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Steinway Musical Instruments Inc. (NYSE:LVB)

Q4 2007 Earnings Call

March 5, 2008 5:00 pm ET

Executives

Dana Messina – CEO

Dennis Hanson – CFO

Donna Lucente – Corporate Controller

Analysts

Arnold Ursaner - CJS Securities

Mimi Noel - Sidoti & Company

Lance James – Voyageur Asset Management

Lawrence Goldstein - Santa Monica Partners

Rick Tortell - Columbia Management

Sandy Goldman - Hartline

Operator

Good afternoon ladies and gentlemen, thank you for standing by. Welcome to the fourth quarter 2007 earnings release conference call for Steinway Musical Instruments. (Operator Instructions) This afternoon the company issued a press release disclosing financial results for the quarter and 12 months ended December 31, 2007. If you have not 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, impact of dealer consolidations on orders, ability of new workers to meet desired production levels, exchange rate fluctuations, variations in the mix of products sold, market acceptance or new product and distribution strategies, ability of suppliers to meet demand, concentration of credit risk, fluctuations in the effective tax rates resulting from shifts in sources of income and the ability to successfully integrate and 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 which are considered to be non-GAAP terms. These measures present operating results on a basis excluding non certain comparable items. Reconciliations of these measures to the most comparable GAAP terms are available on the company’s website, www.steinwaymusical.com.

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

Dana Messina

Thank you for joining us. As always I have Dennis Hanson with me. We also have Donna Lucente today as Dennis’ voice is still on the sidelines.

Overall the results for the quarter were very good. We had basic earnings per share of $0.91, that’s up from $0.13 in 2006. The strike related charges continued to decline. They totaled about $500,000 this quarter or about $0.03 a share. We did not add those back to the adjusted EBITDA numbers that you see in the press release.

Sales for the quarter were $121 million, up 14%. Gross profit was up 23% over last year and gross margins had a nice increase for the quarter, they came in at 32.6% compared to 30.4% last year. Our operating expenses were down 7% or $1.9 million. Most of that was from a reduction in bad debts but other than that, they increased about 4%.

Adjusted EBITDA nearly doubled and was $18.3 million compared to $9.3 million last year. Our capital expenditures for the quarter were $1.3 million, a slight decrease from last year.

Over to our balance sheet it remains in good shape. As of today after recently paying interest on our bonds we have about $24 million in cash. Our inventory was down about $2 million year over year and we hope to continue to make some progress there.

Looking at the piano business it was very, very good year for pianos. Our piano sales for the quarter were $76 million; they were up $4.8 million or 7%. Steinway Grand units were up 1%. They were up 7% overseas but down 4% domestically. And as expected the US institutional sales have been holding up well in this climate. Our mid-price units were down 10% overall. They were up 16% overseas but down 22% domestically. We sold a high number of mid-price instruments in the fourth quarter last year, after our summer relaunch of Essex which included a lot of channel sales. So we were going up against a very tough comp so really the mid-priced business was better than it actually looked on the statements.

Piano gross margin was 41.3%, up from 37.5% in the fourth quarter last year. This was the result of several factors. Our higher margin overseas operations had just a fantastic quarter and they’ve become a larger portion of our total piano segment results. Domestically we sold some limited edition pianos this year which also carry a high margin and compared to the fourth quarter last year, we sold fewer mid-priced pianos so overall that’s a positive mix for us and boosted our overall gross margin percentage.

On the band side, band sales were $45 million, up from $35 million or a 30%. Unit sales of brass and woodwind instruments were up 13% for the quarter. Sales of professional trumpets and trombones continued to recover from the strike and were up $6.5 million over the fourth quarter in 2006. Production is running at well over 100 units per day in our Elkhart brass plant.

Band gross margin was 18.1%, up from 15.9% last year. The improved margin is primarily the result of increased sales of professional brass instruments.

The outlook for the band business, the band business appears to be stable. We don’t believe it is greatly affected by the general economy so we remain cautiously optimistic. We’ve also decided to consolidate and shut down one more plant; our small plant that makes instrument cases. Winding down production at that plant will cost us about $400,000 in 2008 but we expect annual cost savings of about $600,000.

The piano business, we expect our overseas operations to have another good year. Based on the economic climate in the US we believe the domestic business will be softer than 2007.

I also wanted to provide a brief update on Steinway Hall. Since there’s been a great deal of interest and speculation about our Steinway Hall building in Manhattan, I’ll provide the following update but I will not be taking or answering questions about it after the call. After extensive negotiations we’ve reached an agreement in principle to sell a majority interest in Steinway Hall. We will keep our existing retail space. Here are the key elements of the deal.

We will receive cash totaling $22 million paid out over four years. We will retain a vast majority of our existing space which we think is incredibly valuable. The rent that we currently pay under our space lease and the payments that we currently make under the land lease will terminate upon the closing of the deal. And the master lease on the building under which we receive rent will also terminate. I would just like to emphasize that no documents have been executed and that even after execution several contingencies and conditions remain which could prevent closing. However we are optimistic that we will be signing an agreement in the near future and at that point we will provide further details. We anticipate that the transaction will close within the next 60 days.

Now with that, we’ll open it up for questions.

Question-and-Answer Session

Operator

Your first question comes from Arnold Ursaner - CJS Securities

Arnold Ursaner - CJS Securities

Good afternoon. How are you both? So Dana just to make sure I heard these numbers right, the atypical expenses for Elkhart were $500,000 in the quarter?

Dana Messina

Correct.

Arnold Ursaner - CJS Securities

And just to clarify, can you repeat what you said about the bad debt reduction?

Dana Messina

The bad debt, well what I said was our operating expenses were down 7% and most of that was due to reduction in bad debts but our core expense level went up by about 4%.

Arnold Ursaner - CJS Securities

Okay so just remind us, what was the bad debt expense last year and what is it this year please?

Dana Messina

Down about $3.5 million on the quarter.

Arnold Ursaner - CJS Securities

And just, I know you don’t want to say too much more about the building, but just to help us better understand how this could impact your financials, if I were to walk through your financials, remind us where you have the expenses related to the rental you have and the lease payments you get, kind of how the math would work on your rental payments and the money you get in on the lease payments if you will.

Dana Messina

So, it all really, the lease payments that we receive under the master lease and the payments we make under the land lease are contained in other income and expense and then the rent we pay on the space is in our operating expenses.

Arnold Ursaner - CJS Securities

So we should expect the other to essentially disappear and we should also expect the rental expense to be wound down, should be a reduction in your expenses from the rental?

Dana Messina

Correct.

Arnold Ursaner - CJS Securities

Okay. And are, would you want to put any quantification on that or is it too premature?

Dana Messina

It’s too premature.

Arnold Ursaner - CJS Securities

Okay and final question I have for right now is on the piano side, domestic sales have certainly been slowing or challenging, what if any steps are you planning to take on inventory reduction and should we assume or expect that you’ll shut down the Astoria plant better balance inventory during the first half of this year?

Dana Messina

You know, we’d like to take out more inventory whether it was, whether we think 2008 will be a good year or a bad year so we’re committed to take out some inventory and I think that’s going to necessitate taking some weeks out of production. We haven’t come up with a final figure on that but my expectation is that some production will come out to bring these inventories in line. In addition to that I think we believe the domestic business will be slower in 2008 than 2007. Although, you know sales at our own retail stores through February has been quite strong. Our dealer sales haven’t been quite at the same level we’ve achieved, but you know, that being said we read the newspapers like everyone else and we sense that’s there’s a little softness out there.

Arnold Ursaner - CJS Securities

And just if you can, can you update us on production numbers from Elkhart please?

Dana Messina

They’re running on average about 115 horns a day and we’ve hit numbers as high as 150 horns in a day. So that plant is really operating and doing very, very well. The quality levels have been good. Our customers are happy and we’re catching up on our backlog very quickly.

Arnold Ursaner - CJS Securities

Okay, thank you very much.

Operator

Your next question comes from Mimi Noel - Sidoti & Company

Mimi Noel - Sidoti & Company

Most of my questions have been answered but I noticed that there was an expense on the provision for doubtful accounts higher than in prior quarters. I thought that might be winding down, can you elaborate on why that’s there and why it’s growing?

Dana Messina

We always have some provision for doubtful accounts. Most of it comes from the band business because by and large, on the piano side we don’t take a lot of credit exposure but some of our band dealers have found the economy a bit challenging but it’s still not, we’re always going to have some but I don’t think it’s that big a number.

Mimi Noel - Sidoti & Company

Okay and then I do have one or two more questions. In looking at that consolidated gross margin, it looks like it’s the best you’ve had in recent years, can you give me any sense of how sustainable that is or is that a matter of all the stars aligning and you wouldn’t necessarily plan on doing that for quarters to come.

Dana Messina

Well I mean, you can, you start with the basic understanding that our highest margin business comes from Concert Grand Pianos that we sell overseas, followed by Grand Pianos that we sell overseas, followed by domestic Grand Pianos on the Steinway side and then there are lower margins on Boston business and Essex business. So theoretically the highest gross margins, if we could do nothing but sell Concert Grands in our foreign operations and nothing else, that would theoretically have the highest margins. But that’s now how we operate so the mix affects the margins greatly so to the extent that our foreign business is growing and doing very well, our margins are going to be higher. Do I think we are going to see that continue next year? Sure I think the foreign business will do better than the US business. You know the one thing on the foreign side that I’m worried about is the strength of the euro. Obviously as the euro continues to strengthen against other currencies it makes our product more expensive but we haven’t seen any considerable push back in our demand in places like China based on the currency so we’ll see how the year plays out.

Mimi Noel - Sidoti & Company

Okay and the only other thing I wanted to ask is your cash from operations, that’s in the press release but the CapEx actually you provided that for the quarter as $1.3 million?

Dana Messina

Correct.

Mimi Noel - Sidoti & Company

I just want to make sure I understand the history of the balance sheet, you’re average borrowing was actually higher this year but and I think your cash balances were lower than last year but your interest expense was also lower. Was that just from the refinancing that took place in 2006?

Dana Messina

The refinancing drove the rates down so our interest expense is down because of the refinancing. The balance moved around a little bit. It might have been higher this year than last year because we paid out a $25 million dividend that we didn’t pay out in the previous year.

Mimi Noel - Sidoti & Company

Okay. That’s everything that I have for now, thank you.

Operator

Your next question comes from Lance James – Voyageur Asset Management

Lance James – Voyageur Asset Management

Congratulations on a great quarter. Had two questions, one is you’re margin improvement was tremendous. I guess my question is at Elkhart now, should we anticipate that you’re pretty much operating there at if not peak efficiency kind of at the upper end of efficiency levels or do you think that there still is some gross margin improvement potential there just through more efficient manufacturing?

Dana Messina

I think overall on the band side, we have a lot of potential for gross margin improvement. You know we have to do a lot of executing better. We’re getting the production out of the plant. The margins are on what we’re producing are good. But I’m not going to sit here and tell you we’re at peak operating efficiency. I think we still have a ways to go. You know at 20% or so margin in the band business is still not acceptable to us and that’s driven in large part by the fact that we still have too many plants and as we consolidate those that margin will get better. But the one, the facility that was on strike, those margins in that production is very, very good right now.

Lance James – Voyageur Asset Management

Terrific. Second question, just sort of more general in nature is, in terms of your piano sales internationally, was there a significant difference between the market in Europe and your sales there and then your markets in Asia, any comments or color you can give us?

Dana Messina

Well you know, Europe was, when we take Europe as a whole, it was pretty good. You know Western Europe was softer than Eastern Europe on a percentage basis. Eastern Europe was very strong and Asia was you know, unbelievable. You know our Steinway Grand units were up 100% in China in the fourth quarter. So it’s a good market for us right now.

Lance James – Voyageur Asset Management

Thanks again, congratulations.

Operator

Your next question comes from Lawrence Goldstein - Santa Monica Partners

Lawrence Goldstein - Santa Monica Partners

I tuned in late so if you answered the question forgive me, did you say anything about the real estate, the building 57th Street and if not last call you basically told me if you have something to say, you’ll say it. So do you have anything to say more than that?

Dana Messina

You know when you get the transcript you’ll be able to see.

Dennis Hanson

Yes, you tuned in late and you missed the update.

Lawrence Goldstein - Santa Monica Partners

My hard luck, thank you.

Operator

Your next question comes from Rick Tortell - Columbia Management

Rick Tortell - Columbia Management

Good job, I’ll also pass that along. On a big customer last year that had some company-specific stuff that hurt you, Guitar Center, is there an update that you can provide there?

Dana Messina

They continue to do business with us. Their new owners at [Dean] are very focused on reducing working capital and so we’ve seen some of that has been passed on to us so our business with them hasn’t been quite as good as we had hoped but we’re still doing a considerable amount of business with them.

Rick Tortell - Columbia Management

Is there a way for you to track their inventory in the instruments or, so that we know when that becomes normalized they have to come back to the well or …

Dana Messina

We have a pretty good sense of what their inventories are from the management team there and I think their owners at [Dean] remind them probably on an hourly basis what their inventory positions are and how they want them lower.

Rick Tortell - Columbia Management

Okay so we haven’t reached the steady state yet I guess.

Dana Messina

Not yet.

Rick Tortell - Columbia Management

Okay, that’s all I have, thanks guys.

Operator

Your next question comes from Sandy Goldman - Hartline

Sandy Goldman – Hartline

Dana if in fact the real estate transaction goes through as you discussed, what is the tax implication on the $22 million spread over four years?

Dana Messina

You know that will be included in our income and we’ll be having to pay taxes on it.

Sandy Goldman – Hartline

Normal, regular corporate tax rate, whatever that is?

Dana Messina

Right.

Sandy Goldman – Hartline

Thank you.

Operator

Your next question is a follow up from Arnold Ursaner - CJS Securities

Arnold Ursaner - CJS Securities

Can you give us the percent of your band revenues that were from offshore production please?

Dana Messina

It was a little bit lower than normal Arnie because I think we were back ordered quite a bit with some of our suppliers. We didn’t get all we needed so it was running around 35%.

Arnold Ursaner - CJS Securities

And with the agreement you have in place, I don’t think you spoke at all about order trends, could you comment on that?

Dana Messina

We’re in pretty good shape order wise. We don’t typically give you our orders but you know as I said the band business remains pretty stable and we’re cautiously optimistic about it.

Arnold Ursaner - CJS Securities

And again going to the tremendous margins you had in band, typically if I recall you tend to ship more professional instruments in Q1 than you tend to ship in Q4 on a mixed versus student, is that a fair assessment and if so wouldn’t that if anything lead to higher margins?

Dana Messina

Well really most of the professional instruments historically went out in Q4 but because of the big backlog we have Arnie, we’re shipping them as fast as we can make them so you know Q4 because we had good production was higher than Q3. Q1 because our production is going to be higher than Q4 I expect our sales of professional instruments will be better and our margins will be higher.

Arnold Ursaner - CJS Securities

Okay, Dennis tax rate for the year? I know you like to provide it if you can on the public call, so what is your thought on tax rate please?

Dennis Hanson

Donna, what’s your view?

Donna Lucente

I guess Arnie we would tell you that the rate that we’re showing this year for the year would be a good rate in general terms, give or take a percentage or two, to expect for 2008.

Arnold Ursaner - CJS Securities

Okay and CapEx and D&A please for the upcoming year?

Dana Messina

The CapEx about five to six and depreciation and amortization runs about $11 million.

Arnold Ursaner - CJS Securities

Okay, I think that’s it for now, thank you.

Operator

Your next question is a follow up from Mimi Noel - Sidoti & Company

Mimi Noel - Sidoti & Company

Just one last one, Dana I think you previously said that you have excess manufacturing capacity on the band side to the tune of $300,000; I think that’s a dated number. Could you update that or give us a sense of just how much you can scale back in terms of your capacity?

Dana Messina

Well I mean what we’ve told people is that you know we think that we have about 300,000 feet of excess space. We announced in December that we were closing a plant in Kenosha, Wisconsin. At the top of my head I forget how big that plant is; 70,000 feet. And then we announced on this call that we’ll be shutting down our instrument making facility which is small, I think its in the 10 to 20,000 feet range. So we probably have 200,000 feet to go.

Mimi Noel - Sidoti & Company

Okay sure, I get the idea, that’s helpful. Thank you very much.

Operator

Your next question is a follow up from Arnold Ursaner - CJS Securities

Arnold Ursaner - CJS Securities

Let’s expand a little bit on your internet strategy, I know at one point obviously you tried to acquire your way into the business, what are you thinking these days?

Dana Messina

On?

Arnold Ursaner - CJS Securities

On the internet sales of instruments.

Dana Messina

You know, we tried that and because there was a nice opportunity out there to the extent that we seen other opportunity that will work for us with our dealer base, we’ll pursue it but we don’t have anything in the hopper right now.

Arnold Ursaner - CJS Securities

Going back to the whole atypical expenses, I guess looking forward in to ’08 should we assume any additional atypical expenses out of Elkhart in Q1 or through, you know, what should we be thinking about on Elkhart atypical expenses?

Dana Messina

Just I mean we’ll have some Arnie but they’ll be small. They’ll you know, be under $0.50 million.

Arnold Ursaner - CJS Securities

Per quarter or for the first half?

Donna Lucente

I think Arnie as you recall we mentioned the closure of the Kenosha plant, we anticipate cash costs for that about $1 million and if you recall just consolidating a terminated plant or a closed plant into an existing plant always causes some disruption. So we do expect to have a little bit of inefficiency that’s going to happen. We won’t know how that’s really going to turn out until ultimately we get the plants consolidated and we anticipate that in June.

Dana Messina

You know my guess Arnie is maybe $0.50 million for the year from the strike plant and maybe $3 million or so from the plants we’re shutting down.

Arnold Ursaner - CJS Securities

I guess no one’s really point blank asked you, in the past you’ve been a little exposed in the piano sales to housing with some lag and obviously we’ve had housing be atrocious, what correlation do you think you have if any these days to housing?

Dana Messina

You know once housing became volatile and disassociated itself with past kind of trends; you know we really haven’t followed it much at all. I mean at the end of the day the people that buy Steinways have by and large played piano for 30 years so the fact that we’ve gone through this housing bubble and the bursting of it really hasn’t had an affect on them unless obviously they’re real estate brokers. In our domestic institutional business has been very strong. So you know our piano business continues to kind of chug along. We’ll definitely get affected by a tough economy but it hasn’t been bad. January and February in our own retail stores, our sales were up low double-digits over last year. So we definitely haven’t seen at least thus far what everyone else is seeing. Is that sustainable? I don’t think so. Do I think it’s going to be a little bit softer? Yes but we’re not going to feel the full affects of this housing issue. And we didn’t get the full affects of the up and we’re not going to get the full affects of the down.

Arnold Ursaner - CJS Securities

Institutional demand, what are you seeing there?

Dana Messina

It’s good, it’s still very strong. We have a pretty good book-of-business. We have a lot of institutions in the hopper. They like the program and we’re doing well with it so it continues to grow and it continues to be a nice stable part of our business. And our growth has been in the mid single-digits on it so…

Arnold Ursaner - CJS Securities

Have you had any Steinway schools of note in the quarter?

Dana Messina

You know I didn’t write down the name of the school but I know we got a big school in China for something like 17 Steinway Grand Pianos but I forget who it was.

Arnold Ursaner - CJS Securities

I’m all done, thank you very much.

Operator

And as there are no further questions I’d like to turn it back to your host for any closing remarks or statements.

Dana Messina

Alright everyone I think it was a good quarter. We look forward to having on our calls the rest of the year. Thank you very much.

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Source: Steinway Musical Instruments Inc. Q4 2007 Earnings Call Transcript

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