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Steinway Musical Instruments, Inc. (NYSE:LVB)

Q1 2010 Earnings Call Transcript

May 10, 2010 11:00 am ET

Executives

Dana Messina – CEO

Dennis Hanson – Senior EVP

Donna Lucente – Corporate Controller

Analysts

Arnold Ursaner – CJS Securities

Paul Sonkin – The Hummingbird Value Fund

Rick D’Auteuil – Columbia Management

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the first quarter 2010 earnings release conference call for Steinway Musical Instruments. My name is Rosa. I will be your conference coordinator for today. At this time all participants are in a listen-only mode. (Operator instructions) As a reminder, today’s conference call is being recorded for replay purposes.

This morning, the company issued a press release disclosing financial results for the quarter end March 31, 2010. If you have not received a copy, you may download it from the news section of the Company’s Web site, 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 are subject to risks, uncertainties and other factors which could cause actual results to differ materially from those indicated today. For further information on the risk factors is included in the Company’s latest earning release and filings with the SEC.

Today’s presentation will include the term ‘EBITDA’ as well as other adjusted financial measurements. All of which are considered to be non-GAAP terms. These measures present operating results on basis excluding certain non-comparable items. Reconciliations of these measures to the most comparable GAAP terms are available on the Company’s Web site.

Now I’d like to turn the call over to Mr. Dana Messina, your host for today’s presentation. Mr. Messina, please proceed.

Dana Messina

Okay, everyone. Thank you for being here for our first quarter conference call. I’m here with our CFO, Dennis Hanson, and our Corporate Controller, Donna Lucente. We’ll try and make this quick and get everyone through the quarter.

Let’s look at the results. Our first quarter results were pretty good. Adjusted EBITDA came in at $8 million, which is more than double the first quarter of last year. Earnings were $0.17 a share. Revenues were down about 2% overall.

Gross margins improved 450 basis points. And we continue to maintain tight controls of spending reducing operating expenses by 6%. For our bondholders on the call, capital expenditures were about 500,000 for the quarter and depreciation and amortization was 2.7 million.

Overall, on the balance sheet, the first quarter we continue to improve our balance sheet. We ended the quarter with over 90 million in cash. Our piano inventories were down about 15% from last March so we’re in pretty good shape on that standpoint.

Our bank lines are largely in touch, as we ended the year with 120 million of availability and our net debt was reduced to 67 million at the end of the quarter.

In terms of our Piano division, the segment revenues were up about 5%. We had 10% improvement overseas, led by our divisions in Japan and China. Demand is still pretty soft in most of the rest of our markets.

In terms of profitability, Piano gross margins improved to 120 basis points, as we work the entire quarter with a more normal production schedule. We also continued to tightly control spending, operating expenses at our Piano division. We’re down 5%.

On the Band side, Band revenues were down 10% from the first quarter last year. As we said band dealers are ordering later in the year. We had a significant number of orders placed at the very end of March for shipment in the second quarter and third quarter so we expect our revenue to get caught up into past last year.

For the quarter, gross margins increased nearly 800 basis points to 28.8%. Our factories are now running more efficiently. Lower sales, discounts, and rebates also helped improve our gross margins for the quarter.

For the rest of the year, we expect our piano business to remain somewhat soft and while we posted great results in Japan and China, most of our other overseas markets are still experiencing weak demand.

Band dealers seem to begin in confidence and are placing orders. We expect to see band sales improve over the prior year, as band dealers take shipments in late spring and early summer. And if we can meet production levels our gross margins should remain in the mid-to-high 20s.

Now, we’ll open up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions). Our first question comes from Arnold Ursaner. Please go ahead.

Arnold Ursaner – CJS Securities

Hi, good morning, Dana and Dennis.

Dana Messina

Good morning, Arnie.

Arnold Ursaner – CJS Securities

My first question just is a mechanical one. The additional shares that you sold to Mr. Kim, did you have the cash from that in this reported results or did that occurred after that?

Dennis Hanson

The cash is in the results.

Arnold Ursaner – CJS Securities

Okay, thank you. You’ve been trying to work down piano inventories for a while and there’s a lot of seasonal issues, can you comment a little bit more about what is in your inventory and where do you stand relative to your goals or expectations?

Dana Messina

Yes, our piano inventory is exactly where we wanted to be. I think we, by and large now liquidated almost all of the inventory that we didn’t want to have all the excess finished goods. The only place we have some inventories over in the band side and I think that’s going to get corrected over the next couple quarters as our deliveries pickup. So we’re in pretty good shape in terms of our overall inventory and we expect it to be down at the end of the year versus the prior year. We caught up on the piano side and the band side, we will catch up as we get later in the year.

Arnold Ursaner – CJS Securities

Two more quick questions before I jump back in the queue. Dennis, what’s your view on tax rates for the year, please?

Dennis Hanson

It should be right around what you see in the quarter there, Arnie. 38% to 40% is a pretty good estimate for the year.

Arnold Ursaner – CJS Securities

Okay. And Dana, finally, on the band side again, your tone sounds much more upbeat than we’ve seen in quite a while. Perhaps could you talk a little bit about order trends that you’re seeing, how much visibility you have into, let’s say Q2 and Q3, was there a mix issue or you have a lot more professional instruments, just highlight more about your confidence in the outlook for the balance of the year, please?

Dana Messina

So our orders were up low double-digits over the prior year. So the order flow especially at the end of March, it’s very, very strong. So we feel pretty good that we’re going to see good order flow for the rest of the year and we will get deliveries out of our factories in the second quarter and third quarter. The mix is what we expected it to be. So there’s no real change there.

The new products, our new trumpets doing really well, our new clarinets that we’ve introduced is doing pretty well, so we’re making some good progress there. And overall, the band business seems to have stabilized in terms of dealer demand and our ability to operate our factories more efficiently has improved. So we feel pretty good about that business.

Arnold Ursaner – CJS Securities

Thank you very much.

Operator

Paul Sonkin is on line with the question.

Paul Sonkin – The Hummingbird Value Fund

With Hummingbird. Good morning, gentlemen. Dennis, a technical question. What were the actual shares outstanding at the end of the quarter? I know that you had weighted average in the press release.

Dennis Hanson

About 10 million.

Donna Lucente

10 million is the weighted average, it will be closer to 12 million for the remainder of the year.

Dennis Hanson

Yes.

Paul Sonkin – The Hummingbird Value Fund

Okay, so that’s 12 million. Okay. And then, Dana, in terms of the band side great margin improvement, I was wondering if you could sort of quantify where you are in the process of rightsizing the band division. I mean is that pretty much completed, maybe in terms of like square footage, I remember like you said at one point that you needed to remove a million square feet of manufacturing space from the U.S. I guess is there any more color that you could give us in terms of where we’re in that process?

Dana Messina

First of all, we started out with about a million square feet. We were trying to reduce it by half. And that’s where we’re. So we largely eliminated all of the plans that we needed to eliminate. We’ve largely got the production processes down where they’re fairly efficient. We still have more opportunity to make the plans more efficient and margins better by driving some of the lean initiatives and the continuous improvement initiatives that we got going on. But largely, we’re at the point where it’s really going to depend on our ability to drive sales through these plans. So to the extent that we get better volumes, we will be able to see better margins and better profitability out of that business. So five years that that we took rightsizing the business is largely done now. It’s just we got to get the sales guys to do their job.

Paul Sonkin – The Hummingbird Value Fund

Right. And I guess sort of take that a little bit further moving into the capital allocation question. I guess in the past, the band side has been a little bit more competitive. I believe because you said that there were competitors they were in distress, they were dumping inventory for cash. I guess could you comment on the competitive landscape and then comment more on capital allocation opportunities in terms of are you seeing any acquisition? And then even a broader question. You have a lot of cash on the balance sheet. What are you going to do with it?

Dana Messina

Yes, in terms of where we stand with, with acquisitions we’re seeing more opportunities in terms of acquisition flow. We have a couple of acquisitions calls later today. So, it’s definitely busier than it’s been in the last few years. The strong ones seem to be doing okay, the weak ones have largely, – I don’t want to say they disappeared but they’ve largely gone into the nuisance category at this point. So they really not affecting us that much.

Where we’re strong we’re doing very well. And where things like professional trumpets now that we’ve got that factory under control and the workers are doing good job quality wise. The margins are terrific and where the business is terrific. Where we don’t do as well with things like flutes, and other woodwind instruments whereas more competitive in our brands and our products have been strong. We continue to struggle a little bit but we’ve got good opportunities there and we’ll do better.

In terms of allocating capital we’ve got some cash, we’ve got a bunch of debt that we still have to deal with, but we’re in pretty good shape from that standpoint. We don’t have a lot of major investments to make in the band business in terms of our base business. But if we can get an acquisition at a good price, great. If we can, we can always pay down our debt whenever we want, so it’s not something we’re troubled by at this point.

Paul Sonkin – The Hummingbird Value Fund

Okay. All right, thank you very much.

Dana Messina

You’re welcome. And, Paul, thank you for all the positive comments about us.

Operator

Rick D’Auteuil is on line with the question

Rick D’Auteuil – Columbia Management

Hi, guys. A couple of things. Just the guitar center I know that hadn’t really come back. Is there any update there?

Dennis Hanson

They haven’t come back. I mean they’re still doing a little bit of business with us by and large they are running through other old inventories there. They are largely trying to do as much as they can with used band instruments. If that business improves it will be great for us. We’re running assuming that they’re going to stay kind of as they are.

Rick D’Auteuil – Columbia Management

They haven’t just gone to substitute products, it seems now it’s been a couple years I would think that the inventory be largely gone.

Dennis Hanson

They seem to be enamored with fixing used band instruments and trying to run those out.

Rick D’Auteuil – Columbia Management

Okay. What are you doing, maybe an update on the online stuff you might be doing? Is that at all meaningful at this point?

Dennis Hanson

We’re doing some, obviously, we have the archive business which is completely online, but we’re not in the online business on the band side. In terms of the pianos, we do generate a lot of sales leads from our Web site and we’re continuing to focus on that, improve our Web sites and our capabilities in that area and see it’s become more and more important for us to try and connect with our customers directly on the piano side, so we’ll continue to do that.

Rick D’Auteuil – Columbia Management

Okay. And then maybe the status of the financing market for your customers. I know you guys were out there as a bridge, at one point, you didn’t do a lot, but are you seeing more stability there, is there any additional players that have come into the market. Where does that stand?

Dennis Hanson

We haven’t seen anyone new really come in. We‘ve got some dealers that were financing directly now. GE Capital is still fairly active in the market. But by and large the stronger dealers that had they’re on financing, have been able to kind of muddle through with, with their local banks or using us or reducing their inventories, but it’s business is a lot more stable and the dealer base seems more stable and so we really haven’t had any issues that we had related to the balance sheets of our dealers and their ability to finance their inventory seems to have – we pass that.

Rick D’Auteuil – Columbia Management

Are there people you’re still or dealers you’re still turning away for credit purposes or is –

Dennis Hanson

Sure, I mean we have a lot of dealers and we’ve been very tight on credit, if you notice our losses on doubtful accounts are significantly lower than they’ve been years past, because we’ve been dramatically tougher on credit, and that will continue to be the case, but everything seems to be fine there.

Rick D’Auteuil – Columbia Management

Okay. That’s all I have. Thanks.

Dana Massey

Okay.

Operator

Arnie Ursaner is on the line with the question.

Arnold Ursaner – CJS Securities

Hi, just a couple of follow-up questions. Your other income line surprise me by quite a bit. Could you comment about some of the items that are in there and their sustainability?

Dana Massey

Okay. Let’s see. We have obviously the big piece is the rental income from Steinway Hall. We also had some little bits and pieces of we have some solar panels on the roof of our factory in Queens that we got a $200,000 from, we’re a little bit better on foreign exchange, we had a pick up there now.

In terms of sustainability it’s a tough question. Obviously the things like the solar panel that’s not recurring, foreign exchange it’s hard to predict, Steinway Hall will be much choppier going forward. I actually expect the income from Steinway Hall to a net negative for the remainder of the year. Unless we sign more tenants, as some of the leases roll over. But it’s going to be much harder to predict that other income line from years past, one it was really just Steinway Hall.

Arnold Ursaner – CJS Securities

And your piano revenues in the quarter were down, but I believe when you had gone through your fourth quarter call, you had indicated bands of the year could be up 7% to 12%, given your order trends and backlog, is that’s the number you’re comfortable with?

Dennis Hanson

Yes, I mean I think that’s what we’re seeing. In the high single-digits, it’s really more what we’re targeting.

Arnold Ursaner – CJS Securities

And going back to the piano business for a minute, you frequently shut your facility in the summer for kind of schedule vacation, but over the last few years we had a number of unscheduled production shutdowns. Can you give us your best sense right now of Q2 and Q3 shutdowns that are expected and how many days of production we might lose to –?

Dana Messina

In the first quarter we had no unplanned shutdown days. And for the rest of the year we took one week in April and I think that’s the only unplanned shutdown we saw on the U.S. side. The foreign guys are continuing to operate kind of four days a week, but we’ll have to see how our business holds up and as we manage inventories we’ll work that, but you can see what an impact it has on our margins when we actually operate the factories kind of a normal pacing.

Arnold Ursaner – CJS Securities

So normally that will take a week or two shutdown in the summer?

Dana Messina

Yes. We have three weeks. We take a normal three weeks shutdown.

Dennis Hanson

And we still do that.

Dana Messina

Those are all planned in our numbers, yes..

Arnold Ursaner – CJS Securities

I’m just trying to get a feel for last year, you took greater than the three weeks though, between Q2 and Q3, you had some additional unscheduled. I'm just trying to think about how margin trends might look on a year-over-year basis, if you can in fact operate more normally?

Dennis Hanson

I don’t have a lot of the details from last year, but if you look at any of the releases of the conference calls we would typically advise you when we had on plan, we do have quite a few unplanned shutdown weeks last year which was very painful. And we don’t expect other than the April month, as Dana mentioned, we don’t expect to have much in that category this year. So we should be fall in, in a much more favorable.

Dana Messina

I mean typically if we don’t have the unplanned shutdown it’s a couple of 100 basis points on the gross margin side on the domestic piano.

Arnold Ursaner – CJS Securities

I know it’s always harder in your business given the handmade nature of what you do to have sizable capital spending even if you’d like. Dennis, what’s your best view at this point for CapEx for the year and D&A for the year, please?

Dennis Hanson

Depreciation and amortization should run pretty consistent through the year, a year or two, 27 for the quarters so I would multiply that by 4, Arnie. The 500,000 was a little bit lower than (inaudible) was very, very tight quarter. We’ve been doing 3 million to 4 million over the last couple of years on a tight budget. I would expect that will ex the Hall that we would be in that range 3 million to 4 million. Now Steinway Hall, as you know, because we got a (inaudible) you’ve got to do capital expenditure associated with that, that, as Dana said, that’s a little bit choppier, there could be another couple million in closures stick with the Hall.

Arnold Ursaner – CJS Securities

And you mentioned, in terms of global trends for piano that China and Japan were strong, but the U.S. was weak. Can you quantify how far down you were in the U.S. in piano?

Dana Messina

Our sales domestically were flat.

Arnold Ursaner – CJS Securities

Okay. And pretty well balanced between your high end and entry level products?

Dana Messina

The high end was probably a little softer than the mid price. Consumers are a little bit weaker from what we’ve seen. So to the extent that on the margin they can buy a Boston instead of a smaller Steinway, where we’ve seen some of that, but our overall unit numbers for pianos were up as mid-June and sales were up modestly overall, but it was really led by Asia. The domestic stuff was largely flat.

Arnold Ursaner – CJS Securities

Thanks, again.

Operator

Paul Sonkin is on line with the question.

Paul Sonkin – The Hummingbird Value Fund

Yes, I just had a follow-up in terms of your growth plans overseas. I guess sort of like longer-term sort of what can we expect? Are there opportunities for growth outside of Japan and China? I guess is it just on the piano side or do you see growth in the band side of the business abroad?

Dana Messina

In addition to China, there are other pretty good opportunities for us, in Russia, Brazil, and some in India. Although India will be a lot smaller, but there are Brazil is starting to pick up and it’s becoming a real market for us and Russia is choppy but when commodity prices are strong, we’ve seen a real good market there. In China, China is the biggest piano market in the world. And as their consumers and their population becomes wealthier it could be a very significant market for us. It could rival the U.S. in terms of size.

Paul Sonkin – The Hummingbird Value Fund

And what about on the band side?

Dana Messina

The band side, we’re distributing through I think 57 different dealers in China. It’s largely a professional market for us. And again, as incomes pick up there, and our products are more affordable for their consumers, we should do well, especially with our brass instruments. We’re doing pretty well there and our business is growing, but it could be a lot better, it’s still relatively small, I want to say it’s less than on our band sales is probably 2% or 3% of our business and it could be a lot higher than that.

Paul Sonkin – The Hummingbird Value Fund

And that would even increase your margins further because the margins on your higher end instruments are much larger than your lower end?

Dana Messina

Right.

Paul Sonkin – The Hummingbird Value Fund

And I guess that would also fill up the factories. Are you manufacturing any high end instruments abroad or is it all domestic?

Dana Messina

It’s all domestic.

Paul Sonkin – The Hummingbird Value Fund

Okay. All right, thank you.

Dana Messina

In terms of band. Piano there obviously we have Hamburg plant.

Paul Sonkin – The Hummingbird Value Fund

Right. Thank you.

Operator

We have no further questions at this time.

Dana Messina

All right, everyone. Thank you and we’ll talk to you again next quarter.

Dennis Hanson

Thank you.

Operator

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

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