**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 THE QUARTERLY PERIOD ENDED JUNE 29, 2002** |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                      |
| **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 its charter)**

 

 

 

| **DELAWARE**                                                     |       | **35-1910745**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or Other  Jurisdiction of  Incorporation or Organization) |       | (I.R.S. Employer  Identification No.) |
|                                                             |       |                                  |
| **800  South Street, Suite 305  Waltham, Massachusetts**         | ** ** | **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 July 19, 2002: |   | Class A  |   | 477,953   |   |
|-------------------------------------------------------------------------------|--------|----------|--------|-----------|--------|
|                                                                          |   | Ordinary |   | 8,390,896 |   |
|                                                                          |   | Total    |   | 8,868,849 |   |

 

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**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 six months ended June 30, 2001 and June 29, 2002 |   |   |
|          |                                                                                                            |   |   |
|          | Condensed  Consolidated Balance Sheets  December 31, 2001 and June 29, 2002                                     |   |   |
|          |                                                                                                            |   |   |
|          | Condensed  Consolidated Statements of Cash Flows  Six months ended June 30, 2001 and June 29, 2002              |   |   |
|          |                                                                                                            |   |   |
|          | 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  4.**  | **Submission  of Matters to a Vote of Security Holders**                                                        |   |   |
|          |                                                                                                            |   |   |
| **Item 6.**   | **Exhibits and  Reports on Form 8-K**                                                                           |   |   |
|          |                                                                                                            |   |   |
|          | **Signatures**                                                                                                  |   |   |

 

 

2

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

**CONDENSED CONSOLIDATED STATEMENTS OFINCOME**

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

**(Unaudited)**

 
|                                                                               |       | **Three  Months Ended** |       | **Six Months  Ended** |       |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **June 30,2001**        | ** ** | **June 29,  2002**    | ** ** | **June 30,2001** | ** ** | **June 29,  2002** | ** ** |
| Net sales                                                                          |       | $                       | 83,661     |                  | $          | 78,349 |   | $ | 185,242 |   | $ | 166,408 |   |
| Cost of sales                                                                      |       | 56,597                  |       | 53,964                |       | 126,469 |   | 116,660 |   |
| Gross Profit                                                                       |       | 27,064                  |       | 24,385                |       | 58,773 |   | 49,748 |   |
|                                                                               |       |                    |       |                  |       |   |   |   |   |
| Operating  expenses:                                                               |       |                    |       |                  |       |   |   |   |   |
| Sales and  marketing                                                               |       | 10,426                  |       | 9,949                 |       | 22,195 |   | 20,630 |   |
| General and  administrative                                                        |       | 5,140                   |       | 5,362                 |       | 10,771 |   | 10,929 |   |
| Amortization                                                                       |       | 1,044                   |       | 289                   |       | 2,159 |   | 578 |   |
| Other operating  expense                                                           |       | 353                     |       | 250                   |       | 475 |   | 407 |   |
| Total operating  expenses                                                          |       | 16,963                  |       | 15,850                |       | 35,600 |   | 32,544 |   |
|                                                                               |       |                    |       |                  |       |   |   |   |   |
| Income from  operations                                                            |       | 10,101                  |       | 8,535                 |       | 23,173 |   | 17,204 |   |
|                                                                               |       |                    |       |                  |       |   |   |   |   |
| Interest  expense, net                                                             |       | 4,529                   |       | 3,489                 |       | 9,066 |   | 6,790 |   |
| Other income,  net                                                                 |       | (229                    | )          | (1,238                | )          | (394 | ) | (1,543 | ) |
|                                                                               |       |                    |       |                  |       |   |   |   |   |
| Income before  income taxes                                                        |       | 5,801                   |       | 6,284                 |       | 14,501 |   | 11,957 |   |
|                                                                               |       |                    |       |                  |       |   |   |   |   |
| Provision for  income taxes                                                        |       | 2,100                   |       | 2,200                 |       | 5,600 |   | 4,190 |   |
|                                                                               |       |                    |       |                  |       |   |   |   |   |
| Income before  extraordinary loss                                                  |       | 3,701                   |       | 4,084                 |       | 8,901 |   | 7,767 |   |
|                                                                               |       |                    |       |                  |       |   |   |   |   |
| Extraordinary  loss on early extinguishment of debt (net of tax benefit of $2,662) |       | 3,950                   |       | —                |       | 3,950 |   | — |   |
|                                                                               |       |                    |       |                  |       |   |   |   |   |
| Net income  (loss)                                                                 |       | $                       | (249       | )                     | $          | 4,084 |   | $ | 4,951 |   | $ | 7,767 |   |
|                                                                               |       |                    |       |                  |       |   |   |   |   |
| Earnings per  share:                                                               |       |                    |       |                  |       |   |   |   |   |
| Basic earnings  per share before extraordinary loss                                |       | $                       | 0.41       |                  | $          | 0.46 |   | $ | 1.00 |   | $ | 0.88 |   |
| Extraordinary  loss on early extinguishment of debt                                |       | (0.44                   | )          | —                |       | (0.44 | ) | — |   |
| Basic earnings  per share                                                          |       | $                       | (0.03      | )                     | 0.46       |   | $ | 0.55 |   | 0.88 |   |
|                                                                               |       |                    |       |                  |       |   |   |   |   |
| Diluted earnings  per share before extraordinary loss                              |       | $                       | 0.41       |                  | $          | 0.46 |   | $ | 1.00 |   | $ | 0.87 |   |
| Extraordinary  loss on early extinguishment of debt                                |       | (0.44                   | )          | —                |       | (0.44 | ) | — |   |
| Diluted earnings  per share                                                        |       | $                       | (0.03      | )                     | 0.46       |   | $ | 0.55 |   | 0.87 |   |
|                                                                               |       |                    |       |                  |       |   |   |   |   |
| Weighted average  shares:                                                          |       |                    |       |                  |       |   |   |   |   |
| Basic                                                                              |       | 8,931,500               |       | 8,860,834             |       | 8,931,500 |   | 8,854,103 |   |
| Diluted                                                                            |       | 8,931,500               |       | 8,915,071             |       | 8,931,500 |   | 8,891,756 |   |
|                                                                                    |            |                         |            |                       |            |  |  |  |  |  |  |  |  |  |

 

See notes to condensedconsolidated financial statements.

 

3

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

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(In Thousands)**

**(Unaudited)**

** **
|                                                                                                                         |   | **December  31,  2001** |    | **June 29,  2002** |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|--------------------|--------|
| ASSETS:                                                                                                                      |   |                    |    |               |   |
| Current assets:                                                                                                              |   |                    |    |               |   |
| Cash                                                                                                                         |   | $                       | 5,545   |               | $      | 4,214 |   |
| Accounts, notes  and leases receivable, net of allowance forbad debts of $10,909 and $11,067 in  2001 and 2002, respectively |   | 82,188                  |    | 97,233             |   |
| Inventories                                                                                                                  |   | 161,124                 |    | 165,065            |   |
| Prepaid expenses  and other current assets                                                                                   |   | 4,484                   |    | 4,624              |   |
| Deferred tax  assets                                                                                                         |   | 5,636                   |    | 5,931              |   |
| Total current  assets                                                                                                        |   | 258,977                 |    | 277,067            |   |
|                                                                                                                         |   |                    |    |               |   |
| Property, plant  and equipment, net of accumulated depreciation of$45,105 and $50,598 in 2001 and 2002,  respectively        |   | 104,011                 |    | 102,974            |   |
| Goodwill, net of  accumulated amortization of $5,999 and $6,190in 2001 and 2002, respectively                                |   | 27,917                  |    | 28,939             |   |
| Other assets,  net                                                                                                           |   | 13,993                  |    | 12,340             |   |
| Trademarks, net  of accumulated amortization of $12,599 and $13,183in 2001 and 2002, respectively                            |   | 9,142                   |    | 9,463              |   |
|                                                                                                                         |   |                    |    |               |   |
| TOTAL ASSETS                                                                                                                 |   | $                       | 414,040 |               | $      | 430,783 |   |
|                                                                                                                         |   |                    |    |               |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                   |   |                    |    |               |   |
| Current  liabilities:                                                                                                        |   |                    |    |               |   |
| Current portion  of long-term debt                                                                                           |   | $                       | 7,446   |               | $      | 6,978 |   |
| Accounts payable                                                                                                             |   | 7,682                   |    | 7,868              |   |
| Other current  liabilities                                                                                                   |   | 34,095                  |    | 35,137             |   |
| Total current  liabilities                                                                                                   |   | 49,223                  |    | 49,983             |   |
|                                                                                                                         |   |                    |    |               |   |
| Long-term debt                                                                                                               |   | 203,757                 |    | 205,639            |   |
| Deferred tax  liabilities                                                                                                    |   | 27,118                  |    | 27,613             |   |
| Other  liabilities                                                                                                           |   | 13,571                  |    | 15,504             |   |
| Total  liabilities                                                                                                           |   | 293,669                 |    | 298,739            |   |
|                                                                                                                         |   |                    |    |               |   |
| Commitments and  contingent liabilities                                                                                      |   |                    |    |               |   |
|                                                                                                                         |   |                    |    |               |   |
| Stockholders’  equity:                                                                                                  |   |                    |    |               |   |
| Common stock                                                                                                                 |   | 9                       |    | 9                  |   |
| Additional  paid-in capital                                                                                                  |   | 72,178                  |    | 72,584             |   |
| Retained  earnings                                                                                                           |   | 76,711                  |    | 84,478             |   |
| Accumulated  other comprehensive income                                                                                      |   | (12,674                 | )       | (9,174             | )      |
| Treasury stock,  at cost                                                                                                     |   | (15,853                 | )       | (15,853            | )      |
| Total  stockholders’ equity                                                                                             |   | 120,371                 |    | 132,044            |   |
|                                                                                                                         |   |                    |    |               |   |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                             |   | $                       | 414,040 |               | $      | 430,783 |   |

 

See notes to condensedconsolidated financial statements.

 

4

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

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(In Thousands)**

**(Unaudited)**

** **
|                                                                         |   | **Six Months  Ended** |   |
|------------------------------------------------------------------------------|--------|-----------------------|--------|
|                                                                         |   | **June 30,  2001**    |   | **June 29,  2002** |   |
| Cash flows from  operating activities:                                       |   |                  |   |   |   |
| Net income                                                                   |   | $                     | 4,951  |   | $ | 7,767 |   |
| Adjustments to  reconcile net income to cashflows from operating activities: |   |                  |   |   |   |
| Depreciation and  amortization                                               |   | 6,966                 |   | 5,580 |   |
| Early  extinguishment of debt                                                |   | 3,950                 |   | — |   |
| Deferred tax  benefit                                                        |   | (660                  | )      | (212 | ) |
| Other                                                                        |   | 293                   |   | 235 |   |
| Changes in  operating assets and liabilities:                                |   |                  |   |   |   |
| Accounts, notes  and leases receivable                                       |   | (20,037               | )      | (14,334 | ) |
| Inventories                                                                  |   | (18,213               | )      | (1,221 | ) |
| Prepaid expenses  and other current assets                                   |   | 58                    |   | (191 | ) |
| Accounts payable                                                             |   | (4,448                | )      | (2 | ) |
| Other current  liabilities                                                   |   | (1,531                | )      | 553 |   |
| Cash flows from  operating activities                                        |   | (28,671               | )      | (1,825 | ) |
|                                                                         |   |                  |   |   |   |
| Cash flows from  investing activities:                                       |   |                  |   |   |   |
| Capital  expenditures                                                        |   | (3,012                | )      | (2,341 | ) |
| Proceeds from  disposals of fixed assets                                     |   | 1                     |   | — |   |
| Changes in other  assets                                                     |   | 132                   |   | 1,135 |   |
| Cash flows from  investing activities                                        |   | (2,879                | )      | (1,206 | ) |
|                                                                         |   |                  |   |   |   |
| Cash flows from  financing activities:                                       |   |                  |   |   |   |
| Net borrowings  under lines of credit                                        |   | 239                   |   | 4,469 |   |
| Repayments of long-term  debt                                                |   | (115,833              | )      | (3,166 | ) |
| Proceeds from  issuance of debt                                              |   | 150,000               |   | — |   |
| Debt issuance  costs                                                         |   | (4,335                | )      | — |   |
| Proceeds from  issuance of stock                                             |   | —                |   | 406 |   |
| Cash flows from  financing activities                                        |   | 30,071                |   | 1,709 |   |
|                                                                         |   |                  |   |   |   |
| Effect of  foreign exchange rate changes on cash                             |   | 119                   |   | (9 | ) |
|                                                                         |   |                  |   |   |   |
| Decrease in cash                                                             |   | (1,360                | )      | (1,331 | ) |
| Cash, beginning  of period                                                   |   | 4,989                 |   | 5,545 |   |
|                                                                         |   |                  |   |   |   |
| Cash, end of  period                                                         |   | $                     | 3,629  |   | $ | 4,214 |   |
|                                                                         |   |                  |   |   |   |
| Supplemental  Cash Flow Information                                          |   |                  |   |   |   |
| Interest paid                                                                |   | $                     | 10,331 |   | $ | 7,652 |   |
| Taxes paid                                                                   |   | $                     | 7,005  |   | $ | 3,767 |   |

 

See notes to condensedconsolidated financial statements.

 

5

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

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**JUNE 29, 2002**

**(In Thousands Except Share Data)**

**(Unaudited)**

 

 

**(1)****     ****Basis of Presentation**

 

The accompanyingcondensed consolidated financial statements of Steinway Musical Instruments,Inc. and subsidiaries (the “Company”) for the three months and six months endedJune 30, 2001 and June 29, 2002 are unaudited. In the opinion of management, these statements have been prepared on thesame basis as the audited consolidated financial statements as of and for theyear ended December 31, 2001, and include all adjustments which are of a normaland recurring nature, necessary for the fair presentation of financialposition, results of operations and cash flows for the interim period.  The condensed consolidated financial statementsshould be read in conjunction with the consolidated financial statements andnotes thereto contained in the Company’s Annual Report on Form 10-K for thefiscal year ended December 31, 2001 filed with the Securities and ExchangeCommission.  The results of operationsfor the three months and six months ended June 29, 2002 are not necessarilyindicative of the results that may be expected for the entire year.

 

 

**(2)****     ****Summary of Significant Accounting Policies**

 

*Principles of Consolidation -*The consolidated financial statements ofthe Company include the accounts of all of its direct and indirect wholly ownedsubsidiaries, including The Steinway Piano Company, Inc. (“Steinway”), TheSelmer Company, Inc. (“Selmer”), and United Musical Instruments Holdings, Inc.(“UMI”).  Significant intercompany balanceshave been eliminated in consolidation.

 

*Income per Common Share —*Basic income per share is computed usingthe 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 sixmonth periods ended June 30, 2001 and June 29, 2002 is as follows:

 
|                              |   | **Three  months ended** |   | **Six months  ended** |   |
|-----------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                              |   | **2001**                |   | **2002**              |   | **2001** |   | **2002** |   |
| Weighted average  shares:         |   |                    |   |                  |   |   |   |   |   |
| For basic income  per share       |   | 8,931,500               |   | 8,860,834             |   | 8,931,500 |   | 8,854,103 |   |
| Dilutive effect  of stock options |   | —                  |   | 54,237                |   | — |   | 37,653 |   |
| For diluted  income per share     |   | 8,931,500               |   | 8,915,071             |   | 8,931,500 |   | 8,891,756 |   |

 

6

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*Comprehensive Income —*Other comprehensive income is comprisedof foreign currency translation adjustments, additional minimum pensionliabilities, and unrealized gains and losses on certain long-term assets.  Total comprehensive income for the threemonth and six month periods ended June 30, 2001 and June 29, 2002 is asfollows:

 
|                               |   | **Three  months ended** |   | **Six months  ended** |   |
|------------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                               |   | **2001**                |   | **2002**              |   | **2001** |   | **2002** |   |
| Net income  (loss)                 |   | $                       | (249   | )                     | $      | 4,084 |   | $ | 4,951 |   | $ | 7,767 |   |
| Other  comprehensive income (loss) |   | (634                    | )      | 4,180                 |   | (2,882 | ) | 3,500 |   |
| Total  comprehensive income (loss) |   | $                       | (883   | )                     | $      | 8,264 |   | $ | 2,069 |   | $ | 11,267 |   |

 

*New Accounting Pronouncements —* On January 1, 2002 the Company adoptedSFAS No. 142, “Goodwill and Intangible Assets,” which supersedes APB OpinionNo. 17, “Intangible Assets.”  SFAS No.142 eliminates the requirement to amortize goodwill and indefinite-livedassets. If SFAS No. 142 had applied at the beginning of 2001 to goodwill andtrademark assets, the result would have been to increase pretax income for thethree months ended June 30, 2001 by approximately $0.7 million and related netincome by approximately $0.6 million, or $.06 per share.  For the six months ended June 30, 2001, theresult would have been to increase pretax income by approximately $1.5 millionand related net income by approximately $1.1 million, or $.12 per share.  During the second quarter of fiscal year2002, the Company completed the transitional impairment test of goodwill andtrademarks as required by SFAS No. 142. No impairment was indicated. Changes in the balances reported for goodwill, trademarks, and relatedamortization are the result of currency translation.

 

In June 2001, theFASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.”  SFAS No. 143 addresses financial accountingand reporting for obligations associated with the retirement of tangible long-livedassets and the associated asset retirement costs.  SFAS No. 143 is effective for fiscal years beginning after June15, 2002.  The Company does not expectthe adoption of SFAS No. 143 to have a material impact on its financialposition or results of operations.

 

On January 1,2002, the Company adopted SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets,” which addresses the financial accounting andreporting for the impairment or disposal of long-lived assets.  SFAS No. 144 supersedes SFAS No. 121,“Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assetsto Be Disposed Of,” and also supersedes the accounting and certain reportingprovisions of APB Opinion No. 30, “Reporting the Results ofOperations-Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events and Transactions,” forthe disposal of a segment of a business. The adoption of SFAS No. 144 did not have a material impact on theCompany’s financial position or results of operations.

 

On April 30, 2002,the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64,Amendment of FASB Statement No. 13, and Technical Corrections,” whichaddresses, among other things, the treatment of gains and losses resulting fromthe early extinguishment of debt.  SFASNo. 145 rescinds SFAS No. 4, “Reporting Gains and Losses from EarlyExtinguishment of Debt,” which required that all gains and losses from theextinguishment of debt be aggregated and, if material, reported as anextraordinary item.  SFAS No. 145requires that these gains and losses be classified as extraordinary only ifthey meet the criteria set forth in APB Opinion No. 30.  SFAS No. 145 also amends SFAS No. 13,

 

7

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“Accounting forLeases” to require that certain lease modifications that have economic effectssimilar to sale-leaseback transactions be accounted for in the same manner assuch transactions.  The provisions ofSFAS No. 145 related to the rescission of SFAS No. 4 are effective for fiscalyears beginning after May 15, 2002.  Theprovisions related to the amendment of SFAS No. 13 are effective fortransactions occurring after May 15, 2002. The Company does not expect the adoption of SFAS No. 145 to have amaterial impact on its financial position or results of operations.

 

*Reclassifications* — Certain prior year amounts have beenreclassified to conform to the current year presentation.

 

**(3)****        ****Inventories**

 

Inventories consist ofthe following:

 
|            |   | **December  31,  2001** |    | **June 29,  2002** |   |
|-----------------|--------|-------------------------|---------|--------------------|--------|
| Raw materials   |   | $                       | 20,948  |               | $      | 19,471 |   |
| Work in process |   | 52,967                  |    | 58,606             |   |
| Finished goods  |   | 87,209                  |    | 86,988             |   |
| Total           |   | $                       | 161,124 |               | $      | 165,065 |   |

 

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

 

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

 
|                               |   | **Three  months ended** |   | **Six months  ended** |   |
|------------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                               |   | **June 30,  2001**      |   | **June 29,  2002**    |   | **June 30,  2001** |   | **June 29,  2002** |   |
| West 57th  Building income         |   | $                       | (1,164 | )                     | $      | (1,164 | ) | $ | (2,327 | ) | $ | (2,327 | ) |
| West 57th  building expenses       |   | 810                     |   | 810                   |   | 1,624 |   | 1,624 |   |
| Foreign exchange  (gain) loss, net |   | 170                     |   | (584                  | )      | 504 |   | (474 | ) |
| Miscellaneous                      |   | (45                     | )      | (300                  | )      | (195 | ) | (366 | ) |
| Other income,  net                 |   | $                       | (229   | )                     | $      | (1,238 | ) | $ | (394 | ) | $ | (1,543 | ) |

 

**(5)****        ****Commitments and Contingent Liabilities**

 

Certain environmentalmatters are pending against a subsidiary of the Company, which might result inmonetary damages, the amount of which, if any, cannot be determined at thepresent time.  Philips Electronics, aprevious owner of a subsidiary of the Company, has agreed to hold the Companyharmless from any financial liability arising from these environmental matterswhich were pending as of December 29, 1988. Management believes that these matters will not have a material adverseimpact on the Company’s results of operations or financial condition.

 

8

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**(6)****        ****Segment Information**

 

The Company hasidentified two distinct and reportable segments: the piano segment and the bandand orchestral instrument segment. These segments were selected based upon the way in which managementoversees and evaluates the results of each operation.  In the past, the Company has reported net income by segment asits measure of profit or loss. These amounts included intercompany allocationsof items such as interest and taxes not completely under the control of thesegment.  Commencing with this report,the Company will include income from operations as a more meaningfulmeasurement of profit or loss for the segments.  Income from operations for the reportable segments includes certaincorporate costs allocated to the segments based primarily on revenue, as wellas intercompany profit.   Amountsreported as “Other & Elim” include those corporate costs that were notallocated to the reportable segments and the remaining intercompany profitelimination.  The following tablespresent information about the Company’s operating segments for the three monthand six month periods ended June 30, 2001 and June 29, 2002:

 
| **Three  months ended 2001**    |   | **Piano  Segment** |   | **Band and  Orchestral Segment** |       | **Other** |   | **Consol** |       |
|---------------------------------|--------|--------------------|--------|----------------------------------|------------|-----------|--------|------------|------------|
|                            |   | **U.S.**           |   | **Germany**                      |       | **Other** |   | **Total**  |       | **U.S.** |   | **Other** |   | **Total** |   | **& Elim** |   | **Total** |   |
| Net sales to external customers |   | $                  | 24,995 |                             | $          | 7,945     |   | $          | 5,606      |   | $ | 38,546 |   | $ | 44,164 |   | $ | 951 |   | $ | 45,115 |   | $ | — |   | $ | 83,661 |   |
| Income from operations          |   | 2,744              |   | 1,028                            |       | 1,095     |   | 4,867      |       |  5,514 |   | (15 | ) | 5,499 |   | (265 | ) | 10,101 |   |
|                            |   |               |   |                             |       |      |   |       |       |   |   |   |   |   |   |   |   |   |   |
| **Three months ended 2002**     |   | **Piano  Segment** |   | **Band and  Orchestral Segment** | ** ** | **Other** |   | **Consol** | ** ** |
|                            |   | **U.S.**           |   | **Germany**                      |       | **Other** |   | **Total**  |       | **U.S.** |   | **Other** |   | **Total** |   | **& Elim** |   | **Total** |   |
| Net sales to external customers |   | $                  | 24,984 |                             | $          | 8,534     |   | $          | 4,780      |   | $ | 38,298 |   | $ | 39,137 |   | $ | 914 |   | $ | 40,051 |   | $ | — |   | $ | 78,349 |   |
| Income from operations          |   | 3,576              |   | 890                              |       | 707       |   | 5,173      |       | 3,926 |   | 27 |   | 3,953 |   | (591 | ) | 8,535 |   |
|                            |   |               |   |                             |       |      |   |       |       |   |   |   |   |   |   |   |   |   |   |
| **Six months ended 2001**       |   | **Piano  Segment** |   | **Band and  Orchestral Segment** | ** ** | **Other** |   | **Consol** |       |
|                            |   | **U.S.**           |   | **Germany**                      |       | **Other** |   | **Total**  |       | **U.S.** |   | **Other** |   | **Total** |   | **& Elim** |   | **Total** |   |
| Net sales to external customers |   | $                  | 54,322 |                             | $          | 17,292    |   | $          | 11,828     |   | $ | 83,442 |   | $ | 99,574 |   | $ | 2,226 |   | $ | 101,800 |   | $ | — |   | $ | 185,242 |   |
| Income from operations          |   | 6,618              |   | 2,105                            |       | 2,565     |   | 11,288     |       | 12,440 |   | 22 |   | 12,462 |   | (577 | ) | 23,173 |   |
|                            |   |               |   |                             |       |      |   |       |       |   |   |   |   |   |   |   |   |   |   |
| **Six months ended 2002**       |   | **Piano  Segment** |   | **Band and  Orchestral Segment** | ** ** | **Other** |   | **Consol** |       |
|                            |   | **U.S.**           |   | **Germany**                      |       | **Other** |   | **Total**  |       | **U.S.** |   | **Other** |   | **Total** |   | **& Elim** |   | **Total** |   |
| Net sales to external customers |   | $                  | 48,482 |                             | $          | 16,584    |   | $          | 9,652      |   | $ | 74,718 |   | $ | 89,807 |   | $ | 1,883 |   | $ | 91,690 |   | $ | — |   | $ | 166,408 |   |
| Income from operations          |   | 6,184              |   | 1,889                            |       | 1,456     |   | 9,529      |       | 8,758 |   | 53 |   | 8,811 |   | (1,136 | ) | 17,204 |   |

 

9

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**(7)****        ****Summary of Guarantees**

 

On April 19, 2001,the Company completed a $150.0 million 8.75% Senior Note offering.  The proceeds of the offering were used toredeem all of the then outstanding 11% Senior Subordinated Notes, with thebalance paying down the domestic revolving credit facility.

 

The Company’spayment obligations under the 8.75% Senior Notes are fully and unconditionallyguaranteed on a joint and several basis by Selmer, Steinway, UMI and certaindirect and indirect wholly-owned subsidiaries of the Company, each a Guarantor(the “Guarantor Subsidiaries”).  Thesesubsidiaries represent all of the operations of the Company (the “Issuer”)conducted in the United States.  The remainingsubsidiaries, which do not guarantee the 8.75% Senior Notes, represent non-U.S.operations (the “Non Guarantor Subsidiaries”).

 

The followingcondensed consolidating supplementary data illustrates the composition of thecombined Guarantors.  Separate completefinancial statements of the respective Guarantors would not provide additionalmaterial information that would be useful in assessing the financialcomposition of the Guarantors.  Nosingle Guarantor has any significant legal restrictions on the ability ofinvestors or creditors to obtain access to its assets in event of default onthe Guarantee other than its subordination to senior indebtedness.

 

Investments insubsidiaries are recorded by the Issuer on the cost method for purposes of thesupplemental consolidating presentation. Earnings of subsidiaries are therefore not reflected in the Issuer’sinvestment accounts and earnings.  Theprincipal elimination entries eliminate investments in subsidiaries andintercompany balances and transactions.

 

10

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

**CONDENSED CONSOLIDATING STATEMENTS OFINCOME**

**SIX MONTHS ENDED JUNE 29, 2002**

**(In Thousands)**

**(Unaudited)**

 
|                                     |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
| Net sales                                |   | $                    | — |                        | $      | 143,064                          |   | $                          | 28,972 |             | $      | (5,628 | ) | $ | 166,408 |   |
| Cost of sales                            |   | —               |   | 103,665                     |   | 18,459                           |   | (5,464                     | )      | 116,660          |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Gross profit                             |   | —               |   | 39,399                      |   | 10,513                           |   | (164                       | )      | 49,748           |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Operating  expenses:                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Sales and  marketing                     |   | —               |   | 16,168                      |   | 4,478                            |   | (16                        | )      | 20,630           |   |
| General and  administrative              |   | 2,252                |   | 6,468                       |   | 2,209                            |   | —                     |   | 10,929           |   |
| Amortization                             |   | 226                  |   | 350                         |   | 2                                |   | —                     |   | 578              |   |
| Other operating  (income) expense        |   | (1,461               | )      | 1,426                       |   | 426                              |   | 16                         |   | 407              |   |
| Total operating  expenses                |   | 1,017                |   | 24,412                      |   | 7,115                            |   | —                     |   | 32,544           |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Income (loss)  from operations           |   | (1,017               | )      | 14,987                      |   | 3,398                            |   | (164                       | )      | 17,204           |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Interest  (income) expense, net          |   | (548                 | )      | 7,203                       |   | 135                              |   | —                     |   | 6,790            |   |
| Other income,  net                       |   | —               |   | (1,512                      | )      | (31                              | )      | —                     |   | (1,543           | )      |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Income (loss)  before income taxes       |   | (469                 | )      | 9,296                       |   | 3,294                            |   | (164                       | )      | 11,957           |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Provision for  (benefit of) income taxes |   | (148                 | )      | 3,106                       |   | 1,283                            |   | (51                        | )      | 4,190            |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net income  (loss)                       |   | $                    | (321   | )                           | $      | 6,190                            |   | $                          | 2,011  |             | $      | (113 | ) | $ | 7,767 |   |
|                                          |        |                      |        |                             |        |                                  |        |                            |        |                  |        |  |  |  |  |  |  |

 

11

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

**CONDENSED CONSOLIDATINGBALANCE SHEETS**

**JUNE 29, 2002**

**(In Thousands)**

**(Unaudited)**

 
|                                            |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|-------------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
| ASSETS                                          |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Current assets:                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash                                            |   | $                    | — |                        | $      | 2,518                            |   | $                          | 1,696  |             | $      | — |   | $ | 4,214 |   |
| Accounts, notes  and leases receivable, net     |   | —               |   | 87,711                      |   | 10,009                           |   | (487                       | )      | 97,233           |   |
| Inventories                                     |   | —               |   | 135,512                     |   | 30,604                           |   | (1,051                     | )      | 165,065          |   |
| Prepaid expenses  and other current assets      |   | 230                  |   | 3,665                       |   | 729                              |   | —                     |   | 4,624            |   |
| Deferred tax  assets                            |   | —               |   | 5,549                       |   | 4,891                            |   | (4,509                     | )      | 5,931            |   |
| Total current  assets                           |   | 230                  |   | 234,955                     |   | 47,929                           |   | (6,047                     | )      | 277,067          |   |
|                                            |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Property, plant  and equipment, net             |   | 185                  |   | 89,039                      |   | 13,750                           |   | —                     |   | 102,974          |   |
| Investment in  subsidiaries                     |   | 71,143               |   | 255,666                     |   | —                           |   | (326,809                   | )      | —           |   |
| Goodwill, net                                   |   | —               |   | 18,795                      |   | 10,144                           |   | —                     |   | 28,939           |   |
| Other assets,  net                              |   | 4,864                |   | 7,188                       |   | 288                              |   | —                     |   | 12,340           |   |
| Trademarks, net                                 |   | —               |   | 6,280                       |   | 3,183                            |   | —                     |   | 9,463            |   |
|                                            |   |                 |   |                        |   |                             |   |                       |   |             |   |
| TOTAL ASSETS                                    |   | $                    | 76,422 |                        | $      | 611,923                          |   | $                          | 75,294 |             | $      | (332,856 | ) | $ | 430,783 |   |
|                                            |   |                 |   |                        |   |                             |   |                       |   |             |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY      |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Current  liabilities:                           |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Current portion  of long-term debt              |   | $                    | — |                        | $      | 6,347                            |   | $                          | 631    |             | $      | — |   | $ | 6,978 |   |
| Accounts payable                                |   | 286                  |   | 5,994                       |   | 2,075                            |   | (487                       | )      | 7,868            |   |
| Other current  liabilities                      |   | (11,214              | )      | 38,019                      |   | 13,784                           |   | (5,452                     | )      | 35,137           |   |
| Total current  liabilities                      |   | (10,928              | )      | 50,360                      |   | 16,490                           |   | (5,939                     | )      | 49,983           |   |
|                                            |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Long-term debt                                  |   | 150,014              |   | 55,625                      |   | —                           |   | —                     |   | 205,639          |   |
| Intercompany                                    |   | (117,455             | )      | 113,792                     |   | 3,663                            |   | —                     |   | —           |   |
| Deferred tax  liabilities                       |   | —               |   | 20,762                      |   | 6,851                            |   | —                     |   | 27,613           |   |
| Other  liabilities                              |   | 276                  |   | 2,099                       |   | 13,129                           |   | —                     |   | 15,504           |   |
| Total  liabilities                              |   | 21,907               |   | 242,638                     |   | 40,133                           |   | (5,939                     | )      | 298,739          |   |
|                                            |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Stockholders’  equity                      |   | 54,515               |   | 369,285                     |   | 35,161                           |   | (326,917                   | )      | 132,044          |   |
|                                            |   |                 |   |                        |   |                             |   |                       |   |             |   |
| TOTAL  LIABILITIES ANDSTOCKHOLDERS’ EQUITY |   | $                    | 76,422 |                        | $      | 611,923                          |   | $                          | 75,294 |             | $      | (332,856 | ) | $ | 430,783 |   |

 

12

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

**CONDENSED CONSOLIDATING STATEMENTS OFCASH FLOWS**

**SIX MONTHS ENDED JUNE 29, 2002**

** (In Thousands)**

**(Unaudited)**

** **

 
|                                                                                |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|-------------------------------------------------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
| Cash flows from  operating activities:                                              |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net income  (loss)                                                                  |   | $                    | (321   | )                           | $      | 6,190                            |   | $                          | 2,011  |             | $      | (113 | ) | $ | 7,767 |   |
| Adjustments to  reconcile net income (loss)to cash flows from operating activities: |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Depreciation and  amortization                                                      |   | 257                  |   | 4,556                       |   | 767                              |   | —                     |   | 5,580            |   |
| Deferred tax  benefit                                                               |   | —               |   | (130                        | )      | (82                              | )      | —                     |   | (212             | )      |
| Other                                                                               |   | —               |   | 165                         |   | 70                               |   | —                     |   | 235              |   |
| Changes in  operating assets and liabilities:                                       |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Accounts, notes  and leases receivable                                              |   | —               |   | (15,537                     | )      | 838                              |   | 365                        |   | (14,334          | )      |
| Inventories                                                                         |   | —               |   | 1,180                       |   | (2,565                           | )      | 164                        |   | (1,221           | )      |
| Prepaid expenses  and other current assets                                          |   | 9                    |   | (288                        | )      | 121                              |   | (33                        | )      | (191             | )      |
| Accounts payable                                                                    |   | 202                  |   | (86                         | )      | 247                              |   | (365                       | )      | (2               | )      |
| Other current  liabilities                                                          |   | 4,529                |   | (3,241                      | )      | (684                             | )      | (51                        | )      | 553              |   |
| Cash flows from  operating activities                                               |   | 4,676                |   | (7,191                      | )      | 723                              |   | (33                        | )      | (1,825           | )      |
|                                                                                |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash flows from  investing activities:                                              |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Capital  expenditures                                                               |   | —               |   | (2,261                      | )      | (80                              | )      | —                     |   | (2,341           | )      |
| Changes in other  assets                                                            |   | (58                  | )      | 1,160                       |   | —                           |   | 33                         |   | 1,135            |   |
| Cash flows from  investing activities                                               |   | (58                  | )      | (1,101                      | )      | (80                              | )      | 33                         |   | (1,206           | )      |
|                                                                                |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash flows from  financing activities:                                              |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net borrowings  (repayments) underlines of credit                                   |   | (6                   | )      | 5,760                       |   | (641                             | )      | (644                       | )      | 4,469            |   |
| Repayment of  long-term debt                                                        |   | —               |   | (3,166                      | )      | —                           |   | —                     |   | (3,166           | )      |
| Proceeds from  issuance of stock                                                    |   | 406                  |   | —                      |   | —                           |   | —                     |   | 406              |   |
| Intercompany  transactions                                                          |   | (5,018               | )      | 6,544                       |   | (1,526                           | )      | —                     |   | —           |   |
| Cash flows from  financing activities                                               |   | (4,618               | )      | 9,138                       |   | (2,167                           | )      | (644                       | )      | 1,709            |   |
|                                                                                |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Effect of  exchange rate changes on cash                                            |   | —               |   | —                      |   | (9                               | )      | —                     |   | (9               | )      |
|                                                                                |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Increase  (decrease) in cash                                                        |   | —               |   | 846                         |   | (1,533                           | )      | (644                       | )      | (1,331           | )      |
| Cash, beginning  of period                                                          |   | —               |   | 1,672                       |   | 3,229                            |   | 644                        |   | 5,545            |   |
|                                                                                |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash, end of  period                                                                |   | $                    | — |                        | $      | 2,518                            |   | $                          | 1,696  |             | $      | — |   | $ | 4,214 |   |

 

13

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| **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 aworld leader in the design, manufacture and marketing of high quality musicalinstruments.  The piano divisionconcentrates on the high-end grand piano segment of the industry, hand craftingits Steinway pianos in New York and Germany, but also offers vertical pianosand two mid-priced lines of pianos under the Boston and Essex brand names.  Moreover, the Company is the largestdomestic producer of band and orchestral instruments and offers a complete lineof brasswind, woodwind, percussion and stringed instruments and relatedaccessories with well known brand names such as Bach, C.G. Conn, King, andLudwig.  The Company sells its productsthrough dealers and distributors worldwide. Piano customers consist of professional artists, amateur pianists, andinstitutions such as concert halls, universities, and music schools.  Band and orchestral instrument customersconsist primarily of middle school and high school students, but also includeadult amateur and professional musicians.

 

 

**SignificantAccounting Policies**

 

The nature of theCompany’s business - the production and sale of musical instruments - is suchthat it rarely involves application of highly complex or subjective accountingprinciples.  The accounting policiesthat are subject to significant management estimates are those normally foundin traditional businesses and include inventory reserves, accounts receivablereserves, recourse reserves on notes receivable, and warranty reserves.  The Company has significant experience anddata on which to base these estimates. Historical information is adjusted for specific uncertainties, such asnew product introductions, and contemporaneous information, such as pricefluctuations.  Management regularlyperforms assessments of the underlying assumptions and believes that theyprovide a reasonable basis for the estimates contained in the Company’sfinancial statements.

 

 

**Forward-LookingStatements**

 

Certain statements contained in this document are “forward-lookingstatements” within the meaning of Section 21E of the Securities and ExchangeAct of 1934, as amended.  Theseforward-looking statements represent the Company’s present expectations orbeliefs concerning future events.  TheCompany cautions that such statements are necessarily based on certainassumptions which are subject to risks and uncertainties which could causeactual results to differ materially from those indicated herein.  These risk factors include, but are notlimited to, changes in general economic conditions, increased competition,exchange rate fluctuations, variations in the mix of product sold, fluctuationsin effective tax rates resulting from shifts in sources of income and theability to successfully integrate and operate acquired businesses.  Further information on these risk factors isincluded in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2001 and its Final Prospectus filed in August 1996.

 

14

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**Resultsof Operations**

 

*ThreeMonths Ended June 29, 2002 Compared to Three Months Ended June 30, 2001*

 

*Net Sales -*Net sales decreased $5.3 million (6%) to $78.3 millionin the second quarter of 2002. Piano sales remained consistent, decreasing only$0.2 million (less than 1%) to $38.3 million, as a 9% decrease in Steinwayshipments was offset by a 21% increase in shipments of Boston product lines(Boston and Essex pianos).  The decreasein Steinway shipments was primarily a result of the continued economicslowdown, whereas the increase in Boston product shipments, driven by an increasein domestic shipments of over 40%, was attributable to the resurgence of themid-priced piano market.  Band andorchestral instrument sales decreased $5.1 million (11%) on an overall unitdecrease of 15%.   Increased fiscalconstraints on school budgets reduced background instrument sales.  In addition, dealers continued to refurbishtheir rental pool instruments, resulting in fewer orders in the current period.

 

G*ross Profit -* Gross profit decreased by$2.7 million (10%) to $24.4 million. Gross margins decreased from 32.3% in 2001 to 31.1% in 2002.  Piano margins decreased from 37.7% in 2001to 35.9% in 2002, partly as a result of the increase in the proportion ofBoston product sold.  The Company’sGerman manufacturing facility took a week of shutdown in order to controlinventory levels.  The resulting underabsorption of overhead also contributed to the decrease in margins.  Band and orchestral instrument marginsdecreased from 27.7% in 2001 to 26.5% in 2002. This drop was primarily due to under absorption of overhead resultingfrom production levels reduced in line with current demand.  Temporary inefficiencies caused by theimplementation of the manufacturing revitalization project at one of theCompany’s brasswind manufacturing plants was also a factor. The Company’smanufacturing revitalization project was completed in June 2002.  The Company expects a continued impact onmargins into the third quarter as employees complete the retraining processresulting from this project.

 

*Operating Expenses* — Overall operating expenses decreased by $1.1million (7%) to $15.9 million in the second quarter.  $0.4 million of this decrease is attributable to reduced salesand marketing expenses associated with trade shows and advertising.  The remaining decrease is due to theCompany’s implementation of SFAS No. 142, which resulted in a decrease inamortization expense of approximately $0.8 million.

 

*Other Expense, net*—**Other expenses decreased by $2.0 million(48%) to $2.3 million. Lower average outstanding debt balances resulting fromdecreased inventory levels and lower interest rates on the Company’s borrowingsresulted in a decrease in net interest expense of $1.0 million.  Foreign exchange gains of $0.6 million, ascompared to a foreign exchange loss of $0.2 million in the prior period, alsocontributed to the decrease.

 

*Income Taxes* — The Company’s effective tax rate decreased from36.2% in 2001 to 35.0% in 2002 as a result of increased utilization of foreigntax credits.

 

*SixMonths Ended June 29, 2002 Compared to Six Months Ended June 30, 2001*

 

*Net Sales -*Net sales decreased $18.8 million (10%) to $166.4million in the first half of 2002. Piano sales decreased $8.7 million (10%) ona 19% decrease in Steinway shipments, which was partially offset by a 10%increase in Boston product line shipments. The decrease in Steinway shipments, which was more pronounced in theU.S., with units down 24% as compared to a 6% decrease in shipments abroad, wasprimarily a result of the economic slowdown. Boston product also fared well domestically, with units up 20%, drivingthe overall increase in Boston product units. Band and orchestral instrument sales decreased $10.1 million (10%) on anoverall unit decrease of 14%.   Awoodwind instrument promotion 

 

15

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held in the fourth quarter of 2001 shifted a significant number of unitsales, which typically would have occurred in the first quarter, to the prioryear, contributing to the decrease. Reduction of background instrument sales to school districts due to fiscalconstraints on school budgets was also a factor.

 

 

G*ross Profit -* Gross profit decreased by$9.0 million (15%) to $49.7 million. Gross margins decreased from 31.7% in 2001 to 29.9% in 2002.  Piano margins decreased from 37.0% in 2001to 35.8% in 2002 primarily as a result of the under absorption of overheadassociated with the periodic shutdowns at the Company’s piano manufacturingfacilities.  In addition, the lowerproportion of concert grands sold abroad and the increased proportion of Bostonproduct sold negatively impacted gross margin. Band and orchestral instrument margins decreased from 27.4% in 2001 to25.1% in 2002.  This change was due tounder absorption of overhead resulting from reduced production levels as wellas temporary inefficiencies caused by the implementation of the manufacturingrevitalization project completed in June 2002.

 

*Operating Expenses* — Overall operating expenses decreased by $3.1million (9%) to $32.5 million in the first half of 2002.  $1.5 million of this decrease is attributableto reduced sales and marketing expenses due to select promotional events andstreamlined advertising resources.  Theremaining decrease is due to the Company’s implementation of SFAS No. 142,which resulted in a decrease in amortization expense of approximately $1.6million.

 

*Other Expense, net -*Other expenses decreased by $3.4 million (39%) to $5.2million. Lower average outstanding debt balances resulting from working capitalmanagement and lower interest rates on the Company’s borrowings resulted in adecrease in net interest expense of $2.3 million.  The Company also recorded foreign exchange gains of $0.5 millionfor the first half of 2002, as compared to a recorded loss of approximately$0.5 million in the prior year period.

 

*Income Taxes* — The Company’s effective tax rate decreased from38.6% in 2001 to 35.0% in 2002 as a result of the Company’s increasedutilization of foreign tax credits in the current year.

 

**Liquidityand Capital Resources**

 

The Company has relied primarily upon cash provided byoperations, supplemented as necessary by seasonal borrowings under its workingcapital line, to finance its operations, repay long-term indebtedness and fundcapital expenditures.

 

Cash used in operations in the first six months of2002 was $1.8 million, compared to cash used in operations of $28.7 million inthe first six months of 2002.  Thissignificant improvement is due primarily to management’s control of workingcapital and the significant reduction of inventory in the current year period.

 

Capital expenditures of $3.0 million and $2.3 millionin the first half of 2001 and 2002, respectively, were used primarily for thepurchase of new machinery, production facility improvements, and EPA complianceprojects.  The Company expects to expendapproximately $5-6 million in 2002 for capital projects primarily related toequipment modernization and production efficiency.

 

The Company’s real estate term loan, acquisition termloan and domestic seasonal borrowing requirements are accommodated through acommitted credit facility with a syndicate of domestic lenders (the “CreditFacility”).  The Credit Facility, whichwas amended to accommodate the $150.0 million 8.75% Senior Note offeringcompleted on April 19, 2001, provides the Company with a potential 

 

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borrowing capacity of up to $85.0 million in revolving credit loans,based on eligible accounts receivable and inventory balances.  The acquisition term loan and revolvingcredit loan portions of the Credit Facility bear interest at average 30-dayLIBOR plus 1.75%, and the real estate term loan bears interest at average30-day LIBOR plus 1.5%.   The Creditfacility expires on September 14, 2008. As of June 29, 2002, revolving credit loans outstanding wereapproximately $5.1 million and availability based on eligible accountsreceivable and inventory balances, net of letter of credit deductions of $0.7million, was approximately $79.2 million. Open account loans with foreign banks also provide for borrowings bySteinway’s foreign subsidiaries of up to €19.9 million ($19.7 million at theJune 29, 2002 exchange rate).  TheCompany had $0.6 million in foreign loans outstanding as of June 29, 2002.

 

The Company’s long-term financing consists primarilyof $150.0 million of 8.75% Senior Notes and $56.9 million of term loansoutstanding under the Credit Facility. On April 19, 2001, the Company completed a $150.0 million senior noteoffering at 8.75%.  The proceeds of theoffering were used to redeem $110.0 million of previously outstanding SeniorSubordinated Notes, with the balance paying down 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 debt agreements contain restrictive covenants that placecertain restrictions on the Company, including restrictions on its ability toincur additional indebtedness, to make investments in other entities and to paycash dividends.  The Company is incompliance with all such covenants.

 

The Company permits dealers to convert open accountsto notes payable to the Company.  Thenote program is offered in January and October and coincides with thereceivable dating program.  In mostinstances, the note receivable is secured by dealer inventories andreceivables.   Historically, a portionof the Company’s notes receivable has been sold to a third-party financingcompany on a full recourse basis.  TheCompany has not renewed its arrangement, which expired on August 1, 2002, withthe third-party financing company, and intends to maintain all notes receivableinternally.  The Company will not bereceiving a cash infusion from the sale of these notes in September 2002, andwill use the Credit Facility, as needed, to supplement its cash flow.  However, due to the Company’s workingcapital and debt management focus, it expects that additional borrowings on theCredit Facility due to this change in policy to be minimal.

 

Management expects to continue its focus onmaintaining sufficient, but not excessive, inventory levels, repaying debt,maintaining and expanding market share, and improving productionefficiency.  The Company is not aware ofany other trends, demands, commitments, or costs of resources that are expectedto materially impact liquidity or capital resources.  Therefore, management believes that cash on hand, together withcash flows anticipated from operations and available borrowings under theCredit Facility, will be adequate to meet existing debt service requirements,fund continuing capital requirements and satisfy working capital and generalcorporate needs through 2002.

 

 

**NewAccounting Pronouncements**

 

On January 1, 2002the Company adopted SFAS No. 142, “Goodwill and Intangible Assets,” whichsupersedes APB Opinion No. 17, “Intangible Assets.”  SFAS No. 142 eliminates the requirement to amortize goodwill andindefinite-lived assets. If SFAS No. 142 had applied at the beginning of 2001to goodwill and trademark assets, the result would have been to increase pretaxincome for the three months ended June 30, 2001 by approximately $0.7 millionand related net income by approximately $0.6 

 

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million, or $.06 pershare.  For the six months ended June30, 2001, the result would have been to increase pretax income by approximately$1.5 million and related net income by approximately $1.1 million, or $.12 pershare.  During the second quarter offiscal year 2002, the Company completed the transitional impairment test ofgoodwill and trademarks as required by SFAS No. 142.  No impairment was indicated. Changes in the balances reported for goodwill, trademarks, and relatedamortization are the result of currency translation.

 

In June 2001, the FASBissued SFAS No. 143, “Accounting for Asset Retirement Obligations.”  SFAS No. 143 addresses financial accountingand reporting for obligations associated with the retirement of tangiblelong-lived assets and the associated asset retirement costs.  SFAS No. 143 is effective for fiscal yearsbeginning after June 15, 2002.  TheCompany does not expect the adoption of SFAS No. 143 to have a material impacton its financial position or results of operations.

 

On January 1, 2002, the Company adopted SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” whichaddresses the financial accounting and reporting for the impairment or disposalof long-lived assets.  SFAS No. 144supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to Be Disposed Of,” and also supersedes theaccounting and certain reporting provisions of APB Opinion No. 30, “Reportingthe Results of Operations-Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions,” for the disposal of a segment of a business.  The adoption of SFAS No. 144 did not have amaterial impact on the Company’s financial position or results of operations.

 

On April 30, 2002,the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64,Amendment of FASB Statement No. 13, and Technical Corrections,” whichaddresses, among other things, the treatment of gains and losses resulting fromthe early extinguishment of debt.  SFASNo. 145 rescinds SFAS No. 4, “Reporting Gains and Losses from EarlyExtinguishment of Debt,” which required that all gains and losses from theearly extinguishment of debt be aggregated and, if material, reported as anextraordinary item.  SFAS No. 145requires that these gains and losses be classified as extraordinary only ifthey meet the criteria set forth in APB Opinion No. 30.  SFAS No. 145 also amends SFAS No. 13, “Accountingfor Leases” to require that certain lease modifications that have economiceffects similar to sale-leaseback transactions be accounted for in the samemanner as such transactions.  Theprovisions of SFAS No. 145 related to the rescission of SFAS 4 are effectivefor fiscal years beginning after May 15, 2002. The provisions related to the amendment of SFAS No. 13 are effective fortransactions occurring after May 15, 2002. The Company does not expect the adoption of SFAS No. 145 to have amaterial impact on its financial position or results of operations.

 

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| **ITEM 3** | **QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT  MARKET RISK** |
|------------|-----------------------------------------------------------------|

** **

**The Company is exposed to market risk associated withchanges in foreign currency exchange rates and interest rates.  The Company mitigates its foreign currencyexchange rate risk by maintaining foreign currency cash balances and holdingforward foreign currency contracts. These contracts are used as a hedge against intercompany transactionsand are not used for trading or speculative purposes.  The fair value of the forward foreign currency exchange contractsis sensitive to changes in foreign currency exchange rates.  The impact of an adverse change in foreigncurrency exchange rates would not be materially different than that disclosedin the Company’s Annual Report on Form 10-K for the year ended December 31,2001.**

** **

**Although the majority of the Company’s long-term debt is ata fixed interest rate, the Company’s revolving loans and term loans bearinterest at rates that fluctuate with changes in LIBOR.  As such, the Company’s interest expense onits revolving loans and term loans and the fair value of its fixed long-termdebt are sensitive to changes in market interest rates.  The effect of an adverse change in marketinterest rates on the Company’s interest expense and the fair value of itslong-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, 2001.**

 

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| **PART  II** | **OTHER  INFORMATION**                                   |
|--------------|----------------------------------------------------------|
|         |                                                     |
| **ITEM 4**   | **SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS** |

 

At the Company’s Annual Meeting of Shareholders held on May 17, 2002, theBoard of Directors was re-elected in its entirety.  The votes cast for each nominee were as follows:

 
|               |   | **For**    |   | **Withheld** |
|--------------------|--------|------------|--------|--------------|
| Kyle Kirkland      |   | 51,523,770 |   | 722,155      |
| Dana D. Messina    |   | 51,412,989 |   | 832,936      |
| Thomas T. Burzycki |   | 51,751,162 |   | 494,763      |
| Bruce A. Stevens   |   | 51,751,162 |   | 494,763      |
| A. Clinton Allen   |   | 51,743,864 |   | 502,061      |
| Rudolph K. Kluiber |   | 51,748,162 |   | 497,763      |
| Peter McMillan     |   | 51,747,889 |   | 498,036      |

 

The proposal to approve theCompany’s Amended and Restated 1996 Stock Plan (the “Amendment”) wasapproved.  Voting results were48,104,048 votes cast for, 1,697,877 votes against, 514,213 abstentions, and1,929,787 shares not voted.  TheAmendment increased the number of shares of the Company’s Common Stock reservedfor issuance by 721,750, allowed the Company’s outside directors to participatein the Plan, and limited Option Committee membership to outside directors.  It also eliminated the Company’s obligationto obtain substitute stock options during a merger, revised the Plan togenerally conform to the latest tax and other regulatory requirements, andreduced the requirements for future Stock Plan amendments to board approvalonly.

 

The proposal to ratifyDeloitte & Touche to serve as the Company’s independent auditors for thefiscal year ending December 31, 2002 was approved with 52,187,189 votes castfor, 56,222 votes against, and 2,514 abstentions.

 

 
| **ITEM  6** | **EXHIBITS  AND REPORTS ON FORM 8-K** |
|-------------|---------------------------------------|

 

(a)          Exhibits

 

99.1 Sarbanes-Oxley Act §906 Certification

 

(b)         Reports on Form 8-K

 

The Company did not fileany reports on Form 8-K during the quarter ended June 29, 2002.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrants have dulycaused this report to be signed on their behalf by the undersigned, thereuntoduly 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:   August 9, 2002

 

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