Steinway Musical Instruments, Inc. Q3 2008 Earnings Call Transcript

Nov. 7.08 | About: Steinway Musical (LVB)

Steinway Musical Instruments, Inc. (NYSE:LVB)

Q3 2008 Earnings Call

November 06, 2008 4:30 pm ET

Executives

Dana Messina - Chief Executive Officer

Dennis Hanson - Chief Financial Officer

Donna Lucente - Corporate Controller

Analysts

Arnold Ursaner - CJS Securities

Mimi Noel - Sidoti & Company

Jeremy Vance - GE Asset Management

Operator

Welcome to the third quarter 2008 earnings release conference call for Steinway Musical Instruments. My name is Christine and I will be your conference coordinator for today. (Operator Instructions)

This afternoon the Company issued a press release disclosing financial results for the quarter and nine months ended September 30, 2008. If you have not yet received a copy, you may download it from the News section of the Company’s website, www.steinwaymusical.com.

Today’s call will begin with a reading of the Safe Harbor Statement, which will be followed by remarks by Dana Messina, Chief Executive Officer. Mr. Messina will be joined by Dennis Hanson, Chief Financial Officer, and Donna Lucente, Corporate Controller, for the question and answer session.

Today's call contains forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. These statements represent the Company’s present expectations or beliefs concerning future events. The Company cautions 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 today.

These risk factors include the following: changes in general economic conditions, recent geopolitical events, increased competition, work stoppages and slowdowns, ability to successfully consolidate band manufacturing, impact of dealer consolidations on orders, exchange rate fluctuations, variations in the mix of products sold; market acceptance of new product and distribution strategies; ability of suppliers to meet demand; concentration of credit risk; fluctuations in effective tax rates resulting from shifts in sources of income; and the ability to successfully operate acquired businesses. Further information on these risk factors is included in the Company’s filings with the Securities and Exchange Commission.

Today’s presentation will include EBITDA as well as other adjusted financial measurements, all of which are considered to be non-GAAP terms. These measures present operating results on a basis excluding certain non comparable items. Reconciliations of these measures to the most comparable GAAP terms are available on the Company’s website at www.steinwaymusical.com.

Now I would like to turn the conference over to Dana Messina, your host for today’s presentation.

Dana Messina

Welcome to Steinway’s third quarter conference call and financial review. I’m here with Dennis Hanson and Donna Lucente. First of all the third quarter was a good quarter for us particularly in light of the current economic environment. What I am going to do with you now is I am going to walk everyone through the quarter, provide you an update on our balance sheet liquidity, review our operations and then give you an outlook for next year. We had a GAAP loss of $0.03 a share this quarter which included an $8.6 million non-cash write off of goodwill which we will talk about later. Our adjusted EPS without the charge was $0.57 and those figures compared to last year at US$0.05 a share.

Sales for the quarter were a US$100 million up slightly over last year. Gross profit was US$30 million, up 7% over last year. Our gross margin was up 150 basis points. Two of the larger items impacting margins were severance from our band plant closures and the lowered production rate at our domestic piano plant which we had done to reduce inventory.

While our normal operating expenses were flat for the quarter as a result of our annual evaluation of goodwill we rode off some of the goodwill in our band segment and that was the only valuation that was affected. The charge was not based on the results of the third quarter but on our expectations of future cash flows from that division and the declining valuation multiples for businesses in general. There were several factors that led into the impairment. The prolonged strike at our Elkhart brass plant, late deliveries of sourced [student 737] product, and the delayed introduction of certain new domestically manufactures instrument that resulted in higher cost and reduced market shares in certain product categories. Although we believe that domestic band sales at consumer level are not significantly affected by the recession, we expect the recent economic downturn to result in marginally lower revenues. In addition we expect that last year’s consolidation of two major customers, reductions of existing dealer inventories and more stringent credit policies with many customers to have a negative impact on results of the future years. When you factor out the eight typical items in Q3, adjusted EBITDA %was $12.2 million, up 25% so we were quite pleased with our results for the quarter. Capital expenditures were $1.4 million for the quarter, up slightly from $1.3 million last year. Our balance sheet continues to be in very good shape. I wanted to address our liquidity and how we are positioned in the event of a sustained economic downturn here. We ended the quarter with about $23 million in cash and we expect that balance to be higher at year end. Our domestic credit line were virtually unused this entire period and just to remind everyone, we have a $110 million line of credit, it is asset based and covenant light. Our inventory was down about $6 million from last September. We had an inventory in mid PNS level at much better shape and we have progress in our other areas. We tightened up credit on the customer side and expect very little on the way of credit losses. Collections thus far have been consistent and strong. Receivables are down 10% over last year primarily due to better cash collections and our focus on that part of our business. Going over to the operations, first we will talk about piano. The piano business revenues were up to $56 million up $3.7 million or 7%. That includes $2 million from our online music business.

Overall, Steinway Grand units were down about 5%. We were down 6% domestically but most of that hit had been in our consumer markets with our institutional business and their sales holding up quite well. We were down 3% units overseas. The overseas markets appear to be holding up much better than what we have seen here in the United States.

Our mid-priced units were down about 7% for the quarter. W

Gross margins on the piano side came in at 35.1% down from 36.3% in the third quarter of last year. That is purely due on fewer retail sales and a significant increase in our lower margin Steinway upright pianos which had all a negative impact on margins. Just to remind everyone we had a tough comp for margins versus last year as we had a limited edition piano in ’07 which carry a higher average margin than we had this year. Our margins on mid priced pianos were also negatively impacted by a weaker dollar in the quarter.

On the band side, sales were $45 million down about 5% from last year. We were down unit wise about 15% across all our markets. The sales mix for the quarter was more heavily weighted towards higher priced professional instruments so the dollar and margin impact was not very significant in our business with the majority of the unit decline coming in the student instruments. Band gross margins were 23.2% up from 19.5% from last year. We made a lot of progress in our manufacturing operations which were much more efficient than what we saw in the third quarter of ’07. Also with the shortfall in student instrument sales, our gross margin percentage increased as a result of this shift towards higher margin instruments.

In terms of the outlook, with so much uncertainty in the economies worldwide, we wouldn’t be able to reasonably give sales and margin expectations for the fourth quarter. Instead we will give you a general idea of our operational plans and what we are seeing and what we expect for the balance of this year and next year.

On the piano side, first let us talk a little bit about customers in our business model. Just to remind everyone, most of the people that buy Steinway played piano for about 30 years so this is not an impulse purchase. Can it be deferred? Sure, and that is the worry that we have really going into thus economic cycle. The largest demographics buying our pianos are doctors, lawyers and musicians. We are not heavily secured towards the financial sector when we look at our customer base. In terms of our domestic market, our consumer business has been soft and we expect it to get softer. Our institutional business is a much steadier business. These are sales with a long lead time and we had a very good pipeline. Many of our dealers who do well with institutional sales are actually up this year. In the international markets, just to remind everyone we do business in many countries. We have been doing well overseas. The emerging markets where we have seen very good growth namely Russia, China, Brazil, we have not really seen any effect over there. However we read the same newspapers as everybody else and we have prepared ourselves for a slowdown in those markets. Despite what we see as future weakness, we expect the foreign market to continue to outperform the United States.

Given the current environment, we don’t anticipate improvement in our US piano market in the near term and we will continue to cut production to levels that correspond to what we see in terms of sales in the economic environment. As a result of slowing down production, we have to minimize any disruption and we expect to achieve greater manufacturing efficiencies and margins next year.

On the band side, this business has never been one that has been affected much by economic turmoil. Just to remind everybody that we reduced our manufacturing footprint by nearly 50% over the last five years and we have moved to an outsource model for many of our student instruments. We have devoted a lot of attention and effort to moving towards this business model and we believe that this is positioned as well to handle this economic environment and I think the recent results from the band side and the improvement margins in the manufacturing efficiencies are starting to show. We have implemented some significant price increases. We have reduced credits to many of our dealers. And overall we expect sales to be marginally lower but we expect gross margins to improve in profitability to be as good or better in this business.

With that I will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Arnie Ursaner with CJS Securities.

Arnold Ursaner - CJS Securities

How Dana, How are you?

Dana Messina

Good.

Arnold Ursaner - CJS Securities

And Dennis?

Dennis Hanson

Hi, Arnie.

I have a quick question to ask you. Can you walk us through the impact to currency which had tremendous movements since you reported your Q3 results and you have got a lot of different cross currents between yen, euros and dollars, can you walk us through your currency and its impact?

Dana Messina

Because we are naturally hedged across a lot of our different businesses, we didn’t have much of any impact in the third quarter for currencies and the areas where were not naturally hedged, we have gone out and hedged ourselves for the next 18 months. So we don’t really see a lot of volatility and the currencies affecting us one way or the other.

Arnold Ursaner - CJS Securities

Your tax rate was much lower and I know you always try to guide conservatively on tax rate but Dennis what are you thinking for tax rate in the Q4?

Dennis Hanson

Well, let me turn to over to Donna and just to make sure everybody can understand the answer but what you are saying is a rate of 39% for general, for our normal operations, the normal income and then the impact of 1048 and I will let Dana kind of explain on that.

Donna Lucente

Arnie, the 1048 basically results from accruals we have made in the past. We had accrued several years of liabilities and then we settled this with various state taxing authorities so what you are saying is this huge benefit coming through in the current period. We are forecasting a normal of approximately 39 given the dollar value of the benefit that we had this year, we are going to run in the mid 30s for an effective total year rate unless something else changes.

Arnold Ursaner - CJS Securities

See what else, Dana your business generates tremendous free cash flow normally in Q4 as you wind down the seasonal issues related to back-to-school. Can you give us a sense of your priorities for free cash flow in this environment and specifically highlight on your ability to buyback bonds that with discount?

Dana Messina

As you said, we do generate a lot of cash in the fourth quarter and we expect our cash balance to be pretty heavy at the end of the year. We did, in the second quarter, buyback some bonds in the mid 80s. The bonds are again trading in around those levels and so I would expect that we will either maintain the cash balance that is if the credit markets and the banking markets are as crazy as they are now but if we get an opportunity, we probably will buy some of those bonds back. We probably will not be buying stock back in this environment just because of the nervousness in the credit markets but the bonds are good opportunity for us.

Arnold Ursaner - CJS Securities

Okay. Final question for me, I know, I am assuming any sale of your building in this current environment is even less likely than it has been for the last few years. Can you comment on your ability to resign up your key tenants within your building?

Dana Messina

Well remember, most of the tenants in the building, their lease will run through the end of 2010. So, we are in negotiations with them now with the big ones. There will not be any disruption for the next year or so. With some of the smaller tenants that we have resigned a new leases, those had been at higher rates than what we have seen previously so we are in pretty good shape with the building. The tenants like the building. We do not anticipate the major ones being the economies doing anything different but we are signed up through 2010 and we have some time to get that stuff sorted out.

Operator

Your next question comes from the line of Mimi Noel - Sidoti & Company.

Mimi Noel - Sidoti & Company

Couple of questions. Why do you think you saw a concentrated weakness in student band instruments?

Dana Messina

Well, we had a couple of things. One, we continue to get slow deliveries from some of our suppliers in Asia that was the majority of it and then also, we instituted significant price increases that had some impact but buying large, the biggest impact was being light on deliveries from other suppliers.

Mimi Noel - Sidoti & Company

So you're not seeing changes in the cyclicality of the business, and rather, it's typically not cyclical?

Dana Messina

It's not cyclical so it is pretty steady business and we have not seen any change to that.

Dennis Hanson

I think I will just add and I think Dan has mentioned in his script, Mimi, that some of the dealers are cutting back on orders because they are tightening so I think that factored into some of the ones that did not, well a lot of that would normally buy student instruments. So that factored there as well.

Mimi Noel - Sidoti & Company

Okay and I apologize if this was already addressed but domestic inventory, the grand pianos, how are you satisfied with that or is there still some work to do?

Dana Messina

Well, I think we are never satisfied but we made and our managers on the selling side did a great job getting the domestic inventory under control in the last quarter. So…

Mimi Noel - Sidoti & Company

I guess my segway question would be then do you think that there will be anymore unplanned or planned shift downs?

Dana Messina

Well, if we continue to see soft demand at the consumer levels here in the US, we will probably continue to reduce our production in our bond but…

Mimi Noel - Sidoti & Company

Perhaps less reduction schedule…

Dana Messina

…follow on that yet but.

Dennis Hanson

Yes and other kind of to explain on that comment, Mimi, one of the things we are going to do in going forward is instead of having the large weekly shutdown is to reduce the run rate and try to role it back. So that is one of the things we are working on for next year.

Mimi Noel - Sidoti & Company

You press on just to reduce that run rate versus shutting down the plant for a week, okay.

Dennis Hanson

Yes, I mean, you try and not to do that so that you keep good, skilled people in place but at some point, the decision has been made that it is a more efficient way of controlling our inventory and that is what we have done.

Mimi Noel - Sidoti & Company

Okay and this is my last question, Dana, I know you covered it but I dialed in a little bit late, the justification for the impairment charge, I think you listed a couple of things which included marginally lower revenue in the band segment. Would you go over that again?

Dana Messina

Well, you know, a couple of things. One, as I mentioned, we raised prices. Two, we tightened up credit on a lot of our customers. We went through the issues with the couple of our customers that they went bankrupt over the last few years and we wanted to make sure that we did not have to repeat at that especially with the economy getting weaker. So, we tightened up as much as we reasonably could while maintaining our business but we have dealers that would like to buy more instruments that were not extending credit to do that and so that we think will result in, not a lot, but marginally lower sales.

Mimi Noel - Sidoti & Company

Okay, is that effective, starting in this fourth quarter?

Dana Messina

No, we started that probably at the beginning of the year.

Operator

Your next question comes from the line of Jeremy Vance - GE Asset Management.

Jeremy Vance - GE Asset Management

Yes, my question on foreign currency translation with [23.46] bank.

Dana Messina

Okay.

Operator

(Operator instruction) Your have a follow up question from the line of Arnold Ursaner - CJS Securities.

Arnold Ursaner - CJS Securities

Alright. Can you quantify your international growth in the quarter please and the percent of sales from international?

Dana Messina

I think I can. I think our international was, bear with me one second, international piano was, sales were up 12%.

Arnold Ursaner - CJS Securities

Okay and international as a percent of revenue?

Dana Messina

International was about 27% of revenue.

Dennis Hanson

Total.

Dana Messina

Total revenue, right.

Arnold Ursaner - CJS Securities

And plant shutdowns, how many days were you out or shut in the piano facility in [24.51]?

Dana Messina

That is technical question. We predict in the quarter, I had it right here in front of me, where did I? Forty one operation days in New York versus 38 last year and in Germany, 49 days versus 50 last year.

Arnold Ursaner - CJS Securities

And Dana, generally what are you seeing in your dealer traffic, you have your own retail source, what are you seeing in traffic in your stores and generally what sort of inventories do your dealers have?

Dana Messina

Most of our dealers, we negotiated model inventory levels so they all have inventories that turn over, on the Steinway side, a couple of times a year and on the Boston and Essex, four or five times a year. We have seen, traffic overall has been a little bit lower in terms of per traffic to the stores. We have seen a big shift in the number of people that come through the internet and start at least beginning a dialogue with our showrooms and our sales people. They first contact their sale in the internet. There has been large growth in that traffic over the last year so our own retail stores are down but not by, they are not down significantly. The fourth quarter, October started off definitely slow in our retail stores but I do not know if that was more a reflection of the election or the adverse news that is out there everyday about the economy but we definitely saw a littlie bit softness in October.

Arnold Ursaner - CJS Securities

And going to the issue of slow supplies in band coming in from Asia, a couple of questions related to that, with the issue letters of credit, we know a lot of companies who need letters of credit cannot shift because they cannot get it, was that a factor in part of this?

Dana Messina

No. This does not affect us at all. I mean we have the ability to provide letters of credit in large amounts and that really had no effect on us. It was really just the supplier's ability to get ramped up to the levels of production we wanted to get the quality out. It has been a challenge for some of our suppliers really on the volumes and the quality.

Arnold Ursaner - CJS Securities

Well, it goes to an issue that you have been grapping it for a while. You would get product and then would have to send it back if it was not the right quality but you have been working on this for a while. Are you changing suppliers? Are you taking more aggressive actions to find people more capable of getting you the supplies…

Dana Messina

I mean we have changed some suppliers. We actually have our own engineers and inspectors in a lot of these factories now. It had some help but it is still, at the end of the day, we have a reputation for providing very high quality products and the Asian manufacturers are good but they are not great yet we need them to be great. But that will come around, it will take time but that will come around.

Arnold Ursaner - CJS Securities

So, to understand the pattern, normally if the product is going to be here for the back-to-school season, it would have been shipped and arrive in September or so. If it just not arrive, is late getting here or did it get here and was not high enough quality and you have to send it back?

Dana Messina

No, I mean it does not even shipped from the plant. I mean because we have people in the plant that does not get shipped here unless it is good. We just did not have the qualities that delivered to us to ship out.

Arnold Ursaner - CJS Securities

Okay and the stuff you did not get in time obviously you had orders from customers which you are unable to meet because you did not get the product in time, what do you do? Do you sell them higher price product from your inventory at a discount or do you just lose the sales for other people?

Dana Messina

Well, I mean there is a combination. First we try and substitute demand to some other products that we have available. We try and do sort of discounting as possible. That is, I think, one of the reasons why we saw the margins go up is we could not substitute demand to a product that we have on hand that was profitable, we let the sale go up and we will get that customer again next year.

Arnold Ursaner - CJS Securities

And can you update us from the production out of Elkhart?

Dana Messina

We are doing fine. We have consolidated all the materials, operations we need to consolidate. We have made a lot of progress in making the more efficient. We are getting the production levels that we anticipated getting. That is all working fine. There is a lot of room for improvement. I think we are pretty bullish on what our margins can be as we continue to get our factory work us down the learning curve especially now that we have reduced the footprint by about a $0.5 million fee. We have got a lot of opportunity to make some good progress on the margin side.

Operator

At this time, there are no additional questions. Please go ahead with any concluding comments.

Dana Messina

Thank you for listening in. I will talk to you guys next quarter.

Dennis Hanson

Thank you.

Operator

Thank you ladies and gentlemen. This concludes our conference call for today. On behalf of Steinway Musical Instruments, we would like to thank you for your participation. Have a good evening.

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