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EX-31.1 - EX-31.1 - STEINWAY MUSICAL INSTRUMENTS INCa10-17339_1ex31d1.htm
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EX-32.1 - EX-32.1 - STEINWAY MUSICAL INSTRUMENTS INCa10-17339_1ex32d1.htm
EX-31.2 - EX-31.2 - STEINWAY MUSICAL INSTRUMENTS INCa10-17339_1ex31d2.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010

 

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

 

COMMISSION FILE NUMBER 001-11911

 

STEINWAY MUSICAL INSTRUMENTS, INC.

(Exact name of registrant as specified in its charter)

 

DELAWARE

 

35-1910745

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification No.)

 

 

 

800 South Street, Suite 305

 

 

Waltham, Massachusetts

 

02453

(Address of Principal Executive Offices)

 

(Zip Code)

 

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

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

Number of shares of Common Stock issued and outstanding as of November 4, 2010:

 

 

Class A

477,952

 

Ordinary

11,576,660

 

Total

12,054,612

 

 

 



 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

 

PART I

FINANCIAL STATEMENTS

 

 

 

 

 

 

Item 1.

Condensed Consolidated Financial Statements:

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations Three and nine months ended September 30, 2010 and 2009

 

3

 

 

 

 

 

Condensed Consolidated Balance Sheets September 30, 2010 and December 31, 2009

 

4

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows Nine months ended September 30, 2010 and 2009

 

5

 

 

 

 

 

Condensed Consolidated Statement of Stockholders’ Equity Nine months ended September 30, 2010

 

6

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7

 

 

 

 

Item 2.

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

 

20

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

 

29

 

 

 

 

Item 4.

Controls and Procedures

 

29

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

 

 

Item 6.

Exhibits

 

29

 

 

 

 

 

Signatures

 

30

 

2


 


 

PART I                  FINANCIAL STATEMENTS

 

ITEM 1                CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

(In Thousands Except Share and Per Share Amounts)

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net sales

 

$

83,261

 

$

82,634

 

$

230,052

 

$

224,738

 

Cost of sales

 

60,066

 

59,229

 

163,370

 

163,826

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

23,195

 

23,405

 

66,682

 

60,912

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

9,587

 

9,638

 

29,756

 

30,118

 

General and administrative

 

7,768

 

7,491

 

22,096

 

22,860

 

Other

 

46

 

145

 

172

 

347

 

Impairment charges

 

 

976

 

 

976

 

Total operating expenses

 

17,401

 

18,250

 

52,024

 

54,301

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

5,794

 

5,155

 

14,658

 

6,611

 

 

 

 

 

 

 

 

 

 

 

Other expense (income), net

 

110

 

(223

)

(699

)

(1,034

)

Net gain on extinguishment of debt

 

 

 

(104

)

(3,434

)

Interest income

 

(241

)

(320

)

(985

)

(1,302

)

Interest expense

 

2,705

 

2,954

 

8,303

 

8,974

 

Total non-operating expenses

 

2,574

 

2,411

 

6,515

 

3,204

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

3,220

 

2,744

 

8,143

 

3,407

 

 

 

 

 

 

 

 

 

 

 

Income tax provision

 

1,655

 

2,107

 

3,598

 

2,385

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

1,565

 

$

637

 

$

4,545

 

$

1,022

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.13

 

$

0.07

 

$

0.40

 

$

0.12

 

Diluted

 

$

0.13

 

$

0.07

 

$

0.39

 

$

0.12

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares:

 

 

 

 

 

 

 

 

 

Basic

 

12,055,741

 

8,581,343

 

11,503,013

 

8,549,287

 

Diluted

 

12,098,871

 

8,583,320

 

11,559,335

 

8,551,885

 

 

See notes to condensed consolidated financial statements.

 

3



 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

Unaudited

(In Thousands)

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash

 

$

96,214

 

$

65,873

 

Accounts, notes, and other receivables, net of allowances of
$13,554 and $13,643 in 2010 and 2009, respectively

 

52,383

 

45,073

 

Inventories

 

149,300

 

158,030

 

Prepaid expenses and other current assets

 

13,504

 

13,499

 

Deferred tax assets

 

11,582

 

11,431

 

Total current assets

 

$

322,983

 

$

293,906

 

 

 

 

 

 

 

Property, plant and equipment, net of accumulated depreciation of
$110,161 and $105,744 in 2010 and 2009, respectively

 

85,850

 

89,538

 

Trademarks

 

15,064

 

15,284

 

Goodwill

 

23,365

 

24,063

 

Other intangibles, net

 

3,427

 

4,183

 

Other assets

 

14,102

 

12,663

 

Long-term deferred tax assets

 

11,485

 

10,153

 

 

 

 

 

 

 

Total assets

 

$

476,276

 

$

449,790

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Debt

 

$

1,198

 

$

537

 

Accounts payable

 

12,908

 

9,764

 

Other current liabilities

 

34,322

 

36,395

 

Total current liabilities

 

48,428

 

46,696

 

 

 

 

 

 

 

Long-term debt

 

152,012

 

157,703

 

Deferred tax liabilities

 

7,088

 

7,124

 

Pension and other postretirement benefit liabilities

 

36,022

 

35,766

 

Other non-current liabilities

 

5,558

 

6,005

 

Total liabilities

 

249,108

 

253,294

 

 

 

 

 

 

 

Commitments and contingent liabilities

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock

 

14

 

12

 

Additional paid-in capital

 

154,053

 

125,192

 

Retained earnings

 

130,854

 

126,415

 

Accumulated other comprehensive loss

 

(10,685

)

(7,851

)

Treasury stock, at cost

 

(47,068

)

(47,272

)

Total stockholders’ equity

 

227,168

 

196,496

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

476,276

 

$

449,790

 

 

See notes to condensed consolidated financial statements.

 

4



 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(In Thousands)

 

 

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

4,545

 

$

1,022

 

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

 

 

 

 

 

Depreciation and amortization

 

7,302

 

7,845

 

Net gain on extinguishment of debt

 

(104

)

(3,434

)

Intangible asset impairment

 

 

976

 

Stock-based compensation expense

 

1,109

 

890

 

Excess tax benefits from stock-based awards

 

64

 

 

Tax benefit from stock option exercises

 

4

 

 

Deferred tax (benefit) expense

 

(1,257

)

169

 

Provision for (recovery of) doubtful accounts

 

(63

)

1,302

 

Other

 

66

 

(181

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts, notes and other receivables

 

(8,296

)

674

 

Inventories

 

6,353

 

(1,244

)

Prepaid expenses and other assets

 

(324

)

2,026

 

Accounts payable

 

2,990

 

(3,724

)

Other liabilities

 

(1,275

)

(7,790

)

Cash flows from operating activities:

 

11,114

 

(1,469

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(1,841

)

(2,996

)

Other

 

108

 

24

 

Acquisition of businesses, net of cash acquired

 

(353

)

(820

)

Cash flows from investing activities

 

(2,086

)

(3,792

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Borrowings under lines of credit

 

870

 

231,793

 

Repayments under lines of credit

 

(335

)

(214,552

)

Repayments of long-term debt, net of discount

 

(5,633

)

(7,280

)

Proceeds from issuance of common stock

 

28,197

 

605

 

Purchase of treasury stock

 

(349

)

 

Excess tax benefits from stock-based awards

 

(64

)

 

Cash flows from financing activities

 

22,686

 

10,566

 

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash

 

(1,373

)

569

 

 

 

 

 

 

 

Change in cash

 

30,341

 

5,874

 

Cash, beginning of period

 

65,873

 

44,380

 

Cash, end of period

 

$

96,214

 

$

50,254

 

 

 

 

 

 

 

Supplemental Cash Flow Information:

 

 

 

 

 

Interest paid

 

$

12,268

 

$

13,482

 

Income taxes paid

 

$

6,395

 

$

4,139

 

 

See notes to condensed consolidated financial statements.

 

5



 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Unaudited

(In Thousands Except Share Data)

 

 

 

Common
Stock

 

Additional
Paid-In
Capital

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Loss

 

Treasury
Stock

 

Total
Stockholders’
Equity

 

Balance, January 1, 2010

 

$

12

 

$

125,192

 

$

126,415

 

$

(7,851

)

$

(47,272

)

$

196,496

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

4,545

 

 

 

 

 

4,545

 

Foreign currency translation adjustments

 

 

 

 

 

 

 

(2,894

)

 

 

(2,894

)

Changes in pension and other postretirement benefits, net

 

 

 

 

 

 

 

60

 

 

 

60

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

1,711

 

Exercise of 23,850 options for shares of common stock

 

 

2

 

(106

)

 

 

553

 

449

 

Tax benefit of options exercised

 

 

 

4

 

 

 

 

 

 

 

4

 

Stock-based compensation

 

 

 

1,109

 

 

 

 

 

 

 

1,109

 

Issuance of 1,756,821 shares of common stock

 

2

 

27,746

 

 

 

 

 

 

 

27,748

 

Purchase of 21,827 shares of common stock

 

 

 

 

 

 

 

 

 

(349

)

(349

)

Balance, September 30, 2010

 

$

14

 

$

154,053

 

$

130,854

 

$

(10,685

)

$

(47,068

)

$

227,168

 

 

See notes to condensed consolidated financial statements.

 

6


 


 

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

Unaudited

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

 

(1)           Basis of Presentation

 

The accompanying condensed consolidated financial statements of Steinway Musical Instruments, Inc. and subsidiaries (the “Company”) for the three and nine months ended September 30, 2010 and 2009 are unaudited. In the opinion of management, these statements have been prepared on the same basis as the audited consolidated financial statements as of and for the year ended December 31, 2009, and include all adjustments which are of a normal and recurring nature, necessary for the fair presentation of financial position, results of operations and cash flows for the interim periods. We encourage you to read the condensed consolidated financial statements in conjunction with the risk factors, consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the entire year.

 

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

 

(2)           Summary of Significant Accounting Policies

 

Principles of Consolidation - Our condensed consolidated financial statements include the accounts of all direct and indirect subsidiaries, all of which are wholly owned, including the piano (“Steinway”), band (“Conn-Selmer”), and online music (“Arkiv”) divisions. Intercompany balances have been eliminated in consolidation.

 

Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America necessarily requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

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

 

We provide reserves for potential payments of tax to various tax authorities related to uncertain tax positions and other issues. Reserves related to uncertain tax positions are based on a determination of whether and how much of a tax benefit taken in our tax filings or positions is more likely than not to be realized, assuming that the matter in question will be raised by the tax authorities. Potential interest and penalties associated with such uncertain tax positions are recorded as a component of income tax expense. We believe appropriate provisions for outstanding issues have been made.

 

Income tax-related interest and penalties are reported as a component of income tax expense. We file income tax returns at the U.S. federal, state, and local levels, as well as in several foreign jurisdictions. With few exceptions, our returns are no longer subject to examinations for years before 2006.

 

There were no material changes to the liability for uncertain tax positions in the first nine months of 2010. Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in changes in our estimates.

 

7



 

Stock-based Compensation - We record compensation cost on a straight-line basis over the award’s requisite service period for all share-based awards granted. We estimate the fair value of our stock option awards (less estimated forfeitures) and employee stock purchase plan rights on the date of grant using the Black-Scholes option valuation model.

 

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

 

A reconciliation of the weighted-average shares used for the basic and diluted computations is as follows:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Weighted-average shares:

 

 

 

 

 

 

 

 

 

For basic earnings per share

 

12,055,741

 

8,581,343

 

11,503,013

 

8,549,287

 

Dilutive effect of stock-based compensation plans

 

43,130

 

1,977

 

56,322

 

2,598

 

For diluted earnings per share

 

12,098,871

 

8,583,320

 

11,559,335

 

8,551,885

 

 

We did not include any of the 1,141,016 outstanding options to purchase shares of common stock in the computation of diluted earnings per share for the three and nine months ended September 30, 2009 because generally their exercise prices were more than the average market price of our common shares, and therefore antidilutive. We did not include 745,176 outstanding options to purchase shares of common stock in the computation of diluted earnings per share for the three and nine months ended September 30, 2010 because they were antidilutive.

 

Accumulated Other Comprehensive Loss - Accumulated other comprehensive loss is comprised of foreign currency translation adjustments and pension and other postretirement benefits. The components of accumulated other comprehensive loss are as follows:

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Accumulated other comprehensive loss:

 

 

 

 

 

Foreign currency translation adjustment

 

$

4,386

 

$

7,280

 

Pension and other postretirement benefits

 

(15,071

)

(15,131

)

Total accumulated other comprehensive loss

 

$

(10,685

)

$

(7,851

)

 

The components of comprehensive income are as follows:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

Net income

 

$

1,565

 

$

637

 

$

4,545

 

$

1,022

 

Foreign currency translation adjustment

 

6,319

 

2,576

 

(2,894

)

3,690

 

Pension and other postretirement benefits

 

 

3,655

 

83

 

3,655

 

Tax impact of pension and postretirement benefits

 

 

(1,462

)

(23

)

(1,462

)

Total comprehensive income

 

$

7,884

 

$

5,406

 

$

1,711

 

$

6,905

 

 

8



 

Recent Accounting Pronouncements - In March 2010, the Financial Accounting Standards Board issued new guidance which clarifies the scope exception for embedded credit related derivatives. We were required to comply with this new standard as of July 1, 2010 and it did not have a material impact on our financial statements.

 

(3)           Inventories

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Raw materials

 

$

17,213

 

$

18,413

 

Work-in-process

 

35,960

 

42,121

 

Finished goods

 

96,127

 

97,496

 

Total inventory

 

$

149,300

 

$

158,030

 

 

(4)           Goodwill, Trademarks, and Other Intangible Assets

 

Intangible assets other than goodwill and indefinite-lived trademarks are amortized on a straight-line basis over their estimated useful lives. Deferred financing costs are amortized over the repayment periods of the underlying debt. We performed our annual goodwill and intangible asset impairment test as of July 31, 2010 given the timing of our fall budgeting and planning process, which provides multi-year cash flows used to conduct our annual impairment testing of intangible assets. Our analyses of band division trademarks and piano division goodwill and trademarks did not indicate any impairment; therefore, no charge was taken against those assets. No other events or circumstances occurred subsequent to our annual impairment test which would have indicated that these assets may be impaired.

 

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

 

 

 

Piano

 

Band

 

Total

 

Goodwill:

 

 

 

 

 

 

 

Balance, January 1, 2010

 

$

24,063

 

$

 

$

24,063

 

Foreign currency translation impact

 

(698

)

 

(698

)

Balance, September 30, 2010

 

$

23,365

 

$

 

$

23,365

 

 

 

 

 

 

 

 

 

Trademarks:

 

 

 

 

 

 

 

Balance, January 1, 2010

 

$

9,460

 

$

5,824

 

$

15,284

 

Foreign currency translation impact

 

(220

)

 

(220

)

Balance, September 30, 2010

 

$

9,240

 

$

5,824

 

$

15,064

 

 

We have previously recorded cumulative impairment losses of $8.6 million associated with band division goodwill and $1.0 million associated with online music business trademarks.

 

9



 

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

 

 

 

September 30,
2010

 

December 31,
2009

 

Gross deferred financing costs

 

$

5,286

 

$

5,333

 

Accumulated amortization

 

(3,411

)

(3,135

)

Deferred financing costs, net

 

$

1,875

 

$

2,198

 

 

 

 

 

 

 

Gross non-compete agreements

 

$

250

 

$

250

 

Accumulated amortization

 

(119

)

(81

)

Non-compete agreements, net

 

$

131

 

$

169

 

 

 

 

 

 

 

Gross customer relationships

 

$

525

 

$

506

 

Accumulated amortization

 

(254

)

(166

)

Customer relationships, net

 

$

271

 

$

340

 

 

 

 

 

 

 

Gross website and developed technology

 

$

2,176

 

$

2,176

 

Accumulated amortization

 

(1,026

)

(700

)

Website and developed technology, net

 

$

1,150

 

$

1,476

 

 

 

 

 

 

 

Total gross other intangibles

 

$

8,237

 

$

8,265

 

Accumulated amortization

 

(4,810

)

(4,082

)

Other intangibles, net

 

$

3,427

 

$

4,183

 

 

Our band division purchased a music education business in August 2010. We are in the process of conducting the valuation assessment of acquired assets but do not expect the result to be material to our intangible assets.

 

Deferred financing costs increased $0.2 million due to the renegotiation of our domestic credit agreement, which was in process as of September 30, 2010. Deferred financing costs were also affected by the purchase of $5.8 million of our Senior Notes in May and June 2010. These repurchases are described more fully in Note 6. The weighted-average amortization period for deferred financing costs is seven years, and the weighted-average amortization period for all other amortizable intangibles is approximately five years. Total amortization expense, which includes amortization of deferred financing costs, is as follows:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Amortization expense

 

$

300

 

$

328

 

$

911

 

$

995

 

 

10



 

The following table shows the total estimated amortization expense for the remainder of 2010 and beyond:

 

Remainder of 2010

 

$

307

 

2011

 

1,182

 

2012

 

1,066

 

2013

 

717

 

2014

 

121

 

Thereafter

 

34

 

Total

 

$

3,427

 

 

(5)           Other Current Liabilities

 

Our other current liabilities consist of the following:

 

 

 

September 30,
2010

 

December 31,
2009

 

Accrued payroll and related benefits

 

$

11,320

 

$

9,326

 

Current portion of pension and other postretirement benefit liabilities

 

1,235

 

1,456

 

Accrued warranty expense

 

1,449

 

1,553

 

Accrued interest

 

876

 

3,675

 

Deferred income

 

8,041

 

7,210

 

Environmental liabilities

 

2,233

 

2,377

 

Income and other taxes payable

 

2,038

 

3,383

 

Other accrued expenses

 

7,130

 

7,415

 

Total

 

$

34,322

 

$

36,395

 

 

Accrued warranty expense is recorded at the time of sale for instruments that have a warranty period ranging from one to ten years. The accrued expense recorded is generally calculated on a ratio of warranty costs to sales based on our warranty history and is adjusted periodically following an analysis of actual warranty claims. The accrued warranty expense activity for the nine months ended September 30, 2010 and 2009, and the year ended December 31, 2009 is as follows:

 

 

 

September 30,
2010

 

September 30,
2009

 

December 31,
2009

 

Beginning balance

 

$

1,553

 

$

1,451

 

$

1,451

 

Additions

 

587

 

570

 

945

 

Claims and reversals

 

(665

)

(610

)

(865

)

Foreign currency translation impact

 

(26

)

35

 

22

 

Ending balance

 

$

1,449

 

$

1,446

 

$

1,553

 

 

11


 


 

(6)           Long-Term Debt

 

Our long-term debt consists of the following:

 

 

 

September 30,
2010

 

December 31,
2009

 

Senior Notes

 

$

152,506

 

$

158,326

 

Unamortized bond discount

 

(494

)

(623

)

Overseas lines of credit

 

1,198

 

537

 

Total

 

153,210

 

158,240

 

Less: current portion

 

1,198

 

537

 

Long-term debt

 

$

152,012

 

$

157,703

 

 

Scheduled repayments of long-term debt as of September 30, 2010 are as follows:

 

Remainder of 2010

 

$

1,198

 

2011

 

 

2012

 

 

2013

 

 

2014

 

152,506

 

Total

 

$

153,704

 

 

During the second quarter of 2010, we repurchased $5.8 million of our Senior Notes at prices ranging from 95.0% to 98.0% plus interest. As a result, we recorded a net gain on extinguishment of debt of $0.1 million. A summary of the transactions is as follows:

 

Principal repurchased

 

$

5,820

 

Less:

 

 

 

Cash paid

 

(5,633

)

Write-off of deferred financing costs

 

(64

)

Write-off of bond discount

 

(19

)

Net gain on extinguishment of debt

 

$

104

 

 

(7)           Fair Values of Financial Instruments

 

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

 

 

Level 1

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

 

 

 

 

Level 2

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

 

 

 

 

Level 3

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

 

12



 

 

 

include use of option pricing models, discounted cash flow models and similar techniques. (We do not have any assets or liabilities carried at Level 3 fair value.)

 

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

 

The following table presents information about our assets and liabilities measured at fair value on a recurring basis as of September 30, 2010 and December 31, 2009 and the fair value hierarchy of the valuation techniques we utilized.

 

 

 

September 30,
2010

 

December 31,
2009

 

Financial assets:

 

 

 

 

 

Trading securities(1) - Level 1

 

$

1,661

 

$

1,623

 

Foreign currency contracts(2) - Level 2

 

87

 

82

 

 

 

$

1,748

 

$

1,705

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

Foreign currency contracts(2) - Level 2

 

$

112

 

$

3

 

 


(1)   Our trading securities pertain to the Supplemental Executive Retirement Plan (“SERP”) and are held in a Rabbi Trust. We record a corresponding liability for the same amount in our financial statements, which represents our obligation to SERP participants.

 

(2)   Our foreign currency contracts pertain to obligations or potential obligations to purchase or sell euros, pounds, U.S. dollars, and yen under various forward contracts.

 

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

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

Net Carrying
Value

 

Estimated
Fair Value

 

Net Carrying
Value

 

Estimated
Fair Value

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Debt

 

$

153,210

 

$

155,229

 

$

158,240

 

$

144,218

 

 

The carrying values of accounts, notes and other receivables, and accounts payable approximate fair value.

 

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

 

Our common stock is comprised of two classes: Class A and Ordinary. With the exception of disparate voting power, both classes are substantially identical. Each share of Class A common stock entitles the holder to 98 votes. Holders of Ordinary common stock are entitled to one vote per share. Each share of Class A common stock shall automatically convert to Ordinary common stock if, at any time, that share of Class A common stock is not owned by an original Class A holder. In March 2010 Samick Musical Instruments Co., Ltd. (“Samick”) exercised its right to purchase 1,700,000 shares of our ordinary common stock at a price of $16.00 per share, which resulted in a cash payment to us of $27.2 million. As of September 30, 2010 our Chairman and our Chief Executive Officer collectively owned 100% of the Class A common shares, representing approximately 80% of the combined voting power of the Class A common stock and Ordinary common stock.

 

Employee Stock Purchase Plan - We have an employee stock purchase plan under which substantially all employees may purchase Ordinary common stock through payroll deductions at a purchase price equal to 85% of the lower of the fair market values as of the beginning or end of each twelve-month offering period. Stock purchases under the Purchase Plan are

 

13



 

limited to 5% of an employee’s annual base earnings. We have reserved 400,000 shares of common stock for issuance under this plan.

 

Stock Plans - The 2006 Stock Plan provides for the granting of 1,000,000 stock options (including incentive stock options and non-qualified stock options), stock appreciation rights and other stock awards to certain key employees, consultants and advisors. Our stock options generally have five-year vesting terms and ten-year option terms.

 

Our 1996 Stock Plan has expired but still has vested and unvested options outstanding. We reached our registered share limitation in early 2007, and had previously reserved 721,750 treasury stock shares to issue under this plan. We have since issued 122,674 shares of treasury stock to cover options exercised, with 337,876 remaining options outstanding. Since in most instances the average cost of the treasury stock exceeded the price of the options exercised, the difference between the proceeds received and the average cost of the treasury stock issued resulted in a reduction of retained earnings. This reduction was $0.1 million for the nine months ended September 30, 2010. There were no stock option exercises during the three and nine months ended September 30, 2009.

 

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

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Compensation cost included in:

 

 

 

 

 

 

 

 

 

Basic income per share

 

$

0.03

 

$

0.03

 

$

0.08

 

$

0.09

 

Diluted income per share

 

$

0.02

 

$

0.03

 

$

0.08

 

$

0.09

 

Stock-based compensation expense

 

368

 

328

 

1,109

 

890

 

Income tax benefit

 

66

 

51

 

201

 

136

 

 

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

 

Key assumptions used to apply this pricing model to the Stock Plan are as follows:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Risk-free interest rate

 

2.3%

 

3.1%

 

2.3%

 

3.1%

 

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

 

7.2

 

7.4

 

7.2

 

7.4

 

Expected volatility of underlying stock

 

33.8%

 

32.6%

 

33.8%

 

32.6%

 

Expected dividends

 

n/a

 

n/a

 

n/a

 

n/a

 

Weighted-average fair value

 

$7.93

 

$4.70

 

$7.93

 

$4.70

 

 

14



 

The following table sets forth information regarding the Stock Plans:

 

 

 

Number of
Options

 

Weighted-
Average
Exercise
Price

 

Weighted-
Average
Remaining
Contract
Life
(in years)

 

Aggregate
Intrinsic
Value

 

Outstanding, January 1, 2010

 

1,129,276

 

$

20.61

 

 

 

 

 

Granted

 

10,000

 

19.62

 

 

 

 

 

Exercised

 

(23,850

)

18.79

 

 

 

 

 

Forfeited

 

(18,400

)

22.71

 

 

 

 

 

Outstanding, September 30, 2010

 

1,097,026

 

$

20.60

 

6.4

 

$

2,157

 

 

 

 

 

 

 

 

 

 

 

Exercisable, September 30, 2010

 

588,846

 

$

22.27

 

4.8

 

$

435

 

 

The total intrinsic value of the options exercised during the three and nine month periods ended September 30, 2010 was nominal. There were no options exercised during the three and nine months ended September 30, 2009. As of September 30, 2010, there was $3.2 million of unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Stock Plan. This compensation cost is expected to be recognized over a period of 3.2 years. Cash received from option exercises under the Stock Plans for the nine month period ended September 30, 2010 was $0.4 million.

 

The following tables set forth information regarding the Purchase Plan:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Risk-free interest rate

 

0.4%

 

1.9%

 

0.4%

 

2.0%

 

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

 

1.0

 

1.0

 

1.0

 

1.0

 

Expected volatility of underlying stock

 

28.1%

 

25.8%

 

28.0%

 

25.7%

 

Expected dividends

 

n/a

 

n/a

 

n/a

 

n/a

 

Weighted-average fair value of option feature

 

$3.77

 

$5.97

 

$3.09

 

$6.12

 

 

 

 

Number of
Options

 

Weighted-
Average
Exercise
Price

 

Remaining
Contract
Life
(in years)

 

Aggregate
Intrinsic
Value
(in whole $)

 

Outstanding, January 1, 2010

 

24,382

 

$

9.65

 

 

 

 

 

Granted

 

39,509

 

10.66

 

 

 

 

 

Exercised

 

(56,821

)

9.65

 

 

 

 

 

Forfeited

 

(1,285

)

9.65

 

 

 

 

 

Outstanding, September 30, 2010

 

5,785

 

$

16.58

 

0.8

 

$

4,512

 

 

15



 

(9)           Other Expense (Income), Net

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

West 57th Street building income

 

$

(915

)

$

(1,552

)

$

(4,308

)

$

(4,610

)

West 57th Street building expense

 

1,687

 

1,214

 

5,148

 

3,400

 

Foreign exchange (gain) loss, net

 

(403

)

541

 

(1,116

)

890

 

Miscellaneous, net

 

(259

)

(426

)

(423

)

(714

)

Other expense (income), net

 

$

110

 

$

(223

)

$

(699

)

$

(1,034

)

 

Our building on West 57th Street in New York City is managed by an outside company. West 57th Street building income includes all rent and other income attributable to the property; and West 57th Street building expense includes the land lease, real estate taxes, depreciation, and other building costs. Since we utilize a portion of the leasable space for our own retail store, we have allocated a ratable portion of the building expenses to sales and marketing expenses.

 

(10)         Commitments and Contingent Liabilities

 

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

 

Certain environmental laws, such as the Comprehensive Environmental Response, Compensation, and Liability Act, as amended (“CERCLA”), impose strict, retroactive, joint and several liability upon persons responsible for releases of hazardous substances, which liability is broadly construed. Under CERCLA and other laws, we may have liability for investigation and cleanup costs and other damages relating to our current or former properties, or third-party sites to which we sent wastes for disposal. Our potential liability at any of these sites is affected by many factors including, but not limited to, the method of remediation, our portion of the hazardous substances at the site relative to that of other parties, the number of responsible parties, the financial capabilities of other parties, and contractual rights and obligations.

 

We are continuing an existing environmental remediation plan at a facility we acquired in 2000 and subsequently sold. We expect to pay these costs, which approximate $0.6 million, over an 11-year period. We have accrued approximately $0.5 million for the remaining cost of this remediation program, which represents the present value total cost using a discount rate of 4.54%. A summary of expected payments associated with this project is as follows:

 

 

 

Environmental
Payments

 

Remainder of 2010

 

$

31

 

2011

 

61

 

2012

 

61

 

2013

 

61

 

2014

 

61

 

Thereafter

 

362

 

Total

 

$

637

 

 

In 2004, we acquired two manufacturing facilities from G. Leblanc Corporation, now Grenadilla, Inc. (“Grenadilla”), for which environmental remediation plans had already been established. In connection with the acquisition, we assumed the existing accrued liability of approximately $0.8 million for the cost of these remediation activities. Based on a review of past and ongoing investigatory and remedial work by our environmental consultants, and discussions with state regulatory

 

16



 

officials, as well as periodic sampling, we estimate the remaining costs of such remedial plans to be $1.7 million. Pursuant to the purchase and sale agreement, we sought indemnification from Grenadilla for anticipated costs above the original estimate. We filed a claim against the escrow and recorded a corresponding receivable for this amount in prepaid expenses and other current assets in our consolidated balance sheet. Based on the current estimated costs of remediation, this receivable totaled $2.1 million as of September 30, 2010. We have reached an agreement with Grenadilla whereby related environmental costs are paid directly out of the escrow. Currently, the escrow balance exceeds our receivable balance. Should the escrow be reduced to zero, we would seek further indemnification from Grenadilla for these additional costs. However, we cannot be assured that we will be able to recover such costs.

 

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

 

In May 2008 we acquired 100% of the membership interest in ArkivMusic, LLC, an online retailer of classical music. Under the purchase agreement, we are obligated to pay an amount equal to 5% of the net operating profits of Arkiv, if any, in 2010, the sum of which is not to exceed $2.5 million. The final purchase price is dependent upon a calculation derived from the 2010 net operating profits which, when finalized, is expected to result in an additional payment between $1.0 and $1.9 million. Since the final net operating profits for 2010 cannot be calculated until year end, we have not recorded any liability or additional purchase price associated with this acquisition but expect to do so in the fourth quarter of 2010.

 

(11)         Retirement Plans

 

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

 

 

 

Domestic Plan

 

Foreign Plans

 

 

 

Three Months Ended September 30,

 

Three Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Service cost

 

$

87

 

$

83

 

$

133

 

$

144

 

Interest cost

 

864

 

852

 

424

 

438

 

Expected return on plan assets

 

(1,048

)

(921

)

(89

)

(67

)

Amortization of prior service cost (credit)

 

28

 

36

 

(13

)

 

Amortization of net loss

 

489

 

575

 

48

 

2

 

Curtailment loss

 

 

241

 

 

 

Net periodic pension cost

 

$

420

 

$

866

 

$

503

 

$

517

 

 

 

 

Domestic Plan

 

Foreign Plans

 

 

 

Nine Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Service cost

 

$

262

 

$

276

 

$

452

 

$

418

 

Interest cost

 

2,592

 

2,574

 

1,285

 

1,276

 

Expected return on plan assets

 

(3,145

)

(2,667

)

(256

)

(207

)

Amortization of prior service cost (credit)

 

84

 

139

 

(26

)

 

Amortization of net loss

 

1,467

 

1,830

 

128

 

6

 

Curtailment loss

 

 

241

 

 

 

Net periodic pension cost

 

$

1,260

 

$

2,393

 

$

1,583

 

$

1,493

 

 

17



 

On April 1, 2010, we amended our U.K. pension plan prospectively to both limit active participants’ annual increases in pensionable salary and reduce the rate at which participants accrue final benefits. We remeasured the plan’s benefit obligation, plan assets and net periodic pension cost as a result of the plan amendment. Assumptions utilized are as follows:

 

 

 

Benefit Obligation

 

Net Periodic Pension Cost

 

 

 

April 1,

 

January 1,

 

April 1,

 

January 1,

 

Weighted-

 

 

 

2010

 

2010

 

2010

 

2010

 

Average

 

Discount rate

 

5.50%

 

5.80%

 

5.50%

 

5.80%

 

5.62%

 

Expected return on assets

 

n/a

 

n/a

 

5.30%

 

5.30%

 

5.30%

 

Rate of compensation increase

 

3.80%

 

4.80%

 

3.80%

 

4.80%

 

4.20%

 

 

The decrease in our long-term pension benefit obligation was more than offset by an increase in our actuarial loss due to the change in valuation assumptions when the plan was remeasured. The plan amendment resulted in a gross decrease in our pension benefit obligation of $0.6 million through recognition of a prior service credit, which will be amortized over a period of 12 years. On a net basis, our long term pension benefit obligation increased by less than $0.1 million and our accumulated other comprehensive loss decreased by $0.1 million, net of tax.

 

We provide postretirement health care and life insurance benefits to a limited number of certain eligible hourly retirees and their dependents. As a result of terminating one of our collective bargaining agreements in 2009, we have a limited number of participants receiving health care benefits under this plan. Once these participants reach age sixty-five and are eligible for Medicare, no postretirement health care benefits will be provided. We will continue to provide life insurance benefits for eligible retirees. During 2010, we made a settlement payment of $0.1 million associated with this plan. This payment had no material impact on the plan. The components of net periodic postretirement benefit cost for these benefits are as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Service cost

 

$

3

 

$

1

 

$

8

 

$

4

 

Interest cost

 

10

 

13

 

31

 

49

 

Amortization of prior service credit

 

(29

)

(23

)

(86

)

(49

)

Recognized loss

 

 

 

6

 

 

Net periodic postretirement benefit cost (benefit)

 

$

(16

)

$

(9

)

$

(41

)

$

4

 

 

Based on federal laws and regulations, we are not required to make a contribution to our domestic pension plan in 2010. We made a payment of less than $0.1 million to this plan during the period and are currently evaluating what additional amount, if any, we will contribute to this plan in 2010. Our anticipated contributions to the pension plan of our U.K. subsidiary approximate $0.8 million for the current year. As of September 30, 2010, we have made contributions of $0.6 million to this plan. The pension plans of our German entities do not hold any assets and use operating cash to pay participant benefits as they become due. Expected 2010 benefit payments under these plans are $1.2 million, of which $0.9 million was paid through September 2010.

 

(12)         Segment Information

 

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

 

18



 

The following tables present information about our operating segments for the three and nine months ended September 30, 2010 and 2009:

 

 

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

Three Months Ended 2010

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

Net sales to external customers

 

$

22,064

 

$

11,792

 

$

11,144

 

$

45,000

 

$

36,978

 

$

1,283

 

$

38,261

 

$

 

$

83,261

 

Income (loss) from operations

 

1,311

 

1,001

 

1,152

 

3,464

 

3,263

 

129

 

3,392

 

(1,062

)

5,794

 

 

 

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

Three Months Ended 2009

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

Net sales to external customers

 

$

21,123

 

$

12,535

 

$

11,275

 

$

44,933

 

$

36,173

 

$

1,528

 

$

37,701

 

$

 

$

82,634

 

Income (loss) from operations

 

(1,314

)

1,639

 

1,675

 

2,000

 

3,858

 

210

 

4,068

 

(913

)

5,155

 

 

 

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

Nine Months Ended 2010

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

Net sales to external customers

 

$

62,270

 

$

34,457

 

$

32,571

 

$

129,298

 

$

97,402

 

$

3,352

 

$

100,754

 

$

 

$

230,052

 

Income (loss) from operations

 

1,890

 

4,086

 

3,125

 

9,101

 

7,805

 

286

 

8,091

 

(2,534

)

14,658

 

 

 

 

Piano Segment

 

Band Segment

 

Other &

 

Consol

 

Nine Months Ended 2009

 

U.S.

 

Germany

 

Other

 

Total

 

U.S.

 

Europe

 

Total

 

Elim

 

Total

 

Net sales to external customers

 

$

57,739

 

$

36,363

 

$

30,510

 

$

124,612

 

$

96,483

 

$

3,643

 

$

100,126

 

$

 

$

224,738

 

Income (loss) from operations

 

(3,956

)

5,380

 

2,896

 

4,320

 

4,797

 

406

 

5,203

 

(2,912

)

6,611

 

 

19



 

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

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

 

Introduction

 

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

 

Critical Accounting Policies and Estimates

 

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

 

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

 

The significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements included in the Company’s 2009 Annual Report on Form 10-K. Not all of these significant accounting policies require management to make difficult, subjective or complex judgments or estimates. However, management considers the following to be critical accounting policies and estimates based on the definition above.

 

Accounts Receivable

 

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

 

Inventory

 

We establish inventory reserves for items such as lower-of-cost-or-market and obsolescence. We review inventory levels on a detailed basis, concentrating on the age and amounts of raw materials, work-in-process, and finished goods, as well as recent usage and sales dates and quantities to help develop our estimates. Ongoing changes in our business strategy, including a shift from batch processing to single piece production flow, coupled with increased offshore sourcing, could affect our ability to realize the current cost of our inventory, and are considered by management when developing our estimates. We also establish reserves for anticipated book-to-physical adjustments based upon our historical level of adjustments from our annual physical inventories. We account for our inventory using standard costs. Accordingly, variances between actual and standard costs that are not abnormal in nature are capitalized into inventory and released based on calculated inventory turns. Abnormal costs are expensed in the period in which they occur.

 

20



 

Workers’ Compensation and Self-Insured Health Claims

 

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

 

Warranty

 

We establish reserves for warranty claims based on our analysis of historical claims data, recent claims trends, and the various lengths of time for which we warranty our products.

 

Long-lived Assets

 

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

 

We establish long-lived intangible assets based on estimated fair values, and amortize finite-lived intangibles over their estimated useful lives. We test our goodwill and indefinite-lived trademark assets for impairment annually or on an interim basis if events or circumstances indicate that the fair value of an asset may have decreased below its carrying value. Our assessment is based on several analyses, including a comparison of net book value to estimated fair values, market capitalization, and multi-year cash flows.

 

Pensions and Other Postretirement Benefit Costs

 

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

 

Income Taxes

 

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

 

When considered not more likely than not to be realized, a liability has been recorded for uncertain tax positions. When analyzing these positions, we consider the probability of various outcomes which could result from examination, negotiation, or settlement with various taxing authorities. The final outcome on these positions could differ significantly from our original estimates due to the following: expiring statutes of limitations; availability of detailed historical data; results of audits or examinations conducted by taxing authorities or agents that vary from management’s anticipated results; identification of new tax contingencies; release of applicable administrative tax guidance; management’s decision to settle or appeal assessments; or the rendering of court decisions affecting our estimates of tax liabilities; as well as other factors.

 

Stock-Based Compensation

 

We grant stock-based compensation awards which generally vest over a specified period. When determining the fair value of stock options and subscriptions to purchase shares under the employee stock purchase plan (“Purchase Plan”), we use the Black-Scholes option valuation model, which requires input of certain management assumptions, including dividend yield, expected volatility, risk-free interest rate, expected life of stock options granted during the period, and the life applicable to the Purchase Plan subscriptions. The estimated fair value of the options and subscriptions to purchase

 

21



 

shares, and the resultant stock-based compensation expense, can fluctuate based on the assumptions used by management.

 

Environmental Liabilities

 

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

 

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

 

Forward-Looking Statements

 

Certain statements contained in this document are “forward-looking statements” within the meaning of Section 21E of the Securities and Exchange Act of 1934, as amended. These forward-looking statements represent our present expectations or beliefs concerning future events. We caution that such statements are necessarily based on certain assumptions which are subject to risks and uncertainties which could cause actual results to differ materially from those indicated in this report. These risk factors include, but are not limited to, the following: changes in general economic conditions; reductions in school budgets; increased competition; work stoppages and slowdowns; ability to successfully consolidate band manufacturing; impact of dealer consolidations on orders; ability of dealers to obtain financing; exchange rate fluctuations; variations in the mix of products sold; market acceptance of new products, ability of suppliers to meet demand; concentration of credit risk; ability to lease office space; and fluctuations in effective tax rates resulting from shifts in sources of income. Further information on these risk factors is included in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009. We encourage you to read those descriptions carefully. We caution investors not to place undue reliance on the forward-looking statements contained in this report. These statements, like all statements contained in this report, speak only as of the date of this report (unless another date is indicated) and we undertake no obligation to update or revise the statements except as required by law.

 

22



 

Results of Operations

 

Three Months Ended September 30, 2010 Compared to Three Months Ended September 30, 2009

 

 

 

Three Months Ended September 30,

 

 

 

Change

 

 

 

2010

 

 

 

2009

 

 

 

$

 

%

 

Net sales

 

 

 

 

 

 

 

 

 

 

 

 

 

Band

 

$

38,261

 

 

 

$

37,701

 

 

 

560

 

1.5

 

Piano

 

45,000

 

 

 

44,933

 

 

 

67

 

0.1

 

Total sales

 

83,261

 

 

 

82,634

 

 

 

627

 

0.8