10-K 1 a2213507z10-k.htm 10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K


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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2012

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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934

COMMISSION FILE NUMBER 001-11911

STEINWAY MUSICAL INSTRUMENTS, INC.
(Exact name of registrant as specified in its charter)

DELAWARE   35-1910745
(State or Other Jurisdiction of Incorporation or Organization)   (I.R.S. Employer Identification No.)

800 South Street, Suite 305,
Waltham, Massachusetts
(Address of Principal Executive Offices)

 


02453
(Zip Code)

Registrant's telephone number, including area code
(781) 894-9770

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

Title of each class
  Name of each exchange on which registered
Ordinary Common Shares, $.001 par value   New York Stock Exchange

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

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o    No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o    No ý

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements during the past 90 days. Yes ý    No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

Large accelerated filer o   Accelerated filer ý   Non-accelerated filer o   Smaller Reporting Company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No ý

The aggregate market value of the Common Stock held by non-affiliates of the registrant was $129,666,961 as of June 30, 2012.

Number of shares of Common Stock outstanding as of March 7, 2013:

  Ordinary   12,458,614

DOCUMENTS INCORPORATED BY REFERENCE

Parts I-IV – Final Prospectus of the Registrant dated August 1, 1996 filed pursuant to Rule 424(b).

   


Note Regarding Forward-Looking Statements

        Certain statements contained throughout this Annual Report on Form 10-K are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent our present expectations or beliefs concerning future events. We caution readers that such statements are necessarily based on certain assumptions that are subject to risks and uncertainties, which could cause actual results to differ materially from those indicated in this report. These risk factors include, but are not limited to, the factors discussed in Item 1A of this report. We encourage investors to read Item 1A carefully. Undue reliance should not be placed on the forward-looking statements contained in this report. These statements, like all statements contained in this report, speak only as of the date of this report (unless another date is indicated) and we undertake no obligation to update, supplement or revise the statements except as required by law.

Note Regarding Incorporation By Reference

        The Securities and Exchange Commission ("SEC") allows us to disclose certain information by referring the reader to other documents we have filed with the SEC. The information to which we refer is "incorporated by reference" into this Annual Report on Form 10-K. Please read that information.

PART I

Item 1. Business

Company History

        Steinway Musical Instruments, Inc., through its wholly owned subsidiaries, is a global leader in the design, manufacture, marketing and distribution of high quality musical instruments. We are the largest domestic manufacturer of musical instruments. Whenever we refer to the "Company" or to "us," or use the terms "we" or "our" in this annual report, we are referring to Steinway Musical Instruments, Inc. and its subsidiaries.

        Steinway Musical Instruments, Inc., formerly Selmer Industries, Inc., was incorporated in 1993. We are a Delaware corporation with our principal executive offices located at 800 South Street, Suite 305, Waltham, Massachusetts 02453, and our telephone number is (781) 894-9770. Through our corporate website, www.steinwaymusical.com, we provide access free of charge to all of our filings with the SEC, including our Annual Reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. These reports are available immediately following filing with the SEC. Information contained on or connected to our website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this report or any other filing that we make with the SEC. Additionally, the SEC maintains an Internet site at www.sec.gov that contains reports, proxy and information statements and other information regarding issuers like us that file electronically with the SEC.

Financial Information by Segment and Geographic Location

        Information on business segments and geographic areas in which we operated for the years ended December 31, 2012, 2011 and 2010 is contained in Note 19 to the Consolidated Financial Statements included in this report.

Musical Instrument Industry

        We operate two reportable segments within the musical instrument industry: pianos and band & orchestral instruments.

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Pianos – The overall piano market is comprised of two main categories: grand pianos and upright pianos. Steinway & Sons pianos compete in the high-end segment of the market, whereas our Boston and Essex lines compete in the mid-priced segment of the piano market.

        From 2005 to 2008, grand piano sales declined an average of 20% annually in the United States, the world's largest grand piano market. Since we realize the majority of our profit from high-end grand piano sales, which are generally more affected by economic cycles and demographics than by industry trends, our U.S. results were better than the industry results through 2008. However, the effects of the economic crisis severely impacted both our sales and the industry as a whole in 2009. Over the last few years, industry sales have improved, but sales in the U.S. grand piano market remain significantly lower than historical averages. While our sales of grand pianos in the United States and in most of our markets in Europe and Asia have increased, they continue to be at depressed levels. Conversely, our grand piano sales in China, the largest piano market in Asia, have increased annually since 2005.

Band & Orchestral Instruments – Demand for band & orchestral instruments in the domestic market has traditionally been more significantly impacted by factors such as demographic trends and school budgeting than by macroeconomic cycles. Studies have emphasized the importance of music education in a child's development and many school band directors promote band programs as social organizations rather than the first step of intensive music study. We expect this emphasis on music education and steady demographic trends to contribute to a relatively stable domestic market in the long term.

        Imports into the domestic market from offshore low-cost producers have created a highly price sensitive domestic market. Imported instruments have also allowed dealers to source their own proprietary lines in an attempt to improve their margins. To remain competitive in this market, we import some student woodwind and brass instruments, primarily entry-level, made to our specifications. The impact of lower priced imported instruments has also led to consolidation within the industry, leaving Conn-Selmer, Yamaha and Jupiter as the top three remaining full line competitors.

Business and Products

Piano Segment

        The Family of Steinway-Designed Pianos is a comprehensive offering of the world's finest pianos at three distinct price points to suit every buyer looking to purchase a fine quality piano. The family is comprised of our three brands: Steinway & Sons, Boston and Essex.

        Steinway & Sons grand pianos, handcrafted in New York and Germany, are considered to be the highest quality pianos in the world and have one of the most widely recognized and prestigious brand names. We also offer Steinway & Sons upright pianos as well as two mid-priced lines of pianos under the Boston and Essex brand names.

Steinway & Sons Pianos – Steinway & Sons pianos differ from all others in design specifications, materials used and the assembly process. We offer two premium-priced product lines under the Steinway & Sons brand: grand pianos and upright pianos. Grand pianos historically have accounted for the majority of our production. We offer seven sizes 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 & Sons grand pianos are premium pianos in terms of quality and price, with retail prices for ebony pianos generally ranging from $56,600 to $142,300 in the United States. Limited edition pianos and pianos with special veneers sell for retail prices of up to $218,000. Steinway & Sons also offers art case pianos designed by either Steinway master craftsmen or renowned artisans. These unique creations often feature exteriors of

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elaborate marquetry and intricate hand-painting. Many of these pianos are created to commemorate special events and anniversaries.

        In 2012, we sold 2,001 grand pianos, of which 1,098 units were shipped from our New York facility to dealers in the Americas. The remaining 903 units were shipped from our German facility primarily to Europe and Asia.

        Our upright pianos are intended to satisfy the needs of institutions and other customers who are constrained by space limitations. We also provide services such as repair, replacement part sales, tuning and rental of pianos, and restoration. Restoration services range from repairs of minor damage to complete restorations of vintage pianos.

Boston and Essex Pianos – No matter what an individual's level of skill, the Family of Steinway-Designed Pianos can offer an instrument perfectly matched to a customer's needs. To compete in the mid-priced category, we offer our Boston and Essex lines. A synthesis of high technology and the highest musical standards that have made the name Steinway synonymous with musical excellence, these pianos offer a level of performance and quality that we believe is far superior to any pianos in their price range.

        Materials, specifications and superior playing experience put our Boston pianos at the top of the mid-priced range. We also offer Essex pianos as an affordable entry into the Steinway family. Both lines are engineered by Steinway & Sons to achieve optimal performance.

        With certain limited exceptions, we allow only Steinway & Sons dealers to carry Boston and Essex pianos, thereby ensuring that these pianos will be marketed as complementary product lines to the Steinway & Sons line. These pianos, which were designed by us and are produced for us in Asia, provide our dealers with an opportunity to realize better margins in this price range while capturing sales that would have otherwise gone to a competitor. Also, since our research indicates that the vast majority of Steinway customers have previously owned another piano, Boston and Essex pianos provide future Steinway piano customers with the opportunity to join the Steinway family of owners sooner. The Family of Steinway-Designed Pianos increases our business with our dealers, making us their primary supplier in many instances. Retail prices for Boston upright and grand pianos generally range from $7,300 to $50,400 in the United States. Retail prices for Essex pianos range from $4,800 to $19,100 in the United States. Sales of Boston and Essex pianos accounted for 21% of our piano division revenue and 74% of piano unit sales in 2012.

Band Segment

        We are the largest domestic producer of band & orchestral instruments and offer a complete line of brass, woodwind, percussion and string instruments with well-known brand names. We have complemented our domestic manufacturing strategy with a sourcing strategy from Asia to remain competitive in the marketplace. We have established relationships with several overseas manufacturers to produce entry-level student instruments to our design specifications. To ensure that our imported instruments meet our expectations, we have our own quality assurance staff in China to monitor and evaluate our instrument suppliers.

        In 2012, sales of sourced products accounted for approximately 40% of our band division revenue. In addition to entry-level student woodwind and brass instruments from Asia, which comprise approximately 10% of our total band sales, we also import other products such as professional saxophones, outfit drums and accessories from sources worldwide.

Woodwind and Brass Instruments – We manufacture piccolos, flutes, clarinets, oboes, bassoons, trumpets, French horns, tubas, and trombones in our manufacturing facilities in Indiana and Ohio. We sell student-level instruments in three distinct product groupings: "good" entry-level imported

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instruments, "better" mid-priced instruments, which are either imported or manufactured by us, and "best" instruments, the majority of which are manufactured by us. In addition, we also manufacture intermediate and professional-level woodwind and brass instruments. Sales of woodwind and brass instruments accounted for 63% of our band division revenue in 2012.

        We sell our woodwind and brass products under the brand names Bach, Selmer, Selmer Paris, C.G. Conn, Leblanc, King, Armstrong, Holton, and Yanagisawa. Suggested retail prices generally range from $400 to $2,700 for student instruments and from $1,600 to $15,600 for intermediate and professional instruments. We often customize the products that we sell to professional musicians so that the product meets requested design specifications or has certain sound characteristics. We believe that specialization of products helps us maintain a competitive edge in quality and product design. Our specialized woodwind and brass instruments sell for up to $38,000.

        We are the exclusive U.S. distributor for Yanagisawa saxophones and Selmer Paris saxophones and clarinets. The Selmer Paris saxophone is one of the best selling professional saxophones in the world.

Percussion Instruments – We manufacture, source, and distribute acoustical and tuned percussion instruments, including outfit drums, marching drums, concert drums, marimbas, xylophones, vibraphones, orchestra bells, and chimes. We manufacture percussion products in North Carolina and 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 $5,000 for acoustical drum outfits and from $1,250 to $22,000 for tuned percussion instruments, with specialized tuned instruments purchased by symphonies and orchestras selling for up to $28,000. Sales of percussion instruments accounted for 13% of our band division revenue in 2012.

String Instruments – We distribute primarily student-level violins, violas, cellos, and basses. Products are sold under the brand names Glaesel, Scherl & Roth, and William Lewis & Son. Suggested retail prices generally range from $300 to $3,300. We source complete instruments from Asia or import components from Europe and Asia and adjust them at our factory in Ohio. Sales of string instruments accounted for 3% of our band division revenue in 2012.

Accessories – We manufacture mouthpieces and distribute accessories such as music stands, batons, mallets, straps, mutes, reeds, pads, chin rests, strings, bows, cases and instrument care products. Sales of accessories accounted for 21% of our band division revenue in 2012.

Customers

Piano Segment

        Most of our piano sales are to individuals, including both professional artists and amateur pianists. A majority of our Boston and Essex customers are between 40 and 50 years old and have an intermediate level of musical skill. They hold graduate degrees and report annual household income over $150,000. A majority of our Steinway & Sons customers are over 50 years old, and have a more advanced level of musical skill. They also hold graduate degrees and report income over $300,000.

        The institutional segment of the piano market is less sensitive to economic cycles than the consumer segment. Over the past several years, we have increased our marketing and sales focus on the institutional market, particularly in the United States, the United Kingdom and China. We sell pianos to institutions such as concert halls, universities, music schools, houses of worship, hotels, and retirement homes. Approximately 16% of pianos sold in 2012 were to institutional customers. The All-Steinway School program targets music schools, conservatories and universities and encourages

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them to obtain the All-Steinway designation in order to attract the best music students to their programs. This prestigious list grew 12% in 2012, to 152 institutions worldwide.

        Market size and volume trends are difficult to quantify for international piano markets, as there is no single source for worldwide sales data. Outside the United States, our strongest market shares in grand pianos are in Germany, Austria, France, Switzerland, Belgium, and the United Kingdom. We believe that we hold an average grand piano market share of approximately 20% in these countries.

        We expect a large portion of our long-term growth to come from South America and China due to favorable demographic trends and the strong piano culture in these regions. Our revenue from China, the second largest grand piano market in the world, grew 22% in 2012, providing us an estimated market share of 6%.

        In 2012, our piano sales had the following geographic breakdown based on customer location: approximately 45% in the Americas, 26% in Europe, and 29% in the Asia-Pacific region. Our largest piano dealer accounted for approximately 3% of piano sales in 2012, while the top 15 accounts represented 26% of piano sales.

Band Segment

        Band & orchestral instruments are sold to students, amateur and professional musicians, and institutions. The majority of our instruments are purchased or rented from dealers by students enrolled in music education programs in the United States. Students join school bands or orchestras at age 11 or 12 and learn on beginner level instruments, progressing to intermediate or professional-level instruments in high school or college. We estimate that over 75% of our domestic band sales are generated through educational programs. The remaining domestic band sales are to amateur or professional musicians or performing groups, including orchestras and symphonies. Student-level instruments accounted for approximately 60% of band & orchestral unit sales and approximately one-third of instrument revenues in 2012, with intermediate and professional instruments representing the balance.

        Historically, over 80% of our band sales have been in the United States. In recent years, Asian and European markets have presented significant opportunities for growth due to the quality of our instruments and the strength of our brand names. Through collaborative efforts with our overseas distributors, we expect these markets to be a source of revenue growth in the coming years.

        In 2012, approximately 77% of band sales were in the Americas, 10% in Europe, and 13% in the Asia-Pacific region. Our largest group of band dealers under common control accounted for approximately 12% of band sales in 2012, while the top 15 accounts represented approximately 40% of band sales.

Sales and Marketing

Piano Segment

        We distribute our pianos worldwide through nearly 200 independent dealers who operate approximately 300 showrooms. We also have company operated selection centers in Tokyo and Shanghai which serve our dealers in Japan and China. In addition, we sell our pianos through fifteen company operated retail showrooms: nine in the United States and six in Europe. Sales to dealers accounted for approximately 74% of piano segment revenue in 2012. The remaining 26% was generated from sales made directly by us at one of our company operated retail showrooms.

        We continually refine our sales and marketing programs for the consumer and institutional markets and, over recent years, have devoted significant resources to web-based marketing and sales lead generation. We employ district sales managers whose responsibilities include developing close working

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relationships with piano dealers. These highly experienced professionals provide dealers with sales training and technical support, and develop sales and marketing programs for the consumer and institutional markets. These sales managers are also responsible for promoting the Steinway Artist Program.

Steinway Artist Program – Steinway Artists are world-class pianists who voluntarily endorse Steinway & Sons by selecting the Steinway piano. Our Steinway Artist program is unique in that we do not pay artists to endorse our 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. We use these renowned artists in our marketing programs to help reinforce recognition of the Steinway brand name and its association with quality. The Steinway Artist Program currently includes over 1,600 of the world's finest pianists who perform on Steinway pianos.

Young Steinway Artist Program – Often a formal affiliation with Steinway & Sons has not been possible for an emerging artist since all Steinway Artists must personally own a Steinway piano. The financial realities of developing a career can often make that requirement difficult for many otherwise deserving young musicians. In an effort to reach out to young pianists at an early point in their burgeoning careers, we developed the Young Steinway Artist Program. This program allows us to consider pianists between 16 and 35 years of age who own either a Boston or an Essex piano. The select group of approximately 60 talented musicians chosen for the Young Steinway Artist Program has the distinction of an affiliation with the Steinway Artist family as well as access to the worldwide resources of Steinway & Sons.

Concert and Artist Piano Bank – To ensure that all pianists, especially Steinway Artists, have a broad selection of instruments to meet their individual touch and tonal preferences, we maintain the Concert and Artist Piano Bank. The Piano Bank includes approximately 460 instruments worldwide. Of these instruments, approximately 325 are located in the United States. In New York City alone, the Piano Bank includes approximately 150 instruments. Approximately 35% of these pianos are housed at local concert venues and the remaining instruments are at our flagship showroom in New York City where they are made available for various occasions. The remaining domestic-based pianos are leased to dealers around the country who actively support the Steinway Artist program. The Piano Bank promotes our instruments in the music industry and provides management with continual feedback on the quality and performance of recently produced instruments from our most critical customer, the professional pianist. The Piano Bank instruments are generally sold after five years and replaced with new pianos.

Band Segment

        Our band & orchestral, string and percussion instruments and related accessories are distributed worldwide through over 1,400 independent musical instrument dealers and distributors.

        In North America, we market our products through district sales managers who are responsible for sales within assigned geographic territories. Each district sales manager is also responsible for developing relationships with band & orchestral directors. These directors represent all levels of music educators, from those who teach elementary school children through those involved at the college and professional levels. These individuals are the primary influencers in the choice of an instrument brand as they will generally refer students to designated dealers for the purchase of instruments.

        We believe that our well-established, long-standing relationships with influential music educators are an important component of our distribution strategy. As part of our band director outreach and support, we operate a Division of Education to provide an educational forum that supports the day-to-day realities of music classroom management. Led by our Vice President of Education, our

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educational clinicians travel extensively throughout the United States, lecturing and motivating students, educators and parents on the value of music in a child's development. Within our Education Division, we continue to operate Conn-Selmer Institute ("CSI"), a program which assists graduating music education majors transition into teaching careers. CSI also offers refresher courses to experienced music educators, further enhancing our relationships with these key influencers.

        To reach international markets, we primarily sell our instruments through distributors. Our international sales staff includes regional sales directors who have direct contact with our customers in Europe, Latin America and Asia.

        We support our dealers and distributors through advertising and promotional activities. We reach our customers through trade shows, educator conferences, print media, direct mail, the Internet and personal sales calls. We also actively advertise in educator and trade publications and provide educational materials, catalogs and product specifications to students, educators, dealers and distributors.

Competition

Piano Segment

Steinway & Sons Pianos – The level of competition our pianos face depends on the market definition. Steinway & Sons pianos hold a unique position at the top of the grand piano market, both in terms of quality and price. While there are many makers of pianos, only a few compete directly with our Steinway brand. Other manufacturers of primarily higher priced pianos include Bösendorfer and Fazioli.

        Because Steinway pianos are built to last for generations, a relatively large market exists for used Steinways. It is difficult to estimate the significance of used piano sales because most are conducted in the private aftermarket. However, we believe that used Steinway pianos provide the most significant competition in the high end piano market.

Boston and Essex Pianos – Our mid-priced pianos compete with brands such as Bechstein, Schimmel, Kawai, and Yamaha. By working with manufacturers in Asia, we have been able to benefit from labor costs and manufacturing efficiencies similar to those of some of our primary competitors while offering consumers the added benefit of pianos designed by Steinway & Sons.

Band Segment

        We are the largest domestic producer of band & orchestral instruments and we have leading market shares with many of our professional-level instruments. Yamaha, a Japanese corporation, is our largest competitor. New entrants into the domestic market generally experience difficulty competing due to the need for both brand recognition and an effective distribution system.

        Since the economic crisis in 2009, dealers have reduced their purchases of new student-level instruments and focused additional efforts on refurbishing used instruments for their rental inventories. Due to the number of used instruments available as well as the growth of Asian manufacturers, competition for sales of student-level instruments in the United States has intensified in recent years. Offshore producers benefit from low labor costs, enabling them to offer instruments at highly competitive prices. Imported instruments have also allowed dealers to source their own proprietary lines in an attempt to improve their margins. It is difficult to quantify the impact of used and imported musical instruments since the majority of the data is not reported through industry channels.

Patents and Trademarks

        Steinway & Sons pioneered the development of the modern piano with over 150 patents granted since its founding. While we have several patents effective and pending in the United States and in several foreign countries, we do not believe our business is materially dependent upon any single patent.

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        We also have some of the most well-known brand names in the music industry. Our piano trademarks include Steinway, Steinway & Sons, the Lyre design, Boston, Heirloom Collection, Crown Jewel Collection and Essex. Our band & orchestral trademarks include Bach, Selmer, C.G. Conn, Leblanc, King, Armstrong, Ludwig, Musser, Holton, Glaesel, Scherl & Roth, and William Lewis & Son. We consider our trademarks to be important and valuable assets. It is possible that the termination, expiration or infringement of one or more of our trademarks may have an adverse effect on our business, depending on the trademark and the jurisdiction. Accordingly, we maintain trademark registrations in appropriate jurisdictions on an ongoing basis and vigorously pursue any infringement by competitors or other third parties.

Raw Materials, Component Parts, and Sourced Products

        Our raw materials consist primarily of metals and woods. The majority of these materials is sourced from the Americas, with the balance coming from Europe, Asia and Africa. We manufacture our own piano plates and keys to ensure quality and availability of these component parts. Component parts for string and percussion instruments are imported from Europe and Asia. We have had adequate supplies of raw materials and component parts in the past and do not expect any disruption to the supply of these items during 2013 or in the future.

        Our Boston piano line and our Essex piano line are each sole sourced from manufacturers in Asia. Our Selmer Paris instruments, certain component parts and some of our entry-level band instruments are also sourced from single manufacturers. We continually scrutinize these suppliers and the quality of products that they manufacture for us and we believe that we have a sufficient number of qualified band instrument suppliers to ensure availability of all offered products in the upcoming year.

Labor

        As of December 31, 2012, we employed 1,698 people, consisting of 555 salaried employees and 1,143 hourly employees who work primarily in production. Of the 1,698 employees, 1,183 were employed in the United States and the remaining 515 were employed primarily in Europe.

        Approximately 48% of our workforce in the United States is represented by labor unions. In August 2011, we entered into a plant shutdown agreement with employees at our mallet instrument manufacturing facility in LaGrange, Illinois in anticipation of transferring that production to one of our existing facilities. At this time, we have 20 employees working under an extension of their previous labor contract. Since we expect to complete the transfer of production to Elkhart, Indiana by July 31, 2013, employees of the LaGrange facility are not included in our workforce statistics below.

The following table indicates the union representation and the current status of our collective bargaining agreements in the United States:

Location   Union affiliation   Type of
manufacturing
  Number of
employees
  Agreement
expiration

Springfield, OH

  Glass, Molders, Pottery, Plastics & Allied Workers   Piano Plates     23   September 30, 2013

New York, NY

  United Furniture Workers   Pianos     289   December 31, 2015

Eastlake, OH

  United Auto Workers   Band instruments     230   February 12, 2016

Elkhart, IN

  United Auto Workers   Band instrument warehouse     8   March 31, 2017

        In Germany, the workers' council represents all employees other than management. Nevertheless, most employment contract conditions are settled in collective bargaining agreements made between various trade unions and the employer organizations to which we belong. Our agreement with employees at our piano facility in Hamburg, Germany expires on September 30, 2013. We believe that relations with our employees and these unions are generally good.

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Item 1A. Risk Factors

        An investment in our Company involves risk. In addition to the other information in this report, prospective investors should carefully consider the following risks before making an investment. The risks described below are not the only risks we face. There may be additional risks and uncertainties that we do not presently know of or that we currently consider immaterial. All of these risks could adversely affect our business, financial condition, or results of operations.

We operate in competitive markets

        Our success depends upon our ability to maintain our share of the musical instrument market by providing the best instruments in each market segment in which we compete. Increased competition could lead to price reductions, fewer large sales to institutions, reduced operating margins and loss of market share.

        Prices for instruments in the Family of Steinway-Designed Pianos are generally higher than those of our competitors but are in line with consumer expectations for pianos of superior performance and quality. Our Steinway pianos currently compete with brands sold by Bösendorfer and Fazioli, which primarily produce and market pianos at the high end of the market. Because of the potential savings associated with buying a used instrument, as well as the durability of the Steinway piano, a relatively large market exists for used Steinway pianos. It is difficult to estimate the significance of used piano sales, because most are conducted in the private aftermarket. However, we believe that used Steinway pianos provide the most significant competition for us in the high-end piano market.

        Our mid-priced pianos compete with brands such as Bechstein, Schimmel, Kawai, and Yamaha. By working with manufacturers in Asia, we have been able to benefit from labor costs and manufacturing efficiencies similar to those of our primary competitors. Also, with certain limited exceptions, we allow only Steinway dealers to carry the Boston and Essex piano lines, thereby ensuring that these pianos will be marketed as complementary product lines to the Steinway line.

        Our band & orchestral division competes with a number of domestic and Asian manufacturers of musical instruments, including Jupiter and Yamaha. Any of our competitors may concentrate their resources upon efforts to compete in our markets. In addition, Asian 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 us. Our failure to compete effectively could have a negative impact on our results of operations.

Unfavorable economic conditions and changes in consumer preferences could adversely affect our business

        Our business is subject to a number of general economic factors, many of which are out of our control, that may, among other things, result in a decrease in sales and net income. Sales of musical instruments are dependent in part upon discretionary consumer spending, which may be affected by general economic conditions. For example, Steinway, which represents over 60% of our net sales, sells a relatively small number of Steinway & Sons grand pianos each year (2,001 in 2012). Given the small number of pianos we sell, even a slight decrease in sales could adversely affect our profitability. Sales in our band & orchestral division are also dependent upon the continued interest of school-aged children in playing musical instruments. Any decrease in consumer spending, reduction in school budgets or decrease in the number of school-aged children or their interest in music could result in decreased sales, which could adversely affect our business and operating results.

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We generate most of our sales through independent dealers and distributors

        We depend on a network of independent dealers and distributors to distribute a majority of our pianos and all of our band instruments. If our dealers are unsuccessful, they will reduce their purchases from us. This would negatively impact our sales and production rates.

        Because we rely on independent dealers for the majority of our sales, we depend on our dealers having succession and management continuity plans. If our dealers cease their operations due to the lack of such plans, our operating results may be adversely affected as we may be unable to secure adequate replacement representation in all of our existing markets.

We could be subject to work stoppages or other business interruptions as a result of our unionized work force

        A significant portion of our hourly employees are represented by various union locals and covered by collective bargaining agreements. These agreements contain various expiration dates and must be renegotiated upon expiration. If we are unable to negotiate any of our collective bargaining agreements on satisfactory terms prior to expiration, we could experience disruptions in our operations which could have a material adverse effect on our operating results.

Any significant disruption in our supply from key suppliers could delay production and adversely affect our sales

        Our Boston piano line and our Essex piano line are each sole sourced from manufacturers in Asia. Our Selmer Paris instruments, certain component parts and some of our entry-level band instruments are also sourced from single manufacturers. Furthermore, due to the relatively small size of the piano industry, suppliers of machinery and equipment for manufacturing are also limited.

        We are highly dependent on the availability of essential materials and purchased components from our suppliers, some of which may be available only from limited or sole resources. Moreover, we are dependent upon the ability of our suppliers to provide material that meets specifications, quality standards and delivery schedules. Our suppliers' failure to provide expected raw materials or component parts would adversely affect production schedules and profitability.

        Although we have had adequate supplies of raw materials and component parts in the past, there is no assurance that we may not experience serious interruptions in the future. Our continued supply of materials is subject to a number of risks, including: the destruction of our suppliers' facilities or their distribution infrastructure; work stoppages or strikes by our suppliers' employees; the failure of our suppliers to provide materials of the requisite quality; the failure of essential equipment at our suppliers' plants; the failure or shortage of supply of raw materials to our suppliers; and contractual amendments and disputes with our suppliers.

        We cannot assure investors that our suppliers will continue to provide products to us at attractive prices or at all, or that we will be able to obtain such products in the future from these or other providers on the scale and within the time periods we require. Furthermore, we cannot assure investors that substitute raw materials or component parts will meet the strict specification and quality standards we impose. If we are not able to obtain key materials, supplies, components or sourced instruments on a timely basis and at affordable costs, or we experience significant delays or interruptions of their supply, it could have a material adverse effect on our business, financial condition and results of operations.

We experience inherent concentration of credit risk in our accounts receivable

        Historically, a large portion of our sales have been generated by our top 15 customers. As a result, we experience some inherent concentration of credit risk in our accounts receivable due to its

10


composition and the relative proportion of large customer receivables to the total. This is especially true at our band division, which characteristically has the majority of our consolidated accounts receivable balance. We consider the credit health and solvency of our customers when extending credit and when we develop our receivable allowance estimates. If our customers fail to pay a significant portion of outstanding receivable balances, it would have a negative impact on our results of operations.

We may be unable to successfully integrate acquisitions of related companies into our business

        We have historically acquired other businesses whose operations or product lines complement our existing business. We continually explore new opportunities to enter into business combinations with other companies in order to maintain and grow our revenues and market presence. These potential transactions with other companies create risks such as difficulty in assimilating their personnel, customers, technology, products and operations with our personnel, customers, technology, products and operations; disruption of our ongoing business, including loss of management focus on existing businesses; and impairment of relationships with existing executives, employees, customers and business partners. In addition, we may not be able to identify suitable candidates for these transactions or obtain financing or otherwise complete these transactions on acceptable terms. Furthermore, the benefits that we anticipate from these potential transactions may not be realized and we cannot be sure that we will recover our investment in any such strategic transaction.

Shifts in our product mix may result in declines in our gross margins and profit levels

        Our gross margins vary among our product groups and have fluctuated from quarter to quarter as a result of shifts in product mix (that is, how much of each product type we sell in any particular quarter). The introduction of new band instruments, decreases in average selling prices, and shifts in the proportion of student-level instruments to professional-level instruments may cause variances in our gross margins. We also experience variances in our gross margins as a result of shifts in the proportion of our piano retail sales to wholesale sales, as well as changes in amounts of piano sales to territories where we realize more favorable pricing.

Failure of our new products to gain market acceptance may adversely affect our operating results

        New products may not achieve significant market acceptance or generate sufficient sales to permit us to recover development, manufacturing and marketing costs associated with these products. Achieving market acceptance for new products may also require substantial marketing efforts and expenditures to expand consumer demand. These requirements could strain our management, financial and operational resources. Furthermore, failure of our new products to achieve market acceptance could prevent us from maintaining our existing customer base, gaining new customers or expanding our markets and could have a material adverse effect on our business, financial condition and results of operations.

Since we have a limited number of facilities, any loss of use of any of our facilities could adversely affect our operations

        Our operations with respect to specific products are concentrated in a limited number of manufacturing facilities. Because we are heavily dependent on each of these facilities, our operations may be adversely affected if we experience a disruption in business at any particular facility for a prolonged period of time because we may not have adequate substitute facilities available to us.

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We may face difficulties or delays identifying strategic alternatives for our office building

        We derive rental income from our building on West 57th Street in New York City. The master lease that was in effect for ten years expired at the end of 2008; therefore, we have not had guaranteed rental income since that time. We are currently experiencing low occupancy rates as we are in the process of evaluating strategic alternatives for this asset and are not actively seeking new tenants. There can be no assurance that we will be able to identify an alternative that enhances the value of the property or that we will be able to complete a transaction on reasonable terms. If a transaction is consummated, there can be no assurance that any anticipated benefits will actually be realized. Until a transaction is completed, vacancies will negatively impact our cash flow, which adversely affects our operating results. If we decide to re-lease the space, changes in local market conditions, such as an oversupply of properties, may make it more difficult for us to lease space at attractive rental rates or at all. If we are unable to lease a significant amount of space in our building on economically favorable lease terms, including the cost of required renovations or concessions to tenants, our business and operating results could continue to be adversely affected.

Our operations may subject us to liabilities for environmental matters, the costs of which could be material

        Our manufacturing operations involve the use, handling, storage, treatment and disposal of materials and waste products that may be toxic or hazardous. Consequently, we are subject to numerous federal, state and local environmental laws and regulations, specifically those relating to discharges to air, water and land, the handling and disposal of solid and hazardous waste, and the cleanup of properties contaminated by hazardous substances. Many environmental laws impose strict, retroactive, joint and several liability broadly upon owners and operators of properties, including with respect to environmental matters that occurred prior to the time the party became an owner or operator. In addition, we may have liability with respect to third-party sites to which we sent wastes for disposal in the past. Our potential liability at any of these sites is affected by many factors including, but not limited to, the method of remediation, our portion of the hazardous substances at the site relative to that of other responsible parties, the number of responsible parties, the financial capabilities of other parties, and contractual rights and obligations.

        We have obligations and liabilities with respect to the remediation of current and former properties and third-party waste disposal sites. The liabilities and obligations in some cases are covered by an indemnification agreement and we have accrued liabilities for sites where the liability is probable and can be estimated. We cannot guarantee the indemnitor will continue to fund the cleanup liability or that the actual costs of cleanup will not exceed our present accruals. Furthermore, we may be required to fund additional remedial programs in connection with other current, former or future facilities.

        Future events, such as the discovery of additional contamination or other information concerning past releases of hazardous substances at our manufacturing sites (or at sites to which we sent wastes for disposal), changes in existing environmental laws or their interpretation, and more rigorous efforts by regulatory authorities, may require additional expenditures by us to modify operations, install pollution control equipment, clean contaminated sites or curtail our operations. These expenditures could have a material negative impact on our operations.

        In addition, we could be affected by future laws or regulations imposed in response to climate change concerns. Because it is uncertain what laws will be enacted, we cannot predict whether or not these laws or regulations could have a material adverse effect on our business, financial condition and results of operations.

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We may not be able to protect our proprietary information

        We rely in part on patent, trade secret, unfair competition, trade dress and trademark laws to protect our rights to aspects of our business and products, including product designs, proprietary manufacturing processes and technologies. The laws of many foreign countries do not protect proprietary rights to the same extent as laws in the United States. In addition, although we may have rights to a particular trademark in a given country, we may not have similar rights to that trademark in other countries.

Changes in our effective tax rates could affect future results

        As an international company, we are subject to taxation in the United States and various other foreign jurisdictions in which we do business. One of these foreign jurisdictions has higher statutory rates than those in the United States, and certain of our international earnings are also taxable in the United States. Accordingly, our effective tax rates will vary depending on the relative proportion of foreign to U.S. income and absorption of foreign tax credits, changes in the valuation of our deferred tax assets and liabilities, and changes in tax laws. In addition, we are subject to examination of our income tax returns by the U.S. Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our income tax reserves and expense. Should actual events or results differ from our current expectations, charges or credits to our income tax expense reserves and income tax expense may become necessary. Any such adjustments could have a significant impact on our results of operations.

Our international operations are exposed to risks associated with exchange rate fluctuations and customs, regulations, trade restrictions and political, economic and social instability specific to the countries in which we operate

        We manufacture, market and distribute our products worldwide. Sales outside the United States accounted for 47% of our net sales in 2012 and we expect that our international operations could account for a larger portion of our sales in future years as we pursue growth opportunities in China. The various risks inherent in doing business in the United States generally also exist when doing business outside of the United States, and may be exaggerated by the difficulty of doing business in numerous sovereign jurisdictions due to differences in culture, laws and regulations. For example, foreign regulations may limit our ability to produce and sell some of our products or repatriate profits to the United States. In addition, a foreign government may impose trade or foreign exchange restrictions or increased tariffs, which could adversely affect our operations. Our operations may also be negatively impacted by political, economic and social instability in the foreign countries in which we operate. We are also exposed to risks associated with foreign currency fluctuations. A change in the exchange rates of the U.S. dollar, the Japanese yen, the British pound, the Chinese yuan, or the euro relative to each other or other foreign currencies could have a negative impact on us. Although we sometimes engage in transactions to protect against risks associated with foreign currency fluctuations, we cannot be sure that these fluctuations will not have an adverse effect on us.

Further issuances of equity securities may be dilutive to current shareholders

        Our ability to execute our business strategy depends on our access to an appropriate blend of debt financing and equity financing. The interests of our existing shareholders could be diluted if additional equity securities are issued to finance future developments, acquisitions, or repay indebtedness.


Item 1B. Unresolved Staff Comments

        None.

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Item 2. Properties

        We own most of our manufacturing and warehousing facilities, as well as the building that includes Steinway Hall in New York City. The remaining Steinway retail stores are leased. Substantially all of the domestic real estate has been pledged to secure our debt. The following table lists our significant owned and leased facilities:

Location
  Owned/
Leased

  Approximate
Floor Space
(Square Feet)

  Type of Facility and Activity Performed
 

Long Island City, NY

  Owned     450,000   Piano manufacturing and restoration; administrative offices; piano selection center

New York, NY

  Owned     247,000   Piano retail store/showroom; office rental property

Melville, NY

  Leased     9,200   Piano retail store/showroom

Westport, CT

  Leased     11,000   Piano retail store/showroom

Coral Gables, FL

  Leased     6,000   Piano retail store/showroom

Paramus, NJ

  Leased     4,000   Piano retail store/showroom

West Hollywood, CA

  Leased     3,800   Piano retail store/showroom

Pasadena, CA

  Leased     3,500   Piano retail store/showroom

Hinsdale, IL

  Leased     4,400   Piano retail store/showroom

Northbrook, IL

  Leased     4,200   Piano retail store/showroom

Springfield, OH

  Owned     110,000   Piano plate manufacturing

Hamburg, Germany

  Owned     221,000   Piano manufacturing; executive offices; training

  Leased     6,000   Piano retail store/showroom

Munich, Germany

  Leased     10,800   Piano retail store/showroom

Düsseldorf, Germany

  Leased     6,200   Piano retail store/showroom

Frankfurt, Germany

  Leased     3,100   Piano retail store/showroom

Berlin, Germany

  Leased     7,000   Piano retail store/showroom/service workshop

Remscheid, Germany

  Leased     25,000   Piano key manufacturing

Wilkow, Poland

  Owned     10,000   Piano key manufacturing

Shanghai, China

  Leased     22,000   Piano warehouse/showroom/piano selection center/workshop

London, England

  Leased     10,000   Piano retail store/showroom/workshop

Tokyo, Japan

  Leased     11,200   Piano selection center; warehouse

  Leased     1,800   Administrative offices

Eastlake, OH

  Owned     160,000   Brass instrument manufacturing

Elkhart, IN

  Owned     150,000   Brass instrument manufacturing

  Owned     88,000   Woodwind manufacturing; warehouse

  Owned     81,000   Warehouse

  Owned     25,000   Administrative offices

Elkhorn, WI

  Owned     58,000   Former brass instrument manufacturing; held for sale

LaGrange, IL

  Owned     35,000   Percussion instrument manufacturing

Monroe, NC

  Leased     114,000   Percussion instrument manufacturing; warehouse

Cleveland, OH

  Leased     35,000   String instrument manufacturing

London, England

  Leased     8,000   Band instrument office; warehouse

        We spent $7.0 million for capital improvements in 2012 consisting primarily of plant and facility improvements, machinery and tooling, and software and system upgrades. We expect capital spending in 2013 to be in the range of $8.0 to $10.0 million.

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Item 3. Legal Proceedings

General

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

Environmental Matters

        We are required to comply 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 contaminated by hazardous substances, including chlorinated solvents. Our operations are subject to environmental laws and regulations that require us to obtain and maintain permits from regulatory authorities. Non-compliance with environmental laws and regulations or the permits we have been issued could give rise to significant fines, penalties and other costs. We currently do not expect to incur material expenditures relating to environmental compliance in 2013.

        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 liability is broadly construed. Under CERCLA and other laws, we may have liability for investigation and cleanup costs and other damages relating to our current or former properties, or third-party sites to which we sent wastes for disposal. Our potential liability at any of these sites is affected by many factors including, but not limited to, the method of remediation, our portion of the hazardous substances at the site relative to that of other parties, the number of responsible parties, the financial capabilities of other parties, and contractual rights and obligations.

        We are continuing an existing environmental remediation plan at a facility we acquired in 2000. We expect to pay these costs, which approximate $0.5 million, over an 8-year period. We have accrued approximately $0.4 million for the estimated remaining cost of this remediation program, which represents the present value total cost using a discount rate of 4.54%.

        A summary of expected payments associated with this project is as follows:

 
  Environmental
Payments
 

2013

  $ 61  

2014

    61  

2015

    61  

2016

    61  

2017

    61  

Thereafter

    180  
       

Total

  $ 485  
       

        In 2004, we acquired two manufacturing facilities from G. Leblanc Corporation, now Grenadilla, Inc. ("Grenadilla"), for which environmental remediation plans had already been established. In connection with the acquisition, we assumed the existing accrued liability of approximately $0.8 million for the cost of these remediation activities. Based on a review of past and

15


ongoing investigatory and remedial work by our environmental consultants, and discussions with state regulatory officials, as well as recent sampling, we estimate the remaining costs of such remedial plans to be $2.2 million. Accordingly, we have accrued this amount as our environmental liability related to this property as of December 31, 2012. The $2.2 million includes $0.4 million to conduct a pilot study to determine whether or not an alternative method of remediation would be a feasible, more effective option than our existing remediation plan. Should the results of this pilot study indicate that the alternative remediation method is feasible, we would expect to incur an additional $1.0 to $1.5 million in implementation costs. However, we will not accrue these additional costs unless and until the alternative method is determined to be a feasible method which is acceptable to the appropriate environmental remediation compliance authority.

        Pursuant to the purchase and sale agreement, we have sought indemnification from Grenadilla for anticipated costs above the original estimate. We filed a claim against the escrow and recorded a corresponding receivable for this amount in other assets in our consolidated balance sheet. Based on the current estimated costs of remediation, this receivable totaled $1.9 million as of December 31, 2012 and $2.0 million as of December 31, 2011. We reached an agreement with Grenadilla whereby current environmental costs are paid directly out of the escrow. Currently, the escrow balance exceeds our receivable balance.

        Based on our past experience and currently available information, the matters described above, as well as our other liabilities and compliance costs arising under environmental laws, are not expected to have a material impact on our capital expenditures, earnings or competitive position in an individual year. However, some risk of environmental liability is inherent in the nature of our current and former business and we may, in the future, incur material costs to meet current or more stringent compliance, cleanup, or other obligations pursuant to environmental laws.

Item 4. Mine Safety Disclosures

        Not applicable.

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PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

        Our common stock is traded on the New York Stock Exchange ("NYSE") under the "LVB" symbol. On March 1, 2013, we submitted an unqualified certification to the NYSE regarding our compliance with NYSE corporate governance listing standards as of the date of certification. The following table sets forth, for the periods indicated, the high and low share prices of our common stock as reported on the NYSE.

Year Ended December 31, 2012
  High
  Low
 
   

First Quarter

  $ 26.82   $ 24.00  

Second Quarter

    26.19     21.91  

Third Quarter

    26.70     22.49  

Fourth Quarter

    24.93     20.75  

 

Year Ended December 31, 2011
  High
  Low
 
   

First Quarter

  $ 22.53   $ 18.75  

Second Quarter

    28.30     19.77  

Third Quarter

    29.30     20.20  

Fourth Quarter

    28.72     21.01  

        Our common stock was previously comprised of two classes: Class A and Ordinary. With the exception of disparate voting power, both classes were substantially identical. Each share of Class A common stock entitled the holder to 98 votes. Holders of Ordinary common stock are entitled to one vote per share. On June 2, 2011 the owners of the Class A common stock sold all of their Class A shares to other shareholders. Once the Class A stock was no longer held by its original owners, it was converted into Ordinary common stock. This eliminated the 80% voting power previously held by the Class A common stock holders.

Holders of Record – As of March 1, 2013, there were 2,310 beneficial shareholders of our Ordinary common stock.

Dividends – Under our domestic credit facility agreement and the indenture for our senior note debt, we are permitted, within certain limitations, to pay cash dividends on our common stock. Although the limits under our indenture agreement increase as we accumulate earnings over time, we do not currently anticipate paying additional cash dividends on our common stock in the foreseeable future.

        The payment of any future dividends will be determined by the Board of Directors in light of conditions then existing, including our results of operations, financial condition, cash requirements, limitations or restrictions in debt agreements, tax treatment of dividends, business conditions and other factors.

17


Performance Graph – The following line graph compares the yearly percentage change in our cumulative total shareholder return on our Ordinary common stock for the period from December 31, 2007 to December 31, 2012 to the cumulative total return for the Russell 2000 Stock Index ("Russell 2000") and the cumulative total return for a peer group consisting of La-Z-Boy, Inc., Harley-Davidson, Inc., Callaway Golf Company, and Marine Products Corp ("Peer Group").

        The Peer Group was selected by management based on the status of each as a manufacturer and/or distributor of consumer goods in the luxury, leisure, or furniture categories. The performance graph assumes a $100 investment on December 31, 2007 in each of our Ordinary common stock, the Russell 2000, and the common stock of the Peer Group. Steinway Musical Instruments, Inc. is included in the Russell 2000. Total shareholder return for Steinway Musical Instruments, Inc., as well as the Russell 2000 and the Peer Group, is based on the cumulative amount of dividends for a period (assuming dividend reinvestment) and the difference between the share price at the beginning and at the end of the period.

Cumulative Total Returns

GRAPHIC

 
  December 31,  
 
  2007   2008   2009   2010   2011   2012  

Steinway Musical Instruments, Inc.

  $ 100.00   $ 63.51   $ 57.71   $ 72.00   $ 90.82   $ 76.71  

Russell 2000

    100.00     65.20     81.64     102.30     96.72     110.88  

Peer Group

    100.00     49.85     73.09     83.81     85.75     103.02  

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Purchases of Equity Securities by the Issuer

        In May 2008 we announced a share repurchase program, which permits us to make discretionary purchases of up to $25.0 million of our common stock. As of December 31, 2012, we have spent $2.5 million and purchased 102,127 shares under this program. We may make additional purchases of our common stock in 2013.


Equity Compensation Plans

The following table sets forth the equity compensation plan information for our Employee Stock Purchase Plan and our Stock Plans, which are described in Note 14:

 
  Number of
securities to be
issued upon
exercise of
outstanding
options, warrants
and rights

  Weighted-
average exercise
price of
outstanding
options, warrants
and rights

  Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column (a))

 
Plan Category   (a)   (b)   (c)  
Equity compensation plans approved by security holders:                    

1996 Stock Plan

 

 

99,400

 

$

23.97

 

 


 
2006 Stock Plan     541,650     21.78     246,550  
2006 Purchase Plan     12,641     20.56     148,946  
               
Total     653,691   $ 22.09     395,496  
               

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Item 6. Selected Financial Data

        The following table sets forth our selected consolidated financial data as of and for each of the five years in the period ended December 31, 2012, as derived from our audited financial statements. The table should be read in conjunction with our Consolidated Financial Statements, including the footnotes, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this report, as well as previously filed Annual Reports on Form 10-K.

(In thousands except share and per share data)

Years Ended December 31,   2012   2011(1)   2010   2009(2)   2008(3)  

Statement of operations data:

                               

Net sales

  $ 353,717   $ 346,256   $ 318,121   $ 306,436   $ 387,413  

Gross profit

    114,634     105,148     95,950     84,913     115,290  

Income from operations

    28,600     15,930     22,813     13,271     21,193  

Net income

    13,510     1,630     7,900     5,336     8,186  

Earnings per share

                               

Basic

  $ 1.09   $ 0.13   $ 0.68   $ 0.60   $ 0.96  

Diluted

  $ 1.08   $ 0.13   $ 0.68   $ 0.60   $ 0.95  

Weighted average shares:

                               

Basic

    12,409,761     12,232,098     11,640,955     8,855,138     8,557,761  

Diluted

    12,528,048     12,375,107     11,695,086     8,859,554     8,629,647  

Balance sheet data (at December 31):

                               

Cash

  $ 73,406   $ 49,888   $ 119,811   $ 65,873   $ 44,380  

Current assets

    256,332     248,621     328,628     293,906     297,267  

Total assets

    425,667     409,374     485,094     449,790     453,318  

Current liabilities

    53,618     49,975     53,784     46,696     62,554  

Total debt

    68,007     68,017     154,510     158,240     186,750  

Stockholders' equity

    241,845     232,593     228,624     196,496     157,081  

Other financial data:

                               

Capital expenditures

  $ 7,030   $ 6,942   $ 3,732   $ 4,552   $ 5,338  

Cash dividends declared per common share

  $   $   $   $   $  

Margins:

                               

Gross profit

    32.4%     30.4%     30.2%     27.7%     29.8%  

Operating

    8.1%     4.6%     7.2%     4.3%     5.5%  
(1)
In 2011, our results were adversely impacted by a loss on extinguishment of debt of $2.4 million, as well as incremental stock-based compensation expense of $2.0 million related to the accelerated vesting of most of the outstanding awards, and $5.5 million in impairment charges related to goodwill, trademarks, property, plant, and equipment, and assets held for sale. These items are described more fully in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."

(2)
In 2009, our results were beneficially impacted by a gain on extinguishment of debt of $3.4 million. This was partially offset by the $1.0 million impairment of trademarks associated with our online music business. These items are described more fully in our Annual Report on Form 10-K for the period ended December 31, 2009.

(3)
In 2008, our results were adversely impacted by the impairment of our band division goodwill of $8.6 million and facility rationalization charges, including property impairment and severance costs totaling $1.3 million. This was partially offset by a gain on extinguishment of debt of $0.6 million. These items are described more fully in our Annual Report on Form 10-K for the period ended December 31, 2008.

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Thousands)

Introduction

        The following discussion provides an assessment of the results of our operations and liquidity and capital resources together with a brief description of certain accounting policies. Accordingly, the following discussion should be read in conjunction with our Consolidated Financial Statements and the Notes to Consolidated Financial Statements included within this report.

Overview

        Through our operating subsidiaries, we are one of the world's leading manufacturers of musical instruments. Our strategy is to capitalize on our strong brand names, leading market positions, strong distribution networks, and quality products.

Piano Segment – Sales of our pianos are influenced by general economic conditions, demographic trends and general interest in music and the arts. The operating results of our piano segment are primarily affected by Steinway & Sons grand piano sales. Given the total number of these pianos that we sell in any year (2,001 sold in 2012), a slight change in units sold can have a material impact on our business and operating results. Our results are also influenced by sales of Boston and Essex pianos, which together represented 74% of total piano units sold but only 21% of total piano division revenues in 2012. Our Boston piano line and our Essex piano line are each sole sourced from Asia. The ability of these manufacturers to produce and ship products to us could impact our business and operating results. A breakdown of sales by our divisions and their geographic location can be found in Note 19 to the financial statements. In 2012, our piano sales had the following geographic breakdown based on customer location: approximately 45% in the Americas, 26% in Europe, and 29% in the Asia-Pacific region. For the year ended December 31, 2012, our piano segment sales were $216.8 million, representing 61% of our total revenues.

Piano Outlook for 2013 – We anticipate improvement in both sales and gross profit in 2013, barring any severe economic problems in major markets into which we sell. We are currently manufacturing on a full production schedule, which minimizes factory inefficiencies. We have sufficient manufacturing capacity and have hired additional staffing to meet anticipated demand. However, a significant increase in demand would require more staffing and training.

Band Segment – Our student band instrument sales are influenced by trends in school enrollment, school budgeting, and our ability to provide competitively priced products to our dealer network. Management estimates that over 75% of our domestic band sales are generated through educational programs; the remainder is to amateur or professional musicians or performing groups, including symphonies and orchestras.

        Our offerings of sourced products include quality, competitively priced instruments that have our brand names and are built to our specifications. Our product offerings are tailored to the needs of traditional school music dealers who provide full-service rental programs to band students, as well as music retailers and e-commerce dealers selling directly to end consumers from their stores or through the Internet. We believe our product offerings have helped us remain competitive at various price points and will continue to do so in the future.

        In 2012, student level instruments accounted for approximately 60% of band & orchestral unit shipments and approximately one-third of band instrument revenues, with intermediate and professional instruments representing the balance. In 2012, approximately 77% of band sales were in

21


the Americas, 10% in Europe, and 13% in the Asia-Pacific region. For the year ended December 31, 2012, our band sales were $136.9 million, representing 39% of our total revenues.

Band Outlook for 2013 – Instrument orders are currently strong and we expect sales to continue to improve in 2013. Margins should improve due to price increases and manufacturing efficiencies. We currently have sufficient manufacturing capacity to meet anticipated or increased demand, although a significant increase in demand could require additional staffing and training.

Inflation and Foreign Currency Impact – Although we cannot accurately predict the precise effect of inflation on our operations, we do 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 represented 47% of consolidated sales in 2012. We record sales in euro, Japanese yen, British pounds, and Chinese yuan. In 2012, we generated 77% of our international sales through our piano segment. Foreign exchange rate changes decreased reported sales by approximately $4.2 million in 2012. Although currency fluctuations affect international sales, they also affect cost of sales and related operating expenses. Consequently, they generally have not had a material impact on operating income. We use 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. We do not purchase currency-related financial instruments for purposes other than exchange rate risk management.

Taxes – We are subject to U.S. income taxes as well as tax in several foreign jurisdictions in which we do business. One of these foreign jurisdictions has a higher statutory rate than the United States. In addition, certain of our operations are subject to both U.S. and foreign taxes. However, in such cases we receive a credit against our U.S. taxes for foreign taxes paid equal to the percentage that such foreign income (as adjusted for reallocated interest) represents of the total income subject to U.S. tax. Accordingly, our effective tax rates will vary depending on the relative proportion of foreign to U.S. income and the use of foreign tax credits in the United States.

        In 2012, we used $3.0 million of foreign tax credits and carried forward $4.3 million of foreign tax credits generated during the current period. In connection with our recent decision to start repatriating earnings from our operations in China, we recorded a gross tax liability of $6.5 million offset in part by related tax credits of $3.5 million. As a result of this change, we anticipate our foreign tax credit utilization will improve. Accordingly, we reversed $1.4 million of valuation allowances on these deferred tax assets. We recorded an overall effective tax rate of 37.3%, relating primarily to 2012 operations, as well as a 1.6% tax detriment associated with discrete items.

        In 2011, we utilized a minimal amount of foreign tax credits and carried forward $3.7 million of foreign tax credits generated. Based on our 2011 analysis of anticipated foreign tax credit utilization, we recorded an additional $0.4 million of valuation allowances related to these deferred tax assets. Due to the low amount of taxable income, our non-deductible tax items and valuation allowances related to foreign tax credits had an abnormally large impact on our effective tax rate. As a result, we recorded an effective tax rate of 54.5%, which represents an effective tax rate of 55.9% relating primarily to 2011 operations and a 1.4% tax benefit associated with discrete items.

        In 2010, we utilized 100% of the foreign tax credits generated during the year, as well as $2.9 million of credits previously generated. However, due to our expectation for prospective foreign tax credit utilization at that time, we increased our valuation allowances for foreign tax credits generated during 2006 to 2008 for a comparable amount. Accordingly, the net impact on our overall effective tax rate was nominal. Since there was a minimal net impact of discrete items such as uncertain tax positions, our overall effective tax rate of 39.0% related primarily to 2010 operations.

22


Results of Operations

Fiscal Year 2012 Compared to Fiscal Year 2011

 
  For the years ended December 31,    
  Change  
 
  2012    
  2011    
  $   %  

Net sales

                                     

Band

  $ 136,905         $ 130,715           6,190     4.7  

Piano

    216,812           215,541           1,271     0.6  
                                   

Total sales

    353,717           346,256           7,461     2.2  

Cost of sales

                                     

Band

    102,302           102,250           52     0.1  

Piano

    136,781           138,858           (2,077 )   (1.5 )
                                   

Total cost of sales

    239,083           241,108           (2,025 )   (0.8 )

Gross profit

                                     

Band

    34,603     25.3%     28,465     21.8%     6,138     21.6  

Piano

    80,031     36.9%     76,683     35.6%     3,348     4.4  
                                   

Total gross profit

    114,634           105,148           9,486     9.0  

    32.4%           30.4%                    

Operating expenses

   
85,468
         
83,728
         
1,740
   
2.1
 

Impairment and facility rationalization charges

    566           5,490           (4,924 )   (89.7 )
                                   

Total operating expenses

    86,034           89,218           (3,184 )   (3.6 )

Income from operations

   
28,600
         
15,930
         
12,670
   
79.5
 

Other expense, net

   
3,406
         
4,226
         
(820

)
 
(19.4

)

Loss on extinguishment of debt

              2,422           (2,422 )   (100.0 )

Net interest expense

    3,651           5,698           (2,047 )   (35.9 )
                                   

Non-operating expenses

    7,057           12,346           (5,289 )   (42.8 )

Income before income taxes

   
21,543
         
3,584
         
17,959
   
501.1
 

Income tax provision

   
8,033
   
37.3%
   
1,954
   
54.5%
   
6,079
   
311.1
 
                                   

Net income

  $ 13,510         $ 1,630           11,880     728.8  
                                   

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

Overview – Piano division revenue increased due to strong demand in China coupled with incremental retail sales in the Americas. Gross profit also benefited from higher retail sales as well as efficiencies at our domestic piano factory. Band division revenues and gross profit improved due to strong demand for certain brass products and accessories as well as increased production and improved efficiencies at our brass instrument manufacturing plants.

Net Sales – Piano division revenue generated by our Americas region of $100.7 million was $2.5 million higher than the year-ago period despite flat Steinway grand unit shipments. Although sales to dealers were $2.0 million lower, this was more than offset by a $3.9 million increase in retail sales, most of

23


which is attributable to our new stores in Chicago, IL and Pasadena, CA. Standard price increases of approximately 4% also contributed to the revenue improvement. Revenue of $60.8 million generated by our division in Europe was $5.0 million less than the year-ago period largely due to an unfavorable exchange rate impact of $3.9 million. Standard price increases of 4% partially offset the impact of a 4% decrease in Steinway grand unit shipments and a 14% decrease in Boston and Essex unit shipments in this region. Sales of $55.4 million in the Asia-Pacific region of the piano division were $3.8 million higher due to a 3% increase in Steinway grand unit shipments.

        Band division revenue increased $6.2 million during the period. Revenue from accessories improved $3.6 million from the year-ago period. Although woodwind and brass instrument shipments were down 2%, an average selling price increase of 5% and a shift in mix towards step-up and professional brass instruments led to the increase in revenue. Increased availability of inventory produced at our Eastlake, Ohio brass instrument manufacturing facility also contributed to the revenue improvement.

Cost of Sales – Cost of sales was $2.0 million lower than the year-ago period primarily due to the piano division. In 2012, our piano factory in New York ran more efficiently than in 2011, so the increase in cost of materials was more than offset by lower labor and overhead costs. Accordingly, cost of sales by the Americas region was $0.5 million lower despite an increase in revenue. Cost of sales by our Europe and Asia divisions was $1.6 million lower due to the $1.2 million decrease in sales and favorable exchange rate impact.

        Cost of sales by our band division was consistent with the year-ago period despite an increase in revenue. Although manufacturing and purchased product costs increased, the adverse impact was more than offset by a $5.6 million decrease in manufacturing inefficiencies.

Gross Profit – Gross profit was $9.5 million higher primarily due to improved sales and margins at both divisions. Piano margins generated by the Americas increased from 32.1% to 34.2%. Standard price increases and higher retail sales caused the margin improvement. Piano margins generated by the Europe and Asia-Pacific regions rose slightly from 38.5% to 39.2% due to a favorable shift in mix towards larger, higher margin Steinway grand pianos. This more than offset the impact of factory inefficiencies in Germany, which were caused by training of new workers in order to increase future production.

        Gross margins generated by the band division increased from 21.8% to 25.3% in the current period. Margins benefited from increased production and greater efficiency at our brass manufacturing facilities, which were adversely impacted by the strike at our Eastlake, Ohio brass instrument manufacturing facility in 2011. This improvement more than offset the adverse impact of materials, overhead, and sourced-product costs increases. Lower pension costs of $1.1 million also contributed to the margin improvement.

Operating Expenses – Operating expenses were $1.7 million higher than the year-ago period. In 2011, the holders of our Class A common stock sold their shares to other shareholders. In conjunction with this transaction, we incurred an incremental $3.0 million in compensation expense related to the accelerated vesting of most of our stock options and all of our restricted stock and $1.1 million in legal and consulting costs. We also incurred $3.8 million of severance costs associated with the departures of our former Chairman and former Chief Executive officer.

        Excluding these transaction-related charges, sales and marketing costs were $2.8 million higher than the year-ago period. This increase was due to $1.4 million in costs associated with our retail expansion as well as incremental bad debt expense of $0.7 million. Higher promotional and advertising costs were also a factor. Our general and administrative costs increased $6.9 million as 2012 includes $5.7 million of legal and consulting fees related to activities undertaken by our Board of Directors in

24


pursuit of strategic alternatives. We also incurred higher personnel and consulting costs in 2012. A favorable exchange rate impact of $1.2 million partially offset these costs.

Impairment Charges – Impairment charges were $4.9 million lower than the year-ago period. In 2012, we incurred impairment charges related to our band division trademarks of $0.4 million and assets held for sale of $0.2 million. In 2011, we incurred impairment charges related to our band division and online music division goodwill and trademark intangible assets of $4.0 million. We also incurred impairment charges of $1.1 million associated with the long-lived assets at one of our manufacturing facilities as well as a $0.3 million impairment charge related to assets held for sale in 2011.

Non-operating Expenses – Non-operating expenses were $5.3 million less than the year-ago period. In 2011, we extinguished $85.0 million of our 7.00% Senior Notes, which resulted in a loss on extinguishment of debt of $2.4 million. As a result of the debt extinguishment, our net interest expense was $2.0 million lower in the current period. Although we incurred incremental costs associated with our West 57th Street building of $0.5 million, these were more than offset by an increase in foreign exchange gains of $0.8 million.

Results of Operations

Fiscal Year 2011 Compared to Fiscal Year 2010

 
  For the years ended December 31,    
  Change  
 
  2011    
  2010    
  $   %  

Net sales

                                     

Band

  $ 130,715         $ 127,625           3,090     2.4  

Piano

    215,541           190,496           25,045     13.1  
                                   

Total sales

    346,256           318,121           28,135     8.8  

Cost of sales

                                     

Band

    102,250           95,569           6,681     7.0  

Piano

    138,858           126,602           12,256     9.7  
                                   

Total cost of sales

    241,108           222,171           18,937     8.5  

Gross profit

                                     

Band

    28,465     21.8%     32,056     25.1%     (3,591 )   (11.2 )

Piano

    76,683     35.6%     63,894     33.5%     12,789     20.0  
                                   

Total gross profit

    105,148           95,950           9,198     9.6  

    30.4%           30.2%                    

Operating expenses

   
83,728
         
73,137
         
10,591
   
14.5
 

Impairment and facility rationalization charges

    5,490                     5,490     100.0  
                                   

Total operating expenses

    89,218           73,137           16,081     22.0  

Income from operations

   
15,930
         
22,813
         
(6,883

)
 
(30.2

)

Other expense, net

   
4,226
         
370
         
3,856
   
1,042.2
 

Loss (gain) on extinguishment of debt

    2,422           (104 )         2,526     (2,428.8 )

Net interest expense

    5,698           9,586           (3,888 )   (40.6 )
                                   

Non-operating expenses

    12,346           9,852           2,494     25.3  

Income before income taxes

   
3,584
         
12,961
         
(9,377

)
 
(72.3

)

Income tax provision

   
1,954
   
54.5%
   
5,061
   
39.0%
   
(3,107

)
 
(61.4

)
                                   

Net income

  $ 1,630         $ 7,900           (6,270 )   (79.4 )
                                   

25


        Prior to 2011, we reported our operations based on two sales regions: domestic and overseas. Since we do not have comparative data for 2010 using our Americas, Europe, and Asia-Pacific sales regions, our discussion below is provided using the domestic and overseas regional format.

Overview – Higher demand caused revenue at both the band and piano divisions to improve in 2011. Piano division results were significantly better with respect to revenue and gross profit due to increased Steinway grand shipments and higher production volume at both of our manufacturing facilities. Band division results were adversely impacted by a strike at our Eastlake, Ohio brass instrument manufacturing facility, which resulted in less product availability and higher factory variances.

Net Sales – Net sales increased $28.1 million primarily due to the $25.0 million improvement in piano division revenue. Domestically, Steinway grand unit shipments were 7% higher and Boston and Essex shipments were slightly higher than the year-ago period. Overall domestic sales improved $9.1 million, $4.7 of which is attributable to increased retail sales, which were bolstered by the opening of new Company-owned retail facilities in Chicago, Illinois. Overseas, Steinway grand unit shipments were 13% higher as a result of increased wholesale demand in Europe. Boston and Essex unit shipments improved by 10% due to better demand in both Europe and Asia. These increases, coupled with a $6.0 million favorable impact due to foreign exchange, were the primary cause of a $16.0 million improvement in overseas piano revenue in 2011.

        Band division sales increased $3.1 million despite a total unit volume decrease of 2%. Overall woodwind and brass instrument shipments were 3% higher due to improved demand for woodwind products. Brass instrument shipments were consistent with the year-ago period even though we lost an estimated $3.4 million in brass instrument revenues due to the reduced availability of product caused by the strike at our Eastlake, Ohio facility.

Cost of Sales – Cost of sales increased at both divisions compared to the year-ago period. Cost of sales at our domestic piano division increased $4.7 million as a result of the sales improvement. Similarly, cost of sales overseas was $7.6 million higher due to the revenue increase.

        Band division cost of sales increased $6.7 million, $2.0 million of which was attributable to the revenue improvement. However, increased costs on manufactured and sourced products of $2.4 million, as well as factory inefficiencies, adversely impacted costs of sales in 2011.

Gross Profit – Gross profit improved $9.2 million due to higher sales and gross margins at the piano division. Band segment gross profit deteriorated $3.6 million during the period. Gross margin for the band division decreased from 25.1% to 21.8% due to incremental unfavorable plant variances of $1.8 million primarily associated with Eastlake and $0.5 million in additional pension related charges. The remaining deterioration was due to higher material and overhead costs.

        Piano segment gross profit increased $12.8 million during the period. Domestically, piano margins grew from 30.4% to 32.1% due to a shift in mix to Steinway grands sold at retail, which typically generate higher margins. In addition, the factory produced more Steinway grands, which resulted in greater factory efficiencies. Overseas piano margins grew from 36.3% to 38.5% since our factory in Germany also produced and sold more Steinway grands. This improved factory efficiency and generated higher profits.

Operating Expenses – Operating expenses were $10.6 million higher than in the year-ago period, of which $3.8 million is due to severance costs related to the departures of our former Chairman and former Chief Executive Officer and $1.8 million is incremental stock-based compensation. We also incurred $1.1 million of legal and consulting costs primarily related to the sale of Class A Common stock by our former Chairman and former Chief Executive Officer as well as activities undertaken by our Board of Directors in pursuit of strategic alternatives.

26


        In addition to the aforementioned costs, sales and marketing expenses increased $2.2 million due largely to the opening of our new retail facilities in Chicago, Illinois, as well as higher commissions and salaries, and $0.3 million less bad debt recoveries. General and administrative costs were $2.6 million higher due to increased headcount and higher bonuses. Offsetting this was a decrease in other operating expenses of $0.8 million, which was primarily attributable to lower environmental reserves recorded during the period.

Impairment and Facility Rationalization Charges – Impairment and facility rationalization charges increased $5.5 million in the current year. We wrote down $0.3 million of trademarks and $2.7 million of goodwill associated with our online music business, $1.1 million of property, plant and equipment associated with our woodwind instrument manufacturing facility, $1.1 million related to band division trademarks and goodwill, and $0.3 million in assets held for sale by our band division. In the year-ago period we had no impairment charges.

Non-operating Expenses – Non-operating expenses were $2.5 million higher than the year-ago period for several reasons. We incurred incremental operating expenses of $2.7 million from our West 57th Street building. We expect to incur a temporary loss on this facility due to low occupancy rates. Also, our gains from foreign exchange were $0.6 million lower in 2011. We had $3.9 million in net interest saving due to the extinguishment of $85.0 million in principal of our 7.00% Senior Notes in May 2011, which resulted in a loss on extinguishment of $2.4 million.

Liquidity and Capital Resources

        We have relied primarily upon cash provided by operations, supplemented as necessary by seasonal borrowings under our working capital lines, to finance our operations, repay or repurchase long-term indebtedness, finance acquisitions, and fund our capital expenditures. Regarding our overseas divisions, Japan is the only operation that is normally in a borrowing position. These borrowings are likely to be less than $1.0 million at any given time. In 2010, our domestic line went unused. In 2011, we had domestic borrowings for most of the year, as we used a significant portion of our cash to pay down $85.0 million in principal of our bonds in March 2011. However, our domestic line was paid off by December 31, 2011.

Cash Flows – Our statements of cash flows are summarized as follows:

For the years ended December 31,   2012   2011   2010  

Net income:

  $ 13,510   $ 1,630   $ 7,900  

Changes in operating assets and liabilities

    3,176     5,315     17,544  

Other adjustments to reconcile net income to cash flows from operating activities

    12,027     15,636     10,224  
               

Cash flows from operating activities

    28,713     22,581     35,668  

Cash flows from investing activities

    (6,824 )   (10,200 )   (3,962 )

Cash flows from financing activities

    1,621     (83,440 )   23,900  

        In 2012, cash flows provided by operating activities increased $6.1 million. In the current period, cash used for accounts receivable was $0.4 million higher as a result of strong Steinway piano sales near year end, which have yet to be converted to cash. Due to its revenue cycle, our band division typically uses cash for receivables until the fourth quarter. Cash provided by band division receivables was $1.0 million – consistent with the year-ago period. Cash provided by inventory was $6.7 million less than in 2011 since we are increasing our raw and work-in-process inventory at our piano division in order to meet anticipated future demand. Softer sales of our Boston and Essex pianos were also a factor. Cash used for prepaid expenses was $7.0 million lower due to the timing of insurance, real

27


estate taxes, and prepayments for inventory. In addition, we received $1.4 million in tax payment refunds and $0.7 million in proceeds from the sale of a former band instrument manufacturing facility. Cash provided by accounts payable and accrued liabilities was $2.1 million lower largely due to the timing of pension and tax payments.

        In 2011, cash flows provided by operating activities decreased $13.1 million from 2010. Cash generated from accounts receivable was $2.1 million lower in the current period due to timing of sales and related accounts receivable collections at the piano division. Cash used for prepaids and other assets increased $3.6 million as a result of payments made to suppliers and taxes. Cash provided by accounts payable and accrued liabilities was $6.0 million lower due to payments made to inventory suppliers and items related to our West 57th Street building.

        In 2010, cash flows provided by operating activities increased $11.8 million from 2009. Although the sales increase caused a decrease in source of cash from accounts receivable of $13.3 million, we also generated $3.6 million more cash from inventory since the sales improvement helped reduce our finished goods levels. We experienced a shift from use to source of cash of $18.1 million related to accounts payable and accrued expenses during the period. In 2009, we had implemented cost cutting measures to conserve cash and reduce expenditures. In 2010, spending returned to normal levels.

        In 2012, cash used for investing activities was $3.4 million lower than the year-ago period. In 2012, cash used for investing activities was comprised primarily of capital expenditures of $7.0 million. In 2011, our capital expenditures were $6.9 million, but we also paid $2.7 million in contingent consideration for the acquisition of our online music business and $0.6 million for the acquisition of our Chicago retail stores.

        In 2011, cash used for investing activities increased $6.2 million, $3.2 million of which is due to increased capital expenditures, which were abnormally low in 2010. Also, cash used for acquisitions was $2.9 million higher as a result of the additional consideration associated with the acquisition of our online music business and payments made to acquire assets of a piano retail operation in Chicago, Illinois.

        In 2010, cash used for investing activities decreased $1.4 million, $0.8 million of which was due to reduced capital expenditures. The remaining reduction was largely attributable to lower payments for acquisitions. In 2009 we purchased a retail store in Düsseldorf, Germany. In 2010, acquisitions were limited to a small music education business purchased by our band division.

        In 2012, cash provided by financing activities shifted significantly as compared to the year-ago period, since activity was limited to cash provided by issuance of stock of $1.6 million. In 2011, we spent $86.5 million to extinguish a significant portion of our 7.00% Senior Notes, which was partially offset by proceeds from sales of stock of $4.6 million.

        In 2011, cash used for financing activities of $83.4 million was primarily attributable to $86.5 million spent to extinguish a significant portion of our 7.00% Senior Notes. Cash provided by our other debt facilities was $3.6 million lower than in 2010. In the year-ago period we generated an incremental $23.6 million through stock sales.

        In 2010, cash provided by financing activities increased $21.0 million, which was derived from $28.2 million in proceeds received from issuance of our stock and $1.7 million generated from borrowing on our overseas lines of credit. These were offset by $5.6 million used to repurchase $5.8 million in principal of our Senior Notes and $0.3 million used to purchase treasury stock.

Capital Expenditures – Our capital expenditures consist primarily of plant and facility improvements, machinery and tooling, and software and system upgrades. We expect capital spending in 2013 to be in the range of $8.0 to $10.0 million, relating to similar items.

28


Seasonality – Consistent with industry practice, we sell band instruments almost entirely on credit utilizing the two financing programs described below. Due to these programs, we have higher working capital requirements during certain times of the year when band instrument receivable balances reach highs of approximately $33.0 to $35.0 million in August and September, and lesser requirements when they are at lows of approximately $25.0 to $27.0 million in January and February. The financing options, intended to assist dealers with the seasonality inherent in the industry and facilitate the rent-to-own programs offered to students by many retailers, also allow us to match our production and delivery schedules. The following forms of financing are offered to qualified band instrument dealers.

a)
Receivable dating – Payments on purchases made from October through August are due in October of the following year. Dealers are offered discounts for early payment.

b)
Note receivable financing – Dealers that meet certain credit qualifications may convert open accounts to a note payable to us. The note program is offered primarily in October and coincides with the receivable dating program. The terms of the notes generally include payment over a nine to twelve month period with interest ranging from 7.25% to 11.0% (generally 4% to 6% over prime). Interest rates are contingent upon credit ratings and borrowing periods. In certain situations, we have offered long-term arrangements for up to thirty-six months. In most instances, the note receivable is secured by dealer inventories and receivables.

Other Financing Arrangements – We established a program in 2009 to provide financing to certain domestic piano dealers. There was only one dealer remaining on this program as of December 31, 2012. This dealer had total credit availability of $0.3 million. Beyond this program, we generally do not provide extended financing arrangements to our piano dealers. Typically, if financing is required by a dealer, we will facilitate arrangements through third-party providers. We generally provide no guarantees with respect to these arrangements.

Off-balance Sheet Arrangements – We currently do not have any off-balance sheet arrangements that have, or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

Pensions and Other Postretirement Benefits – When determining the amounts to be recognized in the consolidated financial statements related to our domestic pension plan, we used a long-term rate of return on plan assets of 9%, which was developed with input from our investment committee and our third-party advisors, and is consistent with that of prior years. We believe that 9% is consistent with the historical long-term return trends on our domestic pension assets and our expectations for future returns. The discount rate utilized for determining future pension and other postretirement benefit obligations for our domestic plans is based on a long-term bond yield curve which matches the expected benefit payment period under the plan. The bonds used have been rated Aa or AA or better by recognized rating agencies, are non-callable, and have at least $250.0 million par outstanding to ensure they are sufficiently marketable. The weighted-average discount rates used for December 31, 2012 and 2011 were 4.13% and 4.97%, respectively, for our domestic pension plan and 4.10% and 4.91% for our postretirement benefit obligation plan. Our postretirement benefit obligation plan is not material to our consolidated financial statements.

        The weighted-average discount rates (3.81% and 4.97% as of December 31, 2012 and 2011, respectively) and rates of return (5.50% and 5.30% as of December 31, 2012 and 2011, respectively) on plan assets for our foreign pension plan were similarly developed utilizing long-term rates of return and discount rates reasonably expected to occur in the applicable jurisdiction.

Borrowing Activities and Availability – On October 5, 2010, we entered into a domestic credit facility with a syndicate of lenders (the "Credit Facility"). The Credit Facility provides us with a potential

29


borrowing capacity of $100.0 million in revolving credit loans and expires on October 5, 2015. It also provides for borrowings at either London Interbank Offering Rate ("LIBOR") plus a range from 1.75% to 2.25% or as-needed borrowings at an alternate base rate, plus a range from 0.75% to 1.25%; both ranges depend upon availability at the time of borrowing. Borrowings are collateralized by our domestic accounts receivable, inventory and certain fixed assets.

        Our non-domestic foreign currency denominated credit facilities provide for borrowings equivalent to $23.6 million as of December 31, 2012. There have been no material changes to our net borrowing abilities overseas, and we typically are in a borrowing position of less than $1.0 million at any given time. Our non-domestic credit facilities are discussed more fully in Note 12 to the consolidated financial statements.

        At December 31, 2012, our total outstanding indebtedness amounted to $68.1 million, consisting of $67.5 million of 7.00% Senior Notes due March 1, 2014 and $0.6 million of notes payable to foreign banks. We had nothing outstanding on our domestic line of credit as of December 31, 2012 and $84.2 million of net borrowing availability. During 2011 we extinguished $85.0 million in principal of our Senior Note debt. We may consider additional repurchases or restructuring of our Senior Note debt in the future, contingent upon cash availability, interest rates, and the trading prices on our Senior Notes, which are callable at par. Cash interest paid was $4.8 million in 2012, $8.9 million in 2011, and $12.3 million in 2010.

        All of our debt agreements contain covenants that place certain restrictions on us, limiting our ability to incur additional indebtedness, to make investments in other entities, and to make cash dividend payments. We were in compliance with all such covenants as of December 31, 2012 and do not anticipate any compliance issues in 2013. Our domestic debt agreements contain limitations on the amount of discretionary repurchases we may make of our common stock. Our intent and ability to repurchase additional common stock either directly from shareholders or on the open market is directly affected by this limitation. In May 2008 we announced a share repurchase program which permits us to make discretionary purchases of up to $25.0 million of our common stock. To date, we have repurchased 102,127 shares and approximately $22.5 million remains authorized for repurchases under this program. We may make additional purchases of stock under this program in 2013.

        We experience long production and inventory turnover cycles, which we constantly monitor since fluctuations in demand can have a significant impact on these cycles. In normal economic conditions, we are able to effectively utilize cash flow from operations to fund our debt and capital requirements and pay off our seasonal borrowings on our domestic line of credit. We intend to manage accounts receivable and credit risk and ensure inventory levels align with demand. Our intention is to manage cash outflow, maintain sufficient operating cash on hand to meet short-term requirements, and minimize credit facility borrowings.

        As of December 31, 2012 our operations in foreign tax jurisdictions held $31.9 million in cash, comprised of $20.7 million in renminbi, $4.3 million in yen, $2.9 million in euro, and $3.9 million in pounds. Historically we have indefinitely reinvested these earnings. However, due to the strong fourth quarter results of our operations in China, we have determined that the cash generated and expected to be generated by that division in the future exceeds the amount necessary to adequately fund operations there. Accordingly, we no longer intend to reinvest these earnings and have recognized an additional $3.1 million in net tax liability as of December 31, 2012 as a result. The amount of funds we will be able to repatriate to the United States is contingent upon approval of applicable taxing authorities, but we expect to repatriate approximately $15.0 million in 2013. We continue to indefinitely reinvest the earnings of our other operations in foreign tax jurisdictions. We believe that domestic cash flow from operations coupled with our domestic borrowing availability is sufficient to fund domestic operating and debt service activity through 2013. Similarly cash flow from overseas operations coupled with our overseas borrowing availability is sufficient to fund overseas operating activity through 2013.

30


        We do not have any current plans or intentions that will have a material adverse impact on our liquidity in 2013. Our Senior Notes mature on March 1, 2014, and we are currently renegotiating our domestic line of credit, but do not believe any anticipated outcome will have a material adverse impact on our liquidity in 2013. Other than those described, we are not aware of any trends, demands, commitments, or costs of resources that are expected to materially impact our liquidity or capital resources. Accordingly, we believe that cash on hand, together with cash flows anticipated from operations and available borrowings under existing and potential credit facilities will be adequate to meet our debt service requirements, fund continuing capital requirements and satisfy our working capital and general corporate needs through 2013.

Contractual Obligations – The following table provides a summary of our contractual obligations at December 31, 2012.

 
  Payments due by period  
Contractual Obligations
  Total   Less than
1 year
  1 - 3 years   3 - 5 years   More than
5 years
 

Long-term debt(1)

  $ 73,599   $ 5,305   $ 68,294   $   $  

Capital leases

    6     4     2          

Operating leases(2)

    250,827     6,414     10,225     8,556     225,632  

Purchase obligations(3)

    47,821     47,821              

Other non-current liabilities(4)

    63,266     4,532     2,374     2,332     54,028  
                       

Total

  $ 435,519   $ 64,076   $ 80,895   $ 10,888   $ 279,660  
                       

Notes to Contractual Obligations:

(1)
Long-term debt represents long-term debt obligations, the fixed interest on our Senior Notes, and the variable interest on our other loans. We estimated the future variable interest obligation using the applicable December 31, 2012 rates. The nature of our long-term debt obligations is described more fully in the "Borrowing Availability and Activities" section of "Liquidity and Capital Resources."

(2)
Approximately $237.8 million of our operating lease obligations are attributable to the land lease associated with Steinway Hall, which has eighty-five years remaining, and is described in Note 15 in the Notes to Consolidated Financial Statements included within this filing; the remainder is attributable to the leasing of other facilities and equipment.

(3)
Purchase obligations consist of firm purchase commitments for raw materials, finished goods, and equipment.

(4)
Our other non-current liabilities consist primarily of the long-term portion of our pension obligations, which are described in Note 16 in the Notes to Consolidated Financial Statements included within this filing, and obligations under employee and consultant agreements, which are described in Note 15 in the Notes to the Consolidated Financial Statements included within this filing. We have not included $0.1 million of uncertain tax positions within this schedule due to the uncertainty of the payment date, if any.

Critical Accounting Policies and Estimates

        The SEC has issued disclosure guidance for "critical accounting policies." The SEC defines "critical accounting policies" as those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.

31


        Management is required to make certain estimates and assumptions during the preparation of the consolidated financial statements. These estimates and assumptions impact the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Actual results could differ significantly from those estimates.

        The significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements included herein. Not all of these significant accounting policies require management to make difficult, subjective or complex judgments or estimates. However, management considers the following to be critical accounting policies based on the definition above.

    Receivables

            We establish allowances for accounts receivable and notes receivable. We review overall collectibility trends and customer characteristics such as debt leverage, solvency, and outstanding balances in order to develop our estimates. Historically, a large portion of our sales at both our piano and band divisions has been generated by our top 15 customers. As a result, we experience some inherent concentration of credit risk in our accounts receivable due to its composition and the relative proportion of large customer receivables to the total. This is especially true at our band division, which characteristically has a majority of our consolidated accounts receivable balance. We consider the credit health and solvency of our customers when developing our receivable allowance estimates.

    Inventory

            We write down our inventory carrying values for items such as lower-of-cost-or-market and obsolescence. We review inventory levels on a detailed basis, concentrating on the age and amounts of raw materials, work-in-process, and finished goods, as well as recent usage and sales dates and quantities to help develop our estimates. Ongoing changes in our business strategy, including a shift from batch processing to single piece production flow, coupled with increased offshore sourcing, could affect our ability to realize the current carrying value of our inventory, and are considered by management when developing our estimates. We also establish reserves for anticipated book-to-physical adjustments based upon our historical level of adjustments from our annual physical inventories. We account for our inventory using standard costs. Accordingly, variances between actual and standard costs that are normal in nature are capitalized into inventory and released based on calculated inventory turns. Abnormal costs are expensed in the period in which they occur.

    Workers' Compensation and Self-Insured Health Claims

            We establish self-insured workers' compensation and health claims reserves based on our trend analysis of data provided by third-party administrators regarding historical claims and anticipated future claims.

    Long-lived Assets

            We review long-lived assets, such as property, plant, and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. We measure recoverability by comparing the carrying amount of the asset or asset group to the estimated future cash flows the asset or asset group is expected to generate.

            We establish long-lived intangible assets based on estimated acquisition-date fair values, and amortize finite-lived intangibles over their estimated useful lives. We test our goodwill and

32


    indefinite-lived trademark assets for impairment annually or on an interim basis if events or circumstances indicate that the fair value of an asset may have decreased below its carrying value. We determine our reporting units by first identifying our operating segments, and then assess whether any components of these segments constitute a business for which discrete financial information is available and where segment management regularly reviews the operating results of that component. We aggregate components within a reporting unit that have similar economic characteristics.

            Our assessment is based on a comparison of net book value to estimated fair values primarily using an income approach. For purposes of the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. We make assumptions about the amount and timing of future expected cash flows, terminal value growth rates and appropriate discount rates. The amount and timing of future cash flows within our discounted cash flow analysis is based on our most recent operational budgets, long range strategic plans and other estimates. The terminal value growth rate is used to calculate the value of cash flows beyond the last projected period in our analysis and reflects our best estimates for stable, perpetual growth of our reporting units. We use estimates of market participant weighted-average costs of capital as a basis for determining the discount rates to apply to our reporting unit's future expected cash flows, adjusted for the risks and uncertainty inherent in our industry generally and in our internally developed forecasts. We also use a market approach against which we benchmark the results of our income approach to ensure that the results are appropriate.

            Our assessment of indefinite-lived trademarks compares the present value of the future estimated after tax royalty payments, discounted at a risk-adjusted rate of return to the carrying value of the trademark. This relief-from-royalty method estimates the savings in royalties a company would otherwise have had to pay if it did not own the trademark and had to license them from a third party.

    Pensions and Other Postretirement Benefit Costs

            We make certain assumptions when calculating our benefit obligations and expenses. We base our selection of assumptions, such as discount rates and long-term rates of return, on information provided by our actuaries, investment advisors, investment committee, current rate trends, and historical trends for our pension asset portfolios. Our benefit obligations and expenses can fluctuate based on the assumptions management selects.

    Income Taxes

            When appropriate, we record valuation allowances for certain deferred tax assets related to foreign tax credit carryforwards and state net operating loss carryforwards. When assessing the realizability of deferred tax assets, we consider whether it is more likely than not that the deferred tax assets will be fully realized. The ultimate realization of these assets is dependent upon many factors, including the ratio of foreign source income to overall income and generation of sufficient future taxable income in the jurisdictions for which we have loss carryforwards. When establishing or adjusting valuation allowances, we consider these factors, as well as anticipated trends in foreign source income and tax planning strategies which may impact future realizability of these assets.

            A liability has been recorded for uncertain tax positions. When analyzing these positions, we consider the probability of various outcomes which could result from examination, negotiation, or settlement with various taxing authorities. The final outcome of these positions could differ significantly from our original estimates due to the following: expiring statutes of limitations; availability of detailed historical data; results of audits or examinations conducted by taxing authorities or agents that vary from management's anticipated results; identification of new tax

33


    contingencies; release of applicable administrative tax guidance; management's decision to settle or appeal assessments; the rendering of court decisions affecting our estimates of tax liabilities; or other factors.

    Environmental Liabilities

            We make certain assumptions when calculating our environmental liabilities. We base our selection of assumptions, such as cost and length of time for remediation, on data provided by our environmental consultants, as well as information provided by regulatory authorities. We also make certain assumptions regarding the indemnifications we have received from others, including whether remediation costs are within the scope of the indemnification, the indemnifier's ability to perform under the agreement, and whether past claims have been successful. Amounts recorded for our environmental obligations and expenses can fluctuate based on management's assumptions.

        We believe the assumptions made by management provide a reasonable basis for the estimates reflected in our consolidated financial statements.

Recent Accounting Pronouncements

        We adopted certain amendments to Accounting Standards Codification ("ASC") 820, "Fair Value Measurements," effective January 1, 2012. These amendments include a consistent definition of fair value, enhanced disclosure requirements for "Level 3" fair value adjustments and other changes to required disclosures. Their adoption did not have a material impact on our consolidated financial statements.

        We adopted the amendments to ASC 220, "Comprehensive Income," effective January 1, 2012. The amendments pertained to presentation and disclosure only and did not have a material impact on our consolidated financial statements.

        We adopted the amendments to ASC 350, "Intangibles-Goodwill and Others," effective January 1, 2012. The amended guidance allows us to do an initial qualitative assessment of relevant events and circumstances to determine if fair value of a reporting unit is more likely than not less than its carrying value, prior to performing the two-step quantitative goodwill impairment test. The adoption of these amendments did not have a material impact on our consolidated financial statements.

        In July 2012, the Financial Accounting Standards Board amended ASC 350 to provide the option to do an initial qualitative assessment of relevant events and circumstances prior to calculating the fair value of an indefinite-lived intangible asset. This amendment is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. We will comply with the requirements of this pronouncement when it becomes effective. This pronouncement is not expected to have a material impact on our consolidated financial statements.


Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Risk

        We are subject to market risk associated with changes in foreign currency exchange rates and interest rates. We mitigate some of our cash flow exposure to foreign currency fluctuations by holding foreign currency forward and option contracts. These contracts are not designated as hedges for accounting purposes. The contracts relate primarily to intercompany transactions and are not used for trading or speculative purposes. The fair value of these contracts is sensitive to changes in foreign currency exchange rates. As of December 31, 2012, a 10% negative change in foreign currency exchange rates from market rates would increase the fair value of the contracts by $0.2 million. Gains and losses on the foreign currency exchange contracts are defined as the difference between the

34


contract rate at its inception date and the current forward rate. However, any such gains and losses would be offset by corresponding losses and gains, respectively, on the related asset or liability.

Interest Risk

        Our interest rate exposure is limited primarily to interest rate changes on our variable rate debt. Our revolving loans bear interest at rates that fluctuate with changes in PRIME, LIBOR, TIBOR, and EURIBOR and are therefore sensitive to changes in market interest rates. Since we had limited variable rate borrowings for the year ended December 31, 2012, a hypothetical 10% increase in interest rates would have increased our interest expense by a nominal amount.

        Our long-term debt includes $67.5 million of Senior Notes with a fixed interest rate. Accordingly, there would be no immediate impact on our interest expense associated with these Senior Notes due to fluctuations in market interest rates. However, based on a hypothetical 10% immediate decrease in market interest rates, the increase in fair value of our Senior Notes, which would be sensitive to such interest rate changes, would be nominal as of December 31, 2012.


Item 8. Financial Statements and Supplementary Data

        The information required by this item may be found on pages F-1 through F-43 of this Annual Report on Form 10-K.

35



Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

        None.


Item 9A. Controls and Procedures

Disclosure Controls and Procedures

        Our principal executive officer and our principal financial officer, after evaluating together with management the design and operation of our disclosure controls and procedures have concluded that our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) were effective as of December 31, 2012, the end of the period covered by this report.

Internal Control Over Financial Reporting

        There were no changes in our Company's internal control over financial reporting that occurred during the fourth quarter of 2012 that have materially affected, or are likely to materially affect, our Company's internal control over financial reporting.

36



MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of Steinway Musical Instruments, Inc. and its subsidiaries (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company's internal control over financial reporting is a process designed by, or under the supervision of, the Company's principal executive and principal financial officers, and effected by the Company's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company's consolidated financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that:

    (1)
    pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

    (2)
    provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles;

    (3)
    provide reasonable assurance that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

    (4)
    provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.

Internal Control over financial reporting includes the controls themselves, monitoring and internal auditing practices and actions taken to correct deficiencies as identified.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2012. In making this assessment, the Company's management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Management reviewed the results of its assessment with the Audit Committee of its Board of Directors.

Based on its assessment, management determined that, as of December 31, 2012, the Company's internal control over financial reporting is effective.

KPMG LLP, the independent registered public accounting firm that audited the consolidated financial statements included in this annual report, audited the Company's internal control over financial reporting as stated in their report, which appears elsewhere in this report.

By:   /s/ Michael T. Sweeney

Michael T. Sweeney
Chief Executive Officer
March 14, 2013
   

By:

 

/s/ Dennis M. Hanson

Dennis M. Hanson
Chief Financial Officer
March 14, 2013

 

 

37


Item 9B. Other Information

        None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance

        The information called for by this item is hereby incorporated by reference to the Registrant's definitive Proxy Statement for the fiscal year ended December 31, 2012, which Proxy Statement will be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year covered by this report.

Item 11. Executive Compensation

        The information called for by this item is hereby incorporated by reference to the Registrant's definitive Proxy Statement for the fiscal year ended December 31, 2012, which Proxy Statement will be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year covered by this report.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

        The information called for by this item is hereby incorporated by reference to the Registrant's definitive Proxy Statement for the fiscal year ended December 31, 2012, which Proxy Statement will be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year covered by this report.

Item 13. Certain Relationships and Related Transactions, and Director Independence

        The information called for by this item is hereby incorporated by reference to the Registrant's definitive Proxy Statement for the fiscal year ended December 31, 2012, which Proxy Statement will be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year covered by this report.

Item 14. Principal Accounting Fees and Services

        The information called for by this item is hereby incorporated by reference to the Registrant's definitive Proxy Statement for the fiscal year ended December 31, 2012, which Proxy Statement will be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year covered by this report.

38


PART IV

Item 15. Exhibits, Financial Statement Schedules

(a)
The following documents are filed as a part of this report:

1.
  Financial Statements
 
Sequential
Page Number

 

Report of Independent Registered Public Accounting Firm

 

F-2

 

Consolidated Statements of Operations
    Years Ended December 31, 2012, 2011, and 2010

  F-4

 

Consolidated Statements of Comprehensive Income (Loss)
    Years Ended December 31, 2012, 2011, and 2010

  F-5

 

Consolidated Balance Sheets as of December 31, 2012 and 2011

  F-6

 

Consolidated Statements of Cash Flows for the
    Years Ended December 31, 2012, 2011, and 2010

  F-7

 

Consolidated Statements of Stockholders' Equity for the
    Years Ended December 31, 2012, 2011, and 2010

  F-8

 

Notes to Consolidated Financial Statements

  F-9

2.

 

Schedules

 

All required schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are included in the Notes to the Consolidated Financial Statements.

3.

 

Exhibits:    The Exhibits listed below are filed as part of, or incorporated by reference into, this report.

 

 
Exhibit
No.
 
Description
    3.1     Restated Certificate of Incorporation of Registrant(2)
    3.2     Amended and Restated Bylaws of Registrant(12)
    4.1     Indenture, dated as of February 23, 2006, among Steinway Musical Instruments, Inc., as Issuer; the subsidiary guarantors; and the Bank of New York Trust Company, N.A., as Trustee(4)
    4.2     Rights Agreement dated September 26, 2011 between Steinway Musical Instruments, Inc. and Continental Stock Transfer & Trust Company, as Rights Agent, including the Form of Certificate of Designations of Participating Preferred Stock, the Form of Right Certificate, and the Summary of Rights to Purchase Preferred Shares, respectively attached thereto(12)
    4.3     Amendment No. 1 to Rights Agreement between the Company and Continental Stock Transfer & Trust Company(17)
  10.1     Employment Agreement dated as of May 1, 2011 by and between Steinway & Sons and Thomas Kurrer(9)

39


  10.2     Employment Agreement dated as of May 1, 2011 by and between Steinway, Inc. and Ronald Losby(9)
  10.3     Employment Agreement Amendment dated December 21, 2012 between Steinway, Inc. and Ronald Losby(16)
  10.4     Employment Agreement dated May 1, 2011 by and between Steinway Musical Instruments, Inc. and Dennis Hanson(9)
  10.5     Employment Agreement Amendment dated December 21, 2012 between Steinway Musical Instruments, Inc. and Dennis M. Hanson(16)
  10.6     Succession Agreement dated October 24, 2011 by and between Steinway Musical Instruments, Inc. and Dana Messina(13)
  10.7     Employment Agreement dated October 24, 2011 by and between Steinway Musical Instruments, Inc. and Michael Sweeney(13)
  10.8     Succession Agreement dated July 1, 2011 by and between Steinway Musical Instruments, Inc. and Kyle Kirkland(10)
  10.9     Employment Agreement dated December 20, 2011 between Conn-Selmer, Inc. and John M. Stoner, Jr.(14)
  10.10   Distribution Agreement, dated November 1, 1952, by and between H. & A. Selmer, Inc. and Henri Selmer & Cie(1)
  10.11   Loan and Security Agreement dated as of October 5, 2010, among Conn-Selmer, Inc. and Steinway, Inc. as borrowers; the several lenders from time to time parties thereto; and Bank of America, N.A., as Administrative Agent(8)
  10.12   Labor Contract Agreement between Musser Division and Carpenter Local 1027 Mill-Cabinet-Industrial Division affiliate of Chicago Regional Council of Carpenters of the United Brotherhood of Carpenters and Jointers of America(6)
  10.13   Summary Description of Compensation for Non-Employee Directors(11)
  10.14   Steinway Musical Instruments, Inc. 2006 Stock Compensation Plan(5)
  10.15   Steinway Musical Instruments, Inc. 2006 Employee Stock Purchase Plan(5)
  10.16   Subscription Agreement dated as of November 5, 2009, by and among Samick Musical Instruments Co, Ltd., and Steinway Musical Instruments, Inc.(7)
  10.17   Amendment No. 1 to Subscription Agreement between the Company and Samick Musical Instruments Co., Ltd.(17)
  10.18   Agreement between Conn-Selmer, Inc. and U.A.W. Local 2359(15)
  10.19   Agreement Steinway & Sons with Local 81102, F.W.I.U.E.-C.W.A, A.F.L., C.I.O. dated January 1, 2013
  14.0     Code of Ethics and Professional Conduct(3)
  21.1     List of Subsidiaries of the Registrant
  23.1     Consent of Independent Registered Public Accounting Firm – KPMG LLP
  31.1     Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  31.2     Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32.1     Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
  32.2     Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
  101.INS    XBRL Instance Document*
  101.SCH   XBRL Taxonomy Extension Schema Document*
  101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document*
  101.DEF   XBRL Taxonomy Extension Definition Linkbase Document*

40


  101.LAB   XBRL Taxonomy Extension Label Linkbase Document*
  101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document*
    *
    Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

    (1)
    Previously filed with the Commission on February 8, 1994 as an exhibit to the Registrant's Registration Statement on Form S-1.

    (2)
    Previously filed with the Commission on March 27, 1997 as an exhibit to the Registrant's Annual Report on Form 10-K.

    (3)
    Previously filed with the Commission on March 31, 2005 as an exhibit to the Registrant's Annual Report on Form 10-K.

    (4)
    Previously filed with the Commission on February 27, 2006 as an exhibit to the Registrant's Current Report on Form 8-K.

    (5)
    Previously filed with the Commission on July 17, 2007 as an exhibit to the Registrant's Registration Statement on Form S-8.

    (6)
    Previously filed with the Commission on January 31, 2008 as an exhibit to the Registrant's Current Report on Form 8-K.

    (7)
    Previously filed with the Commission on November 5, 2009 as an exhibit to the Registrant's Current Report on Form 8-K.

    (8)
    Previously filed with the Commission on October 8, 2010 as an exhibit to the Registrant's Current Report on Form 8-K.

    (9)
    Previously filed with the Commission on May 3, 2011 as an exhibit to the Registrant's Current Report on Form 8-K.

    (10)
    Previously filed with the Commission on July 6, 2011 as an exhibit to the Registrant's Current Report on Form 8-K.

    (11)
    Previously filed with the Commission on September 2, 2011 in the Registrant's Current Report on Form 8-K.

    (12)
    Previously filed with the Commission on September 28, 2011 as an exhibit to the Registrant's Current Report on Form 8-K.

    (13)
    Previously filed with the Commission on October 25, 2011 as an exhibit to the Registrant's Current Report on Form 8-K.

    (14)
    Previously filed with the Commission on December 23, 2011 as an exhibit to the Registrant's Current Report on Form 8-K.

    (15)
    Previously filed with the Commission on March 15, 2012 as an exhibit to the Registrant's Annual Report on Form 10-K.

    (16)
    Previously filed with the Commission on December 26, 2012 as an exhibit to the Registrant's Current Report on Form 8-K.

    (17)
    Previously filed with the Commission on February 22, 2013 as an exhibit to the Registrant's Current Report on Form 8-K.

41


Signatures

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Steinway Musical Instruments, Inc.        

By:

 

/s/ Michael T. Sweeney

Michael T. Sweeney

 

March 14, 2013

(Date)

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities listed below on March 14, 2013:

Signature
  Title

 

 

 
/s/ Michael T. Sweeney

Michael T. Sweeney
  Director, Chairman, and Chief Executive Officer (Principal Executive Officer)

/s/ Dennis M. Hanson

Dennis M. Hanson

 

Chief Financial Officer (Principal Financial Officer)

/s/ Donna M. Lucente

Donna M. Lucente

 

Controller (Principal Accounting Officer)

/s/ Edward Kim

Eungjong (Edward) Kim

 

Director

/s/ Joon W. Kim

Joon W. Kim

 

Director

/s/ Jong Sup Kim

Jong Sup Kim

 

Director

/s/ Kyle R. Kirkland

Kyle R. Kirkland

 

Director

/s/ Thomas Kurrer

Thomas Kurrer

 

Director

/s/ Don Kwon

Dong Hyun (Don) Kwon

 

Director

/s/ David Lockwood

David Lockwood

 

Director

42


Signature
  Title

 

 

 
/s/ Dana D. Messina

Dana D. Messina
  Director

/s/ John M. Stoner, Jr.

John M. Stoner, Jr.

 

Director

/s/ Gregory S. Wood

Gregory S. Wood

 

Director

43



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

F-1



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
Steinway Musical Instruments, Inc.:

We have audited the accompanying consolidated balance sheets of Steinway Musical Instruments, Inc. and subsidiaries (the Company) as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income (loss), cash flows, and stockholders' equity for each of the years in the three-year period ended December 31, 2012. We also have audited the Company's internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting (Item 9A(b)). Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company's internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

F-2


In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Steinway Musical Instruments, Inc. and subsidiaries as of December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ KPMG LLP
Boston, Massachusetts
March 14, 2013

F-3


Steinway Musical Instruments, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands Except Share and Per Share Data)

For the years ended December 31,   2012   2011   2010  

Net sales

  $ 353,717   $ 346,256   $ 318,121  

Cost of sales

    239,083     241,108     222,171  
               

Gross profit

    114,634     105,148     95,950  

Operating expenses:

                   

Sales and marketing

    45,924     43,581     41,340  

General and administrative

    38,464     38,921     29,688  

Amortization

    1,046     1,101     1,226  

Other operating expenses

    34     125     883  

Impairment and facility rationalization charges

    566     5,490      
               

Total operating expenses

    86,034     89,218     73,137  
               

Income from operations

    28,600     15,930     22,813  

Other expense, net

    3,406     4,226     370  

Loss (gain) on extinguishment of debt

        2,422     (104 )

Interest income

    (1,184 )   (1,339 )   (1,431 )

Interest expense

    4,835     7,037     11,017  
               

Total non-operating expenses, net

    7,057     12,346     9,852  
               

Income before income taxes

    21,543     3,584     12,961  

Income tax provision

    8,033     1,954     5,061  
               

Net income

  $ 13,510   $ 1,630   $ 7,900  
               

Earnings per share – basic

  $ 1.09   $ 0.13   $ 0.68  
               

Earnings per share – diluted

  $ 1.08   $ 0.13   $ 0.68  
               

Weighted average shares:

                   

Basic

    12,409,761     12,232,098     11,640,955  

Diluted

    12,528,048     12,375,107     11,695,086  

See notes to consolidated financial statements.

F-4


Steinway Musical Instruments, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In Thousands)

 
   
 
For the years ended December 31,   2012   2011   2010  

Net income

  $ 13,510   $ 1,630   $ 7,900  

Other comprehensive income (loss)

                   

Foreign currency translation adjustments

    546     490     (3,540 )

Pension and other postretirement benefits

    (10,511 )   (11,382 )   (2,600 )

Effect of income taxes

    3,632     4,551     1,056  
               

Total comprehensive income (loss)

  $ 7,177   $ (4,711 ) $ 2,816  
               

F-5


Steinway Musical Instruments, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(In Thousands Except Share and Per Share Data)

December 31,   2012   2011  

Assets

             

Current assets:

             

Cash

  $ 73,406   $ 49,888  

Accounts, notes and other receivables, net

    43,536     42,322  

Inventories

    125,081     132,401  

Prepaid expenses and other current assets

    9,079     11,917  

Deferred tax assets

    5,230     12,093  
           

Total current assets

    256,332     248,621  

Property, plant and equipment, net

    91,485     86,997  

Trademarks

    13,420     13,743  

Goodwill

    22,916     22,676  

Other intangibles, net

    1,328     2,293  

Other assets

    15,801     18,430  

Long-term deferred tax assets

    24,385     16,614  
           

Total assets

  $ 425,667   $ 409,374  
           

Liabilities and stockholders' equity

             

Current liabilities:

             

Debt

  $ 576   $ 650  

Accounts payable

    12,867     10,702  

Other current liabilities

    40,175     38,623  
           

Total current liabilities

    53,618     49,975  

Long-term debt

    67,431     67,367  

Deferred tax liabilities

    560     2,438  

Pension and other postretirement benefit liabilities

    54,501     48,468  

Other non-current liabilities

    7,712     8,533  
           

Total liabilities

    183,822     176,781  
           

Commitments and contingent liabilities

             

Stockholders' equity:

             

Class A common stock, $.001 par value, 5,000,000 shares authorized, 477,952 shares issued, 0 shares outstanding in 2011 and 2012

         

Ordinary common stock, $.001 par value, 90,000,000 shares authorized, 14,354,617 and 14,286,802 shares issued in 2012 and 2011, respectively, and 12,458,614 and 12,365,399 shares outstanding in 2012 and 2011, respectively

    14     14  

Additional paid-in capital

    162,579     160,996  

Retained earnings

    148,934     135,522  

Accumulated other comprehensive loss

    (25,609 )   (19,276 )

Treasury stock, at cost (1,896,003 and 1,921,403 shares of Ordinary common stock in 2012 and 2011, respectively)

    (44,073 )   (44,663 )
           

Total stockholders' equity

    241,845     232,593  
           

Total liabilities and stockholders' equity

  $ 425,667   $ 409,374  
           

See notes to consolidated financial statements.

F-6



Steinway Musical Instruments, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)

For the years ended December 31,   2012   2011   2010  

Cash flows from operating activities:

                   

Net income

  $ 13,510   $ 1,630   $ 7,900  

Adjustments to reconcile net income to cash flows from operating activities:

                   

Depreciation and amortization

    9,088     8,781     9,550  

Loss (gain) on extinguishment of debt

        2,422     (104 )

Impairment and facility rationalization charges

    566     5,490      

Stock-based compensation expense

    442     3,632     1,447  

(Excess benefit) tax deficiency from stock-based awards

    (11 )   (297 )   63  

Tax benefit from stock option exercises

    23     434     5  

Deferred tax expense (benefit)

    1,500     (5,187 )   (458 )

Provision for (recovery of) doubtful accounts

    668     (29 )   (294 )

Other

    (249 )   390     15  

Changes in operating assets and liabilities, net of effects of businesses acquired:

                   

Accounts, notes and other receivables

    (435 )   (41 )   2,031  

Inventories

    2,644     9,315     9,867  

Prepaid expenses and other assets

    2,484     (4,543 )   (933 )

Accounts payable

    2,159     (1,400 )   2,575  

Other current and non-current liabilities

    (3,676 )   1,984     4,004  
               

Cash flows from operating activities

    28,713     22,581     35,668  

Cash flows from investing activities:

                   

Capital expenditures

    (7,030 )   (6,942 )   (3,732 )

Proceeds from sales of property, plant and equipment

    11     42     20  

Other

    195     (11 )   103  

Payment for acquisition and contingent consideration for previous acquisitions

        (3,289 )   (353 )
               

Cash flows from investing activities

    (6,824 )   (10,200 )   (3,962 )

Cash flows from financing activities:

                   

Borrowings under lines of credit

    4,500     16,607     2,136  

Repayments under lines of credit

    (4,500 )   (18,470 )   (400 )

Repayments of long-term debt, net of premium or discount

        (86,488 )   (5,633 )

Proceeds from issuance of common stock

    1,610     4,614     28,209  

Purchase of treasury stock

            (349 )

Excess benefit (tax deficiency) from stock-based awards

    11     297     (63 )
               

Cash flows from financing activities

    1,621     (83,440 )   23,900  

Effects of foreign exchange rate changes on cash

   
8
   
1,136
   
(1,668

)
               

Increase (decrease) in cash

    23,518     (69,923 )   53,938  

Cash, beginning of year

    49,888     119,811     65,873  
               

Cash, end of year

  $ 73,406   $ 49,888   $ 119,811  
               

Supplemental cash flow information:

                   

Interest paid

  $ 4,804   $ 8,879   $ 12,279  

Income taxes paid

  $ 7,763   $ 6,727   $ 7,429  

See notes to consolidated financial statements.

F-7



Steinway Musical Instruments, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In Thousands Except Share Data)

 
  Common
Stock
  Additional
Paid-In
Capital
  Retained
Earnings
  Accumulated
Other
Comprehensive
Income
(Loss)
  Treasury
Stock
  Total
Stockholders'
Equity
 

Balance, January 1, 2010

  $ 12   $ 125,192   $ 126,415   $ (7,851 ) $ (47,272 )   196,496  

Net income

               
7,900
               
7,900
 

Foreign currency translation adjustment

                      (3,540 )         (3,540 )

Changes in pension and other postretirement benefits, net

                      (1,544 )         (1,544 )

Exercise of 24,950 options for shares of common stock

          14     (106 )         553     461  

Tax benefit of options exercised

          5                       5  

Stock-based compensation

          1,447                       1,447  

Issuance of 1,756,821 shares of common stock

    2     27,746                       27,748  

Purchase of 21,827 shares of treasury stock

                            (349 )   (349 )
                           

Balance, December 31, 2010

    14     154,404     134,209     (12,935 )   (47,068 )   228,624  

Net income

               
1,630
               
1,630
 

Foreign currency translation adjustment

                      490           490  

Changes in pension and other postretirement benefits, net

                      (6,831 )         (6,831 )

Exercise of 274,200 options for shares of common stock

        1,938     (317 )         2,405     4,026  

Tax benefit of options exercised

          434                       434  

Stock-based compensation

          3,632                       3,632  

Issuance of 35,487 shares of common stock

        588                       588  
                           

Balance, December 31, 2011

    14     160,996     135,522     (19,276 )   (44,663 )   232,593  

Net income

               
13,510
               
13,510
 

Foreign currency translation adjustment

                      546           546  

Changes in pension and other postretirement benefits, net

                      (6,879 )         (6,879 )

Exercise of 65,250 options for shares of common stock

        530     (98 )         590     1,022  

Tax benefit of options exercised

          23                       23  

Stock-based compensation

          442                       442  

Issuance of 27,965 shares of common stock

          588                       588  
                           

Balance, December 31, 2012

  $ 14   $ 162,579   $ 148,934   $ (25,609 ) $ (44,073 ) $ 241,845  
                           

See notes to consolidated financial statements.

F-8


Steinway Musical Instruments, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2012, 2011, and 2010
(Tabular Amounts in Thousands Except Share and Per Share Data)

1.     Nature of Business

        Steinway Musical Instruments, Inc. and subsidiaries (the "Company") is one of the world's leading manufacturers of musical instruments. The Company, through its piano ("Steinway") and band ("Conn-Selmer") divisions, manufactures and distributes products within the musical instrument industry. Steinway produces what is considered to be the highest quality piano in the world and has one of the most widely recognized and prestigious brand names. Conn-Selmer is the largest domestic manufacturer of band & orchestral instruments and related accessories, offering complete lines of brass, woodwind, percussion and string instruments. Selmer Paris saxophones, Bach Stradivarius trumpets, C.G. Conn French horns, Leblanc clarinets, King trombones and Ludwig snare drums are considered by many to be the finest such instruments in the world.

        Throughout these financial statements "we," "us," and "our" refer to Steinway Musical Instruments, Inc. and subsidiaries taken as a whole.

2.     Significant Accounting Policies

Principles of Consolidation – Our consolidated financial statements include the accounts of all direct and indirect subsidiaries, all of which are wholly owned. All intercompany balances have been eliminated in consolidation.

Use of Estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of assets and contingent liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant estimates in the consolidated financial statements include accounts receivable allowances, inventory reserves, workers' compensation and self-insured health claims, impairment of long-lived assets, pension and other post retirement benefit cost assumptions, deferred income tax valuation allowances, uncertain tax positions, and environmental liabilities.

Revenue Recognition – Generally, revenue for wholesale transactions is recognized upon shipment following receipt of a valid dealer order. Retail revenue is generally recognized upon delivery to the customer in accordance with the customer's purchase agreement, and restoration revenue is recognized based on the completed contract method. Revenue from restoration services and rentals is not material to the consolidated financial statements and is included within net sales. Shipping and handling fees billed to customers are not material and are included within net sales and the related costs are reported within cost of sales. We provide for the estimated costs of warranties, discounts and returns at the time of revenue recognition.

Depreciation and Amortization – Property, plant and equipment are recorded at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the estimated useful lives of the

F-9


improvements or the remaining term of the respective lease, whichever is shorter. Estimated useful lives are as follows:

Buildings and improvements

  15 – 40 years

Leasehold improvements

  5 – 15 years

Machinery, equipment and tooling

  3 – 10 years

Office furniture and fixtures

  3 – 10 years

Concert and Artist and rental pianos

  15 years

        When impairment indicators are present, we evaluate the recoverability of our long-lived asset groups by comparing the estimated future cash flows expected to be generated by those assets to their carrying value. Should the assessment indicate an impairment, the affected assets are written down to fair value. Assets held-for-sale are included in prepaid expenses and other current assets and are recorded at the lower of cost or fair value less disposal costs. Concert and Artist and rental pianos are periodically transferred from our inventory to fixed assets.

Goodwill, Trademarks, and Other Intangible Assets – Intangible assets other than goodwill and indefinite-lived trademarks are amortized on a straight-line basis over their estimated useful lives. Deferred financing costs are amortized over the repayment periods of the underlying debt. Goodwill and indefinite-lived trademarks are not amortized but are subject to impairment testing. We conduct an impairment test on July 31st each year, and also when events and circumstances indicate that the fair value of any of our reporting units may be below the unit's carrying value. We consider our band division, music education business, piano division, and our online music business to be separate reporting units for purpose of this analysis.

        Our assessment is based on a comparison of net book value to estimated fair values primarily using an income approach. For purposes of the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. We make assumptions about the amount and timing of future expected cash flows, terminal value growth rates and appropriate discount rates. The amount and timing of future cash flows within our discounted cash flow analysis is based on our most recent operational budgets, long range strategic plans and other estimates. The terminal value growth rate is used to calculate the value of cash flows beyond the last projected period in our analysis and reflects our best estimates for stable, perpetual growth of our reporting units. We use estimates of market participant weighted-average costs of capital as a basis for determining the discount rates to apply to our reporting units' future expected cash flows, adjusted for the risks and uncertainty inherent in our industry generally and in our internally developed forecasts. We also use a market approach against which we benchmark the results of our income approach to ensure that the results are appropriate.

Advertising – Advertising costs are expensed as incurred. Advertising expense was $6.5 million for the year ended December 31, 2012, $6.1 million for the year ended December 31, 2011, and $5.2 million for the year ended December 31, 2010.

Income Taxes – We provide for income taxes using an asset and liability approach. We compute deferred income tax assets and liabilities for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. When necessary, we establish valuation allowances to reduce deferred tax assets to the amount that more likely than not will be realized.

F-10


        We report income tax-related interest and penalties as a component of income tax expense. We file income tax returns at the U.S. federal, state, and local levels, as well as in several foreign jurisdictions. With few exceptions, our returns are no longer subject to examinations for years before 2009.

Foreign Currency Translation and Remeasurement – We translate assets and liabilities of non-U.S. operations into U.S. dollars at year end rates, and revenues and expenses at average rates of exchange prevailing during the year. We report the resulting translation adjustments as a separate component of accumulated other comprehensive income or loss. We recognize foreign currency transaction gains and losses in the consolidated statements of operations as incurred.

Foreign Currency Exchange Contracts – We enter into foreign currency exchange contracts to mitigate the risks from foreign currency fluctuations on certain intercompany transactions. These contracts are not designated as hedging instruments for accounting purposes, and are not used for trading or speculative purposes. Gains and losses arising from fluctuations in exchange rates are recognized in the statement of operations. Such gains and losses offset the foreign currency exchange gains or losses associated with the corresponding receivable, payable, or forecasted transaction. We have credit risk to the extent the counterparties are unable to fulfill their obligations on the foreign currency exchange contracts. However, we enter into these contracts with reputable financial institutions and believe we have no significant credit risk.

Stock-Based Compensation – We have an employee stock purchase plan ("Purchase Plan") and stock award plans ("Stock Plans"), which are described in Note 14.

        We measure the grant date fair value of equity awards given to employees in exchange for services and, with the exception of the vesting which was accelerated in 2011, recognize that cost over the period that such services are performed. The cost of share-based awards is recognized on a straight-line basis over each award's requisite service period. We estimate the fair value of our stock option awards and employee stock purchase plan rights on the date of grant using the Black-Scholes option valuation model. See Note 14 for additional information regarding our stockholders' equity and stock arrangements.

Environmental Matters – Potential environmental liabilities are recorded when it is probable that a loss has been incurred and its amount can reasonably be estimated. See Note 15 for additional information.

Segment Reporting – We have two reportable segments: the piano segment and the band & orchestral instrument segment. We consider these two segments reportable as they are managed separately and the operating results of each segment are separately reviewed and evaluated by our senior management on a regular basis. The Company's chief operating decision maker is the Chief Executive Officer.

Retirement Plans – We have defined benefit pension plans covering a majority of our employees, including certain employees in foreign countries. Certain domestic hourly employees are covered by multi-employer defined benefit pension plans to which we make contributions. We also provide postretirement life insurance benefits to certain eligible hourly retirees and their dependents.

        Benefits under the pension and other postretirement benefit plans are generally based on age at retirement and years of service and, for some pension plans, benefits are also based on the employee's annual earnings. The net cost of our pension and other postretirement benefit plans is determined using the projected unit credit method and several actuarial assumptions, the most significant of which are the discount rate, the long-term rate of asset return, and current rate trends. A portion of these costs is not recognized in net earnings in the year incurred because it is allocated to product costs and reflected in inventory at the end of a reporting period.

F-11


Accumulated Other Comprehensive Income (Loss) – Comprehensive income (loss) is comprised of net income, foreign currency translation adjustments, and certain changes in pension and other postretirement benefit liabilities, and is reported in the consolidated statements of comprehensive income (loss) for all periods presented.

Recent Accounting Pronouncements

        We adopted certain amendments to Accounting Standards Codification ("ASC") 820, "Fair Value Measurements," effective January 1, 2012. These amendments include a consistent definition of fair value, enhanced disclosure requirements for "Level 3" fair value adjustments and other changes to required disclosures. Their adoption did not have a material impact on our consolidated financial statements.

        We adopted the amendments to ASC 220, "Comprehensive Income," effective January 1, 2012. The amendments pertained to presentation and disclosure only and did not have a material impact on our consolidated financial statements.

        We adopted the amendments to ASC 350, "Intangibles-Goodwill and Others," effective January 1, 2012. The amended guidance allows us to do an initial qualitative assessment of relevant events and circumstances to determine if fair value of a reporting unit is more likely than not less than its carrying value, prior to performing the two-step quantitative goodwill impairment test. The adoption of these amendments did not have a material impact on our consolidated financial statements.

        In July 2012, the Financial Accounting Standards Board amended ASC 350 to provide the option to do an initial qualitative assessment of relevant events and circumstances prior to calculating the fair value of an indefinite-lived intangible asset. This amendment is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. We will comply with the requirements of this pronouncement when it becomes effective. This pronouncement is not expected to have a material impact on our consolidated financial statements.

3.     Earnings per Common Share

        We compute earnings per share using the weighted-average number of common shares outstanding during each period. Diluted earnings per common share reflects the dilutive impact of shares subscribed under the Employee Stock Purchase Plan ("Purchase Plan") and effect of our outstanding options using the treasury stock method, except when such items would be antidilutive.

        The following table presents the calculation of basic and diluted earnings per share:

For the years ended December 31,   2012   2011   2010  

Numerator:

                   

Net income

  $ 13,510   $ 1,630   $ 7,900  

Denominator:

                   

Weighted-average common shares outstanding – basic

    12,409,761     12,232,098     11,640,955  

Dilutive effect of stock-based compensation plans

    118,287     143,009     54,131  
               

Weighted-average common shares outstanding – diluted

    12,528,048     12,375,107     11,695,086  
               

Net income per share – basic

  $ 1.09   $ 0.13   $ 0.68  

Net income per share – diluted

  $ 1.08   $ 0.13   $ 0.68  

        Antidilutive options not included in our diluted earnings per common share calculation totaled 356,400 as of December 31, 2012, 372,000 as of December 31, 2011, and 739,336 as of December 31, 2010.

F-12


4.     Accounts, Notes and Other Receivables

        Accounts, notes and other receivables are recorded net of allowances for bad debts, discounts and returns. Generally, we reserve all receivables that are in excess of one year past due. We write off receivables in the event of customer bankruptcy, or at management's discretion when collectibility is no longer reasonably possible.

December 31,   2012   2011  

Accounts receivable

  $ 38,803   $ 40,927  

Notes and other receivables

    12,705     12,149  
           

Accounts, notes and other receivables, gross

    51,508     53,076  

Allowance for doubtful accounts

    (6,353 )   (9,083 )

Allowance for discounts and returns

    (1,619 )   (1,671 )
           

Accounts, notes and other receivables, net

  $ 43,536   $ 42,322  
           

A summary of the activity in the allowance for doubtful accounts is as follows:

For the years ended December 31,   2012   2011   2010  

Beginning balance

  $ 9,083   $ 10,316   $ 11,088  

Additions (recoveries)

    668     (29 )   (294 )

Foreign currency translation adjustments

    4     (3 )   (10 )

Deductions and other

    (3,402 )   (1,201 )   (468 )
               

Ending balance

  $ 6,353   $ 9,083   $ 10,316  
               

5.     Inventories

        Inventories are stated at the lower of cost, determined on a first-in, first-out basis, or market. A summary of the net inventories held as of December 31, 2012 and 2011 is as follows:

December 31,   2012   2011  

Raw materials

  $ 18,582   $ 18,242  

Work-in-process

    34,923     33,377  

Finished goods

    71,576     80,782  
           

  $ 125,081   $ 132,401  
           

A summary of the activity in the inventory reserves is as follows:

For the years ended December 31,   2012   2011   2010  

Beginning balance

  $ 12,220   $ 13,054   $ 12,186  

Additions charged to costs and expenses

    2,402     1,824     3,007  

Foreign currency translation adjustments

    10     (11 )   (57 )

Deductions and reclassifications

    (2,736 )   (2,647 )   (2,082 )
               

Ending balance

  $ 11,896   $ 12,220   $ 13,054  
               

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6.     Property, Plant and Equipment, Net

December 31,   2012   2011  

Land

  $ 19,119   $ 19,001  

Buildings and improvements

    78,210     73,265  

Leasehold improvements

    6,185     5,718  

Machinery, equipment and tooling

    62,291     61,614  

Office furniture and fixtures

    11,689     12,403  

Concert and Artist and rental pianos

    30,183     27,331  

Construction-in-progress

    1,366     2,956  
           

    209,043     202,288  

Less accumulated depreciation

    (117,558 )   (115,291 )
           

  $ 91,485   $ 86,997  
           

        Depreciation expense was $8.0 million in 2012, $7.7 million in 2011, and $8.3 million in 2010. We recorded impairment charges of $0.9 million related to buildings and $0.3 million related to machinery, equipment, and tooling at one of our band instrument manufacturing facilities in 2011. These charges are discussed more fully in Note 13.

7.     Goodwill, Trademarks, and Other Intangible Assets

The changes in the carrying amounts of goodwill and trademarks are as follows:

 
  Piano
Segment
  Band
Segment
  Total  

Goodwill:

                   

Balance, January 1, 2011

  $ 25,823   $ 200   $ 26,023  

Impairment charge

    (2,727 )   (200 )   (2,927 )

Foreign currency translation impact

    (420 )       (420 )
               

Balance, December 31, 2011

    22,676         22,676  

Foreign currency translation impact

    240         240  
               

Balance, December 31, 2012

  $ 22,916   $   $ 22,916  
               

 

 
  Piano
Segment
  Band
Segment
  Total  

Trademarks:

                   

Balance, January 1, 2011

  $ 9,157   $ 5,824   $ 14,981  

Impairment charge

    (255 )   (850 )   (1,105 )

Foreign currency translation impact

    (133 )       (133 )
               

Balance, December 31, 2011

    8,769     4,974     13,743  

Impairment charge

        (400 )   (400 )

Foreign currency translation impact

    77         77  
               

Balance, December 31, 2012

  $ 8,846   $ 4,574   $ 13,420  
               

        Our annual impairment testing date of July 31st was selected to coincide with the timing of our fall budgeting and planning process, which provides multi-year cash flows that are used to conduct our annual impairment testing. This date also enables us to have insight into the back-to-school selling

F-14


season results for our band business. The multi-year projections for our band division resulted in reductions in revenue growth assumptions for certain of our woodwind products, which had an adverse effect on our fair value models. Our revenue assumptions were impacted in part by recent changes made to certain product lines, including the decision to discontinue certain models. As a result, we recorded a $0.4 million charge to trademarks as a component of operating expenses in the quarter ended September 30, 2012.

        Our analysis performed in 2011 was impacted by reductions in band revenue growth assumptions and lower profit margins, both of which have a significant impact on our discounted cash flow models. The assumptions were impacted in part by changes made to certain product lines, including the redesign of certain student woodwind instruments and the discontinuation of sourcing some components in favor of in-house manufacturing in order to ensure supply and quality. These changes resulted in increased costs, which caused lower margins despite price increases which we implemented on July 1, 2011. As a result, we recorded a $0.9 million charge to trademarks in 2011. We also wrote off $0.2 million of goodwill associated with the band division's music education business in 2011. In connection with completing this impairment analysis for the band division's reporting units, we also evaluated the recoverability of its long-lived assets. The results of that analysis are discussed in Note 13.

        The 2011 multi-year cash flow forecast associated with our online music business also reflected deterioration in revenue and growth assumptions due to recent decreases in order volume and declining market trends in the compact disc industry. Music consumers are increasingly using other delivery methods such as digital downloading and streaming as preferred methods of obtaining music, both of which require additional investment. As a result, our future anticipated cash flows for this business were reduced and our associated goodwill and trademarks were determined to be impaired. Accordingly, we recorded a $2.7 million charge to goodwill and a $0.3 million charge to trademarks associated with our online music business during the period.

        All impairment charges were taken as a component of operating expenses. Analyses of other intangible assets, including the remaining piano division trademarks and piano division goodwill indicated no impairment. No other events or circumstances occurred subsequent to our annual impairment test which would have indicated that these assets may be impaired.

F-15


        Our cumulative impairment losses are $8.8 million associated with band division goodwill, $1.3 million related to band division trademarks, $2.7 million attributable to online music business goodwill, and $1.2 million associated with online music business trademarks.

December 31,   2012   2011  

Amortizing intangible assets:

             

Gross deferred financing costs

  $ 3,932   $ 3,932  

Accumulated amortization

    (3,130 )   (2,726 )
           

Deferred financing costs, net

  $ 802   $ 1,206  
           

Gross non-compete agreements

  $ 250   $ 250  

Accumulated amortization

    (231 )   (181 )
           

Non-compete agreements, net

  $ 19   $ 69  
           

Gross customer relationships

  $ 843   $ 762  

Accumulated amortization

    (506 )   (349 )
           

Customer relationships, net

  $ 337   $ 413  
           

Gross website and developed technology

  $ 2,176   $ 2,176  

Accumulated amortization

    (2,006 )   (1,571 )
           

Website and developed technology, net

  $ 170   $ 605  
           

Total other intangibles

  $ 7,201   $ 7,120  

Accumulated amortization

    (5,873 )   (4,827 )
           

Other intangibles, net

  $ 1,328   $ 2,293  
           

        In 2011, we wrote off $1.0 million of deferred financing costs, primarily due to the redemption of $85.0 million of our 7.00% Senior Notes in May 2011. These transactions are discussed more fully in Note 12.

        The weighted-average amortization period for deferred financing costs is six years, and the weighted-average amortization period for all other amortizable intangibles is approximately five years. The remaining weighted-average amortization period for deferred financing costs is approximately two years and the remaining weighted-average amortization period for all other amortizable intangibles is approximately one year. Total amortization expense, which includes amortization of deferred financing costs, is as follows:

For the years ended December 31,   2012   2011   2010  

Total amortization expense

  $ 1,046   $ 1,101   $ 1,226  

The following table shows the estimated amortization expense for intangible assets for each of the five succeeding fiscal years:

For the years ended December 31,   Amount  

2013

  $ 709  

2014

    321  

2015

    237  

2016

    49  

2017

    12  
       

Total

  $ 1,328  
       

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8.     Other Assets

December 31,   2012   2011  

Notes receivable, net

  $ 1,547   $ 2,885  

Marketable securities

    1,838     1,583  

Deposits

    6,771     6,632  

Environmental escrow receivable

    1,871     1,998  

Pension assets

    133      

Benefits insurance

    987     2,354  

Other assets

    2,654     2,978  
           

Total

  $ 15,801   $ 18,430  
           

        Deposits include $4.1 million set aside for potential workers' compensation liabilities, $2.1 million for environmental remediation, and $0.4 million for collateral as of December 31, 2012. Deposits include $4.0 million set aside for potential workers' compensation liabilities, $2.1 million for environmental remediation, and $0.4 million for collateral as of December 31, 2011. The use of these funds is therefore restricted unless we replace the deposits with a letter of credit of a similar amount.

9.     Other Current Liabilities

December 31,   2012   2011  

Accrued payroll and related benefits

  $ 15,748   $ 12,965  

Current portion of pension and other postretirement benefit liabilities

    1,389     1,235  

Accrued warranty expense

    1,327     1,242  

Accrued interest

    1,563     1,608  

Deferred income

    10,834     8,971  

Income and other taxes payable

    202     1,105  

Other accrued expenses

    9,112     11,497  
           

Total

  $ 40,175   $ 38,623  
           

        Accrued warranty expense is recorded at the time of sale for instruments that have a warranty period ranging from one to ten years. The accrued expense recorded is generally based on historical warranty costs as a percentage of sales and is adjusted periodically following an analysis of warranty activity.

A summary of the activity in accrued warranty expense is as follows:

For the years ended December 31,   2012   2011   2010  

Beginning balance

  $ 1,242   $ 1,510   $ 1,553  

Additions

    1,099     1,123     894  

Claims and reversals

    (1,031 )   (1,381 )   (896 )

Foreign currency translation

    17     (10 )   (41 )
               

Ending balance

  $ 1,327   $ 1,242   $ 1,510  
               

F-17


10.   Other Expense, Net

For the years ended December 31,   2012   2011   2010  

West 57th Street building income

  $ (1,952 ) $ (2,373 ) $ (4,930 )

West 57th Street building expense

    7,083     6,963     6,786  

Foreign exchange gain, net

    (1,020 )   (254 )   (878 )

Miscellaneous, net

    (705 )   (110 )   (608 )
               

Total

  $ 3,406   $ 4,226   $ 370  
               

        West 57th Street building income includes all rent and other income attributable to the property; West 57th Street building expense includes the land lease, real estate taxes, depreciation, and other building costs. Since we retain a portion of the leasable space for our own retail store use, we have allocated a ratable portion of the building cost to sales and marketing expenses.

11.   Income Taxes

The components of the income tax provision are as follows:

For the years ended December 31,   2012   2011   2010  

U.S. federal:

                   

Current

  $   $ 862   $ 392  

Deferred

    492     (4,863 )   (11 )

U.S. state and local:

                   

Current

    606         353  

Deferred

    141     (383 )   (320 )

Foreign:

                   

Current

    5,927     6,279     4,774  

Deferred

    867     59     (127 )
               

Total

  $ 8,033   $ 1,954   $ 5,061  
               

The components of income (loss) before income taxes are as follows:

For the years ended December 31,   2012   2011   2010  

U.S. operations

  $ (645 ) $ (16,614 ) $ (1,549 )

Non-U.S. operations

    22,188     20,198     14,510  
               

Total

  $ 21,543   $ 3,584   $ 12,961  
               

F-18


Our income tax provision differed from that using the statutory U.S. federal rate of 35% as follows:

For the years ended December 31,   2012   2011   2010  

Statutory federal rate applied to income before income taxes

  $ 7,540   $ 1,254   $ 4,536  

Increase (decrease) in income taxes resulting from:

                   

Foreign income taxes (net of federal benefit)(1)

    (1,080 )   (327 )   (98 )

State income taxes (net of federal benefit)

    62     (230 )   140  

Permanent items

    257     712     528  

Repatriation of foreign earnings

    3,054          

Impact of excess foreign tax credits(2)

    (1,798 )   348     (25 )

Benefit of state net operating losses(3)

        (3 )   (219 )

Uncertain tax positions

    337     (102 )   (34 )

Other

    (339 )   302     233  
               

Income tax provision

  $ 8,033   $ 1,954   $ 5,061  
               

(1)
Includes the impact of foreign taxes that differ from the U.S. federal statutory rate of 35% as well as foreign income also subject to U.S. tax, less the foreign tax credit allowed in the current year.

(2)
Represents the impact of foreign tax credits eligible to offset U.S. taxes. In 2012, we used foreign tax credits of $3.0 million and reversed $1.4 million of valuation allowance. In 2011, we used $0.1 million of foreign tax credits and recorded a valuation allowance of $0.4 million related to foreign tax credits generated in 2008. In 2010, we utilized $2.9 million of foreign tax credits that were either fully or partially reserved and recorded a valuation allowance of $2.7 million relating to foreign tax credits generated in 2006, 2007, and 2008.

(3)
Represents the impact of state net operating losses fully reserved in a prior period which are available to offset current taxable income at the state level.

        At December 31, 2012, accumulated retained earnings of non-U.S. subsidiaries totaled $30.2 million, including $12.9 million related to our subsidiary in China. At the end of 2012, we determined that the future earnings of this subsidiary were likely to exceed the amount needed to fund operations. Accordingly, we no longer intend to indefinitely reinvest these earnings. We provided $3.1 million in 2012 for U.S. income taxes related to this subsidiary, comprised of $6.5 million in gross liability offset by $3.5 million of anticipated foreign tax credit benefit. No additional provision has been made for undistributed earnings of non-U.S. subsidiaries because our current intention is to indefinitely reinvest the remaining earnings for the foreseeable future. At December 31, 2011, accumulated retained earnings of non-U.S. subsidiaries totaled $23.3 million. No provision was made for these earnings in 2011.

F-19


The components of net deferred taxes are as follows:

December 31,   2012   2011  

Deferred tax assets:

             

Uniform capitalization and reserve adjustments to inventory

  $ 6,188   $ 6,373  

Allowance for doubtful accounts

    1,047     2,321  

Accrued expenses and other current assets and liabilities

    6,503     8,228  

Pension and other postretirement benefits within accumulated other comprehensive income (loss)

    18,998     15,366  

Net operating losses

    3,379     3,749  

Foreign tax credits

    23,028     21,129  

Other

    383     392  
           

Total deferred tax assets

    59,526     57,558  

Deferred tax liabilities:

             

Pension contributions

    (4,593 )   (3,036 )

Property, plant and equipment

    (10,781 )   (13,642 )

Foreign earnings

    (3,036 )    

Intangibles

    (2,154 )   (2,299 )
           

Total deferred tax liabilities

    (20,564 )   (18,977 )

Net deferred tax assets before valuation allowances

    38,962     38,581  

Valuation allowances

    (10,877 )   (12,365 )
           

Net deferred tax assets

  $ 28,085   $ 26,216  
           

        The valuation allowances generally take into consideration limitations imposed upon the use of the tax attributes and reduce the value of such items to the likely net realizable amount. The valuation allowances relate to foreign tax credits and state net operating loss carryforwards generated in excess of amounts we expect will more likely than not be utilized. Gross state tax net operating loss carryforwards totaled $65.4 million as of December 31, 2012 and expire in varying amounts from 2013 through 2032. Our foreign tax credit carryforwards expire in varying amounts from 2015 through 2022.

A summary of the activity in the foreign tax credit and net operating loss valuation allowances is as follows:

For the years ended December 31,   2012   2011   2010  

Beginning balance

  $ 12,365   $ 11,663   $ 9,871  

Additions

    460     932     3,985  

Usage, expiration, and reversals

    (1,990 )   (160 )   (1,995 )

Foreign currency translation

    42     (70 )   (198 )
               

Ending balance

  $ 10,877   $ 12,365   $ 11,663  
               

Amounts recorded in other current liabilities and other non-current liabilities in the accompanying consolidated balance sheet relating to uncertain tax positions as of December 31, 2012 and 2011 are as follows:

December 31,   2012   2011  

Other current liabilities

  $ 3   $ 4  

Other non-current liabilities

    148     157  
           

Total

  $ 151   $ 161  
           

F-20


        The liability for uncertain tax positions decreased less than $0.1 million in 2012 primarily as a result of the expiration of statutes of limitations. Although we believe our tax estimates are appropriate, the expiration of any statutes of limitations, the final determination of any tax audits, or related litigation could result in changes to our estimates.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

 
  2012   2011  

Balance, January 1,

  $ 116   $ 1,339  

Gross increase – tax positions taken in a prior year

        1  

Gross decrease – tax positions taken in a prior year

    (1 )   (1 )

Gross increase – tax positions taken in the current year

    7     1  

Payments

         

Lapse of statutes of limitations

    (49 )   (1,224 )
           

Balance, December 31,

  $ 73   $ 116  
           

        With respect to uncertain tax positions, our accruals for payments of interest as of December 31, 2012 were nominal. For the years ended December 31, 2012 and 2011, the net de-recognition of both interest expense and penalties related to uncertain tax positions was nominal.

        Currently, we do not believe that our tax reserves will change significantly during 2013. The total amount of unrecognized tax benefits which would affect our effective tax rate, if recognized, was nominal as of December 31, 2012 and 2011.

        We file income tax returns in the U.S. federal jurisdiction and various state, local, and foreign jurisdictions. With few exceptions, our returns are no longer subject to examinations for years before 2009.

12.   Long-Term Debt

Our long-term debt consists of the following:

December 31,   2012   2011  

Senior Notes

  $ 67,506   $ 67,506  

Unamortized bond discount

    (75 )   (139 )

Overseas lines of credit

    576     650  
           

Total

    68,007     68,017  

Less current portion

    576     650  
           

Long-term debt

  $ 67,431   $ 67,367  
           

Scheduled payments as of December 31, 2012 are as follows:

 
  Amount  

2013

  $ 576  

2014

    67,506  

2015

     
       

Total

  $ 68,082  
       

        Our Senior Notes bear interest at 7.00% and mature on March 1, 2014. On May 2, 2011 we redeemed $85.0 million of our 7.00% Senior Notes at 101.75% of principal plus accrued interest

F-21


pursuant to a call we issued on April 1, 2011. We recorded a net loss on extinguishment of debt of $2.4 million during the second quarter of 2011.

Details of the debt extinguishment recorded in 2011 are as follows:

Principal repurchased

  $ 85,000  

Less:

       

Cash paid

    (86,488 )

Write-off of deferred financing costs

    (706 )

Write-off of bond discount

    (228 )
       

Net loss on extinguishment of debt

  $ (2,422 )
       

        On October 5, 2010, we entered into a new domestic credit facility with a syndicate of lenders (the "Credit Facility"). The Credit Facility provides us with a potential borrowing capacity of $100.0 million in revolving credit loans and expires on October 5, 2015. It also provides for borrowings at either London Interbank Offering Rate ("LIBOR") plus a range from 1.75% to 2.25% or as-needed borrowings at an alternate base rate, plus a range from 0.75% to 1.25%; both ranges depend upon availability at the time of borrowing. Borrowings are collateralized by our domestic accounts receivable, inventory and certain fixed assets. We had nothing outstanding on this Credit facility as of December 31, 2012 and $84.2 million of availability net of borrowing restrictions.

        Our non-domestic credit facilities originating from two German banks provide for borrowings by foreign subsidiaries of up to €15.3 million ($20.1 million at the December 31, 2012 exchange rate), net of borrowing restrictions of €0.1 million ($0.2 million at the December 31, 2012 exchange rate) and are payable on December 31, 2013 or February 28, 2014. These borrowings are collateralized by most of the assets of the borrowing subsidiaries. A portion of the loans can be converted into a maximum of £0.9 million ($1.4 million at the December 31, 2012 exchange rate) for use by our U.K. branch and ¥300 million ($3.5 million at the December 31, 2012 exchange rate) for use by our Japanese subsidiary. Our Chinese subsidiary also has the ability to convert the equivalent of up to €2.5 million into U.S. dollars or Chinese yuan ($3.3 million at the December 31, 2012 exchange rate). Euro loans bear interest at rates of Euro Interbank Offered Rate ("EURIBOR") plus a margin determined at the time of borrowing. Margins fluctuate based on the loan amount and the borrower's bank rating. The remaining demand borrowings bear interest at rates of the Bank of England base rate plus a fluctuating percentage for British pound loans, a base rate contingent upon currency borrowed plus 1.0% for loans of our Chinese subsidiary, and Tokyo Interbank Offered Rate ("TIBOR") plus 2.1% for Japanese yen loans. We had nothing outstanding as of December 31, 2012 on these credit facilities.

        Our Japanese subsidiary also maintains a separate revolving loan agreement that provides additional borrowing capacity of up to ¥300 million ($3.5 million at the December 31, 2012 exchange rate) based on eligible inventory balances. The revolving loan agreement bears interest at an average 30-day TIBOR rate plus 0.9% (outstanding borrowings at 1.1% at December 31, 2012) and expires on June 30, 2013. As of December 31, 2012, we had $0.6 million outstanding on this revolving loan agreement.

        All of our debt agreements contain covenants that place certain restrictions on us, including our ability to incur additional indebtedness, to make investments in other entities, and to pay cash dividends. We were in compliance with all such covenants as of December 31, 2012.

13.   Impairment and Facility Rationalization Charges – Band Segment

        As discussed in Note 7, our band division had indicators of impairment when we conducted our annual impairment testing in 2012 and 2011. As a result, we were required to conduct detailed analyses of our long-lived assets to determine whether or not their recoverability was impaired. Recoverability of

F-22


these assets is determined by comparing forecasted undiscounted net cash flows for the asset groups to their respective carrying values. Our woodwind manufacturing facility in Elkhart, Indiana produces primarily student instruments, which typically generate lower margins. The analysis of long-lived assets indicated no impairment for 2012. In 2011, the change from using certain sourced components to manufacturing these components in-house resulted in a reduction in anticipated future gross margins which was not covered by price increases which we implemented on July 1, 2011. Since the projected gross margins generated by the asset group would be insufficient to recover the book value of the property, plant, and equipment associated with that production, we recorded a $1.1 million impairment charge related to property, plant, and equipment as a component of operating expenses during the third quarter of 2011.

        During 2012, we recognized a loss of $0.2 million on our former manufacturing facility in Kenosha, Wisconsin. This facility was written down to $0.7 million – the sales price we received from the buyer of this property when sold in August 2012. During 2011, we recorded an impairment charge of $0.1 million on this property, which was classified as being held for sale and reported in other assets.

        During 2011, we recorded an impairment charge of $0.2 million on another former manufacturing facility in Elkhorn, Wisconsin. This property, which is classified as being held for sale, has a remaining book value of less than $0.1 million and is reported in other assets.

        Our real estate and equipment assets were valued using either quoted prices for specific assets or management-estimated market prices for similar assets. All impairment charges were booked as a component of operating expenses.

        During 2011, we reached an agreement with our union employees in LaGrange, Illinois to close our tuned percussion instrument manufacturing facility there. As a result, we recorded charges of $0.4 million in severance and related expenses during the first quarter of 2011 as a component of cost of goods sold. However, of December 31, 2011, we did not expect to close our tuned percussion instrument manufacturing facility and reversed the related severance expenses.

        In 2012, we extended the agreement to close this facility with our union employees since we intend to consolidate the production into our woodwind instrument manufacturing facility in Elkhart, Indiana in mid-2013. Accordingly, we recognized $0.4 million of severance charges as a component of cost of goods sold during the fourth quarter of 2012.

14.   Stockholders' Equity and Stock Arrangements

        Our common stock was previously comprised of two classes: Class A and Ordinary. With the exception of disparate voting power, both classes were substantially identical. Each share of Class A common stock entitled the holder to 98 votes. Holders of Ordinary common stock are entitled to one vote per share. On June 2, 2011 the owners of the Class A common stock sold all of their Class A shares to other shareholders. Once the Class A stock was no longer held by its original owners, it was converted into Ordinary common stock. This eliminated the 80% voting power previously held by the Class A common stock holders.

Stockholder Rights Plan – During the third quarter of 2011, we adopted a Stockholder Rights Plan under which stockholders will receive rights to purchase shares of a new series of preferred stock. The rights were distributed to all stockholders of record as of October 7, 2011. To effect the plan, the Board of Directors declared a dividend of one right on each outstanding share of the Company's common stock. The rights become exercisable if any person or group acquires 10% or more (or, in one instance, 35% or more) of our common stock.

        If the rights become exercisable, each right will initially entitle the holder to acquire one one-hundredth (1/100) of a share of a new series of preferred stock at an exercise price of $75 per

F-23


right. In addition, under certain circumstances, the rights will entitle the holders (other than the person or group triggering the rights) to buy shares of our common stock with a cumulative market value of two times the exercise price at a 50% discount off the then current price. Because the rights of any person or group acquiring the specified ownership percentage become void, that person or group would be subject to significant dilution in their holdings.

        Until the rights become exercisable, they will not have any impact on our shares outstanding. The rights will expire on September 26, 2021, unless extended or earlier redeemed or exchanged by us pursuant to the terms of the plan.

Employee Stock Purchase Plan – Under our 2006 Employee Stock Purchase Plan (the "Purchase Plan") substantially all employees may purchase Ordinary common stock through payroll deductions at a purchase price equal to 85% of the lower of the fair market values as of the beginning or end of each twelve-month offering period. Stock purchases under the Purchase Plan are limited to 5% of an employee's annual base earnings. We reserved 400,000 shares for issuance under this plan and may grant options to purchase shares up to ten years from the plan's commencement on August 1, 2006. In 2007, we registered 400,000 shares for potential issuance under this plan. Shares issued under the Purchase Plan were 27,965 and 35,487 during 2012 and 2011, respectively.

Stock Plans – The 2006 Stock Plan provides for the granting of 1,000,000 stock options (including incentive stock options and non-qualified stock options), stock appreciation rights, restricted stock, and other stock awards to certain key employees, consultants and advisors. Our stock options generally have five-year vesting terms and ten-year option terms. In 2007, we registered 1,000,000 shares for potential issuance under this plan. As of December 31, 2012, 211,800 shares have been issued under this plan and 541,650 stock options are outstanding.

        The 1996 Stock Plan, as amended, provided for the granting of 1,500,000 stock options (including incentive stock options and non-qualified stock options), stock appreciation rights and other stock awards to certain key employees, consultants and advisors. This plan expired as of July 31, 2006 and 414,776 shares have gone unused as of December 31, 2012. However, this plan still has options outstanding. We reserved 721,750 treasury stock shares to issue under this plan. We reached our registered share limitation in early 2007, and have since issued 251,574 shares of treasury stock to cover options exercised, with 99,400 remaining options outstanding. Since in most instances the average cost of the treasury stock exceeded the price of the options exercised, the difference between the proceeds received and the average cost of the treasury stock issued resulted in a reduction of retained earnings of $0.1 million and $0.3 million during the year ended December 31, 2012 and 2011, respectively.

The compensation cost and the income tax benefit recognized for the Stock Plans and Purchase Plan are as follows:

For the years ended December 31,   2012   2011   2010  

Compensation cost included in:

                   

Basic and diluted income per share

  $ 0.03   $ 0.21   $ 0.10  

Stock-based compensation expense

    442     3,632     1,447  

Income tax benefit

    89     1,029     265  

        In connection with the sale of Class A common stock mentioned above, vesting of most of the unvested stock options under our Stock Plan was accelerated. Also, we granted 40,000 restricted shares with a fair value of $19.89 per share in early 2011. As a result of the sale of Class A common stock, the vesting of these shares was also accelerated. As a result of these accelerations, we incurred an incremental $2.0 million of stock-based compensation expense in 2011, as compared to 2010.

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        We measure the fair value of options on their grant date, including the valuation of the option feature implicit in our Purchase Plan, using the Black-Scholes option-pricing model. The risk-free interest rate is based on the weighted-average of U.S. Treasury rates over the expected life of the stock option or the contractual life of the option feature in the Purchase Plan. The expected life of a stock option is based on historical data of similar option holders. We segregate our employees into two groups based on historical exercise and termination behavior. The expected life of the option feature in the Purchase Plan is the same as its contractual life. Expected volatility is based on historical volatility of our stock over the expected life of the option, as our options are not readily tradable.

There were no options granted during the years ended December 31, 2012 or 2011.

The following table sets forth information regarding the Stock Plans:

 
  Number of
Options
  Weighted-
Average
Exercise
Price
  Remaining
Contractual
Life
(in years)
  Aggregate
Intrinsic
Value
 

Outstanding at January 1, 2012

    826,076   $ 21.33              

Granted

                     

Exercised

    (65,250 )   15.65              

Forfeited

    (119,776 )   20.23              
                       

Outstanding at December 31, 2012

    641,050   $ 22.12     5.1   $ 2,111  
                   

Exercisable at December 31, 2012

    589,050   $ 22.76     4.9   $ 1,715  
                   

Vested or expected to vest at December 31, 2012

    627,747   $ 22.17     5.0   $ 2,047  
                   

        The total intrinsic value of the options exercised during each of the years ended December 31, 2012, 2011, and 2010 was $0.6 million, $2.1 million, and less than $0.1 million, respectively.

        Cash received from option exercises under the Stock Plan for the year ended December 31, 2012, 2011 and 2010 was $1.0 million, $4.0 million, and $0.5 million, respectively.

        As of December 31, 2012, there was $0.2 million of unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Stock Plan. This compensation cost is expected to be recognized over a period of approximately one year.

Key assumptions used to apply the Black-Scholes pricing model to the Purchase Plan are as follows:

For the years ended December 31,   2012   2011   2010  

Risk-free interest rate

    0.18 %   0.24 %   0.40 %

Weighted-average expected life of option feature (in years)

    1.0     1.0     1.0  

Expected volatility of underlying stock

    28.6 %   28.4 %   28.0 %

Expected dividends

    n/a     n/a     n/a  

        The weighted-average fair value of the option feature in the Purchase Plan is as follows:

For the years ended December 31,   2012   2011   2010  

Option feature in Purchase Plan

  $ 6.68   $ 5.63   $ 3.45  

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The following table sets forth information regarding the Purchase Plan:

 
  Number of
Options
  Weighted-
Average
Exercise
Price
  Remaining
Contractual
Life
(in years)
  Aggregate
Intrinsic
Value
 

Outstanding at January 1, 2012

    10,503   $ 24.70              

Shares subscribed

    32,057     20.85              

Exercised

    (27,965 )   21.04              

Canceled, forfeited, or expired

    (1,954 )   20.97              
                       

Outstanding at December 31, 2012

    12,641   $ 20.56     0.6   $ 7  
                   

        Cash received from share issuances under the Purchase Plan for each of the periods ended December 31, 2012 and 2011 was $0.6 million. Cash received from share issuances under the Purchase Plan for the year ended December 31, 2010 was $0.5 million.

15.   Commitments and Contingent Liabilities

Lease Commitments – We lease various facilities and equipment under non-cancelable operating lease arrangements. These leases expire at various times through 2022. Rent expense for each of the years ended December 31, 2012, 2011 and 2010 was $4.1 million, $3.8 million, and $3.7 million, respectively.

        In March 1999, we acquired the building on West 57th Street in New York City that includes the Steinway Hall retail store for approximately $30.8 million. We entered into a ninety-nine year land lease as part of the transaction. Annual rent payable under the land lease is $2.8 million through 2018. The rent will then be adjusted every twenty years thereafter to the greater of the existing rent or 4% of the fair market value of the land and building combined. Rent expense is being recognized on a straight-line basis over the initial twenty-year fixed rent period.

Future minimum lease payments for our non-cancelable operating leases, excluding the land lease discussed above, and future rental income associated with our building on West 57th Street, are as follows:

For the years ending December 31,   Lease
Payments
  Lease
Income
 

2013

  $ 3,626   $ 2,237  

2014

    2,611     1,737  

2015

    2,034     1,645  

2016

    1,720     1,444  

2017

    1,256     1,197  

Thereafter

    1,734     2,362  
           

Total

  $ 12,981   $ 10,622  
           

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We also lease pianos to institutions in the U.K. and operating lease income associated with this lease program is as follows:

For the years ending December 31,   Lease
Income
 

2013

  $ 701  

2014

    695  

2015

    694  

2016

    691  

2017

    665  

Thereafter

    3,159  
       

Total

  $ 6,605  
       

Employment Agreements and Other Obligations – We maintain employment agreements with certain employees and consultants, including our Chief Executive Officer. Most of these agreements have one-year terms and contain automatic renewal provisions. Our obligation under these agreements at current compensation levels is approximately $2.9 million per year.

        Our former Chairman and former Chief Executive Officer, each of whom is a Director, have established a limited liability corporation to which we pay reimbursement of certain rent, overhead and travel-related expenses. These expenses totaled $0.3 million for the year ended December 31, 2012, and $0.4 million for each of the years ended December 31, 2011 and 2010. There was nothing included in accounts payable relating to these expenses as of December 31, 2012. $0.1 million was included in accounts payable relating to these expenses as of December 31, 2011.

Financing Obligations – Consistent with industry practice, we sell band instruments almost entirely on credit utilizing our receivable dating and notes receivable financing programs, which are offered only to qualified band instrument dealers. We established a program in 2009 to provide financing to certain domestic piano dealers. As of December 31, 2012 and 2011, the total financing available to these dealers was approximately $0.3 million and $1.1 million, respectively. Beyond this program, we generally do not provide extended financing arrangements to our piano dealers. Typically, if financing is required by a dealer, we will facilitate arrangements through a third-party provider. We generally provide no guarantees with respect to these arrangements.

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

        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 liability is broadly construed. Under CERCLA and other laws, we may have liability for investigation and cleanup costs and other damages relating to our current or former properties, or third-party sites to which we sent wastes for disposal. Our potential liability at any of these sites is affected by many factors including, but not limited to, the method of remediation, our portion of the hazardous substances at the site relative to that of other parties, the number of responsible parties, the financial capabilities of other parties, and contractual rights and obligations.

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        We are continuing an existing environmental remediation plan at a facility we acquired in 2000. We expect to pay these costs, which approximate $0.5 million, over an 8-year period. We have accrued approximately $0.4 million for the estimated remaining cost of this remediation program, which represents the present value total cost using a discount rate of 4.54%.

A summary of expected payments associated with this project is as follows:

 
  Environmental
Payments
 

2013

  $ 61  

2014

    61  

2015

    61  

2016

    61  

2017

    61  

Thereafter

    180  
       

Total

  $ 485  
       

        In 2004, we acquired two manufacturing facilities from G. Leblanc Corporation, now Grenadilla, Inc. ("Grenadilla"), for which environmental remediation plans had already been established. In connection with the acquisition, we assumed the existing accrued liability of approximately $0.8 million for the cost of these remediation activities. Based on a review of past and ongoing investigatory and remedial work by our environmental consultants, and discussions with state regulatory officials, as well as recent sampling, we estimate the remaining costs of such remedial plans to be $2.2 million. Accordingly, we have accrued this amount as our environmental liability related to this property as of December 31, 2012. The $2.2 million includes $0.4 million to conduct a pilot study to determine whether or not an alternative method of remediation would be a feasible, more effective option than our existing remediation plan. Should the results of this pilot study indicate that the alternative remediation method is feasible, we would expect to incur an additional $1.0 to $1.5 million in implementation costs. However, we will not accrue these additional costs unless and until the alternative method is determined to be a feasible method which is acceptable to the applicable environmental remediation compliance authority.

        Pursuant to the purchase and sale agreement, we have sought indemnification from Grenadilla for anticipated costs above the original estimate. We filed a claim against the escrow and recorded a corresponding receivable for this amount in other assets in our consolidated balance sheet. Based on the current estimated costs of remediation, this receivable totaled $1.9 million as of December 31, 2012 and $2.0 million as of December 31, 2011. We reached an agreement with Grenadilla whereby current environmental costs are paid directly out of the escrow. Currently, the escrow balance exceeds our receivable balance.

        Based on our past experience and currently available information, the matters described above, as well as our other liabilities and compliance costs arising under environmental laws, are not expected to have a material impact on our capital expenditures, earnings or competitive position in an individual year. However, some risk of environmental liability is inherent in the nature of our current and former business and we may, in the future, incur material costs to meet current or more stringent compliance, cleanup, or other obligations pursuant to environmental laws.

16.   Retirement Plans

        We have defined benefit pension plans covering the majority of our employees, including certain employees in foreign countries. Certain domestic hourly employees are covered by multi-employer defined benefit pension plans to which we make contributions. The corresponding pension plan assets and liabilities belong to third parties and, accordingly, are not reflected in our consolidated financial statements.

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        All of our domestic pension plans have been combined under a master trust, "The Steinway Musical Pension Plan," to facilitate plan monitoring and plan investment management.

        The funded status of all of our pension and other postretirement benefit plans is measured as the difference between each plan's assets at fair value and the projected benefit obligation. We have recognized the aggregate of all underfunded plans in our pension and other postretirement benefit liabilities. The portion of the amount by which the actuarial present value of benefits included in the projected benefit obligation exceeds the fair value of plan assets, payable in the next twelve months, is reflected in other current liabilities. The balance of the liability is included in pension and other postretirement benefit liabilities. The measurement date for our pension and other postretirement plans is December 31.

        During 2011, a new collective bargaining agreement ("CBA") covering our hourly workers at our Eastlake, Ohio facility was ratified. The new agreement increased participants benefit rates and froze future benefit accruals. We remeasured our domestic plan's benefit obligation and assets as a result of the plan amendment. The benefit obligation and net periodic pension cost were measured using a discount rate of 5.06%, and plan assets were measured using an expected rate of return of 9.00%. Our long term pension liability increased by $11.6 million and our accumulated other comprehensive income increased by $6.5 million, net of tax. We also recognized a curtailment loss of $0.7 million, which represented the remaining unrecognized prior service cost for this group.

        On April 1, 2010, we amended our U.K. pension plan prospectively to both limit active participants' annual increases in pensionable salary and reduce the rate at which participants accrue final benefits. We remeasured the plan's benefit obligation, plan assets and net periodic pension cost as a result of the plan amendment. The benefit obligation and net periodic pension cost were measured using a discount rate of 5.50% and a compensation rate of 3.80%; plan assets were measured using an expected rate of return of 5.30%. The decrease in our long-term pension benefit obligation was more than offset by an increase in our actuarial loss due to the change in valuation assumptions when the plan was remeasured. The plan amendment resulted in a gross decrease in our pension benefit obligation of $0.6 million through recognition of a prior service credit, which will be amortized over a period of 12 years. On a net basis, our long term pension benefit obligation increased by less than $0.1 million and our accumulated other comprehensive loss decreased by $0.1 million, net of tax.

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        The following table sets forth the funded status and amounts recognized for our defined benefit pension plans:

 
  Domestic Plan   Foreign Plans  
December 31,   2012   2011   2012   2011  

Change in benefit obligation:

                         

Benefit obligation, beginning of year

  $ 70,302   $ 63,144   $ 33,063   $ 32,401  

Service cost

    49     363     451     646  

Interest cost

    3,357     3,279     1,614     1,782  

Plan participants' contributions

    6     6     43     45  

Amendments

        103          

Actuarial loss

    6,571     7,095     6,298     668  

Foreign currency exchange rate changes

            1,009     (874 )

Benefits paid

    (3,782 )   (3,688 )   (1,389 )   (1,605 )
                   

Benefit obligation, end of year

    76,503     70,302     41,089     33,063  
                   

Change in plan assets:

                         

Fair value of plan assets, beginning of year

    46,128     49,256     8,234     7,383  

Actual return on plan assets

    5,653     (2,089 )   515     463  

Employer contributions

    3,380     2,643     3,358     2,002  

Employee contributions

    6     6     43     45  

Foreign currency exchange rate changes

            439     (54 )

Benefits paid

    (3,782 )   (3,688 )   (1,389 )   (1,605 )
                   

Fair value of plan assets, end of year

    51,385     46,128     11,200     8,234  
                   

Funded status

  $ (25,118 ) $ (24,174 ) $ (29,889 ) $ (24,829 )
                   

Amounts recognized on the statement of financial position consist of:

                         

Pension assets

  $   $   $ 133   $  

Pension and other post retirement benefit liabilities

    (25,118 )   (24,174 )   (30,022 )   (24,829 )
                   

Net amount recognized

  $ (25,118 ) $ (24,174 ) $ (29,889 ) $ (24,829 )
                   

The weighted-average assumptions used to determine our benefit obligations are as follows:

 
  Domestic Plan   Foreign Plans  
December 31,   2012   2011   2012   2011  

Discount rate

    4.13%     4.97%     3.81%     4.97%  

Rate of compensation increase

    n/a     n/a     2.57%     2.60%  

The weighted-average assumptions used to determine our net periodic benefit cost are as follows:

 
  Domestic Plan   Foreign Plans  
For the years ended December 31,   2012   2011   2010   2012   2011   2010  

Discount rate

    4.97%     5.24%     5.95%     4.98%     5.40%     5.63%  

Expected return on assets

    9.00%     9.00%     9.00%     5.50%     5.30%     5.30%  

Rate of compensation increase

    n/a     n/a     n/a     2.59%     2.75%     2.58%  

        The fiscal 2011 weighted-average discount rate of 5.24% for the domestic pension plan represents a rate of 5.26% from January 1 to October 31 and, post plan remeasurement, a rate of 5.06% from November 1 to December 31.

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        The fiscal 2010 weighted-average discount rate of 5.63% for the foreign plans includes a rate of 5.80% from January 1 to March 31 and, post plan remeasurement, a rate of 5.50% from April 1 to December 31 for our U.K. pension plan.

The components of net periodic pension expense for the years ended December 31 are as follows:

For the years ended December 31,   2012   2011   2010  

Domestic Plan:

                   

Service cost

  $ 49   $ 363   $ 350  

Interest cost

    3,357     3,279     3,455  

Expected return on plan assets

    (4,188 )   (4,319 )   (4,194 )

Amortization of prior service cost

        94     113  

Recognized actuarial loss

    1,246     2,003     1,956  

Curtailment loss

        696      
               

Net periodic pension cost

  $ 464   $ 2,116   $ 1,680  
               

Foreign Plans: