10-Q 1 a13-13770_110q.htm 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2013

 

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

 

COMMISSION FILE NUMBER 001-11911

 

STEINWAY MUSICAL INSTRUMENTS, INC.

(Exact name of registrant as specified in its charter)

 

DELAWARE

 

35-1910745

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification No.)

 

 

 

800 South Street, Suite 305

 

 

Waltham, Massachusetts

 

02453

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number including area code: (781) 894-9770

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements during the past 90 days. Yes x    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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x    No 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. See definition of “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

(Do not check if a smaller reporting company)

 

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 x

 

Number of shares of Common Stock issued and outstanding as of August 2, 2013: 12,548,317

 

 

 



Table of Contents

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

 

PART I

FINANCIAL STATEMENTS

 

 

 

 

Item 1.

Unaudited Condensed Consolidated Financial Statements:

 

 

 

 

 

Condensed Consolidated Statements of Operations Three and six months ended June 30, 2013 and 2012

3

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income Three and six months ended June 30, 2013 and 2012

4

 

 

 

 

Condensed Consolidated Balance Sheets June 30, 2013 and December 31, 2012

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows Six months ended June 30, 2013 and 2012

6

 

 

 

 

Condensed Consolidated Statement of Stockholders’ Equity Six months ended June 30, 2013

7

 

 

 

 

Notes to Condensed Consolidated Financial Statements

8

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

20

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

28

 

 

 

Item 4.

Controls and Procedures

29

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 6.

Exhibits

30

 

 

 

 

Signatures

31

 

2



Table of Contents

 

PART I                             FINANCIAL STATEMENTS

 

ITEM 1                           CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

(In Thousands Except Share and Per Share Amounts)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Net sales

 

$

92,353

 

$

85,704

 

$

169,156

 

$

163,657

 

Cost of sales

 

61,063

 

58,339

 

112,516

 

113,145

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

31,290

 

27,365

 

56,640

 

50,512

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

10,969

 

11,072

 

22,249

 

23,057

 

General and administrative

 

11,266

 

10,144

 

19,736

 

19,105

 

Other operating (income) expenses, net

 

(46

)

12

 

(27

)

50

 

Impairment charges

 

500

 

166

 

500

 

166

 

Total operating expenses

 

22,689

 

21,394

 

42,458

 

42,378

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

8,601

 

5,971

 

14,182

 

8,134

 

 

 

 

 

 

 

 

 

 

 

Gain on sale of West 57th Street property

 

(22,725

)

 

(22,725

)

 

Other expense, net

 

1,018

 

1,277

 

1,419

 

1,631

 

Interest income

 

(258

)

(276

)

(540

)

(634

)

Interest expense

 

1,197

 

1,218

 

2,396

 

2,426

 

Total non-operating (income) expenses

 

(20,768

)

2,219

 

(19,450

)

3,423

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

29,369

 

3,752

 

33,632

 

4,711

 

 

 

 

 

 

 

 

 

 

 

Income tax provision

 

9,214

 

1,355

 

10,787

 

1,724

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

20,155

 

$

2,397

 

$

22,845

 

$

2,987

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

1.62

 

$

0.19

 

$

1.83

 

$

0.24

 

Diluted

 

$

1.60

 

$

0.19

 

$

1.82

 

$

0.24

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares:

 

 

 

 

 

 

 

 

 

Basic

 

12,463,406

 

12,378,371

 

12,461,010

 

12,373,143

 

Diluted

 

12,571,105

 

12,506,701

 

12,558,434

 

12,507,559

 

 

See notes to condensed consolidated financial statements.

 

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STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Unaudited

(In Thousands)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

20,155

 

$

2,397

 

$

22,845

 

$

2,987

 

Other comprehensive income (expense) items:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(427

)

(1,976

)

(3,474

)

(1,052

)

Amortization of defined benefit pension and postretirement benefit plans

 

 

 

 

 

 

 

 

 

Prior service credit

 

(173

)

 

(195

)

 

Actuarial losses

 

522

 

 

1,284

 

 

Effect of income taxes

 

(140

)

 

(397

)

 

Total comprehensive income

 

$

19,937

 

$

421

 

$

20,063

 

$

1,935

 

 

See notes to condensed consolidated financial statements.

 

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STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

Unaudited

(In Thousands)

 

 

 

June 30,

 

December 31,

 

 

 

2013

 

2012

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash

 

$

106,500

 

$

73,406

 

Accounts, notes, and other receivables, net of allowances of $8,684 and $7,972 in 2013 and 2012, respectively

 

49,211

 

43,536

 

Inventories

 

133,974

 

125,081

 

Prepaid expenses and other current assets

 

10,331

 

9,079

 

Deferred tax assets

 

5,489

 

5,230

 

Total current assets

 

$

305,505

 

$

256,332

 

 

 

 

 

 

 

Property, plant and equipment, net of accumulated depreciation of $107,746 and $117,558 in 2013 and 2012, respectively

 

67,936

 

91,485

 

Trademarks

 

12,860

 

13,420

 

Goodwill

 

22,727

 

22,916

 

Other intangibles, net

 

905

 

1,328

 

Other assets

 

16,060

 

15,801

 

Long-term deferred tax assets

 

25,999

 

24,385

 

 

 

 

 

 

 

Total assets

 

$

451,992

 

$

425,667

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Debt

 

$

67,968

 

$

576

 

Accounts payable

 

16,344

 

12,867

 

Other current liabilities

 

45,632

 

40,175

 

Total current liabilities

 

129,944

 

53,618

 

 

 

 

 

 

 

Long-term debt

 

 

67,431

 

Deferred tax liabilities

 

700

 

560

 

Pension and other postretirement benefit liabilities

 

52,703

 

54,501

 

Other non-current liabilities

 

6,166

 

7,712

 

Total liabilities

 

189,513

 

183,822

 

 

 

 

 

 

 

Commitments and contingent liabilities

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock

 

14

 

14

 

Additional paid-in capital

 

163,103

 

162,579

 

Retained earnings

 

171,779

 

148,934

 

Accumulated other comprehensive loss

 

(28,391

)

(25,609

)

Treasury stock, at cost

 

(44,026

)

(44,073

)

Total stockholders’ equity

 

262,479

 

241,845

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

451,992

 

$

425,667

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(In Thousands)

 

 

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

22,845

 

$

2,987

 

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

 

 

 

 

 

Depreciation and amortization

 

4,301

 

4,466

 

Impairment charges

 

500

 

166

 

Stock-based compensation expense

 

188

 

211

 

Excess tax benefit from stock-based awards

 

(46

)

(16

)

Tax benefit from stock option exercises

 

48

 

18

 

Deferred tax benefit

 

(2,064

)

(111

)

Provision for doubtful accounts

 

239

 

915

 

Gain on sale of West 57th Street property

 

(22,725

)

 

(Gain) loss on sale of assets

 

(12

)

12

 

Other

 

531

 

(112

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts, notes and other receivables

 

(6,110

)

(5,313

)

Inventories

 

(9,909

)

(8,204

)

Prepaid expenses and other assets

 

(1,082

)

(489

)

Accounts payable

 

3,350

 

1,723

 

Other liabilities

 

4,859

 

(5,905

)

Cash flows from operating activities

 

(5,087

)

(9,652

)

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(2,847

)

(3,431

)

Proceeds from sale of West 57th Street property

 

43,318

 

 

Proceeds from sale of property, plant and equipment

 

117

 

1

 

Other

 

37

 

77

 

Acquisition of subsidiary

 

(1,332

)

 

Cash flows from investing activities

 

39,293

 

(3,353

)

Cash flows from financing activities:

 

 

 

 

 

Borrowings under lines of credit

 

 

4,500

 

Repayments under lines of credit

 

 

(1,000

)

Proceeds from issuance of common stock

 

335

 

298

 

Excess tax benefit from stock-based awards

 

46

 

16

 

Cash flows from financing activities

 

381

 

3,814

 

Effect of foreign exchange rate changes on cash

 

(1,493

)

(236

)

Increase (decrease) in cash

 

33,094

 

(9,427

)

Cash, beginning of period

 

73,406

 

49,888

 

Cash, end of period

 

$

106,500

 

$

40,461

 

Supplemental Cash Flow Information:

 

 

 

 

 

Interest paid

 

$

2,380

 

$

2,427

 

Income taxes paid

 

$

4,628

 

$

4,626

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Unaudited

(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, 2013

 

$

14

 

$

162,579

 

$

148,934

 

$

(25,609

)

$

(44,073

)

$

241,845

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

 

 

 

 

 

22,845

 

(2,782

)

 

 

20,063

 

Exercise of 18,500 options for shares of common stock

 

 

 

288

 

 

 

 

 

47

 

335

 

Tax benefit of options exercised

 

 

 

48

 

 

 

 

 

 

 

48

 

Stock-based compensation

 

 

 

188

 

 

 

 

 

 

 

188

 

Balance, June 30, 2013

 

$

14

 

$

163,103

 

$

171,779

 

$

(28,391

)

$

(44,026

)

$

262,479

 

 

See notes to condensed consolidated financial statements.

 

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STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS

JUNE 30, 2013

Unaudited

(Tabular Amounts In Thousands Except Share, Per Share, Option, and Per Option Data)

 

(1)                                 Basis of Presentation

 

The accompanying condensed consolidated financial statements of Steinway Musical Instruments, Inc. and subsidiaries (the “Company”) for the three and six months ended June 30, 2013 and 2012 are unaudited. In the opinion of management, these statements have been prepared on the same basis as the audited consolidated financial statements as of and for the year ended December 31, 2012, and include all adjustments which are of a normal and recurring nature, necessary for the fair presentation of financial position, results of operations and cash flows for the interim periods. We encourage you to read the condensed consolidated financial statements in conjunction with the risk factors, consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three and six months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the entire year.

 

Throughout this report “we,” “us,” and “our” refer to Steinway Musical Instruments, Inc. and subsidiaries taken as a whole.

 

(2)                                 Summary of Significant Accounting Policies

 

Our significant accounting policies were described in Note 2 to our audited Consolidated Financial Statements included in our 2012 Annual Report on Form 10-K for the fiscal year ended December 31, 2012. There have been no significant changes in our accounting policies during the first six months of 2013.

 

Recent Accounting Pronouncements — We adopted certain amendments to Accounting Standards Codification (“ASC”) 220, “Comprehensive Income,” effective January 1, 2013. These amendments relate only to financial statement presentation of other comprehensive income and, accordingly, the adoption did not have a material impact on our condensed consolidated financial statements.

 

(3)                                 Recent Events

 

On June 30, 2013, Steinway Musical Instruments, Inc. (“SMI”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) with KSTW Holdings, Inc., a Delaware corporation (“Parent”), and KSTW Acquisition, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Acquisition Sub”), providing for the merger of Acquisition Sub with and into SMI, with SMI being the surviving corporation and a wholly owned subsidiary of Parent (the “Merger”).  Parent and Acquisition Sub are affiliates of Kohlberg Management VII, L.P. (“Kohlberg”).

 

On July 15, 2013, Acquisition Sub commenced a cash tender offer (the “Offer”) to acquire all of the outstanding shares of SMI common stock.  Upon the successful closing of the Offer, stockholders of SMI who tender their shares in the Offer will receive $35.00 per share, in cash, payable without interest and less any applicable withholding taxes.

 

The Offer will expire at 11:59 p.m., New York City time, on August 21, 2013, unless extended in accordance with the terms of the Merger Agreement and the applicable rules and regulations of the SEC.  Consummation of the Offer is subject to customary conditions, including, among others, (i) the valid tender of the number of shares that would represent at least a majority of the outstanding shares of common stock of SMI; (ii) Parent’s receipt of the proceeds of the debt financing; (iii) the Rights Agreement shall have no force or effect with respect to the Offer and the Merger; (iv) the absence of certain legal impediments to the consummation of the Merger; and (v) the absence of any change, event or occurrence that has had or would reasonably be expected to have a material adverse effect on SMI.

 

The Merger Agreement provides for a 45-day “go-shop” period, which will end on August 14, 2013, during which time SMI may solicit alternative proposals to the transaction with Kohlberg. Any shares not tendered in the Offer will be acquired in a second-step merger at the same cash price as paid in the Offer.  The transaction is expected to close in the third quarter of 2013.

 

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Table of Contents

 

(4)                                 Other comprehensive income (loss)

 

The changes, net of income tax, in our other comprehensive income (loss) for the three and six months ended June 30, 2013 consist of the following:

 

 

 

Pension and
Other
Postretirement
Benefit Costs

 

Foreign
Currency
Translation
Adjustments

 

Total

 

Balance, April 1, 2013 (net of tax of $18,741)

 

$

(29,902

)

$

1,729

 

$

(28,173

)

Other comprehensive income (loss) before reclassifications

 

 

(427

)

(427

)

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

 

 

 

 

 

Amortization of prior service credit (net of tax of $48)

 

(125

)

 

(125

)

Amortization of actuarial losses (net of tax of $188)

 

334

 

 

334

 

Net current period other comprehensive income (loss)

 

209

 

(427

)

(218

)

Balance, June 30, 2013 (net of tax of $18,601)

 

$

(29,693

)

$

1,302

 

$

(28,391

)

 

 

 

Pension and
Other
Postretirement
Benefit Costs

 

Foreign
Currency
Translation
Adjustments

 

Total

 

Balance, January 1, 2013 (net of tax of $18,998)

 

$

(30,385

)

$

4,776

 

$

(25,609

)

Other comprehensive income (loss) before reclassifications

 

 

(3,474

)

(3,474

)

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

 

 

 

 

 

Amortization of prior service credit (net of tax of $58)

 

(137

)

 

(137

)

Amortization of actuarial losses (net of tax of $455)

 

829

 

 

829

 

Net current period other comprehensive income (loss)

 

692

 

(3,474

)

(2,782

)

Balance, June 30, 2013 (net of tax of $18,601)

 

$

(29,693

)

$

1,302

 

$

(28,391

)

 

Amounts reclassified from accumulated other comprehensive income (loss) associated with pensions are included in the computation of net periodic pension costs discussed in Note 15. Amounts related to our Postretirement Benefit Plan are not material to the condensed consolidated financial statements.

 

(5)                                 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.

 

9



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

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income:

 

$

20,155

 

$

2,397

 

$

22,845

 

$

2,987

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding - basic

 

12,463,406

 

12,378,371

 

12,461,010

 

12,373,143

 

Dilutive effect of stock-based compensation plans

 

107,699

 

128,330

 

97,424

 

134,416

 

Weighted-average common shares outstanding - diluted

 

12,571,105

 

12,506,701

 

12,558,434

 

12,507,559

 

 

 

 

 

 

 

 

 

 

 

Net income per share - basic

 

$

1.62

 

$

0.19

 

$

1.83

 

$

0.24

 

Net income per share - diluted

 

$

1.60

 

$

0.19

 

$

1.82

 

$

0.24

 

 

We did not include 349,900 of the outstanding options to purchase shares of common stock in the computation of diluted earnings per share for the three and six months ended June 30, 2013, because generally their exercise prices were more than the average market price of our common shares, and therefore antidilutive. We did not include 372,000 of the outstanding options to purchase shares of common stock in the computation of diluted earnings per share for the three and six month periods ended June 30, 2012 for the same reason.

 

(6)                                 Inventories

 

 

 

June 30,

 

December 31,

 

 

 

2013

 

2012

 

Raw materials

 

$

19,451

 

$

18,582

 

Work-in-process

 

35,333

 

34,923

 

Finished goods

 

79,190

 

71,576

 

Total inventory

 

$

133,974

 

$

125,081

 

 

Finished goods inventory was impacted by the preliminary purchase price allocation of $1.0 million relating to our acquisition of assets associated with piano retail stores in San Francisco, Sacramento, and Walnut Creek, California on June 2, 2013. This acquisition, which also included $0.4 million of property, plant and equipment, was not material to our financial condition or results of operations.

 

(7)                                 Divestiture of Assets Held for Sale

 

On June 28, 2013 we sold our building on West 57th Street in New York City for $46.3 million, subject to a potential increase based on post-closing conditions. A summary of the transaction is as follows:

 

Gross proceeds:

 

 

 

$

46,300

 

Net assets tendered

 

 

 

 

 

Building

 

22,726

 

 

 

Other assets

 

1,502

 

 

 

Subtotal

 

24,228

 

 

 

Less:

 

 

 

 

 

Deferred rent credits

 

1,783

 

 

 

Total net assets tendered

 

 

 

22,445

 

Subtotal

 

 

 

23,855

 

Capitalized rent asset

 

 

 

1,852

 

Transaction costs

 

 

 

(2,982

)

Net gain on transaction

 

 

 

$

22,725

 

 

Transaction costs consisted of real estate transfer taxes of $1.4 million and commissions, fees, and legal costs of $1.6 million. The capitalized rent asset, which is based on the fair market value of the space we are leasing, will be recognized ratably over the 15-month free rent period. The potential incremental proceeds from this transaction relate to contingent payments from an escrow account. We will not recognize these proceeds, if any, unless and until we receive them. We expect to utilize $4.4 million of foreign tax credits as a result of this transaction. Accordingly, we have removed the valuation allowance of $2.2 million related to these deferred tax assets during the second quarter of 2013. This directly benefited our effective tax rate in the second quarter of 2013.

 

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Table of Contents

 

(8)                                 Goodwill, Trademarks, and Other Intangible Assets

 

Finite-lived intangible assets are amortized on a straight-line basis over their estimated useful lives and tested for impairment whenever events or circumstances indicate that the carrying amount of the asset may not be recoverable. 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 our annual 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, piano division, and our online music business to be separate reporting units.

 

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. However, in the second quarter of 2013, changes in our online music business, including increased costs and a deterioration in our revenue growth assumptions, caused us to test the related trademark asset for recoverability. We determined that the future anticipated cash flows for this business were reduced and our trademark was impaired. As a result, we recorded an impairment charge of $0.5 million for the trademark associated with our online music business, which is included in the piano segment. No other events or circumstances occurred subsequent to our 2012 annual impairment test which would have indicated that our assets may be impaired.

 

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

 

 

 

Piano

 

Band

 

Total

 

Goodwill:

 

 

 

 

 

 

 

Balance, January 1, 2013

 

$

22,916

 

$

 

$

22,916

 

Foreign currency translation impact

 

(189

)

 

(189

)

Balance, June 30, 2013

 

$

22,727

 

$

 

$

22,727

 

 

 

 

 

 

 

 

 

Trademarks:

 

 

 

 

 

 

 

Balance, January 1, 2013

 

$

8,846

 

$

4,574

 

$

13,420

 

Impairment

 

(500

)

 

(500

)

Foreign currency translation impact

 

(60

)

 

(60

)

Balance, June 30, 2013

 

$

8,286

 

$

4,574

 

$

12,860

 

 

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 $1.7 million associated with online music business trademarks.

 

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Table of Contents

 

We also carry certain intangible assets that are amortized. Once fully amortized, these assets are removed from both the gross and accumulated amortization balances. These assets consist of the following:

 

 

 

June 30,
2013

 

December 31,
2012

 

Gross deferred financing costs

 

$

3,932

 

$

3,932

 

Accumulated amortization

 

(3,332

)

(3,130

)

Deferred financing costs, net

 

$

600

 

$

802

 

 

 

 

 

 

 

Gross non-compete agreements

 

$

 

$

250

 

Accumulated amortization

 

 

(231

)

Non-compete agreements, net

 

$

 

$

19

 

 

 

 

 

 

 

Gross customer relationships

 

$

459

 

$

843

 

Accumulated amortization

 

(154

)

(506

)

Customer relationships, net

 

$

305

 

$

337

 

 

 

 

 

 

 

Gross website and developed technology

 

$

 

$

2,176

 

Accumulated amortization

 

 

(2,006

)

Website and developed technology, net

 

$

 

$

170

 

 

 

 

 

 

 

Total gross other intangibles

 

$

4,391

 

$

7,201

 

Accumulated amortization

 

(3,486

)

(5,873

)

Total other intangibles, net

 

$

905

 

$

1,328

 

 

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

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Amortization expense

 

$

200

 

$

261

 

$

463

 

$

523

 

 

The following table shows the total estimated amortization expense for the remainder of 2013 and beyond:

 

Remainder of 2013

 

$

247

 

2014

 

330

 

2015

 

245

 

2016

 

57

 

2017

 

19

 

Thereafter

 

7

 

Total

 

$

905

 

 

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Table of Contents

 

(9)                                 Other Current Liabilities

 

Our other current liabilities consist of the following:

 

 

 

June 30,
 2013

 

December 31,
2012

 

Accrued payroll and related benefits

 

$

15,206

 

$

15,748

 

Current portion of pension and other postretirement benefit liabilities

 

1,368

 

1,389

 

Accrued warranty expense

 

1,427

 

1,327

 

Accrued interest

 

1,566

 

1,563

 

Deferred income

 

9,924

 

10,834

 

Income and other taxes payable

 

9,009

 

202

 

Other accrued expenses

 

7,132

 

9,112

 

Total

 

$

45,632

 

$

40,175

 

 

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 calculated on a ratio of warranty costs to sales based on our warranty history and is adjusted periodically following an analysis of actual warranty claims. The accrued warranty expense activity for the three months ended June 30, 2013 and 2012, and the year ended December 31, 2012 is as follows:

 

 

 

June 30,
2013

 

June 30,
2012

 

December 31,
2012

 

Beginning balance

 

$

1,327

 

$

1,242

 

$

1,242

 

Additions

 

496

 

698

 

1,099

 

Claims and reversals

 

(379

)

(481

)

(1,031

)

Foreign currency translation impact

 

(17

)

(15

)

17

 

Ending balance

 

$

1,427

 

$

1,444

 

$

1,327

 

 

(10)                          Debt

 

Our outstanding debt consists of the following:

 

 

 

June 30,
2013

 

December 31,
2012

 

7.00% Senior Notes

 

$

67,506

 

$

67,506

 

Unamortized bond discount

 

(43

)

(75

)

Overseas lines of credit

 

505

 

576

 

Total

 

67,968

 

68,007

 

Less: current portion

 

67,968

 

576

 

Long-term debt

 

$

 

$

67,431

 

 

Scheduled repayments of outstanding debt as of June 30, 2013 are as follows:

 

Remainder of 2013

 

$

68,011

 

Total

 

$

68,011

 

 

On June 14, 2013, we called all of our outstanding 7.00% Senior Notes, to be redeemed on July 15, 2013. This redemption is discussed further in Note 17.

 

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Table of Contents

 

(11)                          Fair Values

 

Our financial instruments, which are recorded at fair value, consist primarily of foreign currency contracts and marketable equity securities. We assess the inputs used to measure fair value using the following three-tier hierarchy, which indicates the extent to which inputs used are observable in the market.

 

Level 1

 

Valuation is based upon unadjusted quoted prices for identical instruments traded in active markets.

 

 

 

Level 2

 

Valuation is based upon quoted prices for identical or similar instruments such as interest rates, foreign currency exchange rates, commodity rates and yield curves, and model-based valuation techniques for which all significant assumptions are observable in the market.

 

 

 

Level 3

 

Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions include management’s own judgments about the assumptions market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

 

We value our foreign currency contracts using internal and third-party models with observable inputs, including currency forward and spot prices, volatility factors, and net present value factors. Estimated fair value has been determined as the difference between the current forward or option rate and the contract rate, multiplied by the notional amount of the contract, or upon the estimated fair value of purchased option contracts.

 

The following table presents information about our assets and liabilities measured at fair value on a recurring basis as of June 30, 2013 and December 31, 2012 and the fair value hierarchy of the valuation techniques we utilized. We classify these assets and liabilities as either short term or long term based on maturity or anticipated realization dates.

 

 

 

June 30,
2013

 

December 31,
2012

 

Financial assets:

 

 

 

 

 

Trading securities - Level 1

 

$

2,374

 

$

1,952

 

Foreign currency contracts - Level 2

 

1,566

 

779

 

 

 

$

3,940

 

$

2,731

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

Foreign currency contracts - Level 2

 

$

96

 

$

122

 

 

Our trading securities pertain to the Supplemental Executive Retirement Plan (“SERP”) and are held in a Rabbi Trust. We record a corresponding liability for the same amount in our financial statements, which represents our obligation to SERP participants. Our foreign currency contracts pertain to obligations or potential obligations to purchase or sell euros, pounds, U.S. dollars, and yen under various forward and option contracts.

 

We base the estimated fair value of our debt on institutional quotes currently available to us. The cost-based net carrying value and estimated fair value are as follows:

 

 

 

June 30, 2013

 

December 31, 2012

 

 

 

Net Carrying
Value

 

Estimated
Fair Value

 

Net Carrying
Value

 

Estimated
Fair Value

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Debt

 

$

67,968

 

$

68,566

 

$

68,007

 

$

68,631

 

 

The carrying values of accounts, notes and other receivables, and accounts payable approximate fair value. Certain assets, including long-lived assets held and used, and trademarks associated with our online music business, are measured at fair value on a non-recurring basis. We recognized a fair value measurement loss of $0.5 million related to online music business trademarks during the second quarter of 2013.

 

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Table of Contents

 

(12)                          Stockholders’ Equity and Stock-based Compensation Arrangements

 

We have a Stockholder Rights Plan, an Employee Stock Purchase Plan, and Stock Plans, all of which are discussed fully in our Annual Report on Form 10-K for the year ended December 31, 2012.

 

The compensation cost and the income tax benefit recognized for these plans are as follows:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Compensation cost included in:

 

 

 

 

 

 

 

 

 

Basic income per share

 

$

0.01

 

$

0.01

 

$

0.01

 

$

0.01

 

Diluted income per share

 

$

0.01

 

$

0.01

 

$

0.01

 

$

0.01

 

Stock-based compensation expense

 

92

 

100

 

188

 

211

 

Income tax benefit

 

18

 

21

 

39

 

47

 

 

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 have segregated 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 three and six months ended June 30, 2013 or 2012. The following table sets forth information regarding the Stock Plans:

 

 

 

Number of
Options

 

Weighted-
Average
Exercise
Price

 

Weighted-
Average
Remaining
Contract
Life
(in years)

 

Aggregate
Intrinsic
Value

 

Outstanding, January 1, 2013

 

641,050

 

$

22.12

 

 

 

 

 

Granted

 

 

 

 

 

 

 

Exercised

 

(18,500

)

17.99

 

 

 

 

 

Forfeited

 

 

 

 

 

 

 

Outstanding, June 30, 2013

 

622,550

 

$

22.24

 

4.6

 

$

5,011

 

 

 

 

 

 

 

 

 

 

 

Exercisable, June 30, 2013

 

582,550

 

$

23.00

 

4.4

 

$

4,261

 

 

The total intrinsic value of the options exercised during the three and six month periods ended June 30, 2013 was $0.2 million. As of June 30, 2013, there was $0.1 million of unrecognized compensation cost related to nonvested share-based compensation arrangements. This compensation is expected to be recognized over a weighted-average period of approximately one year. Cash received from option exercises under the Stock Plans for the three and six month periods ended June 30, 2013 was $0.3 million.

 

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Table of Contents

 

The following tables set forth information regarding the Purchase Plan:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Risk-free interest rate

 

0.2%

 

0.2%

 

0.2%

 

0.2%

 

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

 

1.0

 

1.0

 

1.0

 

1.0

 

Expected volatility of underlying stock

 

28.7%

 

28.6%

 

28.7%

 

28.6%

 

Expected dividends

 

n/a

 

n/a

 

n/a

 

n/a

 

Weighted-average fair value of option feature

 

$5.98

 

$7.19

 

$5.98

 

$7.19

 

 

 

 

Number of
Options

 

Weighted-
Average
Exercise
Price

 

Remaining
Contract
Life
(in years)

 

Aggregate
Intrinsic
Value

 

Outstanding, January 1, 2013

 

12,641

 

$

20.56

 

 

 

 

 

Shares subscribed

 

15,140

 

20.56

 

 

 

 

 

Exercised

 

 

 

 

 

 

 

Forfeited

 

(1,310

)

20.56

 

 

 

 

 

Outstanding, June 30, 2013

 

26,471

 

$

20.56

 

0.1

 

$

249

 

 

(13)                          Other Expense, Net

 

 

 

Three Months Ended June 30

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

West 57th Street building income

 

$

(518

)

$

(586

)

$

(974

)

$

(1,141

)

West 57th Street building expense

 

1,499

 

1,685

 

3,349

 

3,490

 

Foreign exchange loss (gain), net

 

179

 

131

 

(537

)

(488

)

Miscellaneous, net

 

(142

)

47

 

(419

)

(230

)

Other expense, net

 

$

1,018

 

$

1,277

 

$

1,419

 

$

1,631

 

 

Prior to its sale on June 28, 2013, which is discussed in Note 7, our building on West 57th Street in New York City was managed by an outside company. 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. We allocate a ratable portion of the building expenses that relate to our retail store to sales and marketing expenses.

 

(14)                          Commitments and Contingent Liabilities

 

We are involved in certain legal proceedings regarding environmental matters, which were previously disclosed in our 2012 Annual Report on Form 10-K. 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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Table of Contents

 

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

 

(15)                          Retirement Plans

 

We have defined benefit pension plans covering many of our employees, including certain employees in Germany and the U.K. The components of net periodic pension cost for these plans are as follows:

 

 

 

Domestic Plan

 

Foreign Plans

 

 

 

Three Months Ended June 30,

 

Three Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Service cost

 

$

11

 

$

20

 

$

145

 

$

112

 

Interest cost

 

770

 

829

 

380

 

400

 

Expected return on plan assets

 

(1,137

)

(1,048

)

(143

)

(119

)

Amortization of prior service credit

 

 

 

(13

)

(13

)

Amortization of net loss

 

365

 

310

 

134

 

12

 

Net periodic pension cost

 

$

9

 

$

111

 

$

503

 

$

392

 

 

 

 

Domestic Plan

 

Foreign Plans

 

 

 

Six Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Service cost

 

$

23

 

$

24

 

$

287

 

$

225

 

Interest cost

 

1,540

 

1,679

 

754

 

805

 

Expected return on plan assets

 

(2,275

)

(2,094

)

(287

)

(237

)

Amortization of prior service credit

 

 

 

(26

)

(26

)

Amortization of net loss

 

730

 

623

 

270

 

24

 

Net periodic pension cost

 

$

18

 

$

232

 

$

998

 

$

791

 

 

Based on our domestic plan’s current funded status, we anticipate making contributions of $2.3 million to our domestic plan in 2013 as required by federal laws and regulations. As of June 30, 2013, we have contributed $0.8 million to this plan. Our anticipated contributions to the pension plan of our U.K. subsidiary approximate $0.7 million for the current year. As of June 30, 2013, we have made contributions of $0.4 million to this plan. The pension plans of our German entities hold insurance contracts which relate to a single participant. These entities use operating cash to pay participant benefits as they become due. Expected 2013 benefit payments under these plans are $1.3 million, of which $0.7 million was paid through June 30, 2013.

 

We provide postretirement life insurance benefits to a limited number of certain eligible hourly retirees and their dependents. The activity in this plan is not material to the condensed consolidated financial statements.

 

17



Table of Contents

 

(16)                          Segment Information

 

We have identified 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. We have included the results of our online music division within the “U.S. Piano Segment” as we believe its results are not material and its products and customer base are most correlated with piano operations. Management and the chief operating decision maker use income from operations as a meaningful measurement of profit or loss for the segments. Income from operations for the reportable segments includes certain corporate costs allocated to the segments based primarily on revenue, as well as intercompany profit. Amounts reported as “Other & Elim” contain corporate costs that were not allocated to the reportable segments, and the remaining intercompany profit elimination.

 

The following tables present information about our operating segments as of and for the three and six months ended June 30, 2013 and 2012 and as of the year ended December 31, 2012:

 

 

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

As of June 30, 2013

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property, plant and equipment

 

$

33,520

 

$

15,945

 

$

5,504

 

$

54,969

 

$

12,870

 

$

 

$

12,870

 

$

97

 

$

67,936

 

Total assets

 

167,447

 

75,552

 

41,588

 

284,587

 

249,849

 

5,153

 

255,002

 

(87,597

)

451,992

 

 

 

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

As of December 31, 2012

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property, plant and equipment

 

$

55,596

 

$

16,423

 

$

6,044

 

$

78,063

 

$

13,366

 

$

2

 

$

13,368

 

$

54

 

$

91,485

 

Total assets

 

149,686

 

78,481

 

47,850

 

276,017

 

234,428

 

5,966

 

240,394

 

(90,744

)

425,667

 

 

 

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

Three Months Ended June 30, 2013

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales to external customers

 

$

28,424

 

$

16,234

 

$

12,099

 

$

56,757

 

$

34,750

 

$

846

 

$

35,596

 

$

 

$

92,353

 

Income (loss) from operations

 

1,384

 

3,713

 

1,749

 

6,846

 

5,077

 

61

 

5,138

 

(3,383

)

8,601

 

 

 

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

Three Months Ended June 30, 2012

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales to external customers

 

$

24,049

 

$

14,445

 

$

11,870

 

$

50,364

 

$

34,560

 

$

780

 

$

35,340

 

$

 

$

85,704

 

Income (loss) from operations

 

921

 

3,271

 

1,148

 

5,340

 

3,428

 

10

 

3,438

 

(2,807

)

5,971

 

 

 

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

Six Months Ended June 30, 2013

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales to external customers

 

$

52,679

 

$

26,813

 

$

22,679

 

$

102,171

 

$

65,293

 

$

1,692

 

$

66,985

 

$

 

$

169,156

 

Income (loss) from operations

 

2,807

 

4,334

 

3,059

 

10,200

 

8,170

 

144

 

8,314

 

(4,332

)

14,182

 

 

 

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

Six Months Ended June 30, 2012

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales to external customers

 

$

44,461

 

$

27,036

 

$

23,010

 

$

94,507

 

$

67,458

 

$

1,692

 

$

69,150

 

$

 

$

163,657

 

Income (loss) from operations

 

648

 

5,148

 

2,542

 

8,338

 

4,491

 

80

 

4,571

 

(4,775

)

8,134

 

 

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(17)                          Subsequent Events

 

Following the announcement of the Merger Agreement described in Note 3, three separate putative stockholder class action lawsuits were filed in the Court of Chancery of the State of Delaware against SMI, the members of the SMI board of directors, Parent, Acquisition Sub and Kohlberg & Company, L.L.C.  On July 30, 2013, these lawsuits were consolidated into a single class action.  The complaint alleges that SMI’s directors breached their fiduciary duties to SMI’s stockholders because, among other things, they allegedly failed to take steps to maximize the value of SMI to its public stockholders.  The complaint also alleges that the directors of SMI failed to provide the SMI stockholders with material information and provided them with materially misleading information in the Solicitation/Recommendation Statement on Schedule 14D-9 filed by SMI with the SEC on July 15, 2013.  Management does not expect that this lawsuit will have a material impact on either the Company’s operations or completing the transaction contemplated by the Merger Agreement.

 

On July 15, 2013 we redeemed all of our outstanding Senior Notes, which totaled $67.5 million as of June 30, 2013, at principal plus accrued interest pursuant to a call we issued on June 14, 2013.  We will record a net loss on extinguishment of debt of $0.2 million relating to the write-off of deferred financing costs and bond discount during the third quarter of 2013.

 

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ITEM 2      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Tabular Amounts in Thousands Except Percentages, Share and Per Share Data)

 

Introduction

 

We are a world leader in the design, manufacture, marketing, and distribution of high quality musical instruments. Our piano division concentrates on the high-end grand piano segment of the industry, handcrafting Steinway pianos in New York and Germany. We also offer Steinway upright pianos and two mid-priced lines of pianos under the Boston and Essex brand names. We are also an online retailer of classical music recordings. Through our band division, we are the largest domestic producer of band and orchestral instruments and offer a complete line of brass, woodwind, percussion and string instruments and related accessories with well-known brand names such as Bach, Selmer, C.G. Conn, Leblanc, King, and Ludwig. We sell our products through dealers and distributors worldwide. Our piano customer base consists of professional artists, amateur pianists, and institutions such as concert halls, universities, and music schools. Our band and orchestral instrument customer base consists primarily of middle school and high school students, but also includes adult amateur and professional musicians.

 

Recent Events

 

On June 30, 2013, Steinway Musical Instruments, Inc. (“SMI”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) with KSTW Holdings, Inc., a Delaware corporation (“Parent”), and KSTW Acquisition, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Acquisition Sub”), providing for the merger of Acquisition Sub with and into SMI, with SMI being the surviving corporation and a wholly owned subsidiary of Parent (the “Merger”).  Parent and Acquisition Sub are affiliates of Kohlberg Management VII, L.P. (“Kohlberg”).

 

On July 15, 2013, Acquisition Sub commenced a cash tender offer (the “Offer”) to acquire all of the outstanding shares of SMI common stock.  Upon the successful closing of the Offer, stockholders of SMI who tender their shares in the Offer will receive $35.00 per share, in cash, payable without interest and less any applicable withholding taxes.

 

The Offer will expire at 11:59 p.m., New York City time, on August 21, 2013, unless extended in accordance with the terms of the Merger Agreement and the applicable rules and regulations of the Securities and Exchange Commission (“SEC”).  Consummation of the Offer is subject to customary conditions, including, among others, (i) the valid tender of the number of shares that would represent at least a majority of the outstanding shares of common stock of SMI; (ii) Parent’s receipt of the proceeds of the debt financing; (iii) the Rights Agreement shall have no force or effect with respect to the Offer and the Merger; (iv) the absence of certain legal impediments to the consummation of the Merger; and (v) the absence of any change, event or occurrence that has had or would reasonably be expected to have a material adverse effect on SMI.

 

The Merger Agreement provides for a 45-day “go-shop” period, which will end on August 14, 2013, during which time SMI may solicit alternative proposals to the transaction with Kohlberg. Any shares not tendered in the Offer will be acquired in a second-step merger at the same cash price as paid in the Offer.  The transaction is expected to close in the third quarter of 2013.

 

Critical Accounting Policies and Estimates

 

The SEC has issued disclosure guidance for “critical accounting policies and estimates.” The SEC defines “critical accounting policies and estimates” 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.

 

Management is required to make certain estimates and assumptions during the preparation of the condensed consolidated financial statements. These estimates and assumptions impact the reported amount 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 from those estimates.

 

The significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements included in the Company’s 2012 Annual Report on Form 10-K. 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 and estimates based on the definition above.

 

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Accounts Receivable

 

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 reserve estimates. Historically, a large portion of our sales at both our piano and band divisions has been generated by our top fifteen 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 adjust 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, coupled with increased offshore sourcing, could affect our ability to realize the current cost 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 not abnormal 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 record 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 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 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.

 

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 trademarks and had to license them from a third party.

 

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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 portfolio. Our benefit obligations and expenses can fluctuate significantly 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 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.

 

When appropriate, 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 on 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 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 significantly based on management’s assumptions.

 

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

 

Forward-Looking Statements

 

Certain statements contained in this report are “forward-looking statements” within the meaning of Section 21E of the Securities and Exchange Act of 1934, as amended. These forward-looking statements represent our present expectations or beliefs concerning future events, including with respect to the Offer and related transactions. We caution that such statements are necessarily based on certain assumptions which are subject to risks and uncertainties which could cause actual results to differ materially from those indicated in this report. When used in this report, the words “can,” “will,” “intends,” “expects,” “is expected,” similar expressions and any other statements that are not historical facts are intended to identify those assertions as forward-looking statements. Such statements are based on a number of assumptions that could ultimately prove inaccurate, and are subject to a number of risk factors. We caution investors not to place undue reliance on the forward-looking statements contained in this report. These statements, like all statements contained in this report, speak only as of the date of this report (unless another date is indicated). We do not assume any obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise except as required by law. Risk factors include the following: uncertainties regarding the timing of the closing of the transaction; uncertainties as to the number of stockholders of SMI who may tender their stock in the Offer; the risk of failing to obtain any regulatory approvals or satisfy conditions to the transaction; the risk that Kohlberg is unable to obtain adequate financing; the risk that the transaction will not close or that the closing will be delayed; the risk that SMI’s businesses will suffer due to uncertainty related to the transaction; competitive responses to the transaction; changes in general economic conditions; reductions in school budgets; increased competition; exchange rate fluctuations; variations in the mix of products sold; market acceptance of new products; ability of suppliers to meet demand; concentration of credit risk; ability to fulfill piano orders in a timely manner; and fluctuations in effective tax rates resulting from shifts in sources of income. Further information on these risk factors is included in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012. We encourage you to read those descriptions carefully.

 

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Results of Operations

 

Three Months Ended June 30, 2013 Compared to Three Months Ended June 30, 2012

 

 

 

Three Months Ended June 30,

 

 

 

Change

 

 

 

2013

 

 

 

2012

 

 

 

$

 

%

 

Net sales

 

 

 

 

 

 

 

 

 

 

 

 

 

Band

 

$

35,596

 

 

 

$

35,340

 

 

 

256

 

0.7

 

Piano

 

56,757

 

 

 

50,364

 

 

 

6,393

 

12.7

 

Total sales

 

92,353

 

 

 

85,704

 

 

 

6,649

 

7.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

 

 

 

 

 

 

 

 

 

 

 

 

Band

 

25,312

 

 

 

26,210

 

 

 

(898

)

(3.4

)

Piano

 

35,751

 

 

 

32,129

 

 

 

3,622

 

11.3

 

Total cost of sales

 

61,063

 

 

 

58,339

 

 

 

2,724

 

4.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

 

 

 

 

 

 

 

 

 

 

 

Band

 

10,284

 

28.9%

 

9,130

 

25.8%

 

1,154

 

12.6

 

Piano

 

21,006

 

37.0%

 

18,235

 

36.2%

 

2,771

 

15.2

 

Total gross profit

 

31,290

 

 

 

27,365

 

 

 

3,925

 

14.3

 

 

 

33.9%

 

 

 

31.9%