Steinway Musical Instruments Management Discusses Q1 2013 Results - Earnings Call Transcript

| About: Steinway Musical (LVB)

Steinway Musical Instruments (NYSE:LVB) Q1 2013 Earnings Call May 8, 2013 5:00 PM ET

Executives

Jody Burfening - Managing Director and Principal

Michael T. Sweeney - Chairman, Chief Executive Officer and President

Julie Theriault

Dennis M. Hanson - Chief Financial Officer, Senior Executive Vice President, General Counsel and Secretary

Donna M. Lucente - Principal Accounting Officer, Vice President and Controller

Analysts

Richard D'Auteuil

Eugene Fox - Cardinal Capital Management, L.L.C.

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Steinway Musical Instruments Q1 2013 Financial Results Conference Call. My name is Matt, and I will be your operator for today's call. [Operator Instructions] As a reminder, today's conference call is being recorded for replay purposes.

I would now like to turn the call over to your host, Jody Burfening of LHA. Please go ahead.

Jody Burfening

Thank you, Matt, and thank you, everyone, for joining us today. This afternoon, the company released its financial results for the first quarter ended March 31, 2013. If you have not received a copy of the earnings release, you may download it from the News section of the company's website, steinwaymusical.com.

Today's call will begin with remarks by Michael Sweeney, Chief Executive Officer. Mr. Sweeney will be joined by Dennis Hanson, Chief Financial Officer; Donna Lucente, Vice President and Corporate Controller; and Julie Theriault, Director of Corporate Communications, 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. Further information on these risk factors is included in the company's latest earnings 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 a basis, excluding certain non-comparable items. Reconciliation of these measures to the most comparable GAAP terms are available on the company's website.

With that, I would now like to turn the call over to Mike Sweeney. Good afternoon, Mike.

Michael T. Sweeney

Good afternoon. Thank you, everyone, for joining us to review what we believe is a start of a strong year for Steinway Musical Instruments. Since our last quarterly call, we've entered into an agreement to sell our interest in the Steinway Hall building in New York City. And today, we announce first quarter results that show good progress in building our business and profitability. On our call today, I'll first run through those results and the trends that are contributing to our confidence about 2013. Then I'll touch on the sale of our West 57th Street building, our balance sheet and our outlook for fiscal 2013. After that, we'll open up the call for questions.

First, looking at our consolidated operations. The most significant development is the substantial improvement in our profitability. Overall, gross margin for the quarter increased 330 basis points. Operating income more than doubled, and earnings per share rose fourfold. This improvements occurred despite a slight decrease in total revenue to $76.8 million.

Conn-Selmer, our Band division, posted strong results this quarter. While Band segment revenues were down 7% primarily as a result of lower student instrument shipments, open orders were up 5% at the end of the quarter. Now that our dealers have regained confidence in our ability to meet desired ship dates, this year, we saw more of them schedule deliveries into the second and third quarters when they need the product on their shelves for the back-to-school season.

Price increases and the favorable sales mix of higher-margin professional level and sourced instruments in the first quarter led to particularly good gross margins in our Band business. Compared with the first quarter of last year, gross margins increased 600 basis points.

Piano revenues in the first quarter were up $1.3 million or approximately 3% over the prior year. Worldwide unit sales of Steinway grands were down 4.5% in the first quarter with results quite varied by region. Steinway grand unit sales were very strong in the Americas, up 30 units or 13%. Soft in Europe, down 39 units, and down in Asia-Pacific, 9 units as compared to the prior year period.

Due to the seasonality of our business, the first quarter tends to be our lightest shipping quarter and the percentages for our 3-month period are not as meaningful as they will be in our 9-month or full-year period comparisons.

To gain perspective on meeting our sales goals for the year, our management team in Hamburg looks at Steinway grands sales year-to-date, plus orders on hand. As of the end of March, that calculation shows us up double digits over March 2012.

Sales of Boston and Essex pianos were up significantly this quarter with exceptional results in the Americas and our Asia-Pacific region. These strong results in the mid-price segment increased our confidence in the economic environment and our ability to achieve our revenue goals in 2013. We believe that Boston and Essex offer further attractive growth opportunities and we will continue our focus in this area. In fact, we recently asked John Patton, one of our senior executives, to take full-time responsibility for building this business.

As we've mentioned in previous calls, to meet Steinway demand for this year, we have taken steps to increase production at both of our piano factories. Our manufacturing team is executing well and based on our first quarter production rates, our goals for the year are attainable.

Piano segment gross margins improved 100 basis points compared to the first quarter of 2012. The benefit of a price increase and improved product mix were somewhat offset by the cost of training new employees in Hamburg. This led to gross margins on sales in our European and Asia-Pacific regions remaining at last year's level. We expect to be through the training period by midyear and gross margins should outpace 2012 on a quarter-over-quarter basis. In the Americas, exchange rate driven cost decreases on our Boston pianos and the favorable product mix contributed to our gross margin improvement of 260 basis points over the prior year period.

As you know, over the past few years, we have increased the number of retail stores we operate. The larger retail presence affords us opportunities to control our brand and earn higher margins. In June, we will be opening 2 retail showrooms in the San Francisco Bay Area. We're excited about the San Francisco and Walnut Creek locations for many reasons. Demographically, these are prime areas for Steinway customers and many prominent institutions are located in the Bay Area.

Our goal is to take those businesses several steps further, duplicating the success we've had with our company operated showroom in West Hollywood and Pasadena.

I'd now like to give you a brief update on the sale of our West 57th Street property. On March 26, we announced that we'd entered into an agreement with JDS Development Group to sell our interest in the Steinway Hall building for $46 million in cash. A 14 month lease back of our retail space that is virtually cash free. And potential additional proceeds to be dispersed from funds held in escrow. As we

[Audio Gap]

in this afternoon's release we expect the transaction to close during the second quarter giving us a taxable gain of about $22 million. We're happy with the outcome for a number of reasons, including the price we obtained, the elimination of the negative cash flow and uncertainties from holding the building and the avenues that opens for enhancing our capital structure and our focus on our core musical instruments business.

We'll always have a significant physical presence in New York City and while we are able to remain in our present location until the end of 2014, we've already begun the planning process for the new Steinway Hall.

Turning to our balance sheet. Capital expenditures were $1 million for the quarter, significantly less than the same period last year. Since capital expenditures were minimized during the recession, we're now making some necessary investments in our infrastructure. In 2013, we have budgeted some larger building and maintenance projects. So we expect higher capital expenditures in the remaining quarters of 2013. We should come in at $8 million to $10 million for the year in capital expenditures.

We ended the quarter with nearly $62 million in cash on hand. We had no outstanding balances on our domestic bank lines and more than $100 million available on our various lines of credit.

Our good results in Q4 of 2012 led to very low piano inventory in Europe and Asia at year end. We've made modest progress in rebuilding our inventory, ending the quarter with about $6 million more in finished goods. Most of that increase occurred late in the quarter so that by April, we were in a better position to meet sales projections. Preliminary results indicate that April sales were higher than prior year in all of our operating units.

Due to Steinway Hall's pending sale, we reclassified the building and its related assets and liabilities as current as of March 31. We also reclassified as current the $67 million outstanding on our 7% bonds which mature March 1, 2014.

Overall, our balance sheet is very strong and we are in a good position to consider the optimal capital structure going forward.

After the closing of Steinway Hall transaction, we expect that management will present to the board a variety of options including the payment of ordinary and/or special dividends and/or an expanded stock repurchase program. We do not anticipate large-scale acquisitions in the near term. We have excellent prospects for increased growth in profitability in our core businesses. And we expect to generate significant cash from operations in 2013 and beyond.

With regard to our expectations for 2013, at the macro level, we have an improved economy and housing market in the United States, additional high-margin opportunities in retail, and strong prospects in Asia. At the micro level, we'll soon be in a better position to serve our European markets and the growing Asia market to our increased production capabilities for Steinway grands. And while we continue to view our Band segment as largely a margin improvement story, we also expect revenue improvement.

One final item before we open the call for questions. Last quarter, I discussed the changes we've been contemplating to further Steinway Musical Instruments to a structure that meets best practices for a fully public company. While that process continues, we've started to expand our Investor Relations program. As a first step, Julie, Dennis and I are looking forward to participating in the open higher -- Oppenheimer Consumer Conference in Boston on June 25. And we are working with our Investor Relations advisors, LHA, when identifying and appropriate date for an Investor Day this summer.

This concludes our prepared remarks for today. Operator, we'd like to now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Rick D'Auteuil from Columbia Management.

Richard D'Auteuil

Yes, just on international sales and piano sales in the first quarter, you mentioned low availability and low inventory levels. Did that impact -- did you meet demand or were you unable to meet demand? Were there constraints related to that? And if so, how much?

Michael T. Sweeney

Rick, we were not able to meet all of our demand in our non-U.S. markets. It's impossible for us to quantify exactly how much that is. We do know that many of our dealers have begun ordering far into the future. For instance, some of our models right now won't be available for delivery until September or October. And we can't quite quantify what the impact of that is. But we do know that both our retail operators and our dealers, are all constrained by that inventory situation.

Operator

[Operator Instructions] And Rick has queued up with a follow-up question.

Richard D'Auteuil

Sorry about that. Okay, so historically, when that has happened, are they deferred sales or are they loss sales? What's the expectation? Will the customer wait for the premier brand or will they look at competitive products?

Michael T. Sweeney

We think they're deferred sales. That's why when we look at a combination of our sales to date, plus our order book, while sales in Europe were soft, our order book is strong for the remainder of the year and we expect to be up meaningfully over the prior year. We just haven't been able to deliver those units yet, Rick.

Richard D'Auteuil

Okay. And the order book presumably is stretched out longer than normal. So can you quantify that, to give us some sense of that?

Michael T. Sweeney

Well, it would all be within this year is all that we're looking at, in all...

Richard D'Auteuil

Is typically, at a 3-month lead time and now you're looking -- if you're ordering a piano in Europe right now you're looking at 6 or 7 months? Or...

Michael T. Sweeney

Depends on which model. Some models are available currently, others are 6 or 7 months. Let me check with Julie. Our order rate in Europe is up 19% over the same period last year.

Richard D'Auteuil

And how about Asia?

Julie Theriault

Well, those actually, Rick, those are the pianos coming out of the Hamburg factory, so they would apply to both of those regions.

Richard D'Auteuil

Okay, you're saying from manufactured, okay. Not demand. Okay.

Operator

Our next question comes from Brad Kern from Armored Wolf.

Unknown Analyst

I had a question about the buyer behavior that you're seeing across the different geographies. Looks like in China, the Boston and Essex brands are up a lot versus -- the growth there was really high. Do -- I mean, do those brands have as much awareness in Asia as a Steinway brand and sort of maybe can you just generally describe some of the buyer behavior across the other geographies as well?

Michael T. Sweeney

The buyer behavior in Asia was particularly strong for Boston and Essex, particularly in the grand piano category this year. It was up 50%, in fact, over prior year. It was also very strong in the American business, up a similar amount. We've made a marketing push in China to make sure that our Boston and Essex brands are prominent. Steinway is developing its brand reputation in China but we're still relatively early days. I think it's clear that the musical elite community in China understands Steinway very well. But the high net worth community in China is just beginning to understand how Steinway is differentiated from other piano brands. As people come into our dealer showrooms, however, not everyone has the opportunity to afford a Steinway. But they do have much better reach into the market with our Essex and Boston brands. And I think, our dealers, under the direction of our Shanghai-based management team, have done a very good job of promoting Boston and Essex. And it's a very large market that's available to those brands in China.

Unknown Analyst

Okay. And just a follow-up, are you seeing any impact from competitors like Yamaha, with the decline in the yen? Is that an impact to some of the -- has that hurt your ability to compete in any of the markets that you're in?

Michael T. Sweeney

Certainly not with the Steinway brand. It's really in a market segment of its own. And with regard to our Boston pianos, we've enjoyed that same decrease in the value of the yen. So we're on a level playing field with the other Japanese manufacturers.

Operator

Our next question comes from Eugene Fox of Cardinal Capital Management.

Eugene Fox - Cardinal Capital Management, L.L.C.

Mike, could you talk about what you see for the year in the Band business?

Michael T. Sweeney

We're quite optimistic about the Band business. In fact, I referred earlier to April results being good across the board, it was particularly good in our Band business. The order rates are up and we expect very strong results in the second and third quarter this year. We're very optimistic about it. We're also, Rick -- Gene, pleased to see the continued improvement in our Eastlake manufacturing facility. You may remember that Eastlake was the subject of a work stoppage and ramping that business back up has taken some time. There's been continuous improvement, that improvement continues.

Eugene Fox - Cardinal Capital Management, L.L.C.

How do you think about visibility in that business, Mike?

Michael T. Sweeney

I think we have pretty good visibility for a couple of quarters out because we can track order rates really on a daily basis. So, so far, we're pleased with what we're seeing and the third quarter, of course, is the biggest quarter of the year for Conn-Selmer. So we're pleased with the position for 2013.

Operator

And our next question comes from Joseph Nergis [ph] of Sojourn Investments.

Unknown Analyst

I'm interested in whether or not you guys are thinking about rolling over that debt, taking advantage of the current low interest rate environment for all corporations for that matter?

Michael T. Sweeney

Yes, we're actively engaged in negotiations with our banks now about extending and expanding our credit lines. That's part of an overall process of optimizing our balance sheet. But our banks have been very supportive and we appreciate that support. As I mentioned during my scripted remarks, the board will have an opportunity to consider exactly what the balance sheet structure should be and we'll be considering things like dividends or recapitalizations as part of that. That won't happen until after the sale of Steinway Hall is completed, if it's completed as we expect it will be, this quarter. And the board has not yet come to any conclusions on that.

Operator

And we have a follow-up from Rick from Columbia Management.

Richard D'Auteuil

Yes, just in the past, the company has done a good job of tackling some of their high cost manufacturing; is there anything in that being targeted for this year? I think it's mostly been on the Band side, but are there any major projects targeted for this year?

Michael T. Sweeney

One of the great opportunities for Steinway & Sons, our piano division, is the operating leverage inherent in the large-scale manufacturing facilities that have been invested in by previous generations of stockholders. We're running at relatively modest levels compared to our capacity and each incremental sale is increasingly profitable. So the efficiency gains that we're seeing, and we produced more in the first quarter than we had in the previous quarter. The efficiency gains we're seeing are important on a unit basis. But they're very important on a dollar basis or a euro basis. Based upon the absorption of overhead and the use of our fixed assets. So we do expect, as unit volumes ramp up later in the year, we do expect improvement in margin at the same time.

Richard D'Auteuil

But there's no major downsizing or production efficiency...

Michael T. Sweeney

No, I mean manufacturing efficiency is something we think about and talk about every day. Last year you may remember, we created a global manufacturing organization for the first time. Olaf Gube, who had been running our Hamburg factory, is now responsible for manufacturing worldwide and he's making significant impact. It's through a series of day-to-day steps that the manufacturing efficiency is improving and it's actually the inverse of ramping down production, we ramped up production to take advantage of that fixed overhead that we've got.

Richard D'Auteuil

And then lastly, is there any -- are there any labor agreements that are scheduled to be renegotiated this year?

Michael T. Sweeney

We've just completed our New York agreement and signed a multiyear agreement with our union there, the Furniture Workers Union, very successfully, we're pleased with the outcome of those negotiations. Our foundry and plate maker, O.S. Kelly, a subsidiary of ours, that's based in Springfield, Ohio, has an agreement to be negotiated later this year.

Richard D'Auteuil

What is the labor force there, how many people?

Michael T. Sweeney

About 40 people.

Operator

And we have a follow-up from Eugene Fox of Cardinal Capital Management.

Eugene Fox - Cardinal Capital Management, L.L.C.

Mike or Dennis, can you guys talk about how much in the way of cash taxes you would expect to pay on the proceeds from the sale of the building?

Michael T. Sweeney

We're going to ask Donna, our Corporate Controller, to take that question. She spends much of her life thinking about our tax position. So she's the best person to answer that question.

Dennis M. Hanson

And she sounds better than I do, Gene, so...

Donna M. Lucente

True. We are hoping that if we have the confluence of events that works for us, and we have the right ratio of taxes from different areas, that we'll be able to utilize some foreign tax credits that we have. And we're hoping that the gain that we have on the Hall is going to be essentially tax neutral for federal purposes. We will still have the state tax associated with that and we will have a transfer tax associated with it. But we expect to have it, hopefully, essentially no federal tax associated with it.

Michael T. Sweeney

Gene, that's exactly what I said to Donna when she explained to me that we wouldn't be paying federal taxes on the sale of the Hall. Thank you very much.

Operator

We have no further questions at this time. I will now turn the call back over to Mr. Sweeney for any final remarks.

Michael T. Sweeney

Thanks again, everyone, for joining us today. I'm glad we had an opportunity to go over our results and the reasons we are enthusiastic about our outlook for 2013. For those of you who will be attending the Oppenheimer Consumer Conference, I look forward to seeing you next month. I hope the rest of you join us for our second quarter call later this summer. Thank you, everyone.

Operator

Thank you, ladies and gentlemen. This concludes today's call. Thank you for participating. You may now disconnect.

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