| STEINWAY MUSICAL INSTRUMENTS INC Item 1A Risk Factors An investment in our company involves risk |
| In addition to the other information in this report, prospective investors should carefully consider the following risks before making an investment |
| There may be additional risks and uncertainties that we do not presently know of or that we currently consider immaterial |
| All of these risks could adversely affect our business, financial condition, or results of operations |
| We operate in competitive markets Our success depends upon our ability to maintain our share of the musical instrument market by providing the best instruments at prices equal to or below our competitors providing instruments of comparable quality |
| Increased competition could lead to price reductions, fewer large sales to institutions, reduced operating margins and loss of market share |
| Our piano division currently competes with companies such as Bechstein, Bösendorfer, Fazioli, Kawai and Yamaha, which also produce and market pianos at the higher end of the market |
| Because of the potential savings associated with buying a used instrument, as well as the durability of the Steinway piano, a relatively large market exists for used Steinway pianos |
| It is difficult to estimate the significance of used piano sales, because most are conducted in the private aftermarket |
| However, we believe that used Steinway pianos provide the most significant competition in the high-end piano market |
| Our band & orchestral division competes with a number of domestic and Asian manufacturers of musical instruments, including Jupiter and Yamaha |
| Any of our competitors may concentrate their resources upon efforts to compete in our markets |
| In addition, Asian musical instrument manufacturers have made significant strides in recent years to improve their product quality |
| They now offer a broad range of quality products at highly competitive prices and represent a significant competitive challenge for us |
| Our failure to compete effectively could have a negative impact on our results of operations |
| Economic downturns and changes in consumer preferences could adversely affect our business Our business is subject to a number of general economic factors, many of which are out of our control, that may, among other things, result in a decrease in sales and net income |
| Sales of musical instruments are dependent in part upon discretionary consumer spending, which may be affected by general economic conditions |
| For example, Steinway, which represents more than half of our net sales, sells a relatively small number of Steinway & Sons grand pianos each year (3cmam145 in 2005) |
| Given the small number of pianos we sell, even a slight decrease in sales could adversely affect our profitability |
| Band & orchestral sales are also dependent upon the continued interest of school-aged children in playing musical instruments |
| Any decrease in consumer spending or reduction in school-aged children’s interest in music could result in decreased sales, which could adversely affect our business and operating results |
| Furthermore, terrorist activities, war or other armed conflict involving the United States or its interests abroad may result in a downturn in the US and global economies, thus reducing spending on luxury goods and may exacerbate the risks to our business |
| We could be subject to work stoppages or other business interruptions as a result of our unionized work force A significant portion of our hourly employees are represented by various union locals and covered by collective bargaining agreements |
| These agreements contain various expiration dates and must be renegotiated upon expiration |
| A collective bargaining agreement covering the employees in one of our 11 ______________________________________________________________________ band manufacturing facilities in Elkhart, Indiana, expires in April 2006 and another agreement covering employees in our piano manufacturing facility in New York expires in December 2006 |
| We cannot assure investors that we will be able to reach agreements on terms that are acceptable to us, or at all |
| If we are unable to negotiate any of our collective bargaining agreements on satisfactory terms prior to expiration, we could experience disruptions in our operations |
| Our most recent work stoppage occurred at two of our band & orchestral manufacturing plants in January and March of 2003 and lasted for approximately 13 weeks and 9 weeks, respectively |
| Any future prolonged work stoppage or delay in renegotiating collective bargaining agreements could have a material adverse effect on our operations |
| Any significant disruption in our supply from key suppliers could delay production and adversely affect our sales Our Boston and Essex piano lines, our Selmer Paris instruments, and many of our student level band & orchestral instruments are sourced from single foreign manufacturers |
| We are highly dependent on the availability of essential materials and purchased components from our suppliers, some of which may be available only from limited resources |
| Moreover, we are dependent upon the availability of our suppliers to provide material that meets specifications, quality standards and delivery schedules |
| Our suppliers’ failure to provide expected raw materials or component parts could adversely affect production schedules and profitability |
| Although we have had adequate supplies of raw materials and component parts in the past, there is no assurance that we may not experience serious interruptions in the future |
| Our continued supply of materials is subject to a number of risks including: 1) the destruction of our suppliers’ facilities or their distribution infrastructure; 2) work stoppages or strikes by our suppliers’ employees; 3) the failure of our suppliers to provide materials of the requisite quality; 4) the failure of essential equipment at our suppliers’ plants; 5) the failure or shortage of supply of raw materials to our suppliers; and 6) contractual amendments and disputes with our suppliers |
| We cannot assure investors that our suppliers will continue to provide products to us at attractive prices or at all, or that we will be able to obtain such products in the future from these or other providers on the scale and within the time periods we require |
| Furthermore, we cannot assure investors that substitute raw materials or component parts will meet the strict specification and quality standards we impose |
| If we are not able to obtain key materials, supplies, components or sourced instruments on a timely basis and at affordable costs, or we experience significant delays or interruptions of their supply, it could have a material adverse effect on our business, financial condition and results of operations |
| We may be unable to successfully integrate acquisitions of related companies into our business We have historically acquired other businesses whose operations or product lines complement our existing business, including Leblanc in August 2004 |
| We continually explore new opportunities to enter into business combinations with other companies in order to maintain and grow our revenues and market presence |
| These potential transactions with other companies create risks such as difficulty in assimilating the personnel, customers, technology, products and operations with our personnel, customers, technology, products and operations; disruption of our ongoing business, including loss of management focus on existing businesses; and impairment of relationships with existing executives, employees, customers and business partners |
| In addition, we may not be able to identify suitable candidates for these transactions or obtain financing or otherwise make these transactions on acceptable terms |
| Furthermore, the benefits that we anticipate from these potential transactions may not develop as expected and we cannot be sure that we will recover our investment in any such strategic transaction |
| 12 ______________________________________________________________________ Shifts in our product mix may result in declines in our gross margins and profit levels Our gross margins vary among our product groups and have fluctuated from quarter to quarter as a result of shifts in product mix (that is, how much of each product type we sell in any particular quarter) |
| The introduction of new band products, decreases in average selling prices and shifts in the proportion of student level instruments to professional level instruments may cause variances in our gross margins |
| We also experience variances in our gross margins as a result of shifts in the proportion of our piano retail sales to wholesale sales, as well as changes in amounts of piano sales to territories where we realize more favorable pricing |
| For example, our product sales in the former Eastern Bloc countries generally produce higher margins because most sales are at retail prices |
| We expect fluctuations in gross margins to continue in the future |
| Failure of our new products to gain market acceptance may adversely affect our operating results New products may not achieve significant market acceptance or generate sufficient sales to permit us to recover development, manufacturing and marketing costs associated with these products |
| Achieving market acceptance for new products may also require substantial marketing efforts and expenditures to expand consumer demand |
| These requirements could strain our management, financial and operational resources |
| Furthermore, failure of our new products to achieve market acceptance could prevent us from maintaining our existing customer base, gaining new customers or expanding our markets and could have a material adverse effect on our business, financial condition and results of operations |
| Additionally, price competition among our various brand names may adversely affect our sales, revenues and profitability |
| For example, our mid-priced Essex line of pianos may be priced lower than our Boston line, therefore potentially diminishing sales of our Boston pianos |
| Since we have a limited number of facilities, any loss of use of any of our facilities could adversely affect our operations Our operations with respect to specific products are concentrated in a limited number of manufacturing facilities |
| Because we are heavily dependent on each of these facilities, our operations would be adversely affected if we experience a disruption in business at any particular facility for a prolonged period of time because we would not have adequate substitute facilities available to us |
| Our operations may subject us to liabilities for environmental matters, the costs of which could be material Our manufacturing operations involve the use, handling, storage, treatment and disposal of materials and waste products that may be toxic or hazardous |
| Consequently, we are subject to numerous federal, state and local environmental laws and regulations, specifically those relating to discharges to air, water and land, the handling and disposal of solid and hazardous waste and the cleanup of properties contaminated by hazardous substances |
| Many environmental laws impose strict, retroactive, joint and several liability broadly upon owners and operators of properties, including with respect to environmental matters that occurred prior to the time the party became an owner or operator |
| In addition, we may have liability with respect to third-party sites to which we sent wastes for disposal in the past |
| Our potential liability at any of these sites is affected by many factors including, but not limited to, the method of remediation, our portion of the hazardous substances at the site relative to that of other responsible parties, the number of responsible parties, the financial capabilities of other parties, and contractual rights and obligations |
| 13 ______________________________________________________________________ We have obligations and liability with respect to the remediation of current and former properties and third party waste disposal sites |
| The liabilities and obligations in some cases are covered by indemnification agreements and we have accrued liabilities for sites where the liability is probable and can be estimated |
| We cannot guarantee the indemnitors will continue to fund the cleanup liability or that the actual costs of cleanup will not exceed our present accruals |
| Furthermore, we may be required to fund additional remedial programs in connection with other additional current, former or future facilities |
| Future events, such as the discovery of additional contamination or other information concerning past releases of hazardous substances at our manufacturing sites (or at sites to which we sent wastes for disposal), changes in existing environmental laws or their interpretation, and more rigorous efforts by regulatory authorities, may require additional expenditures by us to modify operations, install pollution control equipment, clean contaminated sites or curtail our operations |
| These expenditures could have a material negative impact on our operations |
| We may not be able to protect our proprietary information We rely in part on patent, trade secret, unfair competition, trade dress and trademark laws to protect our rights to aspects of our business and products, including product designs, proprietary manufacturing processes and technologies |
| The laws of many foreign countries do not protect proprietary rights to the same extent as laws in the United States |
| In addition, although we may have rights to a particular trademark in a given country, we may not have similar rights to that trademark in other countries |
| Changes in our effective tax rates could affect future results As an international company, we are subject to taxation in the United States and various other foreign jurisdictions in which we do business |
| Some of these foreign jurisdictions have higher statutory rates than those in the United States, and certain of our international earnings are also taxable in the United States |
| Accordingly, our effective tax rates will vary depending on the relative proportion of foreign to US income and absorption of foreign tax credits, changes in the valuation of our deferred tax assets and liabilities, and changes in tax laws |
| In addition, we are subject to examination of our income tax returns by the US Internal Revenue Service and other tax authorities |
| We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our income tax reserves and expense |
| Should actual events or results differ from our current expectations, charges or credits to our income tax expense reserves and income tax expense may become necessary |
| Any such adjustments could have a significant impact on our results of operations |
| Our foreign operations are exposed to risks associated with foreign regulations, exchange rate fluctuations, trade restrictions and political, economic and social instability We manufacture, market and distribute our products worldwide |
| As a result, we are subject to the risks normally associated with foreign operations |
| For example, foreign regulations may limit our ability to produce and sell some of our products or repatriate profits to the United States |
| In addition, a foreign government may impose trade or foreign exchange restrictions or increased tariffs, which could adversely affect our operations |
| Our operations may also be negatively impacted by political, economic and social instability in foreign countries in which we operate |
| We are also exposed to risks associated with foreign currency fluctuations |
| A strengthening of the US dollar, the Japanese yen, the British pound, the Chinese yuan or the euro relative to each other or other foreign currencies could have a negative impact on us |
| Although we sometimes engage in transactions to protect against risks associated with foreign currency fluctuations, we cannot be sure that these fluctuations will not have an adverse effect on us |
| Sales outside the United States accounted for approximately 33prca of our net sales in 2005 |
| 14 ______________________________________________________________________ The requirements of complying with the Sarbanes-Oxley Act may strain our resources and distract management As a public company, we are subject to the reporting requirements of the Sarbanes-Oxley Act |
| Sarbanes-Oxley requires that we maintain effective disclosure controls and procedures, corporate governance standards and internal controls over financial reporting |
| Although we devote significant time and resources to ensure ongoing compliance with the reporting requirements of Sarbanes-Oxley, we can give no assurance that we will continue to meet these requirements in the future or that reportable conditions or material weakness in our internal controls and procedures may not arise despite our best efforts prevent them |
| While we have taken and continue to take all steps necessary to comply with Sarbanes-Oxley, including internal controls, our failure to meet the requirements of Sarbanes-Oxley could negatively impact our business, financial condition and results of operations |
| In addition, the effort to comply with these obligations may divert management’s attention from other business concerns |
| Kirkland and Messina exercise significant control over us, which could adversely affect investors Mr |
| Kyle R Kirkland, Chairman of the Board, and Mr |
| Dana D Messina, Chief Executive Officer, hold in the aggregate 100prca of our Class A common stock, representing approximately 86prca of the voting power of our company’s capital stock |
| Kirkland and Messina continue to hold a majority of the voting power, they will be able, acting together, to exercise a controlling influence over our company, including with respect to the composition of our board of directors and, through it, the direction and policies of the Company |
| We cannot assure that Messrs |
| Kirkland and Messina will not pursue other business interests that will conflict with investors’ interests |