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Steinway Musical Instruments, Inc. (NYSE:LVB)

Q2 2008 Earnings Call

August 5, 2008 5:00 pm ET

Executives

Dana Messina - CEO

Dennis Hanson - CFO

Donna Lucente – Corporate Controller

Analysts

Arnold Ursaner - CJS Securities

Andrew Berg - Post Advisory Group

Mimi Noel - Sidoti & Company

Jason Horowitz - Muzinich

[Chase Stalk] - Chesapeake Partners

Brian [Vonhurst] - Prudential

Operator

Welcome to the second quarter 2008 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 six months ended June 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 second quarter conference call and financial review. I’m here with Dennis Hanson and Donna Lucente. We’ll try to make the call brief, hit the highlights, and then turn it over to you guys for questions.

Overall results for this quarter were pretty good and generally better than our expectations. For the quarter we had earnings of $0.35 per share and adjusted earnings of $0.47 per share, and those figures compared to earnings last year of $0.37. Sales for the quarter were $99 million, up 7%. Gross profit was $29 million, up 2% over last year. Our gross margin was down 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.

The cost of discontinued band facilities also impacted our operating expenses. Without those impairment charges, our operating expenses would have been up only 3%. Adjusted EBITDA was $11.2 million, up 4%. Capital expenditures were $1.3 million for the quarter, a decrease of about $200,00 from last year. The balance sheet continues to be in very good shape. We ended the quarter with about $29 million in cash and our inventory was down about $9 million from last June.

For the piano highlights, piano sales were $57 million, up 4%. Our piano business performed as we expected it to. Overall, Steinway Grand units were flat with second quarter of last year. We were up 10% domestically but still below historical averages. Institutional sales have been holding up very well in this market. We were down 9% overseas but that’s because last year we had a tough comp with the sale of 55 pianos to an institution. If you adjust for that, our overseas sales would have been up about 10%. So that market continues to do well.

Our mid-priced pianos were down 15% for the quarter. We were going up against a tough comp last year where we had a fair amount of pipeline filling, particularly overseas when we re-launched our Essex line. Piano gross margin came in at 35.1%. That was down from 36.7% last year. We’ve reduced both the production rate and the number of production days at our New York plant as we try to get our inventory in line. The factory was off for 16 days during the quarter. This includes 6 days that were not incorporated into our original production plan. The unplanned days impacted our margins this quarter by about 70 basis points. Our margins on Boston pianos continue to be impacted by the weak dollar, making that part of the market somewhat difficult for us.

Band highlights: band sales were up 8% to $41 million. In the second quarter we had increased revenues in all our major product categories. Shipments of pro instruments have returned to normal levels and we are up slightly on a year to date basis. Band gross margins were 21.8% down from 22.7%. We had about $600,000 in severance costs from plant closures and if you adjust the margins for that, they were 23.2%, an increase over last year, so we continue to make progress.

As far as outlook on the band side, at this point our band facility rationalization is nearing completion. Consolidation costs have been at or lower than we expected. As far as atypical charges, we have a party now interested in purchasing our Elkhorn plant that we shut down earlier and assuming that sale goes through in the third quarter, we expect to incur only a few thousand dollars of severance costs in the quarter related to that plant. We anticipate a good back to school season for our student business and we expect gross margins to be better than last year.

On piano, while we were weathering the economic climate better than our competitors, we’re cautious about the piano market in general. For the second half of the year we expect our piano sales to be about the same as last year. We’re operating at a lower daily rate than last year at our New York factory so that will continue to have pressure on our gross margins, but we will work to keep our inventories in line.

That’s the end of our formal presentation and we’ll open it up now for questions.

Question-and-Answer Session

Operator

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

Arnold Ursaner - CJS Securities

Focusing a little bit on the New York piano plant, you mentioned you had six unplanned days that were shut and you had 16 days that it was shut in total?

Dana Messina

Right.

Arnold Ursaner - CJS Securities

I thought we were looking perhaps more than another week or two of complete closure of the facility during the quarter. Are you finding that you can do this on a more reduced production schedule rather than just shutting the plant?

Dana Messina

We’ve been handling it by really taking out extra days so the six extra days that we took out really is what reduces the rate..

Arnold Ursaner - CJS Securities

You mentioned in Q3 and 4 you intend to continue to have a reduced production schedule. You mentioned a lower daily rate but you normally have a one week closure in the summer. Are you planning to go beyond that one week closure at this point?

Dennis Hanson

It’s normally three weeks in the summer and right now we’ve not announced any other additional shut downs.

Arnold Ursaner - CJS Securities

Okay. I was a little unclear on your comment regarding the Elkhorn plant. This is not the one that had the lengthy strike, is it?

Dana Messina

No, that’s Elkhart. Elkhorn is in Wisconsin. It’s much smaller. We shut it down earlier this year and we’re now just going through the process of disposing the assets.

Arnold Ursaner - CJS Securities

I have a couple for Dennis if I can. Dennis, can you give us CapEx and D&A for the quarter and your comments or views on the balance of the year?

Dennis Hanson

CapEx, I think we mentioned, was $1.3 million for the quarter which is down a little bit and depreciation and amortization about $2.8 million for the quarter. We expect it to stay pretty much in line with historical numbers, Arnie.

Arnold Ursaner - CJS Securities

My final question if I can, I noticed you have a new category in your revenue components called online music sales. Can you tell us a little more about what it is and perhaps give us an idea of what we should expect in that going forward?

Dana Messina

It’s really a very small business that helps us generate traffic in our different music businesses. It’s called Arkiv Music, A-R-K-I-V, ArkivMusic.com if you want to visit the website and buy some music, but it’s a completely classical music focus seller of old classical recordings and it fits right into our customer base at Steinway. But it’s tiny. I think we did less than $1 million of revenue in the quarter.

Operator

Your next question comes from Andrew Berg from Post Advisory Group.

Andrew Berg - Post Advisory Group

Refresh my memory on that Elkhorn facility. Was that owned or leased, and if it’s owned, any estimates of value as you try to dispose of it?

Donna Lucente

That facility is owned. We took an impairment charge of about $200,000. We only have a few hundred thousand dollars left of net book value so we don’t have a lot of exposure there.

Operator

Your next question comes from Mimi Noel with Sidoti and Company.

Mimi Noel - Sidoti & Company

Do you anticipate any material increases in the sales and marketing expenditure going forward in your effort to convey the Steinway brand as something more accessible to affluent consumers?

Dana Messina

I think that our sales and marketing is pretty extensive in terms of reaching our customer base. We don’t have any near term plans to change it.

Mimi Noel - Sidoti & Company

Just so I understand, are you trying some new things with sales and marketing?

Dana Messina

Always. We always try new things, new ways of reaching people, new ways to generate publicity for our product. That’s something we’ve been doing for over a century now.

Mimi Noel - Sidoti & Company

Okay, but you’re not increasing your efforts there?

Dana Messina

No.

Dennis Hanson

We could be more effective but we’re not doing anything out of the ordinary.

Mimi Noel - Sidoti & Company

Then the other question I had if you’re winding down on the facility rationalization, beyond that, there is still room for improved productivity, correct?

Dana Messina

Sure.

Mimi Noel - Sidoti & Company

Do you have any long range objectives for your gross margin in the band segment?

Dana Messina

We’ve told people that before we had this heavy competition coming from Asia that the band business operated with gross margins in the high 20s and so we’re committed to try to get back there.

Mimi Noel - Sidoti & Company

Okay, and you’re not backing away from that at all?

Dana Messina

No, not yet.

Operator

We’ll go again to Arnie Ursaner with CJS Securities.

Arnold Ursaner - CJS Securities

Dana, we’re hearing a lot about stat e and local governments under tremendous budget pressure and one of the drivers of your band business is the school instrument business. Are you seeing any impact of that yet at all?

Dana Messina

No. Our orders have been holding up extraordinarily well. We see the business being pretty firm this year so we don’t really see it much on that side. The only place we see these local governments attacking us hard is really more on the tax revenue side. That’s more drama for us than the band side. The demand for the business has been very good. We’re pleased with it.

Arnold Ursaner - CJS Securities

And going back to Elkhart, not Elkhorn, but Elkhart, can you give us the production rate there? You mentioned you sort of --

Dana Messina

We were running at about 120 a day and we have been for the last three or four months, so it’s running right where we told people we would get it to and it’s doing really well and the product quality has been great.

Arnold Ursaner - CJS Securities

And you’ve worked down the backlog you’ve had there by a fair amount?

Dana Messina

By a fair amount, yes. We’ve caught up on a lot of the old orders.

Arnold Ursaner - CJS Securities

And final question, your ability to bring in imported goods, can you freshen up the status of that either as a percent of your product or?

Dana Messina

You know, I don’t have a percentage number, but we’re definitely starting to get a better flow of product from Asia. For people that weren’t familiar with it, they were probably $8 million or $9 million behind in orders that we could have shipped and we’re starting to get that product in early in the second quarter but we’re getting a pretty good flow now, so hopefully that issue will be behind us by the end of the fourth quarter.

Arnold Ursaner - CJS Securities

Given most of the back to school sales occur in I guess August, September, October , can you give us a feel for whether these products are likely to be in the dealer’s hands?

Dana Messina

The dealers are going to get, obviously we’re going to turn around everything that we get from Asia. We’re not going to be able to fill all the orders that we have for back to school. We have some substitute products that we’ve made here in the US ourselves, but it would have been better if we could have had everything we needed, but we’ll get a fair amount of it and we’ll be in pretty good shape and I think the back half of the year for band is going to be pretty good.

Arnold Ursaner - CJS Securities

The last time you spoke about the property on 57th Street, you indicated that you were not very optimistic that a sale would occur. Can you update us on the status, please?

Dana Messina

It hasn’t changed. The real estate market hasn’t gotten any better for the financing, so we’re in the process of negotiating new leases with some of the tenants, but at the same time, we’ve not concluded an end to the sale process but we’re pursuing both of them and my expectation is at this point we’ll lease up the building to most of the present tenants and that’s where it will end up, but we’ve not killed the sale but it’s definitely on life support.

Operator

Your next question comes from Jason Horowitz with Muzinich.

Jason Horowitz – Muzinich

Just a couple of quick questions. First, the $900,000 that you referenced in the press release associated with the fixed impairment charge, is that part of the $1.062 million in other expenses that’s added back to EBITDA or is that separate?

Dana Messina

It’s part of that.

Jason Horowitz – Muzinich

Okay, that’s what I thought, and Elkhorn, did I hear you right, that you said the estimated proceeds would be a couple hundred thousand dollars from the sale?

Donna Lucente

We said the estimated remaining value on the books is a couple hundred thousand. We’re still in negotiations for the purchase.

Dana Messina

It ‘s not a material number.

Jason Horowitz – Muzinich

And then the outlook for pianos kind of being flattish in the second half. What gives you the confidence there? Is that just basically on some orders or is it international demand, the outlook there? Just any color on that.

Dana Messina

I guess flat is the new up. Usually you don’t need a lot of confidence to be flat.

Jason Horowitz – Muzinich

Right. Well, nowadays, flat is good, right?

Dana Messina

Maybe to you guys. I view it as being particularly bullish. Our overseas business is holding up pretty well. To give you an example, our Steinway Grand sales in China for the quarter were up 100%, for the year to date they’re up 140%. So there are some places in the world that aren’t experiencing the same drama that you guys in New York seem to be experiencing, so with China doing well, Eastern Europe doing well, South America’s doing well, the United States is definitely choppy but overall, I think we’ll muddle through and be flat.

Jason Horowitz – Muzinich

And then just lastly on free cash, generally you guys generate a lot of cash in the second half of the year, although I guess it’s going to be more in the fourth quarter. Any reason to assume that this year would be any different in terms of the timing of working capital or any other payments?

Dana Messina

No, business as usual on that front. We’re in a pretty good cash position now. We don’t expect the cash flow to be drastically different. We’ve done a better job managing inventory so if we continue to do that we’ll be in pretty good shape at the end of the year.

Operator

Your next question comes from [Chase Stalk] with Chesapeake Partners.

[Chase Stalk] - Chesapeake Partners

Two real quick questions for you. One, what are the trends you’re seeing in the retail environment in the US for July? I know we’re a month and a bit through the third quarter now.

Dana Messina

July has been relatively slow from what we can see. It’s always hard for us to get a read on traffic with just one month. Our own company-owned retail stores have been doing I think fairly well this year. They seem to be doing... They’re down a little bit, but just marginally over the prior year. July was definitely a slow month but July is not a good leading indicator in the piano business. Schools are out, vacations, everything else, factory shut downs. We don’t have a lot of promotional activity.

[Chase Stalk] - Chesapeake Partners

Did you guys buy back any stock in the quarter? I know you put a buy back in place.

Dana Messina

We did. We bought back about $700,000 worth of stock. 67,000 shares I guess. We have a 10-B-5 plan out there and we buy, it’s on autopilot, whenever the stock is at a certain price, they buy some every day.

Operator

We’ll go again to Mimi Noel with Sidoti and Company.

Mimi Noel - Sidoti & Company

Thank you. Looking towards the second half, can you tell me the number of production days that you’ve assumed for 2008 versus 2007? What kind of a fall off in production are you assuming? Or can you not talk about that?

Dana Messina

We’ve told people we’re going to have more shut down days in the third and fourth quarter. We really don’t release the number because that’s a discussion that we have to have with our union. So when we announce it to the union and the employees, then we’re comfortable telling you guys what we’re up to.

Mimi Noel - Sidoti & Company

And then I think the last question for me would be can you break out what domestic Steinway Grand sales were in the US if you back out institutional in the second quarter?

Dana Messina

You know, I don’t have that number with me. I don’t have it to back up the Steinway Grands.

Operator

Your next question comes from Brian [Vonhurst] with Prudential.

Brian [Vonhurst] – Prudential

You guys paid the special dividend last year. Obviously the share repurchase authorization is out there. Can you just talk about preferred uses of free cash flow in the back half of the year?

Dana Messina

We’ve always told people to the extent that we find acquisitions or we have opportunities to pay down debt, we’ll go after those, and if we don’t have those, then we tend to try and turn around and return the cash to the shareholders one way or the other, so I don’t think we have any change in heart with what we do with our cash.

Operator

It appears we have no further questions.

Dana Messina

Thank you and we’ll talk to you next quarter.

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