UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

 

 

COMMISSION FILE NUMBER 001-11911

 

STEINWAY MUSICAL INSTRUMENTS, INC.

(Exact name of registrant as specified in its charter)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:  None

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K.  ý

 

The aggregate market value of the Common Stock held by non-affiliates of the registrant was $149,049,162 as of March 12, 2002.

 

 

Documents incorporated by reference:  Part III - Items 10-13 - Definitive Proxy Statement of the Registrant to be filed pursuant to Regulation 14A, Parts I-IV - Final Prospectus of the Registrant dated August 1, 1996 filed pursuant to Rule 424(b).

 

PART I

 

ITEM 1                   BUSINESS

 

General

 

The Company, through its operating subsidiaries, is a world leader in the design, manufacture and marketing of high quality musical instruments.  The Steinway & Sons grand piano is considered to be the highest quality piano in the world and has one of the most widely recognized and prestigious brand names.  For more than a century, the Steinway concert grand has been the piano of choice for the world’s greatest and most popular pianists.  A survey of thirty of the world’s major symphony orchestras revealed that 98% of piano soloists chose a Steinway grand piano during the 2000/2001concert season.  As the largest domestic manufacturer of band and orchestral instruments, the Company offers a complete line of brasswind, woodwind, percussion and stringed instruments and related accessories. Selmer Paris saxophones, Bach Stradivarius trumpets, C.G. Conn French horns, King trombones and Ludwig snare drums are considered by many to be the finest such instruments in the world.  The Company’s net sales of $353 million for the year ended December 31, 2001 were comprised of $169 million in piano sales and $184 million in band and orchestral instrument sales.

 

The piano division concentrates on the high-end grand piano segment of the industry, hand crafting its Steinway pianos in New York and Germany.  The Company also offers vertical pianos as well as two mid-priced lines of pianos under the Boston and Essex brand names.  The Company sells its pianos worldwide through approximately 200 independent piano dealers and seven Company-operated retail showrooms including those located in New York, London, Munich and Berlin.  In 2001, approximately 59% of piano sales were in the United States, 27% in Europe and the remaining 14% primarily in Asia.

 

The band and orchestral division holds the leading domestic market share in virtually all of its product lines.  Instruments are made by a highly skilled workforce at manufacturing facilities in Indiana, Ohio, North Carolina, Illinois and Arizona, and sold through approximately 1,800 independent dealers and distributors.  Beginner instruments accounted for 75% of band and orchestral unit sales and 49% of instrument revenues in 2001, with advanced and professional instruments representing the balance.  In 2001, approximately 85% of band sales were in the United States, 7% in Europe and the remaining 8% primarily in Asia.

 

Certain statements contained throughout this annual report are “forward-looking statements” within the meaning of Section 21E of the Securities 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, 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 may cause actual results to differ materially from those indicated herein.  Further information on these factors is included in the Company’s Final Prospectus filed in August 1996, particularly the section therein entitled “Risk Factors”.

 

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Products

 

The Company offers pianos, band and orchestral instruments and services through the following subsidiaries and operating divisions:

 

Steinway & Sons offers two premium-priced product lines: grand pianos and vertical pianos.  Steinway pianos differ from all others in design specifications, materials used and the assembly process.  All of Steinway’s patented designs and innovations provide the unique sound and quality of the Steinway piano.

 

Grand pianos historically have accounted for the bulk of Steinway’s production.  Steinway offers eight models of the grand piano ranging from the 5’1” baby grand to the largest 9’ concert grand.  The smaller grands are sold to both individual and institutional customers, while the concert grands are sold primarily to institutions.  Steinway grand pianos are premium pianos in terms of quality and price, with retail prices generally ranging from $34,900 to $89,600 in the United States.  In 2001, Steinway sold 3,319 grand pianos, of which 2,224 units were shipped from its New York facility to dealers in North and Latin America.  The remaining 1,095 units were shipped from its German facility to various countries in Europe and Asia.

 

Vertical pianos offer dealers a complete line of quality pianos to satisfy the needs of institutions and other customers who are constrained by space limitations but unwilling to compromise on quality.  Steinway also provides services, such as restoration, repair, replacement part sales, tuning and regulation of pianos, at locations in New York, London, Hamburg and Berlin.  Restoration services range from minor damage repairs to complete restorations of old pianos.  In the 1990s Steinway expanded its restoration capacity to accommodate an increased focus on the procurement and resale of used Steinway pianos.

 

Boston Piano Company offers two complete lines of grand and vertical pianos for the mid-priced piano market.  These pianos, which are designed by Steinway and produced by Asian manufacturers, provide Steinway dealers with an opportunity to realize better margins in this price range while capturing sales that would have otherwise gone to a competitor.  These pianos provide an alternative product for future Steinway grand piano customers, since Company research indicates that the vast majority of Steinway customers have previously owned another piano.  The product lines also increase Steinway’s business with its dealers, making Steinway the dealer’s primary supplier in many instances, since these three product lines together offer a full spectrum of piano prices and styles.  The Boston line is comprised of nine upright and grand piano models, with retail prices ranging from $6,240 to $37,420.  The Essex line is comprised of four upright and grand piano models with retail prices ranging from $5,200 to $18,100.

 

The Band Instrument Divisions manufacture brasswind and woodwind instruments, including piccolos, flutes, clarinets, oboes, bassoons, saxophones, trumpets, cornets, and trombones at facilities in Elkhart, Indiana, Eastlake, Ohio and Nogales, Arizona.  These divisions also manufacture mouthpieces and distribute accessories such as oils, lubricants, polishes, stands, batons, sax straps, mutes and reeds.  Products are manufactured under the Armstrong, Bach, Conn, Emerson, King, Selmer and Signet brand names and are sold to student, amateur and professional musicians. Suggested retail prices generally range from $650 to $1,600 for student instruments and from $1,000 to $8,000 for step-up and professional instruments.  Products sold to professional musicians are often customized to meet specific design options or sound characteristics. The Company believes that specialization of products helps maintain a competitive edge in quality and product design.

 

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The Company is the exclusive U.S. distributor for Selmer Paris products. The Selmer Paris saxophone is generally considered to be one of the best in the world.  Selmer Paris, in turn, has exclusive distribution rights to certain of the Company’s woodwind and brasswind products in France.

 

The Percussion Division manufactures acoustical and tuned percussion instruments, including outfit drums, marching drums, concert drums, marimbas, xylophones, vibraphones, orchestra bells, chimes, mallets and accessories.  This division manufactures its products in Monroe, North Carolina and LaGrange, Illinois under the Ludwig and Musser brand names.  Ludwig is considered a leading brand name in acoustical drums and timpani and Musser has a strong market position in tuned percussion products.  Suggested retail prices range from $500 to $4,500 for acoustical drum outfits and from $2,000 to $16,000 for tuned percussion instruments.

 

The Stringed Instrument Divisions manufacture and distribute violins, violas, cellos and basses, and accessories such as bridges, covers, mutes, pads, chin rests, rosins, strings, bows, cases and instrument care products.  Products are sold under the Glaesel, Hermann Beyer, Otto Bruckner, Scherl & Roth and William Lewis & Son brand names.  Suggested retail prices generally range from $500 to $2,100 for student instruments and from $1,000 to $10,000 for intermediate and advanced instruments. Components are primarily imported from Europe and Asia and assembled at factories in Cleveland, Ohio and Elkhart, Indiana.

 

Customers

 

The Company’s core piano customer base consists of professional artists and amateur pianists, as well as institutions such as concert halls, conservatories, colleges, universities and music schools.  The majority of Steinway grand piano sales are to individuals.  These individuals are typically over 40 years old, with household income ranging from $150,000 to $300,000 per year and a serious interest in music.  The balance of sales to institutional customers has historically represented a larger portion of international revenue.  Over the past several years, the Company has introduced several unique marketing programs designed to increase institutional sales in the United States.  As a result, domestic shipments to institutions increased nearly 7% in 2000 and another 5% in 2001. The Company’s largest piano dealer accounted for approximately 4% of sales in 2001, while the top 15 accounts represented 27% of sales.

 

The majority of band instruments are purchased by students enrolled in music education programs.  Traditionally, students join school bands or orchestras at age 10 or 11 and learn on beginner level instruments, progressing to an advanced or professional level instrument in high school or college.  Management estimates that 85% of its domestic band sales are generated through educational programs.  The remaining domestic band sales are to professional or amateur musicians or performing groups, including orchestras and symphonies.  The Company’s largest band dealer accounted for approximately 7% of band sales in 2001, while the top 15 accounts represented approximately 29% of sales.

 

Sales and Marketing

 

Pianos. The Company distributes its pianos primarily on a wholesale basis through approximately 200 select dealers around the globe.  These dealers accounted for approximately 85% of pianos sold in 2001. The remaining 15% were sold directly by Steinway & Sons at one of its seven company-operated retail locations.  In 2001, Steinway Hall, the Company’s West 57th Street store, one of the largest and most famous piano stores in the world, was designated a historic landmark by the New York City Landmarks

 

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Preservation Commission.  The Company has a Japanese subsidiary as well as a representative office in China to provide appropriate coverage to the expansive Asian piano market.

 

The Company employs district sales managers, whose responsibilities include developing close working partnerships with domestic and international piano dealers. These highly experienced professionals provide sales training and technical support, as well as sales and marketing programs for consumers and institutions.  The sales managers are also responsible for promoting the Piano Bank and Steinway Artist programs described below.

 

The Concert and Artist Piano Bank.  Virtually all major venues throughout the world own a Steinway piano.  However, to ensure all pianists, and especially Steinway Artists, have a broad selection of instruments to meet their individual touch and tonal preferences, Steinway maintains the famed Concert and Artist Piano Bank (the “Piano Bank”).  The Piano Bank includes approximately 360 instruments worldwide.  Of these instruments, approximately 295 are located in the United States.  In New York City, the Steinway concert department has approximately 108 concert grands available for various occasions.  The balance of the domestic-based pianos are leased to dealers around the country who actively support the Steinway Artists program.  In addition to promoting the Company’s products in the music industry, the Piano Bank provides continuous feedback on the quality and performance of recently produced instruments from its most critical customer, the professional pianist.  The Piano Bank instruments, which have an average age of four years, are generally sold after five years and replaced with new pianos.

 

Steinway Artists.  For years, the Company has successfully used renowned artists in its marketing programs.  This form of marketing has helped solidify brand-name recognition as well as clearly demonstrate that Steinway pianos surpass all other brands in quality.  The “Steinway Artists” program, the endorsement of world-class pianists who voluntarily select the Steinway piano, is unique in that the Company does not pay artists to endorse its instruments.  To become a Steinway Artist, a pianist must not only meet certain performance and professional criteria, he or she must also own a Steinway piano.  The Steinway Artist roster currently includes approximately 1,300 of the world’s finest pianists who perform only on Steinway pianos.  In return for their endorsements, Steinway Artists are provided with access to the Piano Bank described above.

 

Distribution, Sales and Marketing of the Boston and Essex Piano Lines.  The Boston and Essex piano lines are targeted at the mid-priced segment of the market.  The lines provide both a broader product offering for dealers and entry-level products for future Steinway grand piano customers. With certain limited exceptions, the Company allows only Steinway dealers to carry the Boston and Essex piano lines and thus ensures that these pianos will be marketed as complementary product lines.  Increased traffic generated by these pianos creates current and future customers for Steinway.  The availability of a lower-priced Boston alternative has not negatively impacted the sales of other Steinway pianos.  The Boston piano line benefits from the “spillover” effect created by the marketing efforts supporting Steinway’s main product lines.  The Essex piano line, which was introduced in 2000, is experiencing similar complementary benefits without negatively impacting the Company’s Steinway line.

 

Band and Orchestral Instruments.  Band, orchestral and percussion instruments and related accessories are distributed worldwide through approximately 1,800 independent musical instrument dealers and distributors.  These products are marketed by district sales managers and independent sales representatives who are responsible for sales within assigned geographic territories in the United States and Canada.  Each district sales manager is also responsible for developing relationships with band and orchestral directors representing all levels of music education from elementary through universities and professional players. These individuals are the primary influence in the choice of an instrument brand.  Band directors will generally refer students to designated dealers for the purchase of instruments.  Management believes that its well-established, long-standing relationships with these influential music educators are an important component of its distribution strategy.

 

 

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Internationally, products are sold through dealers and distributors located in each major country.  International representatives help market the Company’s products to these dealers and distributors.

 

Dealers and distributors are supported through incentive programs, advertising and promotional activities.  Trade shows, educator conferences, print media, direct mail, telemarketing, the Internet and personal sales calls are the primary methods of reaching customers.  The Company actively advertises in consumer, educator and trade magazines and publications.  In addition, Company representatives attend several trade shows and educator conferences each year providing opportunities to interface directly with customers.

 

The Company’s educational director travels extensively, lecturing and motivating students, educators and parents on the value of music in a child’s development.  The Company also provides educational materials, catalogs and product specifications to students, educators, dealers and distributors.

 

Musical Instrument Industry

 

Pianos. The overall piano industry is comprised of three main categories: high-end grand pianos, mid/low-end grand pianos, and vertical pianos.  Domestic piano sales declined from the early 1970’s through the early 1990’s primarily due to a decrease in vertical pianos.  During this period, verticals were impacted by the increase in competition stemming from electronic alternatives and lower-cost, smaller, mass-produced grand pianos, which competed in the mid/low-end grand piano market. The vertical piano decline did not have a material adverse effect on the Company’s operating results, since the majority of its piano profit is realized from high-end grand piano sales, which are more generally affected by economic cycles.  From the middle through the end of the 1990’s, the industry experienced growth in all categories of pianos, and the introduction of the Boston line in the early 1990’s permitted the Company to compete in the mid-price category without sacrificing quality.   However, the industry is currently being impacted by the recent domestic economic downturn, and all categories of pianos are being adversely affected.  Management believes that the recent economic slowdown will be mitigated by favorable demographics and a general resurgence in music interests.

 

Market size and volume trends are difficult to quantify for international markets, as there is no single source for worldwide sales data.  Steinway’s strongest international markets outside the Americas are Germany, Japan, the United Kingdom, Switzerland and France.

 

Outside of the United States, China, Korea and Japan are the three largest piano markets in the world, with Japan representing the second largest grand piano market.  With its three piano lines, Steinway currently has 6% of the grand piano market share in Japan, compared to an average market share of approximately 12% in other major markets.  While adverse economic conditions in the Asian markets have slowed expansion opportunities, the Company believes that its long-term prospects remain good and continues to target this region in its distribution strategies.

 

Band and Orchestral Instruments.  The Company believes that the band and orchestral instrument industry has historically been impacted more by demographic trends and school budgeting than by macroeconomic cycles.  The domestic band and orchestral instrument industry experienced moderate sales declines starting in the mid to late 1970s, which strongly correlated to a decline in eleven year-old children during the same time period.  Since 1984, the industry had experienced steady growth, consistent with the increases in both student enrollment (grades K through 12) and school expenditures.  While the domestic market

 

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continued to grow through the late 1990’s, domestic supply has recently outpaced the demand. Financial woes in Asia and a stronger U.S. dollar fueled an increase of units imported into the domestic market from offshore low cost producers as well as a decline in exports by domestic manufacturers.  Additionally, key dealers continue to acquire and consolidate smaller dealers, resulting in more efficient use of their existing instrument stock, as well as an increased effort to repair and refurbish existing inventory instead of purchasing new inventories from manufacturers. The combination of these factors has created a highly price sensitive domestic market, where manufacturers have implemented aggressive marketing programs in an attempt to maintain market share positions.

 

The Company believes the outlook for future growth remains positive.  Stable demographic trends and recent studies emphasizing the importance of music education in a child’s development are expected to contribute to the industry’s growth potential.  Recently, the creators of Sesame Street introduced a public service initiative entitled Sesame Street Music Works, in an effort to encourage children to explore music.  Management believes that parents are encouraging their children to pursue musical instruments as a response to recent studies that show participation in music programs increase a student’s ability to excel in other aspects of their education (e.g., college entrance test scores).  In addition, many school band directors are promoting band programs as social organizations rather than the first step of intensive music study.

 

Competition

 

The Company is the largest domestic producer of band and orchestral instruments.  New entrants into the domestic market experience difficulty competing with the Company due to the long learning curve inherent in the production of musical instruments, the high quality standards set by the market, cost of tooling, significant capital requirements, lack of name-brand recognition and the utilization of an effective distribution system.  Foreign musical instrument manufacturers have made significant strides in recent years to improve their product quality.  They now offer a broad range of quality products at highly competitive prices and represent a significant competitive challenge for domestic producers.  The Company is focusing on raising product quality standards, investing in new technology to increase productivity and efficiency in the manufacturing process and developing aggressive marketing programs to maintain its market positions.

 

Few manufacturers compete directly with Steinway & Sons pianos, both in terms of quality and price.  Management believes that used Steinway pianos provide significant competition in its market segment.  Because of the potential savings associated with buying a used Steinway piano, as well as the durability of the instrument, a large market exists for used Steinways.  It is difficult to estimate the significance of used piano sales, since most are conducted in the private aftermarket. Increased emphasis on both restoration services and the procurement, refurbishment and sales of used Steinway pianos has generated additional revenue over the past few years.

 

Patents and Trademarks

 

The Company has several trademarks and patents effective and pending in the United States and in several foreign countries for varying lengths of time.  Steinway has pioneered the development of the modern piano with over 125 patents granted since its founding.  Piano trademarks include Steinway, Steinway & Sons, the Lyre symbol, Boston, designed by Steinway & Sons, and Essex.  Band and orchestral trademarks include Selmer, Bach, Bundy, Signet, William Lewis & Son, Ludwig, Musser, Emerson, Conn, King, Armstrong, Artley, Benge, and Scherl & Roth.  Management considers its various patents and trademarks to be important and valuable assets.

 

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Manufacturing Process

 

The Company manufactures the vast majority of the musical instruments that it sells. The manufacturing process involves essentially two main production phases: the production of component parts and instrument assembly.  Employees perform various forming, drilling, and cutting operations during the parts production phase.  Investment in new equipment in this area over the last several years has allowed the Company to increase its production capacity and improve quality.  Skilled craftsmen assemble component parts for the final assembly of the instruments.  Each instrument is tested or tuned and regulated to the Company’s specifications.

 

The manufacturing process for pianos takes up to nine months to achieve the high quality standards expected for Steinway pianos.  Raw materials are purchased primarily in the United States and Europe.

 

The Company maintains a fairly constant production schedule for band and orchestral instruments in order to minimize labor disruptions and to keep work-in-process inventories relatively stable.  Raw materials used in the production of brasswind and woodwind instruments are purchased primarily in the United States.  Component parts are imported from Europe and Asia for stringed and percussion instruments.

 

Recently the Company has implemented periodic shutdowns of selected manufacturing facilities in order to control inventory levels while maintaining a skilled workforce.

 

Labor

 

As of December 31, 2001, the Company employed 2,847 people, consisting of 2,144 hourly production workers and 703 salaried employees.  Of the 2,847 employees, 2,272 were employed in the United States and the remaining 575 were employed primarily in Europe.

 

Approximately 63% of the Company’s workforce in the United States is represented by labor unions.  Collective bargaining agreements covering these employees expire at various dates through 2003.  Manufacturing employees in Germany are represented by the workers’ council that negotiates annually on their behalf.  The Company believes that its relationship with its employees is generally good.

 

ITEM 2                   PROPERTIES

 

The Company owns most of its manufacturing and warehousing facilities, as well as the building that includes Steinway Hall.  The remaining Steinway retail stores are leased.  Substantially all of the domestic real estate has been pledged to secure the Company’s debt.

 

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The following table lists the Company’s significant owned and leased facilities:

 

				Approximate Floor space (Square Feet)
Location		Owned/Leased				Activity
New York, NY		Owned		449,900		Piano manufacturing; restoration center; administrative offices; training
		Owned		217,000		Piano retail store/showroom, office rental property
Hamburg, Germany		Owned		220,660		Piano manufacturing; executive offices; training
Eastlake, OH		Owned		160,000		Brasswind manufacturing
Elkhart, IN		Owned		144,000		Brasswind manufacturing
		Owned		88,000		Woodwind manufacturing; warehouse; office
		Owned		77,000		Woodwind manufacturing
		Owned		75,000		Warehouse
		Owned		25,000		Administrative offices
Springfield, OH		Owned		110,000		Piano plate manufacturing
Nogales, AZ		Owned		90,000		Band instrument manufacturing
LaGrange, IL		Owned		46,000		Percussion instrument manufacturing
		Leased		18,000		Timpani production
Wilkow, Poland		Owned		9,740		Piano key manufacturing
Monroe, NC		Leased		147,000		Drum and case manufacturing
Cleveland, OH		Leased		52,000		Stringed instrument manufacturing
Munich, Germany		Leased		29,000		Piano retail store/showroom
Wuppertal, Germany		Leased		27,450		Piano key manufacturing
London, England		Leased		20,000		Band instrument office; warehouse

 

The Company spent $7.1 million for capital improvements in 2001.  The majority of the expenditures were used for new machinery, building improvements, and certain EPA compliance projects. The Company expects capital spending in 2002 to be in the range of $7.0 to $8.0 million as it completes EPA compliance projects and continues to modernize equipment and renovate facilities in order to improve production efficiency.

 

ITEM 3                   LEGAL PROCEEDINGS

 

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

 

Environmental Matters - The Company is subject to compliance with various federal, state, local and foreign environmental laws, including those relating to discharges to air, water and land, the handling and disposal of solid and hazardous waste and the cleanup of properties affected by hazardous substances.  Certain environmental laws, such as the Comprehensive Environmental Response, Compensation, and Liability Act, as amended (“CERCLA”), impose strict, retroactive, joint and several liability upon persons responsible for releases of hazardous substances, which responsibility is broadly construed.

 

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As the result of an inspection in 1999, the Indiana Department of Environmental Management (“IDEM”) informed the Company that one of its facilities was not in compliance with several air pollution control rules regulating its use of volatile organic compounds (primarily trichloroethylene).  Immediately after the inspection, the Company took the necessary steps to return the facility to compliance with these rules.  The Company reached an agreement with IDEM regarding the disposition of this matter, including the assessment of certain immaterial fines.  In addition, the Company has agreed to permanently eliminate the use of trichloroethylene from its manufacturing process.  The cost incurred in 2001 for this capital project and upgrades to other related processes totaled $1.6 million.  The project is scheduled for completion in early 2002 with an additional cost of $0.4 million.

 

The Company is also continuing existing environmental remediation programs at facilities acquired in 2000.  The estimated remaining cost of these remediation programs is approximately $0.5 million and has been accrued by the Company.

 

On August 9, 1993, Philips Electronics North America Corporation (“Philips”) agreed to continue to indemnify the Company 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”).  To date, Philips has fully performed its obligations under the Environmental Indemnity Agreement.  The Environmental Indemnity Agreement terminates on December 29, 2008.  Four matters covered by the Environmental Indemnity Agreement are currently pending.  For two of these sites, Philips has entered into Consent Orders with the Environmental Protection Agency (“EPA”) or the North Carolina Department of Environment, Health and Natural Resources, as appropriate, whereby Philips has agreed to pay required response costs.  For the third site, the EPA has notified Selmer it intends to carry out the final remediation remedy itself.  The EPA estimates that this remedy has a present net cost of approximately $12.0 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, the Company was joined as defendant in an action involving a site formerly occupied by a business acquired by the Company in Illinois.  Philips has accepted the defense of this action pursuant to the terms of the Environmental Indemnity Agreement.  The potential liability of the Company at any of these sites is affected by several factors including, but not limited to, the method of remediation, the Company’s 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.

 

The Company operates manufacturing facilities at locations where hazardous substances (including chlorinated solvents) were used.  The Company believes that an entity that formerly operated one such facility may have released hazardous substances at such location, which was leased by the Company through July 2001.  The Company has not contributed to such release.  Further, the Company has a contractual indemnity from certain stockholders of such entity.  Such facility is not the subject of a legal proceeding involving the Company and, to the Company’s knowledge, is not 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.

 

The matters described above and the Company’s other liabilities and compliance costs arising under environmental laws are not expected to have a material impact on the Company’s capital expenditures, earnings or competitive position.  However, some risk of environmental liability is inherent in the nature of the Company’s current and former businesses and the Company might, in the future,

 

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incur material costs to meet current or more stringent compliance, cleanup or other obligations pursuant to environmental laws.

 

ITEM 4                   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

No matter was submitted to a vote of the Company’s security holders during the fourth quarter of the fiscal year ended December 31, 2001.

 

PART II

 

ITEM 5                   MARKET FOR REGISTRANT’S COMMON EQUITY

                                AND RELATED STOCKHOLDER MATTERS

 

The ordinary common stock of the Company is traded on the New York Stock Exchange (“NYSE”) under the symbol “LVB”.  The following table sets forth, for the period indicated, the high and low sales price per share of the ordinary common stock as reported on the NYSE.

 

		High			Low
Fiscal Year Ended December 31, 2000
First Quarter		$	20.94		$	17.50
Second Quarter		20.00			14.50
Third Quarter		18.75			16.38
Fourth Quarter		19.63			16.81
Fiscal Year Ended December 31, 2001
First Quarter		$	17.81		$	16.35
Second Quarter		20.54			16.05
Third Quarter		18.28			14.40
Fourth Quarter		17.45			12.40

 

The Company’s 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.  As of March 18, 2002, there were 1,776 holders of record of the Company’s Ordinary common stock and two holders of record of the Class A common stock.

 

The Company has no plans to pay cash dividends on the common stock.  The Company presently intends to retain earnings to reduce outstanding indebtedness and to fund the growth of the Company’s business.  The payment of any future dividends will be determined by the Board of Directors in light of conditions then existing, including the Company’s results of operations, financial condition, cash requirements, restrictions in financing agreements, business conditions and other factors.

 

The Company is restricted by the terms of its outstanding debt and financing agreements from paying cash dividends on its common stock, and may, in the future, enter into loan or other agreements that restrict the payment of cash dividends on the common stock.

 

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ITEM 6                   SELECTED CONSOLIDATED FINANCIAL DATA

 

The following table sets forth selected consolidated financial data of the Company as of and for the six years ended December 31, 2001, derived from the audited financial statements of the Company.  The table should be read in conjunction with the audited consolidated financial statements of the Company, including the notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.

 

		Years Ended December 31,
		1996			1997			1998			1999			2000 (1)			2001
		(In thousands except share and per share information)
Income Statement Data:
Net sales		$	257,903		$	277,848		$	293,251		$	304,636		$	331,698		$	352,612
Gross profit		84,235			93,281			98,479			100,748			104,958			107,498
Income from operations		33,124			38,249			41,813			41,140			41,689			38,472
Income before extraordinary item		7,421			13,700			16,651			17,345			16,904			15,269
Income per share before extraordinary item:
Basic		1.00			1.45			1.78			1.88			1.89			1.71
Diluted		1.00			1.45			1.75			1.87			1.89			1.71
Weighted average shares:
Basic		7,418,580			9,426,122			9,339,896			9,213,145			8,921,091			8,928,000
Diluted		7,418,580			9,458,841			9,505,640			9,277,798			8,921,108			8,928,000
Other Financial Data:
EBITDA (2)		$	44,520		$	50,175		$	54,072		$	54,822		$	57,352		$	54,059
Interest expense, net		17,107			12,776			11,911			13,276			16,110			16,731
Capital expenditures (3)		5,199			5,634			6,264			5,399			7,890			7,141
EBITDA (2)/interest expense, net		2.6		x	3.9		x	4.5		x	4.1		x	3.6		x	3.2		x
Cash flows from:
Operating activities		$	5,927		$	13,835		$	14,227		$	15,372		$	13,265		$	28,877
Investing activities		(5,039		)	(8,968		)	(5,289		)	(39,312		)	(93,798		)	(7,988		)
Financing activities		(865		)	(3,440		)	(1,718		)	16,304			80,584			(20,411		)
Margins:
Gross profit		32.7		%	33.6		%	33.6		%	33.1		%	31.6		%	30.5		%
EBITDA (2)		17.3		%	18.1		%	18.4		%	18.0		%	17.3		%	15.3		%
Balance Sheet Data (at year end):
Cash		$	3,277		$	5,271		$	12,460		$	4,664		$	4,989		$	5,545
Current assets		140,353			151,622			170,381			171,954			265,453			258,977
Total assets		265,366			266,708			283,927			309,641			421,816			414,040
Current liabilities		37,720			40,429			42,243			44,959			56,575			49,223
Total debt		118,391			115,457			117,028			140,080			223,410			211,203
Stockholders’ equity		67,878			75,761			91,757			98,202			113,207			120,371

 

Notes to Selected Consolidated Financial Data:

 

(1)    The Company acquired UMI in September 2000.

(2)             EBITDA represents earnings before depreciation and amortization, net interest expense and income tax expense (benefit), adjusted to exclude non-recurring charges.  While EBITDA should not be construed as a substitute for operating income or a better indicator of liquidity than cash flow from operating activities, which are determined in accordance with accounting principles generally accepted in the United States of America, it is included herein to provide additional information with respect to the ability of the Company to meet its future debt service, capital expenditure and working capital requirements which the Company believes certain investors find useful.  EBITDA is not necessarily a measure of the Company’s ability to fund its cash needs.

(3)    Capital expenditures for 1999 exclude $30.8 million for the purchase of Steinway Hall.

 

12

 

ITEM 7	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
	CONDITION AND RESULTS OF OPERATIONS

 

Introduction

 

The following discussion provides an assessment of the results of operations and liquidity and capital resources for the Company together with a brief discussion of certain of our accounting policies and should be read in conjunction with the consolidated financial statements of the Company and the notes thereto included elsewhere in this report.

 

Overview

 

The Company, through its operating subsidiaries, is one of the world’s leading manufacturers of musical instruments.  The Company’s strategy is to capitalize on its strong brand names, leading market positions and quality products.  The Company’s net sales of $353 million for the year ended December 31, 2001 were comprised of $169 million in piano sales and $184 million in band and orchestral instrument sales.

 

Piano sales are influenced by general economic conditions, demographic trends and general interest in music and the arts.  The operating results of this segment are primarily affected by Steinway & Sons grand piano sales.  Given the total number of these pianos sold in any year (3,319 sold in 2001), a slight change in units sold can have a material impact on the Company’s business and operating results.  The operating results of the piano segment are also influenced by sales of Boston and Essex pianos, which together represented approximately 50% of total piano units sold and approximately 20% of total piano revenues.  The Boston and Essex piano lines are manufactured in Asia, each by a single manufacturer.  The ability of these manufacturers to produce and ship products to the Company could also materially impact the Company’s business and operating results.  Based on current economic conditions, management estimates that domestic and international piano revenues for 2002 will remain relatively consistent with the 2001 results.  In 2001, approximately 59% of piano sales were in the United States, 27% in Europe and the remaining 14% primarily in Asia.

 

Student band instrument sales are strongly influenced by trends in school enrollment and general attitudes toward music and the arts. Management estimates that 85% of the Company’s domestic band sales are generated through educational programs. The school instrument business is strongly correlated to the number of school children in the United States which, after increasing steadily over the past several years, has stabilized and is expected to remain relatively constant over the next few years.  Beginner instruments accounted for 75% of band and orchestral unit shipments and 49% of instrument revenues in 2001, with advanced and professional instruments representing the balance. In 2001, approximately 85% of band sales were in the United States, 7% in Europe and the remaining 8% primarily in Asia.

 

While the school instrument business has been generally resistant to macroeconomic cycles, sales have been adversely affected recently by conservative dealer buying patterns which have been, in turn, heavily influenced by higher than expected rental instrument returns from their customers and high levels of available inventories from suppliers. Key dealers have recently begun to acquire and consolidate smaller dealers, resulting in more efficient use of their existing instrument stock. Dealers are focusing on selling through current inventories, primarily rental returns and used instruments, before ordering new instruments.  With the increase in product availability, dealers are choosing to use their suppliers for “just in time” inventory needs instead of making substantial investments in their own inventories.  In addition, the strong U.S. dollar has fueled an increase of units imported into the domestic market from offshore

 

13

 

low cost producers as well as a decline in exports by domestic manufacturers.  The combination of these factors has created a highly price sensitive domestic market with excess capacity.  Accordingly, the Company has refined its pricing structure on certain instruments in order to remain competitive in the increasingly efficient band instrument marketplace.  Management expects these trends to continue and, although the Company does not expect to lose market share, it does expect band revenues to remain relatively flat in 2002.

 

Although the Company cannot accurately predict the precise effect of inflation on its operations, it does not believe that inflation has had a material effect on sales or results of operations in recent years.  Sales to customers outside the United States represent approximately 28% of consolidated sales, with international piano sales accounting for over 72% of these international sales.  A significant portion of international piano sales originate from the Company's German manufacturing facility, resulting in sales, cost of sales and related operating expenses denominated in Euros. While currency translation has affected international sales, cost of sales and related operating expenses, it has not had a material impact on operating income.  The Company utilizes financial instruments such as forward exchange contracts and currency options to reduce the impact of exchange rate fluctuations on firm and anticipated cash flow exposures and certain assets and liabilities denominated in currencies other than the functional currency of the affected division.  The Company does not purchase currency related financial instruments for purposes other than exchange rate risk management.

 

The nature of the Company’s 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, recourse reserves on notes receivable, and warranty reserves.  The Company has available more than a century of 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 the Company’s financial statements.

 

The Company’s effective tax rates vary depending on the relative proportion of foreign to U.S. income and the absorption of foreign tax credits in the U.S.  In 2000, a one-time tax benefit associated with the reduction of deferred tax balances caused by an enacted rate reduction in Germany lowered the Company’s effective tax rate from 42% in 1999 to 38% in 2000.  This rate change was effective on January 1, 2001, resulting in a reduction of the Company’s effective tax rate in Germany from 56% in 2000 to 38% in 2001.  In addition, with the overall effective German rates now on par with the U.S. rates, the shift towards income generated from the German divisions no longer results in excess foreign tax credits, thereby allowing the Company to better utilize its overall foreign tax credits.

 

The Company has historically grown through strategic acquisitions of complementary businesses.  Recent acquisitions have included: O.S. Kelly, the largest domestic manufacturer of piano plates, in November 1999, Pianohaus Karl Lang (“PKL”), Germany’s largest retail piano store, in January 2000, and United Musical Instruments Holdings, Inc. (“UMI”), a domestic manufacturer of band and orchestral instruments, in September 2000. The following discussion includes each of these businesses since its date of acquisition.

 

14

 

Results of Operations

 

Fiscal Year 2001 Compared to Fiscal Year 2000

 

Net Sales– Net sales increased $20.9 million (6.3%) to $352.6 million in 2001. Piano sales declined $13.9 million (7.6%) to $169.0 million, reflecting a domestic unit shipment decrease of 20.2% as a result of the U.S. economic slowdown.  However, the decrease in domestic piano sales of 15.2% was partially offset by the strong performance of international piano sales, which increased $2.5 million, or 3.9% in 2001.  Band and orchestral sales increased $34.6 million (23.2%) to $183.6 million on a corresponding increase in band shipments of 23.1%.  This increase was primarily due to the $43.1 million of incremental revenue from UMI, which more than offset the negative effect of dealer consolidation.

 

Gross Profit– Gross profit increased $2.5 million (2.4%) to $107.5 million in 2001.  Gross margins declined to 30.5% from 31.6% in 2000 as a result of declines in both the piano and band margins. Piano margins declined slightly, from 35.6% to 35.1%, despite a favorable sales mix of higher margin concert grands reported by the Company’s international piano operations.  This decline was a result of additional factory shutdowns and the lower absorption of overhead costs in domestic piano operations.   These periodic shutdowns were instituted by management in order to control inventory levels, yet retain the skilled workforce, in response to the slowing economy.  Band instrument margins declined from 26.8% to 26.3% due to production changes at one manufacturing facility, which resulted in additional training costs and labor inefficiencies.  The incremental costs in 2001 of approximately $0.5 million related to a reengineering project at certain band instrument manufacturing plants also adversely impacted gross margin.

 

Operating Expenses – Operating expenses increased $5.8 million (9.1%) to $69.0 million in 2001.  Operating expenses as a percentage of sales increased slightly from 19.1% in 2000 to 19.6% in 2001.  Excluding the incremental operating expenses of UMI of $7.8 million in 2001 and the one-time charges of $1.5 million associated with the acquisition of UMI in 2000, operating expenses remained relatively flat.

 

Other Expense, Net – Other expense increased approximately $0.7 million (4.7%) to $15.0 million in 2001.  This increase is the result of higher interest expense associated with higher average outstanding debt balances incurred primarily as a result of the acquisition of UMI.

 

Fiscal Year 2000 Compared to Fiscal Year 1999

 

Net Sales - Net sales increased $27.1 million (8.9%) to $331.7 million in 2000.  Piano sales increased $9.3 million (5.3%), reflecting higher Steinway shipments which increased 14% overseas and more than 8% overall.  This strong performance by Steinway more than offset a 12% decline in Boston units, which were negatively impacted by significant price increases necessitated by the strengthening Japanese yen.  Band and orchestral sales increased $17.8 million (13.6%).  The acquisition of UMI added $19.8 million of sales, which offset a decline in average selling prices attributable to a change in the volume incentive program offered to band dealers.  Rebate programs previously offered, the cost of which had been included in operating expenses, were replaced with price discount programs.  Overall unit shipments increased 17%.

 

15

 

Gross Profit - Gross profit increased $4.2 million (4.2%) to $105.0 million.  Gross margins declined from 33.1% in 1999 to 31.6% in 2000.  Piano margins increased slightly, from 35.2% to 35.6%, as a result of the higher proportion of Steinway units sold.  Band instrument margins declined from 30.2% to 26.8% primarily due to the change to a volume-based price discount program from a rebate program.  Manufacturing inefficiencies that occurred in the first half of 2000, as well as additional costs associated with the reengineering of two manufacturing plants, also negatively impacted gross margins.

 

Operating Expenses - Operating expenses increased only $3.7 million (6.1%) despite the additions of UMI and PKL in 2000.  Operating expenses decreased as a percentage of sales from 19.6% in 1999 to 19.1% in 2000.  Operating expenses for existing operations declined primarily due to the replacement of rebate programs, which generated $3.6 million of expense in 1999.  This reduction was offset by the addition of $5.3 million in operating expenses from UMI and PKL, as well as $1.5 million of non-recurring charges associated with the UMI acquisition.

 

Other Expense, Net - Other expense increased $2.9 million (25.4%) to $14.3 million in 2000.  This increase is the result of higher interest expenses associated with higher average outstanding debt balances throughout the year and the acquisition of UMI.

 

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 provided by operations was $15.4 million in 1999, $13.3 million in 2000, and $28.9 million in 2001.  The significant increase in 2001 is the result of management’s effective control of inventory in response to the economic downturn and excessive availability of certain band instruments.  In 2000, the Company embarked on a major initiative to effect fundamental changes in its band instrument manufacturing operations.  Approximately $1.8 million and $2.1 million of expenses related to the project were incurred during 2000 and 2001, respectively.  The long-term benefits of the project, which will be completed by mid-2002, are expected to be improved production flow, efficiency and quality.

 

Cash used for the acquisitions of O.S. Kelly, PKL and UMI was $2.6 million in 1999 and $86.6 million in 2000, respectively.  The Company acquired the building that includes the Steinway Hall retail showroom in New York City in March 1999 for $30.8 million.  Funds for the acquisition were provided from cash on hand and a $22.5 million real estate term loan provided by the Company’s existing lender.

 

Capital expenditures of $5.4 million, $7.9 million and $7.1 million in 1999, 2000, and 2001, respectively, were primarily used for purchasing new machinery, building improvements, and certain EPA compliance projects.  The Company expects capital spending in 2002 to be in the range of $7-8 million as it completes EPA compliance projects and continues to modernize equipment and renovate facilities in order to improve production efficiency.

 

Consistent with industry practice, the Company sells band instruments almost entirely on credit utilizing the two financing programs described below.  These programs create large working capital requirements during the year when band instrument receivable balances reach highs of approximately $95-100 million in August and September, and lows of approximately $70-75 million in January and February.  The financing options, intended to assist dealers with the seasonality inherent in the industry

 

16

 

and to facilitate the rent-to-own programs offered to students by many retailers, also allow the Company to match its production and delivery schedules.  The following forms of financing are offered to qualified band instrument dealers:

 

a)        Receivable dating: Payments on purchases made from January through August are due in October.  Payments on purchases made from September to December are due in January.  Dealers are offered discounts for early payment.

 

b)       Note receivable financing: Qualified dealers may convert open accounts to a note payable to the Company.  The note program is offered in January and October and coincides with the receivable dating program.  In most instances, the note receivable is secured by dealer inventories and receivables.  A portion of the Company’s notes receivable are purchased by a third-party financing company on a full recourse basis.  The Company’s current arrangement, which allows the financing company to purchase, at its option, up to an aggregate amount outstanding at any time of $18.0 million of notes receivable, expires in August 2002.  Net notes receivable sales generated approximately $10.1 million and $12.7 million in cash in 2000 and 2001, respectively.  Outstanding balances on these notes were $6.3 million and $6.7 million as of December 31, 2000 and 2001, respectively.

 

Unlike many of its competitors in the piano industry, with limited exceptions, the Company does not provide extended financing arrangements to its dealers.  To facilitate long-term financing required by some dealers, financing has been arranged through a third-party provider which generally involves no guarantee by the Company.

 

The Company’s 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, which was amended and restated to accommodate the $150.0 million bond offering completed on April 19, 2001, provides the Company with a potential borrowing capacity of $85.0 million in revolving credit loans, and expires on September 14, 2008. The real estate term loan portion of the Credit Facility is payable in monthly installments of $0.2 million, based on a twenty-five year amortization, and includes interest at average 30-day LIBOR plus 1.5%.  This term loan is secured by all of the Company’s interests in the Steinway Hall property.  The acquisition term loan portion of the Credit Facility 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 acquisition term loan and revolving credit loans bear interest at average 30-day LIBOR plus 1.75%.  All of the Company’s borrowings under the Credit Facility are secured by a first lien on the Company’s domestic inventory, receivables, and fixed assets.  As of December 31, 2001, there were no revolving credit loans outstanding and availability based on eligible accounts receivable and inventory balances was approximately $85.0 million. Open account loans with foreign banks also provide for borrowings of up to €19.9 million ($17.8 million at December 31, 2001) by Steinway’s foreign subsidiaries.

 

On April 19, 2001, the Company completed a $150.0 million 8.75% Senior Note offering.  The proceeds of this offering were used to redeem $110.0 million of previously outstanding Senior Subordinated Notes, with the balance used to pay down the Credit Facility.  The early retirement of the Senior Subordinated Notes, which were redeemed on June 1, 2001 at 102.75% of the principal amount, generated an extraordinary charge of approximately $4.0 million, net of tax of $2.7 million.

 

At December 31, 2001, the Company’s total outstanding indebtedness amounted to $211.2 million, consisting of $150.0 million of 8.75% Senior Notes, $21.1 million on the real estate term loan, $38.9 million on the acquisition term loan, and $1.2 million of notes payable to foreign banks.  Cash

 

17

 

interest paid was $17.2 million and $19.1 million in 2000 and 2001, respectively.  All of the Company’s debt agreements contain covenants that place certain restrictions on the Company, including its ability to incur additional indebtedness, to make investments in other entities and to pay cash dividends. The Company was in compliance with all such covenants as of December 31, 2001.

 

The Company’s share repurchase program authorizes management to make discretionary repurchases of its ordinary common stock up to a limit of $25.0 million.  Repurchased shares are being held as treasury shares to be used for corporate purposes.  The Company repurchased 26,700 shares at a cost of $0.5 million in 2000 and 114,600 shares at a cost of $1.9 million in 2001.

 

The Company experiences long production and inventory turnover cycles which are constantly monitored by management, since fluctuations in demand can have a significant impact on these cycles.  In 2001, the Company successfully focused on managing its inventory levels and accounts receivable in order to maximize cash flow from operations.  The Company was therefore able to eliminate the outstanding debt on the revolving portion of the Credit Facility as of December 31, 2001.  Looking forward to 2002, the Company anticipates revenues and results from operations to remain essentially flat.  Management expects to continue its focus on maintaining sufficient, but not excessive, inventory levels, repaying debt, maintaining and expanding market share, and improving production efficiency.   The Company is not aware of any trends, demands, commitments, or costs of resources that are expected to materially impact liquidity or capital resources.  Accordingly, 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 debt service requirements, fund continuing capital requirements and satisfy working capital and general corporate needs through 2002.

 

New Accounting Pronouncements

 

In June 1998, the Financial Accounting Standards Board  (“FASB”) released Statement of Financial Accounting Standard (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which was amended by SFAS No. 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 income or as a component of comprehensive income, depending on the type of hedging relationship that exists.  The Company adopted the amended standard January 1, 2001.  The adoption of the amended standard had no material effect on the Company’s results of operations or financial position.

 

In July 2001 the FASB issued SFAS No. 141, “Business Combinations,” which supersedes Accounting Principles Board (“APB”) Opinion No. 16, “Business Combinations,” and SFAS No. 142, “Goodwill and Intangible Assets,” which supersedes APB Opinion No. 17, “Intangible Assets.”  SFAS No. 141 eliminates the pooling-of-interests method of accounting for business combinations and modifies the application of the purchase accounting method.  The provisions of SFAS No. 141 were effective for transactions initiated after June 30, 2001.  SFAS No. 142 eliminates the requirement to amortize goodwill and indefinite-lived assets. This standard will be adopted by the Company in fiscal year 2002.  Upon adoption the Company will cease to record amortization expense on its goodwill and trademark assets.  At December 31, 2001, the Company had $27.9 million of net goodwill and $9.1 million of net trademarks included in the financial statements.  Upon adoption the Company will avoid approximately $3.0 million of annual amortization before any impairments, which would have the pro-forma effect of increasing net income by approximately $2.3 million.  The Company has not yet completed the transitional assessment of the recoverability of its goodwill and trademark assets. However, it does not

 

18

 

expect that any impairment adjustments will be required based on facts and circumstances in existence at December 31, 2001.

 

In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.”  SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs.  SFAS No. 143 is effective for fiscal years beginning after June 15, 2002.  The Company does not expect the adoption of SFAS No. 143 to have a material impact on its financial position or results of operations.

 

In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which addresses the financial accounting and reporting for the impairment or disposal of long-lived assets.  SFAS No. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and also supersedes the accounting and certain reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” for the disposal of a segment of a business.  SFAS No. 144 will be adopted on January 1, 2002.  The Company does not expect the adoption of SFAS No. 144 to have a material impact on its financial position or results of operations.

 

ITEM 7A                               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 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.  As of December 31, 2001, a 10% positive change in foreign currency exchange rates from market rates would decrease the fair value of the contracts by approximately $0.4 million.  Gains and losses on the foreign currency exchange contracts are defined as the difference between the contract rate at its inception date and the current exchange rate.  However, any such gains and losses would generally be offset by corresponding losses and gains, respectively, on the related hedged asset or liability.

 

The Company’s interest rate exposure is limited primarily to interest rate changes on its variable rate debt.  The Credit Facility and term loans bear interest at rates that fluctuate with changes in LIBOR.  For the year ended December 31, 2001, a hypothetical 10% increase in interest rates would have increased the Company’s interest expense by approximately $0.6 million.  The Company uses interest rate caps to manage interest rate risk on foreign debt.  The carrying value of the caps is not material and a 10% change in interest rates would not have a material effect on the fair value of the caps.

 

The Company’s long-term debt includes $150.0 million of Senior Notes with a fixed interest rate.  Accordingly, there would be no immediate impact on the Company’s interest expense associated with these Notes due to fluctuations in market interest rates.  However, based on a hypothetical 10% immediate decrease in market interest rates, the fair value of the Company’s Senior Notes, which would be sensitive to such interest rate changes, would be increased by approximately $4.0 million as of December 31, 2001.  Such fair value changes may affect the Company’s determination whether to retain, replace or retire these Notes.

 

19

 

ITEM 8                   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

INDEPENDENT AUDITORS’ REPORT

CONSOLIDATED FINANCIAL STATEMENTS:

Consolidated Statements of Income for the Years Ended December 31, 1999, 2000 and 2001

Consolidated Balance Sheets as of December 31, 2000 and 2001

Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 2000 and 2001

Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 1999, 2000 and 2001

Notes to Consolidated Financial Statements

Schedule II - Valuation and Qualifying Accounts

 

20

 

INDEPENDENT AUDITORS’ REPORT

 

 

To the Board of Directors and Stockholders of

Steinway Musical Instruments, Inc.:

 

 

We have audited the accompanying consolidated balance sheets of Steinway Musical Instruments, Inc. and subsidiaries as of December 31, 2000 and 2001, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2001.  Our audits also included the financial statement schedule listed in the Index at Item 14(a)(1).  These financial statements and financial statement schedule are the responsibility of the Company’s management.  Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with auditing standards generally accepted in the United States of America.  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Steinway Musical Instruments, Inc. and subsidiaries as of December 31, 2000 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.  Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

 

/s/  DELOITTE & TOUCHE LLP

Boston, Massachusetts

February 22, 2002

 

21

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001

 

		1999			2000			2001
		(In Thousands Except Share and Per Share Amounts)
Net sales		$	304,636		$	331,698		$	352,612
Cost of sales		203,888			226,740			245,114
Gross profit		100,748			104,958			107,498
Operating expenses:
Sales and marketing		37,527			37,342			42,251
General and administrative		17,790			19,694			21,909
Amortization		3,928			3,856			4,255
Other operating expenses		363			887			611
Non-recurring charges		—			1,490			—
Total operating expenses		59,608			63,269			69,026
Income from operations		41,140			41,689			38,472
Other (income) expense:
Other income, net		(1,881		)	(1,825		)	(1,778		)
Interest income		(907		)	(1,291		)	(2,306		)
Interest expense		14,183			17,401			19,037
Other expense, net		11,395			14,285			14,953
Income before income taxes		29,745			27,404			23,519
Provision for income taxes		12,400			10,500			8,250
Net income before extraordinary loss		17,345			16,904			15,269
Extraordinary loss on early extinguishment of debt (net of tax benefit of $2,662)		—			—			3,950
Net income		$	17,345		$	16,904		$	11,319
Earnings per share:
Basic earnings per share before extraordinary loss		$	1.88		$	1.89		$	1.71
Extraordinary loss on early extinguishment of debt		—			—			(0.44		)
Basic earnings per share		$	1.88		$	1.89		$	1.27
Diluted earnings per share before extraordinary loss		$	1.87		$	1.89		$	1.71
Extraordinary loss on early extinguishment of debt		—			—			(0.44		)
Diluted earnings per share		$	1.87		$	1.89		$	1.27
Weighted average shares:
Basic		9,213,145			8,921,091			8,928,000
Diluted		9,277,798			8,921,108			8,928,000

 

See notes to consolidated financial statements.

 

22

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2000 AND 2001

 

		December 31, 2000			December 31, 2001
		(In Thousands Except Share Data )
ASSETS
Current assets:
Cash		$	4,989		$	5,545
Accounts, notes and leases receivable, net of allowance for bad debts of $11,377 and $10,909 in 2000 and 2001, respectively		93,042			82,188
Inventories		160,296			161,124
Prepaid expenses and other current assets		3,005			4,484
Deferred tax assets		4,121			5,636
Total current assets		265,453			258,977
Property, plant and equipment, net		106,415			104,011
Other assets, net		20,645			23,135
Cost in excess of fair value of net assets acquired, net of accumulated amortization of $5,231and $5,999 in 2000 and 2001, respectively		29,303			27,917
TOTAL ASSETS		$	421,816		$	414,040
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt		$	9,516		$	7,446
Accounts payable		11,206			7,682
Other current liabilities		35,853			34,095
Total current liabilities		56,575			49,223
Long-term debt		213,894			203,757
Deferred tax liabilities		26,316			27,118
Other non-current liabilities		11,824			13,571
Total liabilities		308,609			293,669
Commitments and contingent liabilities
Stockholders’ equity:
Class A Common Stock, $.001 par value, 5,000,000 shares authorized, 477,953 shares issued and outstanding		—			—
Common stock, $.001 par value, 90,000,000 shares authorized, 8,453,547 and 8,368,496 shares outstanding in 2000 and 2001, respectively		9			9
Additional paid-in capital		71,724			72,178
Retained earnings		65,392			76,711
Accumulated other comprehensive loss		(9,966		)	(12,674		)
Treasury stock, at cost (659,400 and 774,000 shares in 2000 and 2001, respectively)		(13,952		)	(15,853		)
Total stockholders’ equity		113,207			120,371
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	421,816		$	414,040

 

See notes to consolidated financial statements.

 

23

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001

 

		1999			2000			2001
		(In Thousands)
Cash flows from operating activities:
Net income		$	17,345		$	16,904		$	11,319
Adjustments to reconcile net income to cash
flows from operating activities:
Depreciation and amortization		11,618			12,342			13,803
Early extinguishment of debt		—			—			6,612
Deferred tax expense (benefit)		(2,079		)	(2,349		)	(1,421		)
Other		274			240			431
Changes in operating assets and liabilities:
Accounts, notes and leases receivable		(5,028		)	4,739			9,864
Inventories		(8,883		)	(20,242		)	(3,520		)
Prepaid expense and other current assets		(251		)	365			(2,533		)
Accounts payable		104			2,161			(3,440		)
Other current liabilities		2,272			(895		)	(2,238		)
Cash flows from operating activities:		15,372			13,265			28,877
Cash flows from investing activities:
Capital expenditures		(36,192		)