gross margins increased from 30.3% in 1999 to 31.0% in 2000. Piano margins increased from 34.0% in 1999 to 35.3% in 2000 as a result of strong retail sales, coupled with a shift in sales mix from Boston pianos to Steinway & Sons pianos. Band and orchestral instrument margins increased slightly from 25.7% in 1999 to 25.8% in 2000. 14 OPERATING EXPENSES - Overall operating expenses increased by $2.2 million (16%) to $15.9 million in the third quarter. These expenses included $1.3 million of non-recurring charges directly related to the acquisition of UMI and $0.2 million of expenses associated with the relocation of Emerson flute production from leased facilities into UMI facilities. Excluding the effect of non-recurring charges in the quarter, expenses as a percentage of sales increased slightly from 18.8% in 1999 to 19.0% in 2000. OTHER EXPENSE, NET - Other expenses increased by $1.0 million (35%) to $3.9 million. Net interest expense increased $0.6 million in the current year period due to higher average debt balances and the acquisition of UMI. INCOME TAXES - The Company's effective tax rate decreased from 37.0% in 1999 to 23.0% in 2000, reflecting a one-time tax benefit of $0.8 million associated with the reduction of deferred tax balances caused by a decrease in the German tax rate. NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED OCTOBER 2, 1999 NET SALES - Net sales increased $9.3 million (4%) to $241.3 million in the first nine months of 2000. Piano sales increased $6.9 million (6%) over the prior year period. Unit increases of 7% for Steinway pianos more than offset an 8% decline in Boston units. Band and orchestral instrument sales increased $2.4 million (2%) on a 3% increase in unit shipments. GROSS PROFIT - Gross profit increased by $0.8 million (1%) to $75.0 million in 2000. Gross margins declined from 32.0% in 1999 to 31.1% in 2000. Piano margins decreased from 35.1% in 1999 to 34.7% in 2000 primarily due to increased costs in the Boston line caused by a stronger yen. Lower average selling prices and production inefficiencies in the first half of the year adversely affected band instrument margins resulting in a decline in margins from 28.5% in 1999 to 26.9% in 2000. OPERATING EXPENSES - Operating expenses increased by $1.5 million (3%) to $44.8 million in the current year period. Excluding non-recurring charges incurred in the third quarter, operating expenses remained flat with the prior year. Expenses as a percentage of sales decreased slightly from 18.7% in 1999 to 18.6% in 2000. OTHER EXPENSE, NET - Other expenses increased by $1.3 million (15%) to $10.2 million in the current year period. Virtually all of the increase can be attributed to higher net interest expense resulting from higher average outstanding debt balances and the acquisition of UMI. INCOME TAXES - The Company's effective tax rate decreased from 40.0% in 1999 to 37.3% in 2000. This decrease was primarily due to a one-time tax benefit associated with the reduction of deferred tax balances caused by a 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 nine months was $10.8 million in 1999 and $9.6 million in 2000. Net working capital requirements decreased from $31.3 million in 1999 to $29.0 million in 2000. This change reflects a decrease in accounts receivable balances offset by an increase in inventory 15 balances in the current year period. A decline in Boston piano shipments has led to a temporary buildup in inventory of this product. The Company acquired the building that includes the Steinway Hall retail showroom in New York City in the first quarter of 1999 for $30.8 million. Additional capital expenditures of $3.1 million and $6.2 million in the first nine months of 1999 and 2000, respectively, were primarily used for the purchase of new machinery and building improvements. 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. In January 2000, the Company's subsidiary, Steinway & Sons, acquired Pianohaus Karl Lang, located in Munich, Germany, for approximately $2.3 million. Pianohaus Karl Lang is Germany's largest retail piano store and is expected to strengthen Steinway's foreign distribution network. On September 14, 2000, the Company entered into an amended and restated credit agreement (the "Credit Facility") with their existing lender to accommodate the acquisition of UMI. The Credit Facility, which expires on September 14, 2008, provided a $45.0 million term loan and increased the Company's potential borrowing capacity for its domestic seasonal borrowing requirements from $60.0 million to $120.0 million in revolving credit loans. The term loan is repayable in monthly installments of $0.4 million for the first five years and monthly installments of $0.6 million in years six through eight. The term loan and revolving credit loans bear interest at the average 30-day Libor rate plus 1.75%. As of September 30, 2000, revolving credit loans outstanding were $57.0 million and additional availability based on eligible accounts receivable and inventory balances, was approximately $63.0 million. Open account loans with foreign banks also provide for borrowings by Steinway's foreign subsidiaries of up to 40 million Deutsche marks ($18.0 million at the September 30, 2000 exchange rate). The Company's long-term financing consists primarily of $110.0 million of Senior Subordinated Notes and $66.7 million outstanding on term loans. 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. On June 1, 2000, the Senior Subordinated Notes became redeemable at the Company's option, in whole or in part, at 104.125% of the principal amount plus accrued and unpaid interest thereon to the applicable redemption date. The Company repurchased a total of 26,700 shares of its common stock in 2000 at a cost of $0.5 million. No shares were repurchased in the third quarter. The Company has undertaken a major initiative to effect fundamental changes in its band instrument manufacturing operations in 2000. New three-year contracts with the unions representing Selmer's employees were completed at the end of the first quarter. The project to implement the contract changes is expected to take up to twenty-four months to complete and will require an investment of approximately $2.0 million in 2000. While there will be certain short-term expenses and production disruption associated with this project, the long-term benefits are expected to be improved production flow, efficiency and quality. 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 2000. 16 NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board released Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", which was amended by SFAS 138, "Accounting for Certain Derivative Instruments and Hedging Activities" in 2000. These statements require that all derivatives be recognized at fair value in the balance sheet, and that the corresponding gains or losses be reported either in the statement of operations or as a component of comprehensive income, depending on the type of hedging relationship that exists. The Company will adopt the amended standard January 1, 2001. Based on the results of the analysis to date, management does not expect the adoption of the amended standard to have a material effect on the Company's results of operations or financial position. In December 1999, the Securities and Exchange Commission ("SEC") released Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition", which sets forth the SEC's views on appropriate revenue recognition practices. The Company believes that its current revenue recognition practices are in accordance with SAB No. 101. 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, 1999. 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, 1999. 17 PART II OTHER INFORMATION ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits EXHIBIT # DESCRIPTION --------- ----------- 27.1. Steinway Musical Instruments, Inc. - Financial Data Schedule 27.2 The Selmer Company, Inc. - Financial Data Schedule (b) Reports on Form 8-K The following reports on Form 8-K were filed during the quarter ended September 30, 2000: ITEM# DESCRIPTION FILING DATE ----- ----------- ----------- 5,7 A report announcing the agreement to acquire United Musical Instruments Holdings, Inc. July 25, 2000 2,5,7 A report announcing the completion of the acquisition of United Musical Instruments Holdings, Inc. September 29, 2000 18 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 --------------------------------- Dana D. Messina Director, President and Chief Executive Officer /s/ Dennis M. Hanson --------------------------------- Dennis M. Hanson Senior Executive Vice President and Chief Financial Officer THE SELMER COMPANY, INC. /s/ Thomas T. Burzycki --------------------------------- Thomas T. Burzycki Director, President and Chief Executive Officer /s/ Michael R. Vickrey --------------------------------- Michael R. Vickrey Executive Vice President and Chief Financial Officer Date: November 14, 2000 19