Steinway Musical Instruments, Inc. 2005 Annual Report

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Steinway Musical Instruments, Inc. 2005 Annual Report 2005 annual report extending our reach Contents p3 Letter to Shareholders p9 Form 10-K p11 Business Description p17 Risk Factors p25 Selected Consolidated Financial Data p26 Management’s Discussion & Analysis p38 Report of Independent Registered Public Accounting Firm p39 Consolidated Financial Statements p43 Notes to Consolidated Financial Statements p73 Management’s Report on Internal Control Over Financial Reporting p81 Shareholder Information Corporate Profile Steinway Musical Instruments, through its operating subsidiaries, is a world leader in the design, manufacture and marketing of high quality musical instruments. The Company has one of the most valuable collections of brands in the music industry. Through a worldwide network of dealers, Steinway Musical Instruments’ products are sold to professional, amateur and student musicians, as well as to orchestras and educational institutions. The Company employs a workforce of over 2,400 and operates 14 manufacturing facilities in the United States and Europe. Financial Highlights (In thousands except per share data) 2005 2004 Change Net Sales $ 387,143 $ 375,034 3% Grossss MarginM 28.8% 29.1% Operatingrating IncomeI $ 34,837 $ 34,241 2% Adjustedsted EBITDAEBITD 1 49,015 50,842 -4% Net Income 13,792 15,867 -13% Earningsnings Per Share – BasicBas $ 1.71 $ 1.97 -13% Earningsnings Per Share – Diluted 1.67 1.91 -13% Book Value Per Share2 $ 18.34 $ 18.1318 1% Free Cash Flow3 $ 26,425 $ 18,6871 41% Total Debt $ 204,692 $ 222,792 -8% Less Cash (34,952) (27,372) Net Debt $ 169,749,740 $ 195,420 -13% 1 Adjusted EBITDA represents earnings before net interest expense, income taxes, depreciation and amortization, excluding adjustments for non-recurring, infrequent or unusual items. A summary of these adjustments and reconciliations of non-GAAP financial measures to GAAP can be found on page 80. 2 Book value per share is defined as stockholders’ equity divided by common shares outstanding at year end. 3 Free cash flow is defined as cash flow from operating activities reduced by capital expenditures. Pianos Band & Orchestral Instruments Steinway & Sons produces the highest quality Conn-Selmer is the largest domestic manufacturer pianos in the world and has one of the most widely of band & orchestral instruments and related recognized and prestigious brand names. For over accessories. The company manufactures a full line a century the Steinway concert grand has been the of musical instruments – from trumpets, trombones, piano of choice for the world’s greatest and most saxophones, tubas and French horns to clarinets, popular pianists. Steinway also offers a complete flutes, violins, and percussion instruments – and line of mid-priced pianos under the Boston and has leading domestic market shares in virtually all Essex brand names. of these categories. Some of its most well-known brands include Bach, Selmer, C.G. Conn, Leblanc, King, Armstrong, Ludwig, Musser, Holton, Martin, Glaesel, Vito, Scherl & Roth, Emerson, William Lewis & Son, Noblet, Artley, and Benge. 2005 Annual Report 1 Quality in Any Language… Our instruments are played in virtually every major orchestra and by many of the world’s most renowned musicians. We have a worldwide network of nearly 1,900 dealers and an excellent reputation for providing unparalleled customer service. 2 Steinway Musical Instruments Dear Shareholders We accomplished much during this busy year. Band Segment Our Company has been making great products Last year, we told you we were seeing the beginnings for 153 years, but we believe we can do even better. of a turnaround in our band business. With a sales We continued to make great strides in implementing increase of 7% and gross profit up 12%, we can finally our continuous improvement initiative. It is our say that we have turned the corner. Our product and goal to have every employee actively engaged in distribution strategies are working successfully. improving our business every day. We are just now Orders increased 10% over the prior year and open beginning to see the financial payoff from these orders at the end of December were up 59%. Our efforts. Our band business has been transformed imported student instruments continue to do by well-executed improve- well. With some additional focus, ment programs. Almost every we increased export sales by metric with which we measure Sales 20% in 2005 and we expect strong our band business has $400M sales overseas again in 2006. improved. We are very excited $350M We are very encouraged by the about the prospects for $300M improvement in band margins we this business in 2006. We $250M saw in the second half of 2005. have begun the continuous $200M We also made substantial progress improvement journey in our $150M in customer service. Our warehouse piano business as well and $100M is now offering 24-hour turnaround see many significant long- $50M on accessory orders and we term opportunities. 2001 2002 2003003 2004 2005 established a website to sell repair From a financial perspective, Piano Sales Band Sales parts. These advances are just some we had reasonable results in of the many ways we have made it 2005. We saw a marginal easier for dealers to do business increase in sales and a slight decline in margins. with us. During the first part of 2005, we completed We hope to improve upon these results in the the integration of our Leblanc acquisition. Also, we upcoming year. Our balance sheet improved during increased the bench strength of our band segment’s 2005, as we reduced debt $18 million and lowered senior management team. We believe these new receivables and inventory by $19 million. leaders have the managerial skills our Company needs to succeed in this competitive industry. 2005 Annual Report 3 The Choice of Artists Worldwide… Steinway Artist Lang Lang performed during Steinway & Sons Hamburg’s 125th Anniversary celebration in April. This Chinese-born virtuoso has been called one of the greatest classical pianists of our time. At age 23, he is attracting a new generation of piano enthusiasts. 4 Steinway Musical Instruments We know that to remain competitive in the global since we use the entire capacity of some of our OEM band instrument market, we must also make our suppliers of student instruments, we will continue to manufacturing operations more efficient. By develop relationships with overseas manufacturers. sourcing some student instruments from Asia and increasing U.S. production of other products, Piano Segment we have been able to improve gross margins. Our We occupy a unique position within the piano continuous improvement initiative in the United industry, which helped us post respectable results in States is an important part of our quest to improve a very competitive marketplace. Our overseas piano efficiencies. Already, we have seen a drastic operations did very well, led by significant increases reduction in work-in-process in shipments to China and strong inventory, and expect to see sales to former Eastern Bloc countries. Our domestic business improvements in other areas Net Debt had some challenges, particularly in the upcoming year. $250M in our Company-operated show- $200M rooms where we had unusually Band Outlook high turnover of salespeople. $150M Our band segment’s manage- Also, competition in the mid- ment team is working more $100M priced segment of the market was closely than ever with our fierce as pricing pressure from dealers to understand their $50M Chinese-made pianos continued needs and help their busi- to impact this segment. As a nesses. In turn, this focus will 2001 202002 2003 200404* 2005 result, our unit sales of Boston help us better coordinate * LeblancL ppurchased and Essex pianos declined 11%. product availability from our All in all, total piano revenues Company-operated plants and held steady with 2004 results. our OEM suppliers. We expect sales growth in several areas of our band business in 2006, During 2005, we made significant progress on some particularly in exports, accessories, and acoustic of our key initiatives. First, we devoted a great deal percussion. However, we anticipate continued of attention to improving customer satisfaction. downward pricing pressure in the band industry. As a consumer products company, we understand Our ability to ramp up production of certain that customer satisfaction is the lifeblood of our instruments at our U.S. plants will be one of the present business and our future success. Recently, keys to further margin improvement. In addition, we introduced our extranet website intended for 2005 Annual Report 5 “ Extending Our Reach… Sourcing is an important part of our global manufacturing strategy. Conn-Selmer will continue to develop relationships with Asian manufacturers to supply student- level band instruments. The new Steinway-designed Essex pianos will be made at two ” of the most advanced piano factories in China. 6 Steinway Musical Instruments the exclusive use of Steinway dealers. Through this line in the Steinway family of products. In 2000, to extranet, the first in the industry, our U.S. dealers offer our dealers a way of attracting an even greater now have online access to Steinway promotional number of consumers to the Steinway family, we materials, training course schedules and service began offering a third line of Steinway-designed information. Dealers can also view their own instruments with the Essex piano. Although the account activity and order parts and literature concept was a good one, we did not quite hit the through the website. mark with the design or the pricing. It took us quite a while to select the right manufacturers Second, we continue to introduce exciting new but, in 2006, we will reintroduce the Essex line, products. A year ago, we unveiling several new models. reintroduced the Steinway Our new Essex pianos will be Model A grand piano in the made at two of the most advanced United States.
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