**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

###### **Washington, D.C. 20549**

** **

**FORM 10-Q**

** **
| **ý** |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|----------------------------------------------------------------------------------------------|

 

**FOR THEQUARTERLY PERIOD ENDED SEPTEMBER 29, 2001**

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

** **

**COMMISSIONFILE NUMBER 001-11911**

 

 

**STEINWAY MUSICAL INSTRUMENTS, INC.**

 (Exact name of registrant as specified in itscharter)

 

| **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 reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements during the past 90 days.   Yes ý    No o

 
| Number of shares  of Common Stock issued and outstanding as of October 31, 2001: |   | Class A  |   | 477,953   |   |
|----------------------------------------------------------------------------------|--------|----------|--------|-----------|--------|
|                                                                             |   | Ordinary |   | 8,463,096 |   |
|                                                                             |   | Total    |   | 8,941,049 |   |

 

**STEINWAY MUSICAL INSTRUMENTS, INC.AND SUBSIDIARIES**

**FORM 10-Q**

**INDEX**

 

 
| **PART  I.**  | **FINANCIAL  INFORMATION**                                                                                                 |   |
|---------------|----------------------------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                                       |   |
| **Item  1.**  | **Condensed  Consolidated Financial Statements:**                                                                          |   |
|          |                                                                                                                       |   |
|          | Condensed  Consolidated Statements of Income Three months and nine months ended  September 30, 2000 and September 29, 2001 |   |
|          |                                                                                                                       |   |
|          | Condensed  Consolidated Balance Sheets December 31, 2000 and September 29, 2001                                            |   |
|          |                                                                                                                       |   |
|          | Condensed  Consolidated Statements of Cash Flows Nine months ended September 30, 2000  and September 29, 2001              |   |
|          |                                                                                                                       |   |
|          | Notes  to Condensed Consolidated Financial Statements                                                                      |   |
|          |                                                                                                                       |   |
|          |                                                                                                                       |   |
| **Item  2.**  | **Management’s  Discussion and Analysis of Financial Conditionand Results of Operations**                             |   |
|          |                                                                                                                       |   |
| **Item 3.**   | **Quantitative  and Qualitative Disclosures about Market Risk**                                                            |   |
|          |                                                                                                                       |   |
|          |                                                                                                                       |   |
| **PART  II.** | **OTHER  INFORMATION**                                                                                                     |   |
|          |                                                                                                                       |   |
| **Item 6.**   | **Exhibits and  Reports on Form 8-K**                                                                                      |   |
|          |                                                                                                                       |   |
|          | **Signatures**                                                                                                             |   |

 

** STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OFINCOME**

**(In Thousands Except Share and PerShare Amounts)**

**(Unaudited)**

** **
|                                                                               |   | **Three Months Ended**    |   | **Nine Months Ended**           |   |
|------------------------------------------------------------------------------------|--------|---------------------------|--------|---------------------------------|--------|
|                                                                               |   | **September 30,****2000** |   | **September 29,**** 2001** |   | **September 30,**** 2000** |   | **September 29,**** 2001** |   |
|                                                                               |   |                      |   |                            |   |   |   |   |   |
| Net sales                                                                          |   | $                         | 75,702 |                            | $      | 82,885 |   | $ | 241,301 |   | $ | 268,127 |   |
| Cost of sales                                                                      |   | 52,260                    |   | 58,576                          |   | 166,321 |   | 185,045 |   |
|                                                                               |   |                      |   |                            |   |   |   |   |   |
| Gross Profit                                                                       |   | 23,442                    |   | 24,309                          |   | 74,980 |   | 83,082 |   |
| Operating  expenses:                                                               |   |                      |   |                            |   |   |   |   |   |
| Sales and  marketing                                                               |   | 8,555                     |   | 9,544                           |   | 26,326 |   | 31,739 |   |
| General and  administrative                                                        |   | 4,798                     |   | 5,548                           |   | 13,886 |   | 16,319 |   |
| Amortization                                                                       |   | 938                       |   | 1,044                           |   | 2,762 |   | 3,203 |   |
| Other  operating expense                                                           |   | 118                       |   | 148                             |   | 342 |   | 623 |   |
| Non-recurring  charges                                                             |   | 1,490                     |   | -                               |   | 1,490 |   | - |   |
| Total  operating expenses                                                          |   | 15,899                    |   | 16,284                          |   | 44,806 |   | 51,884 |   |
|                                                                               |   |                      |   |                            |   |   |   |   |   |
| Income from  operations                                                            |   | 7,543                     |   | 8,025                           |   | 30,174 |   | 31,198 |   |
|                                                                               |   |                      |   |                            |   |   |   |   |   |
| Interest  expense, net                                                             |   | 4,236                     |   | 4,416                           |   | 11,203 |   | 13,482 |   |
| Other income,  net                                                                 |   | (328                      | )      | (692                            | )      | (1,004 | ) | (1,086 | ) |
|                                                                               |   |                      |   |                            |   |   |   |   |   |
| Income before  income taxes                                                        |   | 3,635                     |   | 4,301                           |   | 19,975 |   | 18,802 |   |
|                                                                               |   |                      |   |                            |   |   |   |   |   |
| Provision for  income taxes                                                        |   | 835                       |   | 1,787                           |   | 7,455 |   | 7,387 |   |
|                                                                               |   |                      |   |                            |   |   |   |   |   |
| Net income  before extraordinary loss                                              |   | 2,800                     |   | 2,514                           |   | 12,520 |   | 11,415 |   |
|                                                                               |   |                      |   |                            |   |   |   |   |   |
| Extraordinary  loss on early extinguishment of debt (net of tax benefit of $2,662) |   | -                         |   | -                               |   | - |   | 3,950 |   |
|                                                                               |   |                      |   |                            |   |   |   |   |   |
| Net income                                                                         |   | $                         | 2,800  |                            | $      | 2,514 |   | $ | 12,520 |   | $ | 7,465 |   |
|                                                                               |   |                      |   |                            |   |   |   |   |   |
| Earnings per  share (basic and diluted)                                            |   |                      |   |                            |   |   |   |   |   |
| Before  extraordinary loss:                                                        |   | $                         | 0.31   |                            | $      | 0.28 |   | $ | 1.40 |   | $ | 1.28 |   |
| Extraordinary  loss on early extinguishment of debt                                |   | -                         |   | -                               |   | - |   | (0.44 | ) |
| Net income                                                                         |   | $                         | 0.31   |                            | $      | 0.28 |   | $ | 1.40 |   | $ | 0.84 |   |
|                                                                               |   |                      |   |                            |   |   |   |   |   |
| Weighted  average shares:                                                          |   |                      |   |                            |   |   |   |   |   |
| Basic                                                                              |   | 8,921,724                 |   | 8,947,342                       |   | 8,917,621 |   | 8,936,781 |   |
| Diluted                                                                            |   | 8,921,724                 |   | 8,947,342                       |   | 8,917,634 |   | 8,936,781 |   |

 

See notes to condensedconsolidated financial statements.

**STEINWAY MUSICAL INSTRUMENTS, INC.AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(In Thousands)**

**(Unaudited)**

 
|                                                                                                                                       |   | **December 31,**** 2000** |          | **September 29,**** 2001** |          |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------|---------------|---------------------------------|---------------|
|                                                                                                                                       |   |                           |          |                            |          |
| ASSETS:                                                                                                                                    |   |                           |          |                            |          |
| Curent assets:                                                                                                                             |   |                           |          |                            |          |
| Cash                                                                                                                                       |   | $                              | 4,989         |                            | $             | 5,357 |   |
| Accounts,  notes and leases receivable, net of allowance for bad debts of $11,377 and  $11,368 in 2000 and 2001, respectively              |   | 93,042                         |     | 109,982                         |     |
| Inventories                                                                                                                                |   | 160,296                        |          | 171,347                         |          |
| Prepaid  expenses and other current assets                                                                                                 |   | 3,005                          |          | 2,994                           |          |
| Deferred tax  assets                                                                                                                       |   | 4,121                          |          | 4,038                           |          |
| Total current  assets                                                                                                                      |   | 265,453                        |          | 293,718                         |          |
|                                                                                                                                       |   |                           |          |                            |          |
| Property,  plant and equipment, net of accumulated depreciation of $36,760 and $43,334  in 2000 and 2001, respectively                     |   | 106,415                        |     | 103,982                         |     |
| Other assets,  net                                                                                                                         |   | 20,645                         |          | 20,500                          |          |
| Cost in excess  of fair value of net assets acquired, net of accumulated amortization of  $5,231 and $5,822 in 2000 and 2001, respectively |   | 29,303                         |     | 28,336                          |     |
|                                                                                                                                       |   |                           |          |                            |          |
| TOTAL ASSETS                                                                                                                               |   | $                              | 421,816       |                            | $             | 446,536 |   |
|                                                                                                                                       |   |                           |          |                            |          |
|                                                                                                                                       |   |                           |          |                            |          |
| LIABILITIES  AND STOCKHOLDERS' EQUITY                                                                                                      |   |                           |          |                            |          |
| Current  liabilities:                                                                                                                      |   |                           |          |                            |          |
| Current  portion of long-term debt                                                                                                         |   | $                              | 9,516         |                            | $             | 9,938 |   |
| Accounts  payable                                                                                                                          |   | 11,206                         |          | 7,774                           |          |
| Other current  liabilities                                                                                                                 |   | 35,853                         |          | 35,933                          |          |
| Total current  liabilities                                                                                                                 |   | 56,575                         |          | 53,645                          |          |
|                                                                                                                                       |   |                           |          |                            |          |
| Long-term debt                                                                                                                             |   | 213,894                        |          | 235,283                         |          |
| Deferred tax  liabilities                                                                                                                  |   | 26,316                         |          | 25,055                          |          |
| Other  liabilities                                                                                                                         |   | 11,824                         |          | 12,646                          |          |
| Total  liabilities                                                                                                                         |   | 308,609                        |          | 326,629                         |          |
|                                                                                                                                       |   |                           |          |                            |          |
| Commitments  and contingent liabilities                                                                                                    |   |                           |          |                            |          |
|                                                                                                                                       |   |                           |          |                            |          |
| Stockholders'  equity:                                                                                                                     |   |                           |          |                            |          |
| Common stock                                                                                                                               |   | 9                              |          | 9                               |          |
| Additional  paid-in capital                                                                                                                |   | 71,724                         |          | 72,178                          |          |
| Retained  earnings                                                                                                                         |   | 65,392                         |          | 72,857                          |          |
| Accumulated  other comprehensive income                                                                                                    |   | (9,966                         | )             | (10,849                         | )             |
| Treasury  stock, at cost                                                                                                                   |   | (13,952                        | )             | (14,288                         | )             |
| Total  stockholders' equity                                                                                                                |   | 113,207                        |          | 119,907                         |          |
|                                                                                                                                       |   |                           |          |                            |          |
| TOTAL  LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                |   | $                              | 421,816       |                            | $             | 446,536 |   |

 

See notes to condensedconsolidated financial statements.

**STEINWAY MUSICAL INSTRUMENTS, INC.AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(In Thousands)**

**(Unaudited)**

 
|                                                                          |   | **Nine Months Ended**           |   |
|-------------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                          |   | **September 30,**** 2000** |   | **September 29,**** 2001** |   |
| Cash flows  from operating activities:                                        |   |                            |   |   |   |
| Net income                                                                    |   | $                               | 12,520 |   | $ | 7,465 |   |
| Adjustments to  reconcile net income to cash flows from operating activities: |   |                            |   |   |   |
| Depreciation  and amortization                                                |   | 8,769                           |   | 10,369 |   |
| Early  extinguishment of debt                                                 |   | -                               |   | 3,950 |   |
| Deferred tax  benefit                                                         |   | (2,019                          | )      | (1,003 | ) |
| Other                                                                         |   | 155                             |   | 472 |   |
| Changes in  operating assets and liabilities:                                 |   |                            |   |   |   |
| Accounts,  notes and leases receivable                                        |   | (21,767                         | )      | (17,720 | ) |
| Inventories                                                                   |   | (10,523                         | )      | (12,783 | ) |
| Prepaid  expenses and other current assets                                    |   | (666                            | )      | (331 | ) |
| Accounts  payable                                                             |   | (356                            | )      | (3,387 | ) |
| Other current  liabilities                                                    |   | 4,269                           |   | 2,502 |   |
| Cash flows  from operating activities                                         |   | (9,618                          | )      | (10,466 | ) |
|                                                                          |   |                            |   |   |   |
| Cash flows  from investing activities:                                        |   |                            |   |   |   |
| Capital  expenditures                                                         |   | (6,193                          | )      | (4,478 | ) |
| Proceeds from  disposals of fixed assets                                      |   | 122                             |   | 221 |   |
| Business  acquisition, net of cash acquired                                   |   | (32,484                         | )      | - |   |
| Changes in  other assets                                                      |   | 114                             |   | 63 |   |
| Cash flows  from investing activities                                         |   | (38,441                         | )      | (4,194 | ) |
|                                                                          |   |                            |   |   |   |
| Cash flows  from financing activities:                                        |   |                            |   |   |   |
| Net borrowings  (repayments) under lines of credit                            |   | 47,676                          |   | (13,233 | ) |
| Proceeds from  issuance of long-term debt                                     |   | -                               |   | 150,000 |   |
| Repayments of  long-term debt                                                 |   | (920                            | )      | (117,512 | ) |
| Debt issuance  costs                                                          |   | -                               |   | (4,478 | ) |
| Proceeds from  issuance of stock                                              |   | 693                             |   | 454 |   |
| Purchase of  treasury stock                                                   |   | (483                            | )      | (336 | ) |
| Cash flows  from financing activities                                         |   | 46,966                          |   | 14,895 |   |
|                                                                          |   |                            |   |   |   |
| Effect of  foreign exchange rate changes on cash                              |   | 169                             |   | 133 |   |
|                                                                          |   |                            |   |   |   |
| Increase  (decrease) in cash                                                  |   | (924                            | )      | 368 |   |
| Cash,  beginning of period                                                    |   | 4,664                           |   | 4,989 |   |
|                                                                          |   |                            |   |   |   |
| Cash, end of  period                                                          |   | $                               | 3,740  |   | $ | 5,357 |   |
|                                                                          |   |                            |   |   |   |
|                                                                          |   |                            |   |   |   |
| Supplemental  Cash Flow Information                                           |   |                            |   |   |   |
| Interest paid                                                                 |   | $                               | 8,469  |   | $ | 11,815 |   |
| Taxes paid                                                                    |   | $                               | 12,237 |   | $ | 9,293 |   |

 

See notes to condensedconsolidated financial statements.

**STEINWAY MUSICAL INSTRUMENTS, INC.AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**SEPTEMBER 29, 2001**

**(In Thousands Except Share Data)**

**(Unaudited)**

 

 

**(1)   Basisof Presentation**

 

        The accompanying condensed consolidated financial statementsof Steinway Musical Instruments, Inc. and subsidiaries (the “Company”) for thethree months and nine months ended September 30, 2000 and September 29, 2001are unaudited.  In the opinion ofmanagement, these statements have been prepared on the same basis as theaudited consolidated financial statements as of and for the year ended December31, 2000, and include all adjustments which are of a normal and recurringnature, necessary for the fair presentation of financial position, results ofoperations and cash flows for the interim period.  The condensed consolidated financial statements should be read inconjunction with the consolidated financial statements and notes theretocontained in the Company’s Annual Report on Form 10-K for the fiscal year endedDecember 31, 2000. The results of operations for the three months and ninemonths ended September 29, 2001 are not necessarily indicative of the resultsthat may be expected for the entire year.

 

        On September 15, 2000, the Company completed the acquisitionof United Musical Instruments Holdings, Inc. (“UMI”) pursuant to a stockpurchase agreement dated as of July 20, 2000. The acquisition, which had an aggregate purchase price of approximately$84.0 million, was accounted for as a purchase.

 

**(2)   Summaryof Significant Accounting Policies**

 

        *Principles of Consolidation -*The consolidated financialstatements of the Company include the accounts of all of its direct andindirect wholly owned subsidiaries, including The Steinway Piano Company, Inc.(“Steinway”), The Selmer Company, Inc. (“Selmer”), and United MusicalInstruments, Inc. (“UMI”).  Significantintercompany balances have been eliminated in consolidation.

 

        *Income per Common Share –*Basic income per share is computedusing the weighted average number of common shares outstanding during eachperiod.  Diluted income per common sharereflects the effect of the Company’s outstanding options using the treasurystock method, except when such items would be antidilutive.  A reconciliation of the weighted averageshares used for the basic and diluted computations for the three month and ninemonth periods ended September 30, 2000 and September 29, 2001 is as follows:

 

 
|                             |   | **Three months ended** |   | **Nine months ended** |   |
|----------------------------------|--------|------------------------|--------|-----------------------|--------|
|                             |   | **2000**               |   | **2001**              |   | **2000** |   | **2001** |   |
| Weighted average shares:         |   |                   |   |                  |   |   |   |   |   |
| For basic income per share       |   | 8,921,724              |   | 8,947,342             |   | 8,917,621 |   | 8,936,781 |   |
| Dilutive effect of stock options |   | -                      |   | -                     |   | 13 |   | - |   |
| For diluted income per share     |   | 8,921,724              |   | 8,947,342             |   | 8,917,634 |   | 8,936,781 |   |

 

        *ComprehensiveIncome –*Other comprehensive income (loss) is comprised offoreign currency translation adjustments, additional minimum pensionliabilities, and unrealized losses on certain long-term assets.  Total comprehensive income (loss) for thethree month and nine month periods ended September 30, 2000 and September 29,2001 is as follows:

** **
|                               |   | **Three months ended** |   | **Nine months ended** |   |
|------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                               |   | **2000**               |   | **2001**              |   | **2000** |   | **2001** |   |
|                               |   |                   |   |                  |   |   |   |   |   |
| Net Income                         |   | $                      | 2,800  |                  | $      | 2,514 |   | $ | 12,520 |   | $ | 7,465 |   |
| Other  comprehensive income (loss) |   | (1,902                 | )      | 1,999                 |   | (3,530 | ) | (883 | ) |
| Total  comprehensive income        |   | $                      | 898    |                  | $      | 4,513 |   | $ | 8,990 |   | $ | 6,582 |   |

 

*        New AccountingPronouncements -* On January 1, 2001, the Company adoptedStatement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting forDerivative Instruments and Hedging Activities” (“SFAS 133”), which establishesaccounting and reporting standards for derivative instruments.  All derivatives, whether designated inhedging relationships or not, are required to be recorded on the balance sheetat fair value.  If the derivative isdesignated as a fair value hedge, the changes in the fair value of thederivative and of the hedged item attributable to the hedged risk arerecognized in earnings.  If thederivative is designated as a cash flow hedge, the effective portions of changesin the fair value of the derivative are recorded in other comprehensive incomeand are recognized in the income statement when the hedged item affectsearnings.  Ineffective portions ofchanges in the fair value of cash flow hedges are recognized in earnings.

 

        The Company uses derivative instruments to manage exposuresto foreign exchange rate fluctuations. The Company’s objectives for holding derivatives are to minimize therisks using the most effective methods to eliminate or reduce the impacts of theseexposures.  The Company monitors itsforeign currency exposures daily to maximize the overall effectiveness of itsforeign currency hedge positions. Principal currencies hedged include the Euro, British pound and Japaneseyen.  Options and forwards used to hedgea portion of forecasted international intercompany revenue for up to one yearin the future are designated as cash flow hedging instruments.  Forwards and options not designated ashedging instruments under SFAS 133 are also used to hedge the impact of thevariability in exchange rates on accounts receivable and payable balances.

 

        For options designated as cash flow hedges, changes in thetime value are excluded from the assessment of hedge effectiveness.  Hedge ineffectiveness, determined inaccordance with SFAS 133, had no impact on earnings for the three months andnine months ended September 29, 2001 as the Company did not have any qualifyinghedged transactions.  For the threemonths and nine months ended September 29, 2001, other income included a netforeign currency loss of $4 and gain of $9, respectively, for forward contractsnot designated as hedging instruments.

 

In July 2001, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 141, “BusinessCombinations” (“SFAS 141”).  SFAS 141requires the purchase method of accounting for business combinations initiatedafter June 30, 2001 and eliminates the pooling-of-interests method.  The Company does not believe that theadoption of SFAS 141 will have a significant impact on its financialstatements.

 

        In July 2001 the FASB issued SFAS No. 142, “Goodwill and OtherIntangible Assets” (“SFAS 142”), which is effective January 1, 2002.  SFAS 142 requires, among other things, thediscontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassificationof certain existing recognized intangibles as goodwill, reassessment of theuseful lives of existing recognized intangibles, reclassification of certainintangibles out of previously reported goodwill and the identification ofreporting units for purposes of assessing potential future impairments ofgoodwill.  SFAS 142 also requires theCompany to complete a transitional goodwill impairment test six months from thedate of adoption.  The Company iscurrently assessing but has not yet determined the impact of SFAS 142 on itsfinancial position and results of operations.

 

    In June 2001 the FASB issued SFAS No. 143, “Accounting for AssetRetirement Obligations” (“SFAS 143”), which is effective January 1, 2003.  SFAS 143 requires that the fair value of aliability for an asset retirement obligation be recognized in the period inwhich it is incurred if a reasonable estimate of fair value can be made.  The associated asset retirement costs arecapitalized as part of the carrying amount of the long-lived asset.  The Company does not believe that theadoption of SFAS 143 will have a significant impact on its financialstatements.

 

    In August 2001 the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets” (“SFAS 144”), which is effectiveJanuary 1, 2002.  This statement retainscertain requirements of SFAS No. 121, “Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to be Disposed Of” and requires thatone accounting model be used for long-lived assets to be disposed of bysale.  In addition, SFAS 144 broadensthe presentation of discontinued operations to include more discrete componentsof a company’s operations. The Company does not believe that the adoption ofSFAS 144 will have a significant impact on its financial statements.

 

**(3)   Inventories**

 

        Inventories consist of the following:

 
|             |   | **December 31,****2000** |    | **September 29,**** 2001** |   |
|------------------|--------|--------------------------|---------|---------------------------------|--------|
|             |   |                     |    |                            |   |
| Raw Materials    |   | $                        | 20,961  |                            | $      | 22,122 |   |
| Work in  process |   | 53,711                   |    | 57,022                          |   |
| Finished goods   |   | 85,624                   |    | 92,203                          |   |
| Total            |   | $                        | 160,296 |                            | $      | 171,347 |   |

 

**(4)   Other (Income)Expense, Net**

 

**       **Other(income) expense, net consists of the following:

 
|                               |   | **Three months ended**          |   | **Nine months ended**           |   |
|------------------------------------|--------|---------------------------------|--------|---------------------------------|--------|
|                               |   | **September 30,**** 2000** |   | **September 29,**** 2001** |   | **September 30,**** 2000** |   | **September 29,****2001** |   |
|                               |   |                            |   |                            |   |   |   |   |   |
| West 57th  Building income         |   | $                               | (1,164 | )                               | $      | (1,164 | ) | $ | (3,491 | ) | $ | (3,491 | ) |
| West 57th  building expenses       |   | 814                             |   | 810                             |   | 2,441 |   | 2,434 |   |
| Foreign  exchange (gain) loss, net |   | 206                             |   | (51                             | )      | 454 |   | 453 |   |
| Miscellaneous                      |   | (184                            | )      | (287                            | )      | (408 | ) | (482 | ) |
| Other (income)  expense, net       |   | $                               | (328   | )                               | $      | (692 | ) | $ | (1,004 | ) | $ | (1,086 | ) |

 

**(5)   Commitments andContingent Liabilities**

 

        Certain environmental matters are pending against asubsidiary of the Company, which might result in monetary damages, the amountof which, if any, cannot be determined at the present time.  Philips Electronics, a previous owner of asubsidiary of the Company, has agreed to hold the Company harmless from anyfinancial liability arising from these environmental matters which were pendingas of December 29, 1988.  Managementbelieves that these matters will not have a material adverse impact on theCompany’s results of operations or financial condition.

 

**(6)   SegmentInformation**

 

The Company has identified two distinct andreportable segments: the piano segment and the band and orchestral instrumentsegment.  These segments were selectedbased upon the way in which management oversees and evaluates the results ofeach operation.  The following tablespresent information about the Company’s operating segments for the three monthand nine month periods ended September 30, 2000 and September 29, 2001:

 

 
| **Three months ended 2000**                  |   | **Piano Segment** |   | **Band and Orchestral  Segment** |   |      |   |      |   |
|----------------------------------------------|--------|-------------------|--------|----------------------------------|--------|-----------|--------|-----------|--------|
|                                         |   | **U.S.**          |   | **Germany**                      |   | **Other** |   | **Total** |   | **U.S.** |   | **Other** |   | **Total** |   | **Other & Elim** |   | **Consol Total** |   |
| Revenues from  external customers            |   | $                 | 28,394 |                             | $      | 7,752     |   | $         | 5,193  |   | $ | 41,339 |   | $ | 32,898 |   | $ | 1,465 |   | $ | 34,363 |   | $ | - |   | $ | 75,702 |   |
| Net income  (loss)                           |   | 742               |   | 1,017                            |   | 583       |   | 2,342     |   | (1,592 | ) | 6 |   | (1,586 | ) | 2,044 |   | 2,800 |   |
|                                         |   |              |   |                             |   |      |   |      |   |   |   |   |   |   |   |   |   |   |   |
| **Three months ended 2001**                  |   | **Piano Segment** |   | **Band and Orchestral  Segment** |   |      |   |      |   |
|                                         |   | **U.S.**          |   | **Germany**                      |   | **Other** |   | **Total** |   | **U.S.** |   | **Other** |   | **Total** |   | **Other & Elim** |   | **Consol Total** |   |
| Revenues from  external customers            |   | $                 | 24,018 |                             | $      | 8,939     |   | $         | 4,765  |   | $ | 37,722 |   | $ | 44,101 |   | $ | 1,062 |   | $ | 45,163 |   | $ | - |   | $ | 82,885 |   |
| Net income  (loss)                           |   | (266              | )      | 608                              |   | 404       |   | 746       |   | (1,135 | ) | 23 |   | (1,112 | ) | 2,880 |   | 2,514 |   |
|                                         |   |              |   |                             |   |      |   |      |   |   |   |   |   |   |   |   |   |   |   |
| **Nine months ended 2000**                   |   | **Piano Segment** |   | **Band and Orchestral  Segment** |   |      |   |      |   |
|                                         |   | **U.S.**          |   | **Germany**                      |   | **Other** |   | **Total** |   | **U.S.** |   | **Other** |   | **Total** |   | **Other & Elim** |   | **Consol Total** |   |
| Revenues from  external customers            |   | $                 | 89,642 |                             | $      | 25,299    |   | $         | 14,539 |   | $ | 129,480 |   | $ | 108,315 |   | $ | 3,506 |   | $ | 111,821 |   | $ | - |   | $ | 241,301 |   |
| Net income  (loss)                           |   | 2,603             |   | 1,499                            |   | 1,275     |   | 5,377     |   | (560 | ) | (26 | ) | (586 | ) | 7,729 |   | 12,520 |   |
|                                         |   |              |   |                             |   |      |   |      |   |   |   |   |   |   |   |   |   |   |   |
| **Nine months ended 2001**                   |   | **Piano Segment** |   | **Band and Orchestral  Segment** |   |      |   |      |   |
|                                         |   | **U.S.**          |   | **Germany**                      |   | **Other** |   | **Total** |   | **U.S.** |   | **Other** |   | **Total** |   | **Other & Elim** |   | **Consol Total** |   |
| Revenues from  external customers            |   | $                 | 78,340 |                             | $      | 26,231    |   | $         | 16,593 |   | $ | 121,164 |   | $ | 143,675 |   | $ | 3,288 |   | $ | 146,963 |   | $ | - |   | $ | 268,127 |   |
| Net income  (loss) before extraordinary loss |   | 1,115             |   | 1,918                            |   | 1,210     |   | 4,243     |   | (1,877 | ) | (53 | ) | (1,930 | ) | 9,102 |   | 11,415 |   |

 

 

**(7)   Summaryof Guarantees**

 

        On April 19, 2001, the Company completeda $150.0 million 8.75% Senior Note offering. The proceeds of the offering were used to redeem all of the existing 11%Senior Subordinated Notes with the balance paying down the revolving creditfacility.

 

        The Company’s payment obligations underthe new notes are fully and unconditionally guaranteed on a joint and severalbasis by Selmer, Steinway, UMI and certain direct and indirect wholly-ownedsubsidiaries of the Company, each a “Guarantor” (the “GuarantorSubsidiaries”).  These subsidiariesrepresent all of the operations of the Company conducted in the UnitedStates.  The remaining subsidiaries,which do not guarantee the new notes, represent foreign operations (the “NonGuarantor Subsidiaries”).

 

        The following condensed consolidatingsupplementary data illustrates the composition of the combined Guarantors.  Separate complete financial statements ofthe respective Guarantors would not provide additional material informationwhich would be useful in assessing the financial composition of theGuarantors.  No single Guarantor has anysignificant legal restrictions on the ability of investors or creditors toobtain access to its assets in event of default on the Guarantee other than itssubordination to senior indebtedness.

 

        Investments in subsidiaries are recordedby the issuer on the cost method for purposes of the supplemental consolidatingpresentation.  Earnings of subsidiariesare therefore not reflected in the issuer’s investment accounts and earnings.  The principal elimination entries eliminateinvestments in subsidiaries and intercompany balances and transactions.

** STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATING STATEMENTS OFINCOME**

**NINE MONTHS ENDED SEPTEMBER 29, 2001**

** (In Thousands)**

**(Unaudited)**

 
|                                                                               |   | **Issuer****Of Notes** |   | **Guarantor****Subsidiaries** |   | **Non****Guarantor****Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|------------------------------------------------------------------------------------|--------|------------------------|--------|-------------------------------|--------|--------------------------------------|--------|------------------|--------|------------------|--------|
|                                                                               |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Net sales                                                                          |   | $                      | -      |                          | $      | 227,906                              |   | $                | 48,544 |             | $      | (8,323 | ) | $ | 268,127 |   |
| Cost of sales                                                                      |   | -                      |   | 163,467                       |   | 30,161                               |   | (8,583           | )      | 185,045          |   |
|                                                                               |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Gross Profit                                                                       |   | -                      |   | 64,439                        |   | 18,383                               |   | 260              |   | 83,082           |   |
|                                                                               |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Operating  Expenses:                                                               |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Sales and  marketing                                                               |   | -                      |   | 24,648                        |   | 7,157                                |   | (66              | )      | 31,739           |   |
| General and  administrative                                                        |   | 3,216                  |   | 10,028                        |   | 3,335                                |   | (260             | )      | 16,319           |   |
| Amortization                                                                       |   | 200                    |   | 2,195                         |   | 808                                  |   | -                |   | 3,203            |   |
| Other  operating (income) expense                                                  |   | (2,421                 | )      | 2,020                         |   | 698                                  |   | 326              |   | 623              |   |
| Total  operating expenses                                                          |   | 995                    |   | 38,891                        |   | 11,998                               |   | -                |   | 51,884           |   |
|                                                                               |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Income (loss)  from operations                                                     |   | (995                   | )      | 25,548                        |   | 6,385                                |   | 260              |   | 31,198           |   |
|                                                                               |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Interest  (income) expense, net                                                    |   | (1,708                 | )      | 14,892                        |   | 298                                  |   | -                |   | 13,482           |   |
| Other (income)  expense, net                                                       |   | 1                      |   | (1,155                        | )      | 68                                   |   |             |   | (1,086           | )      |
|                                                                               |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Income before  income taxes                                                        |   | 712                    |   | 11,811                        |   | 6,019                                |   | 260              |   | 18,802           |   |
|                                                                               |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Provision for  income taxes                                                        |   | 334                    |   | 4,642                         |   | 2,313                                |   | 98               |   | 7,387            |   |
|                                                                               |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Net income  before extraordinary loss                                              |   | 378                    |   | 7,169                         |   | 3,706                                |   | 162              |   | 11,415           |   |
| Extraordinary  loss on early extinguishment of debt (net of tax benefit of $2,662) |   | 742                    |   | 3,208                         |   |                                 |   |             |   | 3,950            |   |
|                                                                               |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Net income (loss)                                                                  |   | $                      | (364   | )                             | $      | 3,961                                |   | $                | 3,706  |             | $      | 162 |   | $ | 7,465 |   |

 

 

**STEINWAY MUSICAL INSTRUMENTS, INC.AND SUBSIDIARIES**

**CONDENSED CONSOLIDATING BALANCESHEETS**

**SEPTEMBER 29, 2001**

**(In Thousands)**

**(Unaudited)**

** **
|                                                      |   | **Issuer****Of Notes** |   | **Guarantor****Subsidiaries** |   | **Non****Guarantor****Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|-----------------------------------------------------------|--------|------------------------|--------|-------------------------------|--------|--------------------------------------|--------|------------------|--------|------------------|--------|
| ASSETS                                                    |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Current  assets:                                          |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Cash                                                      |   | $                      | -      |                          | $      | 2,204                                |   | $                | 3,153  |             | $      | - |   | $ | 5,357 |   |
| Accounts,  notes and leases receivable, net               |   | -                      |   | 100,226                       |   | 9,756                                |   | -                |   | 109,982          |   |
| Inventories                                               |   | -                      |   | 144,461                       |   | 27,925                               |   | (1,039           | )      | 171,347          |   |
| Prepaid  expenses and other current assets                |   | 183                    |   | 1,987                         |   | 824                                  |   | -                |   | 2,994            |   |
| Deferred tax  assets                                      |   | -                      |   | 5,305                         |   | 3,426                                |   | (4,693           | )      | 4,038            |   |
| Total current  assets                                     |   | 183                    |   | 254,183                       |   | 45,084                               |   | (5,732           | )      | 293,718          |   |
|                                                      |   |                   |   |                          |   |                                 |   |             |   |             |   |
|                                                      |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Property,  plant and equipment, net                       |   | 232                    |   | 89,902                        |   | 13,848                               |   | -                |   | 103,982          |   |
| Investment in  subsidiaries                               |   | 71,143                 |   | 252,042                       |   | -                                    |   | (323,185         | )      | -                |   |
| Other assets,  net                                        |   | 4,996                  |   | 12,713                        |   | 3,473                                |   | (682             | )      | 20,500           |   |
| Cost in excess  of fair value of net assets acquired, net |   | -                      |   | 18,940                        |   | 9,396                                |   | -                |   | 28,336           |   |
|                                                      |   |                   |   |                          |   |                                 |   |             |   |             |   |
| TOTAL ASSETS                                              |   | $                      | 76,554 |                          | $      | 627,780                              |   | $                | 71,801 |             | $      | (329,599 | ) | $ | 446,536 |   |
|                                                      |   |                   |   |                          |   |                                 |   |             |   |             |   |
| LIABILITIES  AND STOCKHOLDERS' EQUITY                     |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Current  liabilities:                                     |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Current portion  of long-term debt:                       |   | $                      | -      |                          | $      | 5,900                                |   | $                | 4,038  |             | $      | - |   | $ | 9,938 |   |
| Accounts  payable                                         |   | 13                     |   | 6,045                         |   | 1,716                                |   | -                |   | 7,774            |   |
| Other current  liabilities                                |   | (16,917                | )      | 46,127                        |   | 11,669                               |   | (4,946           | )      | 35,933           |   |
| Total current  liabilities                                |   | (16,904                | )      | 58,072                        |   | 17,423                               |   | (4,946           | )      | 53,645           |   |
|                                                      |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Long-term debt                                            |   | 150,080                |   | 85,203                        |   | -                                    |   | -                |   | 235,283          |   |
| Intercompany                                              |   | (112,602               | )      | 107,563                       |   | 5,039                                |   | -                |   | -                |   |
| Deferred tax  liabilities                                 |   | -                      |   | 18,771                        |   | 6,284                                |   | -                |   | 25,055           |   |
| Other  liabilities                                        |   | 105                    |   | 1,519                         |   | 11,704                               |   | (682             | )      | 12,646           |   |
| Total  liabilities                                        |   | 20,679                 |   | 271,128                       |   | 40,450                               |   | (5,628           | )      | 326,629          |   |
|                                                      |   |                   |   |                          |   |                                 |   |             |   |             |   |
| Stockholders'  equity                                     |   | 55,875                 |   | 356,652                       |   | 31,351                               |   | (323,971         | )      | 119,907          |   |
|                                                      |   |                   |   |                          |   |                                 |   |             |   |             |   |
| TOTAL  LIABILITIES AND STOCKHOLDERS' EQUITY               |   | $                      | 76,554 |                          | $      | 627,780                              |   | $                | 71,801 |             | $      | (329,599 | ) | $ | 446,536 |   |

 

**STEINWAY MUSICAL INSTRUMENTS, INC.AND SUBSIDIARIES**

**CONDENSED CONSOLIDATING STATEMENTS OFCASH FLOWS**

**NINE MONTHS ENDED SEPTEMBER 29, 2001**

** (In Thousands)**

**(Unaudited)**

** **
|                                                                                 |   | **Issuer  Of Notes** |   | **Guarantor****Subsidiaries** |   | **Non****Guarantor****Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------------------------------------------|--------|----------------------|--------|-------------------------------|--------|--------------------------------------|--------|------------------|--------|------------------|--------|
| Cash flows  from operating activities:                                               |   |                 |   |                          |   |                                 |   |             |   |             |   |
| Net income  (loss)                                                                   |   | $                    | (364   | )                             | $      | 3,961                                |   | $                | 3,706  |             | $      | 162 |   | $ | 7,465 |   |
| Adjustments to  reconcile net income (loss) to cash flows from operating activities: |   |                 |   |                          |   |                                 |   |             |   |             |   |
| Depreciation  and amortization                                                       |   | 240                  |   | 8,218                         |   | 1,911                                |   | -                |   | 10,369           |   |
| Early  extinguishment of debt                                                        |   | 742                  |   | 3,208                         |   | -                                    |   | -                |   | 3,950            |   |
| Deferred tax  benefit                                                                |   |                 |   | (498                          | )      | (505                                 | )      | -                |   | (1,003           | )      |
| Other                                                                                |   | 4                    |   | 355                           |   | 113                                  |   | -                |   | 472              |   |
| Changes in  operating assets and liabilities:                                        |   |                 |   |                          |   |                                 |   |             |   |             |   |
| Accounts,  notes and leases receivable                                               |   | -                    |   | (17,985                       | )      | 265                                  |   | -                |   | (17,720          | )      |
| Inventories                                                                          |   | -                    |   | (8,685                        | )      | (3,838                               | )      | (260             | )      | (12,783          | )      |
| Prepaid  expenses and other current assets                                           |   | (71                  | )      | 180                           |   | (440                                 | )      | -                |   | (331             | )      |
| Accounts  payable                                                                    |   | (129                 | )      | (3,252                        | )      | (6                                   | )      | -                |   | (3,387           | )      |
| Other current  liabilities                                                           |   | (369                 | )      | 1,539                         |   | 1,234                                |   | 98               |   | 2,502            |   |
| Cash flows  from operating activities                                                |   | 53                   |   | (12,959                       | )      | 2,440                                |   | -                |   | (10,466          | )      |
|                                                                                 |   |                 |   |                          |   |                                 |   |             |   |             |   |
| Cash flows  from investing activities:                                               |   |                 |   |                          |   |                                 |   |             |   |             |   |
| Capital  expenditures                                                                |   | (185                 | )      | (3,597                        | )      | (696                                 | )      | -                |   | (4,478           | )      |
| Proceeds from  disposals of fixed assets                                             |   | -                    |   | 221                           |   | -                                    |   | -                |   | 221              |   |
| Changes in  other assets                                                             |   | (25                  | )      | 88                            |   | -                                    |   | -                |   | 63               |   |
| Cash flows  from investing activities                                                |   | (210                 | )      | (3,288                        | )      | (696                                 | )      | -                |   | (4,194           | )      |
|                                                                                 |   |                 |   |                          |   |                                 |   |             |   |             |   |
| Cash flows  from financing activities:                                               |   |                 |   |                          |   |                                 |   |             |   |             |   |
| Net borrowings  (repayments) under lines of credit                                   |   | (105                 | )      | (13,380                       | )      | 252                                  |   | -                |   | (13,233          | )      |
| Proceeds from  issuance of long-term debt                                            |   | 150,000              |   | -                             |   | -                                    |   | -                |   | 150,000          |   |
| Repayment of  long-term debt                                                         |   | -                    |   | (117,162                      | )      | (350                                 | )      | -                |   | (117,512         | )      |
| Debt issuance  costs                                                                 |   | (4,478               | )      | -                             |   | -                                    |   | -                |   | (4,478           | )      |
| Proceeds from  issuance of stock                                                     |   | 454                  |   | -                             |   | -                                    |   | -                |   | 454              |   |
| Purchase of  treasury stock                                                          |   | (336                 | )      | -                             |   | -                                    |   | -                |   | (336             | )      |
| Intercompany  dividends                                                              |   | -                    |   | 701                           |   | (701                                 | )      | -                |   | -                |   |
| Intercompany  transactions                                                           |   | (145,378             | )      | 145,630                       |   | (252                                 | )      | -                |   | -                |   |
| Cash flows  from financing activities:                                               |   | 157                  |   | 15,789                        |   | (1,051                               | )      | -                |   | 14,895           |   |
|                                                                                 |   |                 |   |                          |   |                                 |   |             |   |             |   |
| Effect of  exchange rate changes on cash                                             |   | -                    |   | -                             |   | 133                                  |   | -                |   | 133              |   |
|                                                                                 |   |                 |   |                          |   |                                 |   |             |   |             |   |
| Increase  (decrease) in cash                                                         |   | -                    |   | (458                          | )      | 826                                  |   | -                |   | 368              |   |
| Cash,  beginning of period                                                           |   | -                    |   | 2,662                         |   | 2,327                                |   | -                |   | 4,989            |   |
|                                                                                 |   |                 |   |                          |   |                                 |   |             |   |             |   |
| Cash, end of  period                                                                 |   | $                    | -      |                          | $      | 2,204                                |   | $                | 3,153  |             | $      | - |   | $ | 5,357 |   |

 

**(8)Extraordinary Loss**

 

On April 19, 2001, the Company completed a $150.0million 8.75% Senior Note offering.  Theproceeds of this offering were used to redeem $110.0 million of previouslyoutstanding Senior Subordinated Notes, together with accrued interest, with thebalance used to pay down the committed, revolving credit facility with asyndicate of domestic lenders (the “Credit Facility”).  The early retirement of the SeniorSubordinated Notes, which were redeemed on June 1, 2001 at 102.75% of theprincipal amount, generated an extraordinary charge of approximately $4.0million, net of tax of $2.7 million. The Company’s current long-term financing includes the $150.0 millionSenior Notes and $61.6 million of term loans outstanding under the CreditFacility.  The Company’s debt agreementscontain restrictive covenants that place certain restrictions on the Company,including restrictions on the Company’s ability to incur additionalindebtedness, to make investments in other entities, or to pay cash dividends.

 
| **ITEM  2** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL****CONDITION  AND RESULTS OF OPERATIONS** |
|-------------|-----------------------------------------------------------------------------------------------------|
|        | **(Dollars in thousands)**                                                                          |

 

 

**Introduction**

 

                The Company,through its operating subsidiaries, is one of the world’s leading manufacturersof musical instruments.  EffectiveSeptember 15, 2000, the Company completed the acquisition of United MusicalInstruments Holdings, Inc. (“UMI”) through its wholly owned subsidiary,Selmer.  The acquisition of UMI wasaccounted for as a purchase for financial reporting purposes.  The aggregate purchase price approximated$84.0 million.  The financial statementsof the Company as of and for the three months and nine months ended September29, 2001 include the effects of the acquisition and the results of operationsfor UMI.

 

                Certain statementscontained in the following Discussion and Analysis of Financial Condition and Resultsof Operations are “forward-looking statements” within the meaning of Section21E of the Securities and Exchange Act of 1934, as amended.  These forward-looking statements representthe Company’s present expectations or beliefs concerning future events.  The Company cautions that such statementsare necessarily based on certain assumptions which are subject to risks anduncertainties, including, but not limited to, changes in general economicconditions, increased competition, exchange rate fluctuations, and theavailability of production capacity and qualified workers which could causeactual results to differ materially from those indicated herein.  Further information on these risk factors isincluded in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2000 and its Final Prospectus filed in August 1996.

 

 

 

**Resultsof Operations**

 

*ThreeMonths Ended September 29, 2001 Compared to Three Months Ended September 30,2000*

 

*                Net Sales*-Net sales increased $7.2 million (9%) to $82.9 million in the third quarter of2001. This increase was primarily attributable to the addition of UMI, whichresulted in an increase of band and orchestral instrument sales of $10.8million (31%) to $45.2 million on an overall unit sales increase of 25%.  Offsetting this, piano sales decreased $3.6million (9%) to $37.7 million due to the ongoing economic softness in theUnited States, which continues to affect both the high-end and the mid-pricedpiano markets.  This resulted in adecrease of domestic Steinway shipments of 18% in the current period. However,this decrease continued to be mitigated by Steinway shipments to Europe andAsia, which increased 9% over the prior year period.

 

G*ross Profit*- Gross profit increased by$0.9 million (4%) to $24.3 million due to the addition of UMI.  The decline in gross margins to 29.3% from31.0% in the prior year was primarily due to piano margins, which decreased to32.7% from 35.3% in 2000 as a result of additional factory shutdowns and thelower absorption of overhead costs in our domestic piano operations. Band andorchestral instrument margins improved to 26.5% in 2001 from 25.8% in 2000 dueto increased production and sales of higher margin instruments.

 

                *Operating Expenses*–Overall operating expenses increased by $0.4 million (2%) to $16.3 million inthe third quarter. Excluding the incremental UMI expenses of $2.1 million in2001 and the one-time charges of $1.5 million for the acquisition of UMI andthe relocation of the Emerson facility in the third quarter of 2000, expensesdecreased slightly to $14.2 million as compared to $14.4 million in the prioryear period.   This decrease wasprimarily a result of the continued fiscal control over sales and marketingexpenses.

 

*                Other Expense, net*-Otherexpenses decreased by $0.2 million (5%) to $3.7 million.  Foreign exchange gains and an increase ininterest income on band receivables contributed to the net decrease in expense.

 

                *Income Taxes*– The Company’s effective tax rate increased to 41.5% from 23.0% in 2000.  The 23.0% rate in 2000 reflected a one-timebenefit caused by a reduction in the German tax rate. Additionally, the currentperiod effective rate of 41.5% is a result of the increased foreign sourceincome typically generated in the second half of the year.  Foreign source income is taxed at a higherrate than domestic earnings.

 

##### *Nine Months EndedSeptember 29, 2001 Compared to Nine Months Ended September 30, 2000*

 

*                Net Sales*–Netsales increased $26.8 million (11%) to $268.1 million primarily due to the UMIacquisition. Band and orchestral instrument sales increased $35.1 million (31%)to $147.0 million, and units increased 29% compared to the prior period. As anoffset, piano sales decreased $8.3 million (6%) in 2001 on unit decreases of36% for Boston pianos and 8% for Steinway pianos, primarily due to thecontinued economic softness in the United States.

 

                *Gross Profit*–Gross profit increased by $8.1 million (11%) to $83.1 million.  Gross margins decreased slightly to 31.0%from 31.1% in the prior period.  Pianomargins improved to 35.6% from 34.7% as a result of both the higher proportionof Steinway units sold and the increased number of high margin concert grandssold abroad. Gross margins for band instruments also improved, increasing to27.2% in 2001 from 26.9% in 2000 due to the larger proportion of higher margininstruments sold.

 

                *OperatingExpenses*–Operating expenses increased by $7.1million to $51.9 million in the current year period.  Excluding the incremental operating expenses of UMI of $8.2million and the one-time charges of $1.5 million for the acquisition of UMI andthe relocation of the Emerson facility in the third quarter of 2000, operatingexpenses increased less than 1%. This increase was attributable to sales andmarketing efforts associated with the introduction of the Essex pianos.

 

                *OtherExpense, Net*–Other expenses increased by $2.2 million(22%) to $12.4 million in the current year period.  Virtually all of the change was due to an increase in netinterest expense, which resulted from higher average outstanding debt balancesdue to increased inventory levels and the additional debt associated with theacquisition of UMI.

 

*                Income Taxes*–TheCompany’s effective tax rate increased to 39.3% from 37.3% in 2000. The 37.3%rate in 2000 included the one-time benefit noted above.  The current effective rate is morereflective of a normal rate for the Company.

 

**Liquidityand Capital Resources**

 

                The Company hasrelied primarily upon cash provided by operations, supplemented as necessary byseasonal borrowings under its working capital line, to finance its operations,repay long-term indebtedness and fund capital expenditures.

 

                Cash used inoperations in the first nine months of 2001 increased $0.9 million compared to2000. Higher interest payments and the temporary build-up of certain inventorycategories exceeded  strong collectionsof band and orchestral instrument receivables.

 

                Capitalexpenditures of $6.2 million and $4.5 million in the first nine months of 2000and 2001, respectively, were used primarily for the purchase of new machinery,building improvements and certain EPA compliance projects.  The Company expects to continue the currentequipment modernization and production efficiency projects in process whilemaintaining a lower level of expenditures in 2001.

 

                The Company’sdomestic seasonal borrowing requirements are accommodated through a committed,revolving credit facility with a syndicate of domestic lenders (the “CreditFacility”).  The Credit Facility, whichwas amended and restated to accommodate both the acquisition of UMI and the$150.0 million bond offering completed in the second quarter, provides theCompany with a potential borrowing capacity, on a revolving basis, of up to$85.0 million, based on eligible accounts receivable and inventorybalances.  The Credit Facility bearsinterest at average 30-day LIBOR plus 1.75% and expires on September 14,2008.  As of September 29, 2001, revolvingcredit loans outstanding were $29.6 million and additional availability wasapproximately $55.4 million.  Openaccount loans with foreign banks also provide for borrowings by Steinway’sforeign subsidiaries of up to 39 million Deutsche marks ($18.2 million at theSeptember 29, 2001 exchange rate).

 

On April 19, 2001, the Company completed a $150.0million 8.75% senior note offering.  Theproceeds of this offering were used to redeem $110.0 million of previouslyoutstanding Senior Subordinated Notes, with the balance used to pay down the CreditFacility.  The early retirement of theNotes, which were redeemed on June 1, 2001 at 102.75% of the principal amount,generated an extraordinary charge of approximately $4.0 million, net of tax of$2.7 million.  The Company’s currentlong-term financing includes the $150.0 million senior notes and $61.6 millionof term loans outstanding under the Credit Facility.  The Company’s debt agreements contain restrictive covenants thatplace certain restrictions on the Company, including restrictions on the Company’sability to incur additional indebtedness, to make investments in otherentities, or to pay cash dividends.

 

                Managementbelieves that cash on hand, together with cash flows anticipated fromoperations and available borrowings under its domestic and foreign creditfacilities, will be adequate to meet existing debt service requirements, fundcontinuing capital requirements and satisfy working capital and generalcorporate needs through 2001.

**NewAccounting Pronouncements**

 

                OnJanuary 1, 2001, the Company adopted Statement of Financial AccountingStandards (SFAS) No. 133, “Accounting for Derivative Instruments and HedgingActivities” (“SFAS 133”), which establishes accounting and reporting standardsfor derivative instruments.  Allderivatives, whether designated in hedging relationships or not, are requiredto be recorded on the balance sheet at fair value.  If the derivative is designated as a fair value hedge, thechanges in the fair value of the derivative and of the hedged item attributableto the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effectiveportions of changes in the fair value of the derivative are recorded in othercomprehensive income and are recognized in the income statement when the hedgeditem affects earnings.  Ineffectiveportions of changes in the fair value of cash flow hedges are recognized inearnings.

 

                TheCompany uses derivative instruments to manage exposures to foreign exchangerate fluctuations.  The Company’sobjectives for holding derivatives are to minimize the risks using the mosteffective methods to eliminate or reduce the impacts of these exposures.  The Company monitors its foreign currencyexposures daily to maximize the overall effectiveness of its foreign currencyhedge positions.  Principal currencieshedged include the Euro, British pound and Japanese yen.  Options and forwards used to hedge a portionof forecasted international intercompany revenue for up to one year in thefuture are designated as cash flow hedging instruments.  Forwards and options not designated ashedging instruments under SFAS 133 are also used to hedge the impact of thevariability in exchange rates on accounts receivable and payable balances.

 

                For options designated as cashflow hedges, changes in the time value are excluded from the assessment ofhedge effectiveness.  Hedgeineffectiveness, determined in accordance with SFAS 133, had no impact onearnings for the three months and nine months ended September 29, 2001 as theCompany did not have any qualifying hedged transactions.  For the three months and nine months endedSeptember 29, 2001, other income included a net foreign currency loss of $4 andgain of $9, respectively, for forward contracts not designated as hedginginstruments.

 

        In July 2001, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 141, “Business Combinations” (“SFAS 141”).  SFAS 141 requires the purchase method ofaccounting for business combinations initiated after June 30, 2001 andeliminates the pooling-of-interests method. The Company does not believe that the adoption of SFAS 141 will have asignificant impact on its financial statements.

 

                In July 2001 the FASB issuedSFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), which iseffective January 1, 2002.  SFAS 142 requires,among other things, the discontinuance of goodwill amortization.  In addition, the standard includesprovisions for the reclassification of certain existing recognized intangiblesas goodwill, reassessment of the useful lives of existing recognizedintangibles, reclassification of certain intangibles out of previously reportedgoodwill and the identification of reporting units for purposes of assessingpotential future impairments of goodwill. SFAS 142 also requires the Company to complete a transitional goodwillimpairment test six months from the date of adoption.  The Company is currently assessing but has not yet determined theimpact of SFAS 142 on its financial position and results of operations.

 

                In June 2001 the FASBissued SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS143”), which is effective January 1, 2003. SFAS 143 requires that the fair value of a liability for an assetretirement obligation be recognized in the period in which it is incurred if areasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of thecarrying amount of the long-lived asset. The Company does not believe that the adoption of SFAS 143 will have asignificant impact on its financial statements.

 

                In August 2001 the FASB issuedSFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”(“SFAS 144”), which is effective January 1, 2002.  This statement retains certain requirements of Statement ofFinancial Accounting Standards No. 121, “Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to be Disposed Of” and requiresthat one accounting model be used for long-lived assets to be disposed of bysale.  In addition, SFAS 144 broadensthe presentation of discontinued operations to include more discrete componentsof a company’s operations. The Company does not believe that the adoption ofSFAS 144 will have a significant impact on its financial statements.

 

**ITEM 3   QUANTITATIVEAND QUALITATIVE DISCLOSURES** ABOUT MARKET RISK

** **

**                The Company is subject to marketrisk associated with changes in foreign currency exchange rates and interestrates.  The Company mitigates itsforeign currency exchange rate risk by maintaining foreign currency cashbalances and holding forward foreign currency contracts.  These contracts are used as a hedge againstintercompany transactions and are not used for trading or speculativepurposes.  The fair value of the forwardforeign currency exchange contracts is sensitive to changes in foreign currencyexchange rates.  The impact of anadverse change in foreign currency exchange rates would not be materiallydifferent than that disclosed in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2000.**

** **

**                The Company’s revolving loansand term loans bear interest at rates that fluctuate with changes in theLIBOR.  Substantially all of theCompany’s long-term debt, except the term loans referred to above, is at fixedinterest rates.  Accordingly, theCompany’s interest expense on its revolving loans and term loans and the fairvalue of its fixed long-term debt is sensitive to changes in market interestrates.  The effect of an adverse changein market interest rates on the Company’s interest expense and the fair value ofits long-term debt would not be materially different than that disclosed in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2000.**

 
| **PART II** | **OTHER INFORMATION**                 |
|-------------|---------------------------------------|
|        |                                  |
| **ITEM  6** | **EXHIBITS  AND REPORTS ON FORM 8-K** |

 

(a)   Exhibits

 

4.1           ThirdAmendment to the Second Amended and Restated Credit Agreement dated as ofAugust 31, 2001 among Selmer Company, Inc., Steinway, Inc. and United MusicalInstruments USA, Inc., as borrowers; certain wholly owned subsidiaries of theborrowers (as may be amended from time to time), as guarantors; the severallenders from time to time parties thereto; and GMAC Commercial Credit LLC, asAdministrative Agent

 

 

(b)   Reports on Form 8-K

 

The Company did not fileany reports on Form 8-K during the quarter ended September 29, 2001.

 

SIGNATURES

 

                Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrantshave duly caused this report to be signed on their behalf by the undersigned,thereunto duly authorized.

 

 

 

 
|   | STEINWAY MUSICAL INSTRUMENTS, INC.              |
|--------|-------------------------------------------------|
|   |                                            |
|   | /s/  Dana D.  Messina                      |
|   | Dana D. Messina                                 |
|   | Director, President and Chief Executive Officer |
|   |                                            |
|   | /s/  Dennis  M. Hanson                     |
|   | Dennis M. Hanson                                |
|   | Senior Executive Vice President and             |
|   | Chief Financial Officer                         |

 

 

Date:   November 13, 2001