**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form  10-KSB**

 

**ANNUAL REPORT PURSUANT TO**

**Section 13 Or 15(d) Of The SecuritiesExchange Act Of 1934**

 

**For the fiscal year ended June 30, 2005**

 

**Commission file number:  0-31955**

 

**QRS MusicTechnologies, Inc.**

(Nameof small business issuer in its charter)

 
| **Delaware**                                                              | ** ** | **36-3683315**                        |
|---------------------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization)           |       | (I.R.S.  Employer Identification No.) |
|                                                                      |       |                                  |
| **2011 Seward Avenue, Naples, Florida**                                   | ** ** | **34109**                             |
| (Address  of principal executive offices)                                 |       | (Zip  Code)                           |
|                                                                      |       |                                  |
| Issuer’s  telephone number **(239) 597 - 5888**                      |       |                                  |
|                                                                      |       |                                  |
| Securities  registered under Section 12(b) of the Exchange Act: |       |                                  |
|                                                                      |       |                                  |
| **None**                                                                  | ** ** | ** **                            |
|                                                                      |       |                                  |
| Securities  registered under Section 12(g) of the Exchange Act: |       |                                  |
|                                                                      |       |                                  |
| **Common, $0.01 par value**                                               |
| (Title  of class)                                                         |

 

Check whether the issuer(1) filed all reports required to be filed by Section 13 or15(d) of the Exchange Act during the past 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. ý Yes o No

 

Checkif there is no disclosure of delinquent filers in response to Item 405 ofRegulation S-B is not contained in this form, and no disclosure will becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of thisForm 10-KSB or any amendment to this Form 10-KSB. ý

 

Theissuer’s revenues for its most recent fiscal year were $20,247,169.14.

 

Theaggregate market value of the voting and non-voting common equity held bynon-affiliates computed by reference to the average of the closing bid ($2.20)and closing asked ($2.25) price of such common equity, as of June 30, 2005was $6,799,916.

 

The number of sharesoutstanding of the issuer’s common stock as of June 30, 2005 was9,458,956.

 

TransitionalSmall Business Disclosure Format (Check one): Yes o; No ý

 

 

----

 

**PART I**

 

**Item 1. Description of Business.**

 

**GENERAL**

 

QRSMusic Technologies, Inc. (“Company”) is a Delaware Corporation which wasformed in January, 1990.  During fiscalyear ended June 30, 2005, Company’s primary lines of business weremanufacture and sale of Pianomation® Music Instrument Digital Interface(“MIDI”), manufacture and sale of Story & Clark pianos, sale of MIDICDs and floppy disks, distribution of piano supply parts, manufacture anddistribution of the Gulbransen Digital Hymnal, and manufacture and sale ofmusic rolls for player pianos.  All financialstatements presented are consolidated statements. The Company’s fiscal yearends each June 30, and the fiscal years ended June 30, 2004, andJune 30, 2005 are referred to as “fiscal 2004” and “fiscal 2005”,respectively. The Company maintains its corporate offices and a showroom inNaples, Florida.  The Company has awarehouse, teaching facility, Pianomation® development facility and showroom inLas Vegas, Nevada, piano manufacturing and Pianomation® assembly and showroomfacilities in Seneca, Pennsylvania, and a piano roll manufacturing andwarehouse facility and software development facility in Buffalo, New York.  During Fiscal 2005 the Company leased spacein Hong Kong to help with procurement and sales to the Chinese and surroundingmarkets.  During Fiscal 2004, the Companybegan utilizing space in Sydney, Australia in a building at the time owned byan affiliated company.  The Company usedthe space to inventory pianos and pianomation units that will be sold in theAustralian market.  During Fiscal 2005the affiliated company was sold to a non-affiliated party, and subsequently theCompany moved its sales offices to another location.  (Please refer to Item 12 for additionalinformation.)  See “Consolidated FinancialStatements” for financial information.

 

 **PIANOMATION®**

 

ThePianomation® MIDI System is a Musical Instrument Digital Interface equippedplayback system for acoustic and digital pianos.  Pianomation®, which is Company’s flagshipproduct, automates Company’s own line of Story & Clark pianos, and canbe retrofitted by independent installers into virtually any brand of piano.Several major piano manufacturers, have selected Pianomation® as an OEM choicefor factory installation in new instruments.

 

ThePianomation® product consists of an electronic processor and a mechanicalassembly which drives solenoid actuators. The processor receives MIDI signalsfrom a MIDI master controller such as a CD player, disk drive or personalcomputer. The signals received from the master controller are processed by thePianomation® processor which in turn causes the mechanical solenoid actuatorsto “play” the piano’s keys. The MIDI signal contains, and the Pianomation®processor transmits, the information necessary to control the duration of eachnote and the level of expression and foot pedal operation. The Pianomation®system is unique as it is the only system currently available which not onlycontrols the mechanical operation of a piano but synchronizes the MIDI signalwith a separate track containing an audio music signal and stores both tracks inanalog format on a CD. This allows the Pianomation® system to enhance the pianoperformance with a vocalist, symphony orchestra or other recorded music.

 

Theease of installation and minimal service requirements of the Pianomation®system and the software which allows the conversion of a digital signal intoanalog format are principal features.  Aunique low profile solenoid rail actuates the keys, and can be easily regulatedto the touch of the host piano to a high degree of sensitivity.  In fact, Pianomation® can actually play atvolume levels below the capabilities of the human pianist for the ultimate inbackground music.  The sustain pedal isoperated by a specially designed solenoid, or can be simulated by the system’sexclusive “Magic Pedal” feature.

 

Pianomation’s®flexibility and open-ended architecture allow a wide range of use andflexibility for all current and future playback formats.  With QRS CDs, Pianomation® can playunobtrusively with solo piano music or with concert-quality performances thatinclude audio accompaniment; with QRS videos, Pianomation® can be used forgroup sing-alongs or karaoke; with QRS floppies, Pianomation® can drive ageneral MIDI system for the MIDI enthusiast; and, with various computerprograms, it can serve the working musician as a MIDI slave, interacting on asophisticated level with all manner of MIDI equipment.  The Transcription Series and SyncAlongCDs continue to be popular items in the Pianomation CD series, and the librariesof available CDs are expanded every year. The SyncAlong Series CDs leverage the Pianomation system advantagesto allow the end-user to experience the true audio recordings of majorrecording artists.  The Company in fiscal2004 introduced a download service called “Net Piano.”   This subscription service allows theconsumer to log into a specified internet site and download music to play ontheir Pianomation system.  The Companyalso sells the Playola System of portable piano automation. Unlike the Pianomation®System which requires installation by a trained technician, the Playola systemconsists of only two components which can be easily placed on and removed froma piano by a user. Playola is also MIDI compatible.

 

2

----

 

Pianomation®Manufacturer

 

Thecomponents of the Pianomation® MIDI System and Playola system are manufacturedfor the Company by a number of different suppliers. With the exception of anumber of small pieces, the Company has located more than one supplier for eachcomponent. It maintains an inventory of components which it believes would besufficient to continue its business if the single source vendor of small piecesshould cease to adequately supply ordered parts. The Company assembles some ofthe Pianomation® System and Playola components in its Pennsylvania facility. Inlarge part, the Pianomation® System is shipped in kit form for installation bya technician into an acoustic piano. The Company believes there to be amplesources and quantities of raw materials for the manufacture of allcomponents.  As technology advances, theCompany continues to develop and introduce new user-interface devices (“frontends”) that can be utilized to play the Pianomation system.  In Fiscal 2005 the company debuted the Ancho,Petine and Q-Touch interfaces as the music industry’s annual trade show inJanuary in Anaheim, CA.  Each frontend has unique properties that leverage the advantages of current technology toenhance and benefit the Pianomation player system.  The introduction of new front ends, anddiscontinuation of older models also enables the Company to address conditionsof supply of electronic components.

 

Pianomation®Distribution

 

TheCompany distributes the Pianomation® system as an option on itsStory & Clark pianos, through approximately 240 independent pianoretailers and independent piano technicians who install the system on pianosinitially sold by the retailer or as a retrofit on pianos owned by customers.The Company also distributes through OEM sales to piano manufacturers such asYoung Chang Pianos and other distributors who private label the system. Playolais distributed though the same network of independent piano retailers.

 

**STORY &CLARK PIANOS**

 

TheCompany imports and sells pianos under the Story & Clark trademark,and manufactures a select number of specialty pianos bearing theStory & Clark trademark.  TheStory & Clark line includes reproducing player pianos, grand pianos,console and studio pianos, nickelodeons, custom leaded glass panel pianos, rollplayers, and various piano accessories such as piano benches and lamps. Theterm player piano is used to describe any acoustic piano that has been modifiedto play itself.  A nickelodeon is a pianothat plays itself, and has additional instruments (such as drums, xylophone,castanets, etc.) that are mounted on or near the piano and are also played bythe same solenoid system.

 

AllStory & Clark pianos, including imported pianos, are thoroughlyserviced and prepared by factory piano technicians prior to sale. All Story &Clark pianos are pre-slotted to allow for easy later installation of thePianomation® system.

 

InSeptember 2004 the Company introduced a new commercial line of pianosmarketed under the Gulbransen brand name.  The Gulbransen brand of pianosis offered through different sales channels as well as several traditionaldealer accounts.  The primary focus of the Gulbransen line is direct salesthrough the Internet as well as catalog sales. The Gulbransen line increases exposure to QRS’s unique line of productsfrom venue specific Grand Pianos to Nickelodeons and Violins.  QRS Music’sPianomation® technology will be available on the Gulbransen line ofpianos.  The Company purchased the Gulbransen name and the Digital Hymnalin 2003.  The Gulbransen name is anestablished name in the piano industry. The piano was first produced in 1905 and was one of the few piano brandsmanufactured during World War II.

 

PianoManufacture

 

Amajority of the Company’s line of pianos are imported from the Peoples Republicof China.  Specialty pianos and all pianoprep services are performed at the Company’s 46,000 square foot facility inSeneca, Pennsylvania. The Company believes that there is an adequate supply ofall materials used to build its specialty pianos in Pennsylvania. The Companyalso believes there are other sources of imported pianos if current supply wereinterrupted.

 

Thename Story & Clark is used on pianos imported from various pianomanufacturers located in the People’s Republic of China.  For Fiscal 2005 and Fiscal 2004 combinedimported piano sales represented 38.41% and 48.29% of overall salesrespectively.

 

PianoDistribution

 

TheCompany distributes its pianos and technology products through a network ofapproximately 400 to 500 independent piano stores around the country.

 

3

----

 

TheCompany may enter into an agreement with a financing company when the dealer(purchaser) desires to finance his purchases. For the year ended June 30, 2005, approximately 23.21% of theCompany sales were subject to these financing agreements. Under theseagreements, the entire sale is financed. Total amount of material cost incurredby the Company due to repurchasing of repossessed merchandise amounted to$58,935 for the year ended June 30, 2005. Company also retails its pianos through its own showroom in Las Vegas.

 

**PLAYERPIANO ROLLS**

 

TheCompany is the only major manufacturer in the world of paper player pianorolls.  The Company has master recordingdata for over 5,000 music titles for player piano rolls and maintains aninventory of over 45,000 music rolls at its Buffalo facility. The Companycontracts with copyright owners for nonexclusive rights to produce variousmusical selections and then with artists who actually perform the musicalselection. The Company has master rolls representing the only player pianoperformance of Liberace and one of only a few of the performances of ScottJoplin, Fats Waller, George Gershwin and other famous pianists.  Celebrity performances are recorded on aspecially equipped piano called a marking piano.  Each key on the marking piano is connectedpneumatically to a metal stylus on unit sitting next to the piano.  There is a blank roll of piano roll paperthat passes over a drum equipped with a piece of carbon paper.  As a key is depressed on the piano, the metalstylus descends against the piano roll paper, and a carbon mark is made on theunderside of the paper.  As long as thekey is depressed, the stylus stays down. Once the key is released, the stylus raises. Once the performance iscomplete, the roll with the carbon marks is taken out, and the carbon lines arecut out with an exacto knife.  Thisbecomes the pattern for the piano rolls that will be mass-produced.  Celebrity performances are recorded on themarking piano because it requires no knowledge of player piano roll arrangingby the performer.  The artist is onlyrequired to sit at the piano and play as they normally would.  Upon completion of the performance there is apattern of the exact performance that can then be reproduced in the form of aperforated piano roll.  When thecompleted roll is played on a customer’s piano, the original artist’sperformance will be duplicated exactly. For fiscal year ended June 30, 2005 and 2004 player piano roll andrelated items sales represented 3.38% and 3.39% of total overall salesrespectively. Non-celebrity performances are done on a digital keyboard orcomputer.  All raw materials for therolls are readily available from multiple sources. The Company also sellsplayer piano accessories.

 

RollDistribution.

 

Playerpiano rolls and player piano accessories are primarily sold though mail ordercatalog.  The Company maintains aprospect list of over 89,000 qualified buyers. The Company also sells player piano rolls and accessories on itsinternet web site and through a few independent dealers.

 

**MIDICDS, FLOPPY DISKS and NETPIANO**

 

The Company has an inventoryof over 2000 musical data files in MIDI format which it sells in CD, DVD andfloppy disk format and as downloads on its internet web site. The CDs areprimarily used for electronic player devices such as Pianomation®.  The web downloads are part of a new onlineservice called NetPiano. Total music sales for Pianomation (including CD,floppy and downloadable format) for fiscal year ended June 30, 2005 and2004 were 4.86% and 5.06% of total overall sales respectively.

 

**COMPETITION**

 

Pianomation®has two major competitors, Yamaha Music and PianoDisc. The Yamaha Disklaviersystem is only available as a factory installed option on Yamaha pianos. ThePianoDisc system is retrofitable. Principal competitive factors are reliability, features, systemflexibility and ease of installation. The Company believes it competes well asa result of the reliability of its system, ease of installation, and its stronglibrary of live recorded background music including vocals as well as pianosignal on one CD.

 

Thehigh caliber of the software offered for use on the Pianomation Systemcontinues to be one of the strongest selling points of the system.  The Sync Along Series of CDs, availableexclusively in the QRS Library, is a deciding factor in many consumers choiceof player systems.

 

4

----

 

Story & Clark competes with very large (SteinwayPianos, Samick Pianos, Young Chang Pianos, and Kawai Music) and several otheroffshore piano manufacturers and has a very small portion of the market.Principal competitive factors are distribution channels, trademark and valueadded features. While it is one of only a handful of domestic pianomanufacturers, The Company competes by filling niche markets including playerpianos and nickelodeons rather than competing in the mass distribution marketfor standard home-use and commercial-use pianos.

 

Currentlyno other company sells new player piano rolls. Although several small companies do specialty recuts and small runs ofunique rolls. Used player piano rolls are sold by numerous individuals.

 

**PIANOMATIONAND OTHER PIANO SALES**

 

ForFiscal 2004 and Fiscal 2005, perforated paper roll players represented lessthan one percent of piano sales.  Totalpiano sales for fiscal year ended June 30, 2005 and 2004 represented38.72% and 36.25% of total overall sales respectively.  Sales of technology related products forfiscal year ended June 30, 2005 and 2004 represented 50.72% and 49.72% ofoverall sales respectively. Approximately 61.7% of Story & Clarkpianos sold were retrofitted with the Pianomation® system in fiscal year 2005and approximately 55.1% in fiscal year 2004.

 

**EMPLOYEES**

 

TheCompany employs 53 full-time employees.

 

**RESEARCHAND DEVELOPMENT**

 

TheCompany is involved in several research and development projects both in thearea of Pianomation products and pianos. The expenditures for fiscal year 2005 were $684,000 and for fiscal 2004they were $338,000. All research and development expenses were borne directlyby the Company. Other than new products discussed elsewhere herein, all otherpublicly announced new products are in the research and development stage. TheCompany is undertaking several large projects as it works to maintain itsleading edge in technology for the music industry.  As these projects progress in theirdevelopment cycle more funds are required to bring them to fruition.  Development for the Petine and Ancho userinterfaces for the Pianomation player system was nearly completed in fiscal2005, and these interfaces were introduced and are now a part of the QRSproduct line of technology devices.

 

Infiscal 2004 the Company introduced a new patented service that delivers a vastlibrary of content via the internet to the thousands of Pianomationâ player pianos installed worldwide.  This service, called Net Piano, delivers thesong from a specified secure site to a QRS version of Media Player or thecustomers Windows Media Player. The customer can then take that song and playit on their pianomation-equipped piano.

 

**PATENTSTRADEMARKS AND LICENSES**

 

TheCompany has 6 United States Trademark registrations: RegistrationNo. 658,518 (QRS logo), Registration No. 2,190,286 (QRS),Registration No. 2,562,052 (Hobart M. Cable), RegistrationNo. 2,490,762 (Story & Clark), Registration No. 2,227,035(Pianomation), and Registration No 744,841 (Gulbransen).

 

TheCompany also holds and or has rights (some exclusive) to ten patents related toboth existing product offerings, such as NetPiano, and the Gulbransen DigitalHymnal and several other products currently under development.

 

QRSobtains rights to use the music for both the Pianomation library and music rolllibrary from the appropriate copyright holders. In some cases those rights are administered by an agency, and sometimesby the copyright holder themselves.

 

5

----

 

**Item 2. Description of Property.**

 

TheCompany owns a 24,000 square foot building in Buffalo, New York which is usedfor piano roll manufacture and warehouse, a 46,000 square foot building inSeneca, Pennsylvania which is used for specialty piano manufacturing,Pianomation® System assembly and warehouse facility, and a 17,000 square footbuilding in Seneca, Pennsylvania which is used for a warehouse. The Companyleases from its Chairman and largest shareholder, 4,000 square feet of officeand warehouse space in Naples, Florida. The Naples location is the Company’s principal corporate office. TheCompany leases from its Chairman and largest shareholder approximately 6,000square feet of showroom and warehouse space in Las Vegas, Nevada. The terms ofthe office space arrangements for Las Vegas and Naples are comparable tosimilar spaces available on the open market. In Fiscal 2004, the Company utilized, without charge, warehouse space inNew South Wales, Australia provided by Alltech International Holdings, anaffiliate of the Company’s Chairman.  InFiscal 2005, the Company’s Chairman was no longer an affiliate of Alltech andthe Company later moved it’s showroom and warehouse space to a location inBalmain, Australia which it leases from an independent third party.

 

Theprinciple provisions of those leases are as follows:

 
| **Description and Location** | ** ** | **Base Rent Per Month** | ** ** | **Date of Lease** | ** ** | **Expiration** | ** **     |
|------------------------------|------------|-------------------------|------------|-------------------|------------|----------------|----------------|
|                         |       |                    |       |              |       |           |           |
| Offices and  Warehouse       |       | $                       | 2,000      |              | 01/01/1993 |           | 12/31/2012     |   |
| Naples, Florida              |       |                    |       |              |       |           |           |
|                         |       |                    |       |              |       |           |           |
| Showroom and  Warehouse      |       | $                       | 6,250      |              | 04/01/2000 |           | Month-to-month |   |
| Las Vegas, Nevada            |       |                    |       |              |       |           |           |
|                         |       |                    |       |              |       |           |           |
| Showroom and  Warehouse      |       | $                       | 3,555*     |              | 04/27/2005 |           | 05/05/2006     |   |
| Balmain, Australia           |       |                    |       |              |       |           |           |
|                         |       |                    |       |              |       |           |           |
| Office and  Warehouse        |       | $                       | 3,904*     |              | 12/15/2004 |           | 12/15/2006     |   |
| Hong Kong                    |       |                    |       |              |       |           |           |

 

----

*convertedto US $ from native currency as of 06/30/05.

 

**Item 3. Legal Proceedings.**

 

Alawsuit filed in Clark County Nevada District Court in October 2000 byFamily Music against the Company, Richard Dolan and a former employee of theCompany was settled on February 3, 2005. The lawsuit was settled withoutany payment to the plaintiff or any other consideration by the Company.

 

OnAugust 20, 2003 a default judgment in the amount of approximately $478,000was entered against the Company in the United States Bankruptcy Court, SouthernDistrict of Ohio, Western Division. The default judgment was granted toDwight’s Piano Co (formerly known as Baldwin Piano & Organ Company andsubsidiaries, a former customer of the Company) and was based upon claims thatpreferential transfers were made to the Company during the 90 day period priorto Baldwin’s bankruptcy filing on May 31, 2001. Because a judgment wasentered against the Company by the Court, the entire amount of the judgment wasaccrued as of June 30, 2003. The Company filed a motion seeking vacationof the judgment and raised several defenses available to it under theBankruptcy Code.  On January 3, 2005the United States Bankruptcy Court, Southern District of Ohio, WesternDivision, approved a negotiated settlement agreement between the Company andDwight’s Piano Co.  The negotiatedsettlement agreement reduced the Company’s preference liability to$61,395.  Upon the consummation of thesettlement, the United States Bankruptcy Court immediately entered an Ordervacating the default judgment entered, and subsequently dismissed thelitigation initiated by Dwight’s Piano Co. against the Company, withprejudice.  As a result of the negotiatedsettlement, for the year ended June 30, 2005 the Company recognized incomeof $416,206, reflected as a reduction of selling, general and administrativeexpenses.

 

**Item 4. Submission of Matters to a Vote of Security Holders.**

 

No matters were submitted to shareholders.

 

6

----

 

**PART II**

 

**Item 5. Market for Common Equity Related Stockholder Mattersand Small Business Issuer Purchases of Equity Securities**

 

OnAugust 6, 2001 the Company’s common stock began quotation on the OTCBBunder the symbol QRSM. Prior to that time, the Company’s common stock wasquoted on the Electronic Pink Sheets. The high and low bids of the Company’scommon stock for each quarter during fiscal years ended June 30, 2005 and2004 are as follows:

 
| **Fiscal Year Ended June 30,  2005** | ** ** | **High Bid Price** | ** ** | **Low Bid Price** | ** ** |
|-------------------------------------------|------------|--------------------|------------|-------------------|------------|
| First Quarter                             |       | 2.50               |       | 1.45              |       |
| Second Quarter                            |       | 2.25               |       | 1.40              |       |
| Third Quarter                             |       | 3.84               |       | 1.98              |       |
| Fourth Quarter                            |       | 2.20               |       | 1.60              |       |
|                                      |       |               |       |              |       |
| **Fiscal Year Ended June 30,  2004** | ** ** | **High Bid Price** | ** ** | **Low Bid Price** | ** ** |
| First Quarter                             |       | 1.55               |       | .85               |       |
| Second Quarter                            |       | 1.60               |       | 1.20              |       |
| Third Quarter                             |       | 2.90               |       | 1.25              |       |
| Fourth Quarter                            |       | 2.90               |       | 2.15              |       |

 

Trading information is asreported by the National Association of Securities Dealers Composite feed orother qualified interdealer quotation medium and as compiled by Pink Sheets,LLC.  Such over-the-counter quotationsreflect inter-dealer prices, without retail markup, markdown or commission, andmay not necessarily represent actual transactions.

 

Therecords of American Registrar and Transfer Co., the Company’s transfer agent,indicate that there are 130 registered owners of the Company’s common stock asof June 30, 2005.

 

TheCompany has paid no dividends on common stock in the past five fiscalyears.  The Company has no intention ofpaying dividends on common stock in the foreseeable future. The Companydeclared and paid no preferred stock dividends in fiscal year 2005 and$521,773  in fiscal year 2004.  All shares of preferred stock are owned bythe Company’s Chairman.

 

InApril, 2004, the Company issued 100,000 shares of its common stock to one individual.The issuance was for consulting services performed by a non-employee. Theshares were issued in a private transaction pursuant toSection 4(2) of the Securities Act of 1933.

 

**Item 6. Management’s Discussion and Analysis or Plan ofOperation.**

 

**GENERAL.**

 

SPECIALNOTE REGARDING FORWARD-LOOKING STATEMENTS.

 

Certainstatements in this Form 10-KSB constitute “forward-looking” statementswithin the meaning of the Private Securities Litigation Reform Act of1995.  Such forward-looking statementsinvolve known and unknown risks, uncertainties and other factors which maycause the actual results, performance or achievements of the Company to bematerially different from any future results, performance or achievementsexpressed or implied by such forward-looking statements.  Such factors include, among others, thefollowing: the effects of the changes in Homeland Security policies,specifically relating to the effects on international and domestictransportation of goods, the state of the economy; the financial condition ofmajor OEM’s such as Baldwin Piano Co. and Young Chang Pianos; competition;seasonality; success of operating initiatives; new product development andintroduction schedules; acceptance of new product offerings; advertising andpromotional efforts; adverse publicity; changes in business strategy ordevelopment plans; availability and terms of capital; labor and employeebenefit costs; changes in government regulations; uncertainty regardingeconomic recovery of the United States and international economies in generaland consumer spending in particular, and other factors particular to theCompany.

 

TheCompany is a Delaware Corporation and is a manufacturer and distributor ofpianos, pianomation units, and music for

 

7

----

 

electronic player systems (in a variety offorms) and music rolls for use in player pianos. The Company has three whollyowned subsidiaries, one in Hong Kong one in Australia, and the third was formedin the US for purposes of the Gulbransen asset acquistion.  All statements made encompass the maincompany and the two subsidiaries.  TheCompany sells its products to dealers and end-users, predominately in theUnited States and has offices in New York, Pennsylvania, Florida and Nevada recentlystarted leasing space in Balmain, Australia and Hong Kong.

 

**Critical Accounting Policies and Estimates**

 

SUMMARY

 

Theconsolidated financial statements include the accounts and transactions of QRSMusic Technologies Inc. and its wholly-owned subsidiaries.  All significant inter-company transactionsand balances are eliminated in consolidation. The preparation of consolidated financial statements requires theCompany to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent liabilities. On an on-going basis, the Company evaluates itsestimates, including those related to revenue recognition, product returns andallowances, bad debts, inventory valuation, goodwill and intangible assets,income taxes, warranty provisions, contingencies and litigation. The Companybases its estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual amountsmay differ from these estimates under different assumptions or conditions. TheCompany believes the following critical accounting policies affect its moresignificant judgments and estimates used in the preparation of its consolidatedfinancial statements.

 

REVENUE RECOGNITION

 

Sales of products are generally recognized by theCompany upon shipment to its customers. Stated terms of each sale are generally FOB shipping point and title forthe products transfers to the customer upon shipment.  The Company may, at times, arrange financingof customers’ purchases through commercial financing companies.  These arrangements generally require theCompany to repurchase pianos financed and repossessed by the commercialfinancing companies.  The purchase priceis typically the total unpaid balance owed to the finance companies plusreasonable expenses.  Shipping andhandling costs are included in selling expenses net of amounts invoiced to thecustomer per the order. The Company’s products generally carry a warranty.These costs are accrued at the point of shipment and, at June 30, 2005,the Company had a reserve for returns of $91,000.

 

ALLOWANCE FOR DOUBTFUL ACCOUNTS

 

No single customer of the Company has representedgreater than 10% of revenues or accounts receivable in fiscal 2005 or fiscal2004.  The Company maintains allowancesfor doubtful accounts for estimated losses resulting from the inability of itscustomers to make required payments.  Ifthe financial condition of the Company’s customers were to deteriorate,resulting in an impairment of their ability to make payments, additionalallowances may be required. The Company does not request collateral from itscustomers but collectibility is enhanced through the use of credit cardpayments. The Company assesses collectibility based on a number of factorsincluding, but not limited to, past transaction history with the customer, thecredit-worthiness of the customer, independent credit reports, industry trendsand the macro-economic environment. The Company’s experience with thebankruptcy of Baldwin Piano has lead it to re-address terms it offers to largercustomers and OEM accounts.  As ofJune 30, 2005 and 2004 the Company maintained an allowance for doubtfulaccounts of approximately $214,000 and $73,000, respectively.

 

INVENTORIES

 

Inventoriesare valued at the lower of cost or market using the first-in, first-out (FIFO)method.  On a regular basis the Companyreviews its inventories for slow-moving and obsolete items and adjusts thevalue of such inventory to its estimated net realizable value.  As of June 30, 2005 and 2004,resepectively, the Company reflected a reserve for slow-moving and obsoleteinventory of approximately $770,000 and $487,000.

 

The Company believes that the mix of inventoryreflects the current customer demand for products. The Company maintainsseveral hundred suppliers for both manufactured and distributed components andproducts.  The Company feels that thereare many sources for component suppliers, and maintains a listing ofalternative source for many critical parts. No assurances can be given as to maintaining a supply from any onedistributor.  Currently, the Companydoesn’t have any knowledge from any distributor as to a reduction ordiscontinuation of products currently being purchased.  The Company has no information indicatingthat any distributor intends to reduce or discontinue products currently beingpurchased.

 

8

----

 

LONG-LIVED ASSETS, INTANGIBLE ASSETS AND GOODWILL

 

TheCompany adopted SFAS No. 141, “Business Combinations,” and SFAS 142,“Goodwill and Other Intangible Assets,” effective July 1, 2002.  Under these standards, all acquisitionssubsequent to June 30, 2001 must be accounted for under the purchasemethod of accounting, and purchased goodwill is no longer subject to amortization.  Rather, it is subject to periodic impairmenttests based on its fair value.  Goodwillrepresents the excess cost over the fair value of tangible net assets of theCompany and is recorded on the consolidated balance sheet in other assets.  The Company reviews the carrying value of thegoodwill annually and at other times when facts or circumstances indicate thatthe recorded amount of goodwill may be impaired.  If this review indicates that goodwill is notrecoverable, the Company’s carrying value of the goodwill is reduced by theestimated shortfall.  As of June 30,2005, no impairment has been recorded.

 

INCOME TAXES

 

Aspart of the process of preparing the consolidated financial statements, theCompany is required to estimate its income taxes in each of the jurisdictionsin which it operates. This process involves the Company estimating its actualcurrent tax exposure together with assessing temporary differences resultingfrom differing treatment of items, such as depreciation, amortization, andinventory reserves, for tax and accounting purposes. These differences resultin deferred tax assets and liabilities, which are included within theconsolidated balance sheets. The Company must then assess the likelihood thatits deferred tax assets will be recovered from future taxable income and, tothe extent it believes that recovery is not likely, the Company must establisha valuation allowance. In the event that actual results differ from theseestimates, or the Company adjusts these estimates in future periods, theCompany may need to establish an additional valuation allowance which couldmaterially impact its financial position and results of operations.

 

TheCompany has substantial deferred tax assets associated with inventoryadjustments, allowance for doubtful accounts and other accruals which willreduce taxable income in the future.  TheCompany believes that it is more likely than not that the deferred tax assetswill be utilized.

 

**FISCAL2005 COMPARED TO FISCAL 2004.**

 

SALES

 

Totalsales increased 9.4% from $18.51 million in fiscal 2004 to $20.25 million infiscal 2005.  The majority of theincrease is attributable to an increase in the sales of Pianomation equippedStory & Clark pianos, and to an increase in Pianomation Hardware sales.  In fiscal 2003 the company changed focus frommanufacturing and production to sales and marketing.  Changes involved included expanding the pianoline, adjusting the mix of piano sizes and finishes, and realigning talent tofocus on procuring, maintaining, and developing a network of dealers andtechnicians.  These efforts not only ledto a substantial increase in piano sales, but also had the benefit of exposingdealers to the advantages of the Pianomation system, and thereby increasing thesales of Pianomation Hardware.  Althoughthere was only a small net change in the number of Story & Clarkdealers, the company was benefited by a stronger penetration with the currentdealers and a shifting of dealers in some markets to a larger store or chainaffording more opportunities for customer sales.  The number of Pianomation units factoryinstalled on Story and Clark pianos continues to increase, as well as thenumber of units sold to dealers for installation.  The overall growth trend continues as thepiano dealers are enjoying good sell through on the products they havereceived, and continue to keep the product on their showroom floors.

 

COSTS AND EXPENSES

 

Totalcost of sales increased 12.5% from $12.5 million in fiscal 2004 to $14 millionin fiscal 2005.  As a percentage ofsales, cost of sales increased 2.0% from 67.5% in fiscal 2004 to 69.5% infiscal 2005.  While higher salesaccounted for a higher total cost of sales, the Company has experiencedincreases in transportation costs during the fiscal year 2005.

 

Selling,general and administrative expenses increased 16.0% from $3.27 million infiscal 2004 to $3.79 million in fiscal 2005. The increase is a result of additional advertising expenses, increasedcommissions and selling expenses due to increased sales, an increase inshipping and delivery costs as a result of the rising transportation costs,increased legal and accounting expenses, and increased office expenses relatedto establishing new offices in Hong Kong and Australia and the funding of aprofit share plan on behalf of the company employees, and an increase inaccrued tax expense, offset by a decrease in bonuses paid to the officers,relative to last year, and a reversal of a previous charge associated with theBaldwin preference action.  During Fiscal2003, Baldwin Piano and Organ, a large OEM account of the Company’s, declaredbankruptcy and as a result the Company was party to a preference action broughtby the estate of the company.  TheCompany recognized the entire expense as bad debt during fiscal 2003.  During fiscal 2005 the suit was settled for alesser amount, and the Company reversed the difference to its current bad debtexpense.  This reduction in selling,general and administrative expenses was reflected in the

 

9

----

 

third quarter financials.

 

Researchand development expenses increased 102.5% from $338,000 in fiscal 2004 to$684,000 in fiscal 2005 due to the varying development times of products indevelopment.  The Company is undertakingseveral large projects as it works to maintain its leading edge in technologyfor the music industry.  As theseprojects progress in their development cycle more funds are required to bringthem to fruition.  Development for thePetine and Ancho user interfaces for the Pianomation player system was nearlycompleted in fiscal 2005, and these interfaces were introduced and are now apart of the QRS product line of technology devices.  Several other products are nearing completionand the Company plans to introduce them during fiscal 2006.  Still others are in the early stages ofdevelopment, and no completion date has been determined.

 

INTERESTEXPENSE, NET.

 

Netinterest expense increased 42.9% from $23,000 in fiscal 2004 to $33,000 infiscal 2005.  The increase is due to theadditional borrowing undertaken in fiscal 2005. The additional borrowing was used to finance the acquisition ofinventory for the Gulbransen piano line.

 

PROVISIONFOR INCOME TAXES.

 

TheCompany’s effective tax rate for fiscal 2005 and fiscal 2004 were 34.5% and38.6%, respectively.

 

LIQUIDITYAND CAPITAL RESOURCES.

 

Theprimary sources of the Company’s cash are net cash flows from operatingactivities and short-term vendor financing. Currently, the Company does not have available any established lines ofcredit with banking facilities.

 

TheCompany’s cash amounted to $603,000 and $1.6 million at June 30, 2005 and2004, respectively.  Fiscal 2005 earningsbefore interest, taxes, depreciation and amortization (“EBITDA”) decreased$685,000 to $1.86 million from $2.54 million in fiscal 2004. The Company’s cashand cash equivalent decreased for year ended June, 30, 2005 as compared to theyear ended June 30, 2004 as a result of the increase in inventory, and theincrease in both research and development and administrative expenses.  The importation of pianos from China requiresthat the pianos be paid upon shipping from overseas, instead of purchasingparts and paying for them 30 days after receipt. This process has a negativeimpact on cash flow as it requires the use of funds 90 to 120 days prior to thereceipt of funds for an item, although the increased sales and additional fundsavailable due to the decrease in cost of sales have allowed the Company tomaintain proper inventory levels. Although prepayment is the norm, one supplier did extend terms onseveral shipments near the end of fiscal 2005 Also during both fiscal year 2004 the Company made payments on theoutstanding preferred stock dividends. The accounts receivable for fiscal year ended June 30, 2005 werehigher than fiscal year ended June 30, 2004, due to increased sales, andthe timing of those sales.  During fiscal2005 the Company experienced a lower EBITDA largely due to an increase inresearch and development spending and funding of the Company’s profit sharingplan.

 

TheCompany had a note payable to a lending institution due May 2002 whichrequired a balloon payment of approximately $919,000 payable at that time (seeNote 4 to the Financial Statements).  TheCompany refinanced this note prior to the due date.  The new note payable in monthly installmentsof $13,751, plus accrued interest at the prime rate (6% at June 30, 2005)and due in May 2007, requires the Company to satisfy certain testsconcerning tangible capital funds and debt coverage ratio.  The Company is in compliance with thesecovenants.

 

TheCompany entered into a demand note payable with its majority shareholder for$500,000 bearing an interest rate of 6% per annum.  The Company has since made a partial paymentagainst the note of $250,000.

 

TheCompany believes its current available cash position, coupled with its cashforecast for the year and periods beyond, is sufficient to meet its cash needson both a short-term and long-term basis. There are no major capital expenditures planned for in the foreseeable future,nor any payments planned for off-balance sheet obligations.  Except as stated above, the Company’smanagement is not aware of any known trends or demands, commitments, events, oruncertainties, as they relate to liquidity which could negatively affect theCompany’s ability to operate and grow as planned.

 

Future contractualobligations of the Company are as follows:

 

10

----

 

PAYMENTS DUE BY PERIOD

 
| **Contractual**   | ** ** | ** ** | ** ** | **Next 12** | ** ** | ** **    | ** ** | **After**   | ** ** |
|-------------------|------------|------------|------------|-------------|------------|---------------|------------|-------------|------------|
| **Obligations**   | ** ** | **Total**  | ** ** | **Months**  | ** ** | **1-3 Years** | ** ** | **4 Years** | ** ** |
|              |       |       |       |        |       |          |       |        |       |
| Long Term  Debt   |       | $          | 108,834    |        | $          | 108,834       |       |        |       | — |   |
|              |       |       |       |        |       |          |       |        |       |
| Operating  Leases |       | $          | 270,309    |        | $          | 138,885       |       | $           | 95,424     |   | $ | 36,000 |   |
|                   |            |            |            |             |            |               |            |             |            |  |  |  |  |

 

Recent Accounting Pronouncements

 

In January 2004, the FASB issued Interpretation No. 46,“Consolidation of Variable Interest Entities: an Interpretation of ARBNo. 51” (FIN 46).  FIN 46 addressesconsolidation by business enterprises of entities in which equity investors donot have the characteristics of a controlling financial interest or do not havesufficient equity at risk for the entity to finance its activities withoutadditional subordinated financial support from other parties.  Variable interest entities are required to beconsolidated by their primary beneficiaries if they do not effectively disperserisks among parties involved.  Theprimary beneficiary of a variable interest entity is the party that absorbs amajority of its expected residual returns. The consolidation requirements of FIN 46 apply immediately to variableinterest entities created after January 31, 2004 and apply to existingentities in the first fiscal year or interim period beginning afterJune 15, 2004.  Certain newdisclosure requirements apply to all financial statements issued afterJanuary 31, 2004.  The adoption ofFIN 46 did not have a material effect on the Company’s financial statements andrelated disclosures because it does not have any variable interest entityrelationships.

 

In April 2003, FASB issued SFAS 149, “Amendment ofStatement 133 on Derivative Instruments and Hedging Activities.”  SFAS 149 amends and clarifies financialaccounting and reporting for derivative instruments, including certainderivative instruments embedded in other contracts and for hedging activitiesunder SFAS 133, “Accounting for Derivative Instruments and HedgingActivities.”  The changes in SFAS 149improve financial reporting by requiring that contracts with similarcharacteristics be accounted for similarly. SFAS 149 is effective, with some exceptions, for contracts entered intoor modified after June 30, 2003.** **Effective July 1, 2003 theCompany adopted SFAS 149 which did not have a material impact on its financialposition or results of operations because the Company does not use derivativeinstruments.

 

**In May 2003, the FASB issued SFAS 150, “Accounting for CertainFinancial Instruments with Characteristics of Both Liabilities and Equity”(“SFAS 150”).  SFAS 150 establishesstandards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equity.  SFAS 150 requires that an issuer classify afinancial instrument that is within its scope as a liability (or an asset insome circumstances).  The requirements ofthis statement apply to issuers’ classification and measurement of freestandingfinancial instruments, including those that comprise more than one option orforward contract.  SFAS 150 is effectivefor financial instruments entered into or modified after May 31, 2003, andotherwise is effective at the beginning of the first interim period beginningafter June 15, 2003.  The Companyadopted SFAS 150, and there was no material impact on its financial position,results of operations, or consolidated cash flows.**

** **

**In December 2004, the FASB issued SFAS No. 123 (revised 2004),“Share-Based Payment (SFAS No, 123 ®),” effective as of the first interim orannual reporting period that begins after June 15, 2005.  SFAS No. 123 ® requires entities tomeasure and recognize the cost of employee services received in exchange for anaward of equity instruments based on the grant-date fair value of the award(with limited exceptions).  The Companyis currently evaluating the impact of the revised rule on the Company’sresults of operations and financial position.**

 

11

----

 

**Item 7. Financial Statements.**

 

**QRSMusic Technologies Inc.**

**Table of Contents**

**June 30, 2005 and 2004**

** **
| **Independent Auditors’ Report**                            | ** ** |
|------------------------------------------------------------------|------------|
| ** **                                                       | ** ** |
| **Financial  Statements**                                        | ** ** |
| ** **                                                       | ** ** |
| Consolidated Balance Sheets                                      |       |
|                                                             |       |
| Consolidated Statements of  Income                               |       |
|                                                             |       |
| Consolidated Statements of  Changes in Stockholders’ Equity |       |
|                                                             |       |
| Consolidated Statements of  Cash Flows                           |       |
|                                                             |       |
| Notes to  the Consolidated Financial Statements                  |       |

 

12

----

 

**Independent Auditors’ Report**

 

Board of Directors ofQRS Music Technologies Inc.

 

We have audited theaccompanying consolidated balance sheets of QRS Music Technologies Inc. as ofJune 30, 2005 and 2004, and the related consolidated statements of income,changes in stockholders’ equity and cash flows for the years then ended.  These consolidated financial statements arethe responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

We conducted our audits inaccordance with standards of the Public Company Accounting Oversight Board(United States).  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement.  The Company is not required to have, nor werewe engaged to perform, an audit of its internal control over financialreporting.  Our audits includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the consolidated financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of QRS Music Technologies Inc. as ofJune 30, 2005 and 2004, and the results of their operations and their cashflows for the years then ended in conformity with accounting principlesgenerally accepted in the United States.

 
| ALTSCHULER, MELVOIN AND  GLASSER LLP |
|--------------------------------------|
|                                 |
| Chicago, Illinois                    |
| August 25, 2005                 |

 

13

----

 

**QRSMusic Technologies Inc.**

**Consolidated Balance SheetsJune 30, 2005 and 2004**

 
| ** **                                                                                                                                                                                                                                      | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
|                                                                                                                                                                                                                                            |       |       |       |       |       |
| **Assets**                                                                                                                                                                                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                                                                                                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current assets                                                                                                                                                                                                                                  |       |       |       |       |       |
| Cash                                                                                                                                                                                                                                            |       | $          | 603,004    |       | $          | 1,602,571 |   |
| Accounts receivable (net of allowance for  doubtful accounts of $214,400 and $73,400 as of June 30, 2005 and 2004,  respectively)                                                                                                          |       | 906,909    |       | 803,909    |       |
| Inventories                                                                                                                                                                                                                                     |       | 7,911,851  |       | 5,652,583  |       |
| Advances due from stockholder                                                                                                                                                                                                                   |       | 0          |       | 18,000     |       |
| Income taxes refundable                                                                                                                                                                                                                         |       | 233,000    |       | 79,000     |       |
| Deferred income taxes                                                                                                                                                                                                                           |       | 620,000    |       | 620,000    |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                       |       | 181,570    |       | 88,866     |       |
|                                                                                                                                                                                                                                            |       | 10,456,334 |       | 8,864,929  |       |
|                                                                                                                                                                                                                                            |       |       |       |       |       |
| Property, plant and equipment                                                                                                                                                                                                                   |       | 1,202,904  |       | 1,050,246  |       |
|                                                                                                                                                                                                                                            |       |       |       |       |       |
| Other assets                                                                                                                                                                                                                                    |       | 123,829    |       | 109,780    |       |
|                                                                                                                                                                                                                                            |       |       |       |       |       |   |   |
|                                                                                                                                                                                                                                            |       | $          | 11,783,067 |       | $          | 10,024,955 |   |
|                                                                                                                                                                                                                                            |       |       |       |       |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                                                                                                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current liabilities                                                                                                                                                                                                                             |       |       |       |       |       |
| Current portion of long-term debt                                                                                                                                                                                                               |       | $          | 108,834    |       | $          | 165,012 |   |
| Accounts payable (including $30,737 and  $24,487 due to related parties as of June 30, 2005 and 2004,  respectively)                                                                                                                       |       | 1,462,267  |       | 516,623    |       |
| Accrued expenses                                                                                                                                                                                                                                |       | 536,066    |       | 413,993    |       |
| Note payable due to stockholder                                                                                                                                                                                                                 |       | 250,000    |       | 0          |       |
| Liability for preferential payment                                                                                                                                                                                                              |       | 0          |       | 477,601    |       |
|                                                                                                                                                                                                                                            |       | 2,357,167  |       | 1,573,229  |       |
|                                                                                                                                                                                                                                            |       |       |       |       |       |
| Long-term debt                                                                                                                                                                                                                                  |       | 0          |       | 123,640    |       |
|                                                                                                                                                                                                                                            |       |       |       |       |       |
| Commitments and contingencies                                                                                                                                                                                                                   |       |       |       |       |       |
|                                                                                                                                                                                                                                            |       |       |       |       |       |
| Stockholders’ equity                                                                                                                                                                                                                       |       |       |       |       |       |
| Series A preferred stock, voting, $.01  par value, 2,000,000 shares authorized, 534,925 shares issued and outstanding  in 2005 and 2004, liquidation value of $2,300,180, and $2,171,796,  respectively, as of June 30, 2005 and 2004 |       | 5,349      |       | 5,349      |       |
| Class A common stock, voting, $.01 par  value, 40,000,000 shares authorized, 9,458,956 shares issued and outstanding  in 2005 and 2004                                                                                                     |       | 94,590     |       | 94,590     |       |
| Additional paid-in capital                                                                                                                                                                                                                      |       | 5,160,075  |       | 5,160,075  |       |
| Retained earnings                                                                                                                                                                                                                               |       | 4,165,886  |       | 3,068,072  |       |
|                                                                                                                                                                                                                                            |       | 9,425,900  |       | 8,328,086  |       |
|                                                                                                                                                                                                                                            |       |       |       |       |       |
|                                                                                                                                                                                                                                            |       | $          | 11,783,067 |       | $          | 10,024,955 |   |

 

See accompanying notes

 

14

----

 

**QRSMusic Technologies Inc.**

**Consolidated Statements of IncomeYears Ended June 30, 2005 and 2004**

 
| ** **                                                                                                              | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
|                                                                                                                    |       |       |       |       |       |
| Net sales                                                                                                               |       | $          | 20,247,169 |       | $          | 18,512,717 |   |
|                                                                                                                    |       |       |       |       |       |
| Cost of sales (including $49,500 to related  parties in each of 2005 and 2004)                                          |       | 14,064,682 |       | 12,502,577 |       |
|                                                                                                                    |       |       |       |       |       |
| **Gross profit**                                                                                                        |       | 6,182,487  |       | 6,010,140  |       |
|                                                                                                                    |       |       |       |       |       |
| Operating expenses                                                                                                      |       |       |       |       |       |
| Selling,  general and administrative (including $77,384 and $84,000 to related parties  in 2005 and 2004, respectively) |       | 3,790,904  |       | 3,267,189  |       |
| Research and development                                                                                                |       | 684,217    |       | 337,814    |       |
|                                                                                                                    |       | 4,475,121  |       | 3,605,003  |       |
| ** **                                                                                                              |       |       |       |       |       |
| **Income from operations**                                                                                              |       | 1,707,366  |       | 2,405,137  |       |
| ** **                                                                                                              |       |       |       |       |       |
| Interest expense (including $20,548 to  related parties in 2005)                                                        |       | 32,552     |       | 22,773     |       |
|                                                                                                                    |       |       |       |       |       |
| **Income before income taxes**                                                                                          |       | 1,674,814  |       | 2,382,364  |       |
| ** **                                                                                                              |       |       |       |       |       |
| Income tax expense (benefit)                                                                                            |       |       |       |       |       |
| Federal                                                                                                                 |       | 503,000    |       | 901,000    |       |
| State                                                                                                                   |       | 74,000     |       | 169,000    |       |
| Deferred                                                                                                                |       | 0          |       | (151,000   | )          |
|                                                                                                                    |       | 577,000    |       | 919,000    |       |
| ** **                                                                                                              |       |       |       |       |       |
| **Net income**                                                                                                          |       | 1,097,814  |       | 1,463,364  |       |
| ** **                                                                                                              |       |       |       |       |       |
| Less current year preferred stock dividends  in arrears                                                                 |       | (128,382   | )          | (128,382   | )          |
|                                                                                                                    |       |       |       |       |       |
| **Income available to common stockholders**                                                                             |       | $          | 969,432    |       | $          | 1,334,982 |   |
| ** **                                                                                                              |       |       |       |       |       |
| **Net income per common share**                                                                                         |       |       |       |       |       |
| Basic                                                                                                                   |       | $          | 0.10       |       | $          | 0.14 |   |
| Assuming dilution                                                                                                       |       | $          | 0.10       |       | $          | 0.14 |   |
|                                                                                                                    |       |       |       |       |       |
| **Shares used in computing per share amounts**                                                                          |       |       |       |       |       |
| Basic                                                                                                                   |       | 9,458,956  |       | 9,370,595  |       |
| Assuming dilution                                                                                                       |       | 9,570,956  |       | 9,466,595  |       |

 

See accompanying notes

 

15

----

 

**QRSMusic Technologies Inc.**

**Consolidated Statements ofChanges in Stockholders’ EquityYears Ended June 30, 2005 and 2004**

 
| ** **                                                                          | ** ** | **Series A  Preferred Stock** | ** ** | **Common  Stock** | ** ** | **Additional** | ** ** | ** ** | ** ** | **Total**   | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------|------------|----------------|------------|------------|------------|-------------|------------|
| ** **                                                                          | ** ** | **Number  of**                | ** ** | ** **        | ** ** | **Number  of** | ** ** | ** ** | ** ** | **Paid-In** | ** ** | **Retained** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                          | ** ** | **Shares**                    | ** ** | **Amount**        | ** ** | **Shares**     | ** ** | **Amount** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Equity** | ** ** |
| ** **                                                                          | ** ** | ** **                    | ** ** | ** **        | ** ** | ** **     | ** ** | ** ** | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance,  June 30, 2003                                                        |       | 534,925                       |       | $                 | 5,349      |           | 9,258,956  |       | $          | 92,590      |       | $ | 5,334,848 |   | $ | 1,604,708 |   | $ | 7,037,495 |   |
| Net income                                                                          |       |                          |       |              |       |           |       |       |       |        |       | 1,463,364 |   | 1,463,364 |   |
| Issuance of  common stock                                                           |       |                          |       |              |       | 200,000        |       | 2000       |       | 347,000     |       |   |   | 349,000 |   |
| Series A  preferred stock dividends paid (net of dividends previously accrued) |       |                          |       |              |       |           |       |       |       | (521,773    | )          |   |   | (521,773 | ) |
| Balance,  June 30, 2004                                                        |       | 534,925                       |       | 5,349             |       | 9,458,956      |       | 94,590     |       | 5,160,075   |       | 3,068,072 |   | 8,328,086 |   |
| Net income                                                                          |       |                          |       |              |       |           |       |       |       |        |       | 1,097,814 |   | 1,097,814 |   |
| **Balance,  June 30, 2005**                                                    |       | 534,925                       |       | $                 | 5,349      |           | 9,458,956  |       | $          | 94,590      |       | $ | 5,160,075 |   | $ | 4,165,886 |   | $ | 9,425,900 |   |

 

See accompanying notes

 

16

----

 

**QRSMusic Technologies Inc.**

**Consolidated Statements of CashFlowsYears Ended June 30, 2005 and 2004**

** **
| ** **                                               | ** ** | **2005**   | ** ** | **2004**  | ** ** |
|----------------------------------------------------------|------------|------------|------------|-----------|------------|
| **Operating activities**                                 |       |       |       |      |       |
| Net income                                               |       | $          | 1,097,814  |      | $          | 1,463,364 |   |
| Depreciation and amortization                            |       | 148,554    |       | 136,338   |       |
| Loss on disposition of assets                            |       | 29,760     |       | 5,762     |       |
| Provision for (benefit) bad debts                        |       | (308,499   | )          | 9,003     |       |
| Issuance of common stock for services                    |       | 0          |       | 289,000   |       |
| Deferred tax expense (benefit)                           |       | 0          |       | (151,000  | )          |
| Changes in                                               |       |       |       |      |       |
| Accounts receivable                                      |       | (272,102   | )          | 154,097   |       |
| Inventories                                              |       | (2,259,268 | )          | (597,388  | )          |
| Incomes taxes refundable                                 |       | (154,000   | )          | 106,000   |       |
| Prepaid expenses and other current assets                |       | (92,704    | )          | 134,133   |       |
| Other assets                                             |       | (14,049    | )          | (14,761   | )          |
| Accounts payable                                         |       | 945,644    |       | 43,755    |       |
| Accrued expenses                                         |       | 122,073    |       | 154,871   |       |
| **Net cash provided by (used in) operating  activities** |       | (756,777   | )          | 1,733,174 |       |
| ** **                                               |       |       |       |      |       |
| **Investing activities**                                 |       |       |       |      |       |
| Acquisitions of property and equipment                   |       | (330,972   | )          | (200,138  | )          |
| Repayments of advances due from stockholder              |       | 18,000     |       | 0         |       |
| Advances to stockholder                                  |       | 0          |       | (18,000   | )          |
| **Net cash (used in) investing activities**              |       | (312,972   | )          | (218,138  | )          |
| ** **                                               |       |       |       |      |       |
| **Financing activities**                                 |       |       |       |      |       |
| Repayments of long-term debt                             |       | (179,818   | )          | (357,627  | )          |
| Proceeds from note payable – stockholder            |       | 500,000    |       | 0         |       |
| Repayments on note payable – stockholder            |       | (250,000   | )          | 0         |       |
| Series A preferred stock dividends  paid            |       | 0          |       | (521,773  | )          |
| **Net cash provided by (used in) financing  activities** |       | 70,182     |       | (879,400  | )          |
| ** **                                               |       |       |       |      |       |
| **Increase (decrease) in cash**                          |       | (999,567   | )          | 635,636   |       |
| ** **                                               |       |       |       |      |       |
| **Cash**                                                 |       |       |       |      |       |
| Beginning of year                                        |       | 1,602,571  |       | 966,935   |       |
| ** **                                               |       |       |       |      |       |   |   |
| **End of year**                                          |       | $          | 603,004    |      | $          | 1,602,571 |   |
| ** **                                               |       |       |       |      |       |
| **Supplemental disclosures of cash flow  information**   |       |       |       |      |       |
| Interest paid                                            |       | $          | 32,552     |      | $          | 22,773 |   |
| Income taxes paid                                        |       | $          | 731,000    |      | $          | 964,000 |   |

 

See accompanying notes

 

**Supplementalschedule of noncash financing activities**

 

On December 11, 2002, the Company,through a newly formed, wholly owned subsidiary, acquired certain assets ofGulbransen, Inc.  As part of theacquisition, the Company was to issue 100,000 shares of its common stock uponthe completion of certain documentation. During the year ended June 30, 2004, the Company issued the 100,000shares of common stock.

 

17

----

 

**QRS MusicTechnologies Inc.**

**Notes tothe Consolidated Financial Statements**

**YearsEnded June 30, 2005 and 2004**

 

**Note 1    Natureof Operations and Significant Accounting Policies**

** **

**Nature of Operations**—QRS Music Technologies, Inc. (the “Company”)is a manufacturer and distributor of pianos, pianomation units, and compactdiscs and music rolls for use in player pianos. The Company sells its products to dealers and end-users, predominantlyin the United States.

 

ChurchServices, Inc., a wholly owned subsidiary, was established during the yearended June 30, 2003 to acquire certain assets of Gulbransen, Inc.

 

TheCompany has divisions in Buffalo, NY; Seneca, PA; Naples, FL; and Las Vegas,NV, and operates a sales office in Sydney, Australia, and a procurement officein Hong Kong.

 

**Principles of Consolidation**—The consolidated financial statementsinclude the accounts of the Company and its wholly owned subsidiary, ChurchServices, Inc.  All significantintercompany transactions and balances have been eliminated in consolidation.

 

**Use of Estimates**—The preparation of financial statements in conformity withgenerally accepted accounting principles requires management to make estimatesand assumptions that affect the amounts reported in the financial statementsand accompanying notes.  Actual resultscould differ from those estimates.

 

**Revenue Recognition**—The Company recognizes sales when productsare shipped.  The Company may, at times,arrange financing of customers’ purchases through commercial financingcompanies.  These arrangements generallyrequire the Company to repurchase pianos financed and repossessed by thecommercial financing companies.  Thepurchase price is typically the total unpaid balance owed to the finance companiesplus reasonable expenses.

 

Pianospurchased from the finance companies are recorded into inventory on the samebasis as the Company records purchases of pianos from independent pianosuppliers.

 

InNovember 2002, the Emerging Issues Task Force (“EITF”) reached a consensuson EITF Issue 00­21, “Accounting for Revenue Arrangements with MultipleDeliverables.”  EITF Issue 00­21 providesguidance on how to determine when an arrangement that involves multiplerevenue-generating activities or deliverables should be divided into separateunits of accounting for revenue recognition purposes, and if this division isrequired, how the arrangement consideration should be allocated among theseparate units of accounting.  Theguidance in the consensus is effective for revenue arrangements entered into infiscal periods beginning after June 15, 2004.  Effective July 1, 2003 the Companyadopted EITF Issue 00-21, which did not have a material effect on its financialposition, results of operation or cash flows.

 

**Segments**—In June 1997, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information,” which established annual reporting standards for anenterprise’s operating segments and related disclosures about its products,services, geographic areas and major customers. The Company’s operations are within one reportable segment operating inthe United States.

 

**Concentration**- A majority of the Company’s line of pianos are imported from thePeoples Republic of China.  The Importand Export Company of Dongbei Pianos (Group) Co. supplies the largestpercentage of the imported pianos.  TheCompany also believes there are other sources of imported pianos available atcomparable prices if the current supply were interrupted.

 

**Cash**—At June 30, 2005 and 2004, the Company had deposits atfour commercial banks.  Deposits areinsured by the Federal Deposit Insurance Corporation (FDIC) up to$100,000.  Deposits may from time to timeexceed federally insured limits.

 

18

----

 

**Accounts Receivable**—The Company grants trade credit todomestic and international customers. Receivables are valued at management’s estimate of the amount that willultimately be collected.  The allowancefor doubtful accounts is based on the specific identification of uncollectibleaccounts and the Company’s historical collection experience.

 

**Inventories**—Inventories are valued at the lower of cost or market underthe first-in, first-out (FIFO) method.

 

**Property, Plant and Equipment**—Property, plant and equipment are valuedat cost and depreciated using the straight-line method over the estimateduseful lives of the assets.  Maintenanceand repairs are charged to income as incurred. Expenditures that materially extend the useful lives of assets arecapitalized.

 

**Goodwill**—The Company adopted SFAS 141, “Business Combinations,” andSFAS 142, “Goodwill and Other Intangible Assets,” effective July 1,2002.  Under these standards, allacquisitions subsequent to June 30, 2001 must be accounted for under thepurchase method of accounting and purchased goodwill is no longer subject toamortization.  Rather, it is subject toperiodic impairment tests based on its fair value.  Goodwill represents the excess cost over thefair value of tangible net assets of the Company and is recorded on theconsolidated balance sheet in other assets. The Company reviews the carrying value of the goodwill annually and atother times when facts or circumstances indicate that the recorded amount ofgoodwill may be impaired.  If this reviewindicates that goodwill is not recoverable, the Company’s carrying value of thegoodwill is reduced by the estimated shortfall. As of June 30, 2005 and 2004, respectively, the Company has $60,000of goodwill included in other assets on the consolidated balance sheets and noimpairment has been recorded.

 

**Advertising**—The Company expenses advertising as the costs areincurred.  Advertising expense wasapproximately $119,000 and $72,000 for the years ended June 30, 2005 and2004, respectively.

 

**Research and Development**—The Company expenses research anddevelopment as the costs are incurred.

 

**Deferred Income Taxes**—Deferred income tax assets and liabilitiesare recognized for the expected future tax consequences of events that have beenincluded in the financial statements or tax returns.  Under this method, deferred income tax assetsand liabilities are determined based on the financial statement and tax basisof assets and liabilities (Note 8).

 

**Earnings Per Share**—The Company computes earnings per share (“EPS”) underStatement of Financial Accounting Standard (SFAS) No. 128, “Earnings perShare.”  Basic net earnings lesspreferred dividends are divided by the weighted average number of common sharesoutstanding during the year to calculate basic net earnings per commonshare.  Diluted net earnings per commonshare are calculated to give effect to the potential dilution that could occurif convertible preferred stock, warrants, options or other contracts to issuecommon stock were exercised and resulted in the issuance of additional commonshares.

 

Thecomputation of basic and diluted EPS was as follows:

 
| ** **                                       | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|--------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net income                                       |       | $         | 1,097,814  |      | $          | 1,463,364 |   |
| Preferred  stock dividends                       |       | (128,382  | )          | (128,382  | )          |
| Income  available to common stockholders         |       | $         | 969,432    |      | $          | 1,334,982 |   |
|                                             |       |      |       |      |       |
| Denominator                                      |       |      |       |      |       |
| Basic  weighted average shares outstanding       |       | 9,458,956 |       | 9,370,595 |       |
| Weighted  average shares outstanding for options |       | 112,000   |       | 96,000    |       |
| Diluted  weighted average shares outstanding     |       | 9,570,956 |       | 9,466,595 |       |
|                                             |       |      |       |      |       |
| Basic net  income per share                      |       | $         | 0.10       |      | $          | 0.14 |   |
| Diluted net  income per share                    |       | $         | 0.10       |      | $          | 0.14 |   |

 

19

----

 

In 2005and 2004, 534,925 weighted average common shares from the conversion of convertiblepreferred stock were not included in the computation because they wereantidilutive.

 

**Fair Value of Financial Instruments**—The carrying amounts offinancial instruments including cash, accounts receivable, accounts payable,and short-term debt approximate their fair values because of the relativelyshort maturity of these instruments.  Thecarrying value of long-term debt, including the current portion, approximated****fair value based upon market prices for the same or similarinstruments.

 

**Recent Accounting Pronouncements**— The FASB has issuedInterpretation No. 46 (FIN-46R) (Revised December 2003), “Consolidationof Variable Interest Entities: an Interpretation of ARB No. 51” (FIN46).  FIN 46 addresses consolidation bybusiness enterprises of entities in which equity investors do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties.  Variable interest entities are required to beconsolidated by their primary beneficiaries if they do not effectively disperserisks among parties involved.  Theprimary beneficiary of a variable interest entity is the party that absorbs amajority of its expected residual returns. The consolidation requirements of FIN 46 apply immediately to variableinterest entities created after January 31, 2004 and apply to existingentities in the first fiscal year or interim period beginning afterJune 15, 2004.  The adoption of FIN46 did not have a material effect on the Company’s financial statements andrelated disclosures because it does not have any variable interest entityrelationships.

 

InApril 2003, FASB issued SFAS 149, “Amendment of Statement 133 onDerivative Instruments and Hedging Activities.” SFAS 149 amends and clarifies financial accounting and reporting forderivative instruments, including certain derivative instruments embedded inother contracts and for hedging activities under SFAS 133, “Accounting forDerivative Instruments and Hedging Activities.” The changes in SFAS 149 improve financial reporting by requiring thatcontracts with similar characteristics be accounted for similarly.  SFAS 149 is effective, with some exceptions,for contracts entered into or modified after June 30, 2003.  Effective July 1, 2003 the Companyadopted SFAS 149 which did not have a material impact on its financial positionor results of operations because the Company does not use derivativeinstruments.

 

InMay 2003, the FASB issued SFAS 150, “Accounting for Certain FinancialInstruments with Characteristics of Both Liabilities and Equity” (“SFAS 150”).  SFAS 150 establishes standards for how anissuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. SFAS 150 requires that an issuer classify a financial instrument that iswithin its scope as a liability (or an asset in some circumstances).  The requirements of this statement apply toissuers’ classification and measurement of freestanding financial instruments,including those that comprise more than one option or forward contract.  SFAS 150 is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning afterJune 15, 2003.  The Company adoptedSFAS 150, and there was no material impact on its financial position, resultsof operations, or cash flows.

 

**In December 2004, the FASB issued SFASNo. 123 (revised 2004), “Share-Based Payment (SFAS No, 123R),” effectiveas of the first interim or annual reporting period that begins afterJune 15, 2005.  SFAS No. 123 Rrequires entities to measure and recognize the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award (with limited exceptions).  The Company is currently evaluating theimpact of the revised rule on the Company’s results of operations andfinancial position.**

 

20

----

 

**Note 2    Inventories**

** **

Inventoriesat June 30, 2005 and 2004 consist of:

 
| ** **         | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|--------------------|------------|-----------|------------|-----------|------------|
|               |       |      |       |      |       |   |   |
| Raw  materials     |       | $         | 5,746,815  |      | $          | 3,771,127 |   |
| Finished  goods    |       | 2,936,315 |       | 2,368,196 |       |
|               |       | 8,683,130 |       | 6,139,323 |       |
| Valuation  reserve |       | (771,279  | )          | (486,740  | )          |
|               |       |      |       |      |       |   |   |
|               |       | $         | 7,911,851  |      | $          | 5,652,583 |   |

 

**Note 3    Property, Plant and Equipment**

** **

Property,plant and equipment at June 30, 2005 and 2004 consist of:

 
| ** **                                | ** ** | **2005**   | ** ** | **2004**   | ** ** | **Lives**   | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|-------------|------------|
|                                      |       |       |       |       |       |        |       |
| Land and buildings                        |       | $          | 878,303    |       | $          | 878,303     |       | 10-39 years |   |
| Leasehold improvements                    |       | 613,316    |       | 566,370    |       | 10-20 years |       |
| Machinery and equipment                   |       | 394,402    |       | 462,080    |       | 5-7 years   |       |
| Office equipment                          |       | 539,762    |       | 333,396    |       | 5-7 years   |       |
| Vehicles                                  |       | 52,261     |       | 41,840     |       | 5 years     |       |
| Construction in process                   |       | 0          |       | 34,612     |       |        |       |
|                                      |       | 2,478,044  |       | 2,316,601  |       |        |       |
| Accumulated depreciation and amortization |       | (1,275,140 | )          | (1,266,355 | )          |        |       |
|                                      |       |       |       |       |       |        |       |
| Net book value                            |       | $          | 1,202,904  |       | $          | 1,050,246   |       |   |   |

 

Depreciationand amortization expense amounted to $148,554 and $136,338 for the years endedJune 30, 2005 and 2004, respectively.

 

**Note 4    Long-Term Debt**

** **

Long-termdebt at June 30, 2005 and 2004 consists of:

 
| ** **                                                                                                                                                                                                                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                                                                                                                        |       |     |       |     |       |
| Note payable - lending institution -  payable in monthly installments of $13,751 plus accrued interest at the prime  rate (6% at June 30, 2005 and 4% at June 30, 2004), due  May 2007, secured by all assets of the Company |       | $        | 108,834    |     | $          | 288,652 |   |
|                                                                                                                                                                                                                                        |       |     |       |     |       |
| Current portion                                                                                                                                                                                                                             |       | (108,834 | )          | (165,012 | )          |
|                                                                                                                                                                                                                                        |       |     |       |     |       |
|                                                                                                                                                                                                                                        |       | $        | 0          |     | $          | 123,640 |   |

 

Thenote payable requires the Company to satisfy certain financial tests concerningtangible capital funds and debt service coverage ratio.  As of June 30, 2005 the Company was incompliance with these financial covenants.

 

21

----

 

**Note 5    Related-Party Transactions**

** **

During the year ended June 30, 2004 the Company advanced$18,000 to its major stockholder.  Suchadvance was evidenced by an unsecured demand note bearing interest at 6 percentper annum.  During the year endedJune 30, 2005 such advance was repaid in full, plus $44 in interest.

 

During the year ended June 30, 2005 the Company wasadvanced $500,000 from its major stockholder. Such advance was evidenced by an unsecured demand note bearing interestat 6 per cent per annum.  During the yearended June 30, 2005 a payment of $250,000 was made, leaving a balance dueof $250,000.  Interest in the amount of$20,548 was accrued for the year.

 

The Company leases propertyfrom its major stockholder under a 20-year operating lease which expiresDecember 2012.  Annual leasepayments are $24,000.  On April 1,2000, the Company entered into an additional rental agreement with the samestockholder.  The lease is on amonth-to-month basis for $6,250 per month. Rent expense incurred related tothese agreements amounted to $99,000 for the years ended June 30, 2005 and2004.

 

Beginning in 2004, in New South Wales, Australia, the Companybegan utilizing space in a building owned by Alltech InternationalHoldings, Inc.  At the time theCompany’s chairman and majority shareholder was also chairman and majorityshareholder of Alltech International Holdings. At the time one of the Company’s directors was also an officer ofAlltech International Holdings.  TheCompany used the space to inventory pianos and pianomation units that will besold in the Australian market.  AlltechInternational Holdings also provided some managerial and accounting servicesfor transactions in Australia in exchange for a commission on the productsold.  Alltech International Holdings,Inc was sold during Fiscal 2005 and currently has no common officers, directorsor related parties to the Company.  Duringthe fourth quarter of 2005, the Company vacated the space it was previouslyutilizing, and no longer utilizes any managerial or accounting services fromAlltech International Holdings.  Expensesrelating to this arrangement amounted to $27,884 and $34,500 in 2005 and 2004,respectively.

 

**Note 6    Stockholders’ Equity**

** **

Each share of the Series A Preferred Stock isconvertible into one share of common stock. Cumulative dividends (when declared) on the Series A PreferredStock will be paid at a rate of 6 percent per annum of the original liquidationvalue on June 30 and December 31. The preferred liquidation amount is $4 per share.  The holders of the preferred shares are entitledto one vote per share with respect to all matters submitted to a vote of theCompany’s stockholders.  During the yearended June 30, 2004, the Company declared and paid dividends totaling$521,773 to holders of the preferred shares. Dividends in arrears on the Series A Preferred Stock amounted to$160,480 and $32,096 at June 30, 2005 and 2004, respectively.

 

In April 2004, the Company issued 100,000 shares of itscommon stock (valued at $289,000) to a non-employee in exchange for consultingservices performed.

 

During the year ended June 30, 2002, in exchange forconsulting services, the Company granted an option to purchase 200,000 sharesof stock at $1 per share exercisable until February 15, 2007.  As of June 30, 2005 these options werestill outstanding.

 

**Note 7    Employee Benefit Plan**

** **

The Company maintains a profit sharing plan for the benefitof all employees that meet certain eligibility requirements.  Company contributions for the years endingJune 30, 2005 and 2004 were $215,570 and $74,710, respectively.

 

22

----

 

**Note 8    Income Taxes**

** **

The components of the netdeferred tax assets and liabilities as of June 30, 2005 and 2004 are asfollows:

 
| ** **                                                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                   |       |     |       |     |       |
| Deferred tax assets (liabilities)                                      |       |     |       |     |       |
| Allowance for doubtful accounts                                        |       | $        | 164,000    |     | $          | 99,000 |   |
| Variation in inventories between tax and  financial reporting purposes |       | 356,000  |       | 240,000  |       |
| Accrued judgement for preferential payments                            |       | 0        |       | 181,000  |       |
| Other accruals                                                         |       | 100,000  |       | 100,000  |       |
|                                                                   |       |     |       |     |       |   |   |
| Net deferred tax asset                                                 |       | $        | 620,000    |     | $          | 620,000 |   |
|                                                                        |            |          |            |          |            |  |  |  |

 

A reconciliation of theprovision for income taxes and the amount computed by applying the federalstatutory rate to income before income tax expense is as follows:

 
| ** **                                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                  |       |     |       |     |       |   |   |
| Computed  income tax expense at federal statutory rate                |       | $        | 569,000    |     | $          | 810,000 |   |
| Income tax  expense at state rates (net of federal income tax effect) |       | 49,000   |       | 112,000  |       |
| Other                                                                 |       | (41,000  | )          | (3,000   | )          |
|                                                                  |       |     |       |     |       |   |   |
|                                                                  |       | $        | 577,000    |     | $          | 919,000 |   |

 

**Note 9    Commitments and Contingencies**

** **

The Company is contingently liable under its third partyfinancing agreements, arranged for its customers, in the amounts of $2,224,000and $1,915,000 at June 30, 2005 and 2004, respectively.  The total pianos repurchased by the Companyunder these commitments amounted to $58,935 and $17,188 for the years endedJune 30, 2005 and 2004, respectively. A reserve for returns of $91,000 at June 30, 2005 and 2004,respectively, is included in accrued expenses in the accompanying balancesheets.

 

The Company is a party to various other claims, legal actionsand complaints arising in the ordinary course of business.  In the opinion of management, all suchmatters are adequately covered by insurance, or if not so covered, are withoutmerit or are of such kind or involve such amounts that unfavorable dispositionwould not have a material effect on the Company’s financial position, resultsof operations or liquidity.

 

The Company has entered into various royalty and licensingagreements with third parties.  Royaltyand licensing expense for the years ended June 30, 2005 and 2004,respectively, amounted to approximately $413,000 and $425,000.

 

23

----

 

On August 20, 2003 a default judgment in theamount of approximately $478,000 was entered against the Company in the UnitedStates Bankruptcy Court, Southern District of Ohio, Western Division. Thedefault judgment was granted to Dwight’s Piano Co (formerly known as BaldwinPiano & Organ Company and subsidiaries, a former customer of theCompany) and was based upon claims that preferential transfers were made to theCompany during the 90 day period prior to Baldwin’s bankruptcy filing onMay 31, 2001. Because a judgment was entered against the Company by theCourt, the entire amount of the judgment was accrued as of June 30, 2003.The Company filed a motion seeking vacation of the judgment and raised severaldefenses available to it under the Bankruptcy Code.  On January 3, 2005 the United StatesBankruptcy Court, Southern District of Ohio, Western Division, approved anegotiated settlement agreement between the Company and Dwight’s Piano Co.  The negotiated settlement agreement reducedthe Company’s preference liability to $61,395. Upon the consummation of the settlement, the United States BankruptcyCourt immediately entered an Order vacating the default judgment entered,and subsequently dismissed the litigation initiated by Dwight’s Piano Co.against the Company, with prejudice.  Asa result of the negotiated settlement, for the year ended June 30, 2005the Company recognized income of $416,206, reflected as a reduction of selling,general and administrative expenses.

 

**The Company has entered into a two year lease for office and warehousespace in Hong Kong, a one year lease for showroom and warehouse space inBalmain, Australia and a six month lease for warehouse space in Las Vegas,Nevada.  All leases have the option torenew at the end of the commitment period. Total rent expense and related costs for all operating leases was $138,900and $99,000 for the years ended June 30, 2005 and 2004, respectively.**

** **

**Total minimumlease payments under these operating leases are as follows:**

** **
| 2006  |   | $ | 138,885 |   |
|-------|--------|---|---------|--------|
| 2007  |   | $ | 47,424  |   |
| 2008  |   | $ | 24,000  |   |
| 2009  |   | $ | 24,000  |   |
| 2010  |   | $ | 24,000  |   |
| 2011  |   | $ | 12,000  |   |
| Total |   | $ | 270,309 |   |

 

**Note 10  Asset Acquisition**

** **

**OnDecember 11, 2002, the Company, through a newly formed, wholly ownedsubsidiary, acquired certain assets of Gulbransen, Inc. for $164,177 incash, 100,000 shares of the Company’s common stock and future royalty payments(through November 1, 2032) based on sales volume.  The common stock was to be issued upon thecompletion of certain documentation.  Thepurchase price was negotiated based on the fair value of the inventorypurchased plus a multiple of prior financial results and perceivedopportunities.  During the year endedJune 30, 2004, the Company issued the 100,000 shares of common stock.**

** **

The acquisition has been accounted for as a purchase underthe provisions of SFAS 141, “Business Combinations.”  The total purchase price has been allocatedto the tangible and intangible assets of the Company based on their respectivevalues.  The following provides anallocation of the purchase price:

 

24

----

 
| Inventory       |   | $      | 164,177 |   |
|-----------------|--------|--------|---------|--------|
| Goodwill        |   | 60,000 |    |
|            |   |   |    |   |
| Purchase  price |   | $      | 224,177 |   |

 

25

----

 

**Item 8.    Changes Inand Disagreements with Accountants on Accounting and Financial Disclosure.**

 

None

 

**Item 8A. Controls andProcedures.**

 

Evaluationof Disclosure Controls and Procedures and Changes in Internal Control overFinancial Reporting

 

During the third quarter of the fiscal year endingJune 30, 2004 the Company’s chief executive officer and chief financialofficer learned of instances of insufficiencies in certain disclosure controlsand procedures and internal controls during the fiscal year endingJune 30, 2003 and for the first three quarters of fiscal 2004.  As a result, an evaluation was performed ofthe involved disclosure controls and procedures and internal controls and therewas found to be a significant deficiency, and necessary improvements needed tobe made to ensure these deficiencies would not be repeated.  The matter was discussed with the auditcommittee, the independent auditors, corporate counsel and the Board ofDirectors.  The correction of thedeficiency was assigned the highest priority, and action has been taken tocorrect it.

 

As a result of the evaluation the following conclusionswere reached:

 

Therewas no fraud affecting the Company’s financial statements.

 

Discussedbelow is specific information regarding the disclosure controls and proceduresdeficiency and the internal control deficiencies and the correspondingcorrective actions as implemented through May 19, 2004.

 

Inthe 3rd quarter of the fiscal year ending June 30, 2004, the Companydiscovered that a default judgment in the amount of approximately $478,000 plusinterest had been entered against it in United States Bankruptcy Court,Southern District of Ohio, Western Division. Due to a gap in the disclosure controls and procedures system thereceipt of process was not handled in an appropriate manner, and did not cometo the attention of management or counsel within the appropriate time to beproperly reviewed and assessed for effect on the Company’s financial statementsand action necessary for proper disclosure. Management has reviewed itsprocedures and taken appropriate actions to ensure these matters will behandled in the appropriate manner.  Thecompany has appointed its current registered agent in the State of Delaware toact as registered agent in all states where the Company has offices. TheCompany intends to instruct the registered agent that copies of all receipts ofprocess are to be sent to the chief executive officer, chief financial officer,corporate counsel and chairman of the board. Such matters that materially affect the Company’s financial positionwill be immediately brought to the attention of the audit committee, who willin turn prepare a separate analysis of the impact on the Company’s financialreporting.  It has also been determinedthat the audit committee will meet on a more frequent basis.  As a regular course of business at all Boardmeetings the audit committee will review with the Board of Directors anyoutstanding issues.  If the auditcommittee believes an item of a significant nature has arisen, it willimmediately request a special Board Meeting to review the circumstances.

 

TheCompany is currently in the process of changing their internal communicationand computer system in order to continue to address ongoing changingregulations and past deficiencies.  Withthe deployment of the new communication and computer system new procedures andprocess flows are also being developed and refined to further insure theaccuracy and timeless of all reporting.

 

Inaddition to internal improvements, the company is also taking steps to increasethe size and makeup of their Board of Directors.  Such changes are planned to take effect in fiscal2006.

 

The Company is committed to ongoing periodic reviews of itscontrols and their effectiveness. Controls have improved and management has noreason to believe that the financial statements included in this report are notfairly stated in all material respects. Management believes its practices and procedures, although not as matureor as formal as management intends them to be in the future, are adequate underthe circumstances, and that there are no material inaccuracies or omissions inthis Form

 

**Item8B. Other Information**

 

None

 

26

----

 

**PART III**

 

**Item 9. Directors, Executive Officers, Promoters and ControlPersons; Compliance With Section 16(a) of the Exchange Act.**

 

DIRECTORSAND OFFICERS.  The Directors andExecutive Officers of the Company and the positions held by each of them are asfollows.  All directors serve until theCompany’s next annual meeting of shareholders.

 
| ** **        | ** ** | ** ** | ** ** | **Serving as**    | ** ** | ** **                          |
|-------------------|------------|------------|------------|-------------------|------------|-------------------------------------|
| ** **        | ** ** | ** ** | ** ** | **Director of**   | ** ** | **Position Held With**              |
| **Name**          | ** ** | **Age**    | ** ** | **Company Since** | ** ** | **the Company**                     |
|              |       |       |       |              |       |                                |
| Richard  A. Dolan |       | 69         |       | 1990              |       | Director, Chairman                  |
|              |       |       |       |              |       |                                |
| Ann  A. Jones     |       | 40         |       | 1996              |       | Secretary, Treasurer,  Chief        |
|              |       |       |       |              |       | Financial Officer,  Director        |
|              |       |       |       |              |       |                                |
| Geoffry  Matlin   |       | 54         |       | 1998              |       | Director                            |
|              |       |       |       |              |       |                                |
| Thomas  A. Dolan  |       | 46         |       |              |       | President, Chief Executive  Officer |

 

BIOGRAPHICALINFORMATION.

 

RichardA. Dolan

 

Formore than the past six years, Mr. Dolan has been majority shareholder, anda director of Company. He also served as President and Chief Executive officerthrough June, 2002.  He was the founderof and had been the principal owner and Chairman of Alltech InternationalHoldings since 1971, prior to selling in 2005. Prior to 1971 he was ResearchDirector of Simoniz in Europe. Mr. Dolan has a Bachelor of Science inchemistry from DePaul University, a Master of Science degree in chemistry fromRoosevelt University.

 

AnnA. Jones

 

Ms. Joneshas been Secretary, Treasurer, Chief Financial Officer and Director of Companysince 1996. From June 1988 to June 1996 Ms. Jones has served invarious capacities with Company including customer service and manager.

 

GeoffryMatlin

 

GeoffryMatlin has been a director of the Company since September 1998. FromNovember 1995 until December 1997 Mr. Matlin was the corporatecontroller of Alltech Associates, Inc., a manufacturer and distributor ofchromatography equipment.  From January 1998 until August 2004Mr. Matlin held the positions of Chief Financial Officer, Secretary andTreasurer of Alltech Associates, Inc.  From August 2004 untilthe present Mr. Matlin is the financial analyst for AlltechAssociates, Inc. a wholly owned subsidiary of WR Grace.

 

ThomasA. Dolan

 

ThomasA. Dolan, son of Chairman Richard A. Dolan, has been the President and ChiefExecutive Officer of the the Company since July 2002.  Employed by the Company since 1994,Mr. Dolan has served in various capacities including

 

27

----

 

regional and national sales and manager ofresearch and development.  Mr. Dolanhas a bachelor’s degree in Industrial Administration and Economics from IowaState University, and an Electrical Engineering degree from the University ofArizona He has worked for Motorola, Inc. in its component productsdivision and Johnson Controls as a Sales Engineer.

 

SECTION 16(a) BENEFICIALOWNERSHIP REPORTING COMPLIANCE

 

Basedsolely upon review of Forms 3 and 4 and amendments thereto furnished to theCompany under Rule 16a-3(e) during its most recent fiscal year andwritten representations received from reporting persons, no person who was adirector, officer or 10% beneficial owner failed to timely file reportsrequired by Section 16(a) of the Exchange Act.

 

TheCompany has not yet adopted a code of ethics. It is in the process of draftingan appropriate code of ethics. The Company expects to adopt a code of ethicswithin in late fiscal 2006.

 

Currentlythe Company maintains an audit committee that is comprised of its onlyindependent board member, Geoff Matlin.  Mr. Matlinis considered a financial expert by virtue of both his education andexperience.

 

**Item 10. Executive Compensation.**

 

Thefollowing table sets forth information concerning compensation for services inall capacities by the Company and its subsidiaries for fiscal years endedJune 30, 2003, 2004 and 2005 of those persons who were, at June 30,2005, the Chief Executive Officer of the Company and other highly compensatedexecutive officers and employees of Company.

 

SUMMARY COMPENSATION TABLE

 
| **Name and  Principal  postion** | ** ** | **Year** | ** ** | **Salary** | ** ** | **Other Annual  Compensation** | ** ** | **Long-Term Compensation  Securities  Underlying  Options/SARs** | ** ** |
|----------------------------------|------------|----------|------------|------------|------------|--------------------------------|------------|------------------------------------------------------------------|------------|
| Richard  Dolan Chairman          |       | 2003     |       | —     |       |                           |       |                                                             |       |
|                             |       | 2004     |       |       |       |                           |       |                                                             |       |
|                             |       | 2005     |       | —     |       |                           |       |                                                             |       |
| Ann Jones,  CFO                  |       | 2003     |       | $          | 87,000     |                           |       |                                                             |       |   |
|                             |       | 2004     |       | $          | 87,000     |                           | $          | 69,000                                                           |       |   |   |
|                             |       | 2005     |       | $          | 87,000     |                           | $          | 69,000                                                           |       |   |   |
| Tom Dolan,  Pres., CEO           |       | 2003     |       | $          | 85,000     |                           |       |                                                             |       |   |
|                             |       | 2004     |       | $          | 87,000     |                           | $          | 85,000                                                           |       |   |   |
|                             |       | 2005     |       | $          | 87,000     |                           | $          | 85,000                                                           |       |   |   |

 

TheCompany intends to compensate outside directors for attendance at boardmeetings. Such director compensation has not been determined but is expected tobe less than $2,000 per meeting.

 

**Item 11. Security Ownership of Certain Beneficial Owners andManagement and Related Stockholder Matters.**

 

PRINCIPALSHAREHOLDERS.

 

The following table setsforth as of June 30, 2005, the number of Company’s voting securitiesbeneficially owned by persons who own five percent or more of Company’s votingstock, by each director, and by all officers and directors as a group.  The table presented below includes sharesissued and outstanding, and warrants to purchase shares and options exercisablewithin 60 days.

 

28

----

 
| ** **                   | ** ** | **Name and Address**                    | ** ** | **Type of**           | ** ** | **Number of**    | ** ** | **Percent of** | ** ** |
|------------------------------|------------|-----------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|
| **Title and Class**          | ** ** | **Of Beneficial Owner**                 | ** ** | **Ownership**         | ** ** | **Shares Owned** | ** ** | **Class**      | ** ** |
|                         |       |                                    |       |                  |       |             |       |           |       |
| Common Stock  $.01 par value |       | Richard  Dolan  2011 Seward Ave.        |       | Record and Beneficial |       | 5,819,274        | *          | 58             | %          |
|                         |       | Naples,  FL 34109                       |       |                  |       |             |       |           |       |
|                         |       |                                    |       |                  |       |             |       |           |       |
| Common Stock  $.01 par value |       | Ann  Jones  2011 Seward Ave.            |       | Record and Beneficial |       | 200,063          | **         | 2              | %          |
|                         |       | Naples,  FL 34109                       |       |                  |       |             |       |           |       |
|                         |       |                                    |       |                  |       |             |       |           |       |
| Common Stock  $.01 par value |       | Geoffry  Matlin  2011 Seward Ave.       |       | Record and Beneficial |       | 24,250**         |       |           | ***        |
|                         |       | Naples,  FL 34109                       |       |                  |       |             |       |           |       |
|                         |       |                                    |       |                  |       |             |       |           |       |
| Common Stock  $.01 par value |       | Thomas  Dolan  2011 Seward Ave.         |       | Record and Beneficial |       | 359,227          | ****       | 4              | %          |
|                         |       | Naples,  FL 34109                       |       |                  |       |             |       |           |       |
|                         |       |                                    |       |                  |       |             |       |           |       |
| Common Stock  $.01 par value |       | All  Officers and Directors  As a Group |       | Record and Beneficial |       | 6,411,814        |       | 62             | %          |
|                         |       |                                    |       | (4 persons)           |       |             |       |           |       |

 

**Item 12. Certain Relationships and Related Transactions.**

 

The Company leases from Richard A. Dolan 4,000 square feetof warehouse and office space located in Naples, Florida.  Richard A. Dolan is the Company’s,controlling shareholder and a Member of Company’s Board of Directors.  The lease was executed January 1, 1993and has a term of 20 years.  Rental is$24,000 per year.

 

Company also leases from Mr. Dolan 6,000 square feetof showroom space in Las Vegas, Nevada. That lease is month-to-month with rental payments of $75,000 per year.

 

----

***Includes 442,190 shares owned by family members of whichMr. Richard Dolan disclaims ownership. It also includes 534,925 shares of Series A preferred stock whichis convertible into shares of common stock.**

** **

**** The directors and officers have sole voting and investment power asthe shares beneficially owned by them.**

** **

***** Less than one percent.**

** **

******  Includes 143,900 shares ownedby family members of Mr. Thomas Dolan.**

 

29

----

 

TheCompany declared and paid $521,773 in preferred stock dividends in fiscal year2004.  All shares of preferred stock areowned by the Company’s Chairman

 

TheCompany has no and is not currently considering adopting any policy regardingtransactions with affiliates. In the future the Company will not advance fundsto affiliates.

 

Infiscal 2004 in New South Wales, Australia, the Company utilized spaces in abuilding owned by Alltech International Holdings, Inc.  The Company’s chairman and majorityshareholder was also chairman and majority shareholder of Alltech InternationalHoldings.  One of the Company’sdirectors, Geoff Matlin was also an officer of Alltech International Holdings.During fiscal 2005 the Alltech International Holdings was sold to annon-affilitated party, and the Company moved its offices from the AlltechInternational Holdings building.

 

OnSeptember 15, 2004, the Company borrowed $500,000 from Richard Dolan theCompany’s Chairman and majority shareholder. The Company issued toMr. Dolan a demand note which bears interest at 6% per annum (accruedquarterly).  On April 15, 2005 theCompany repaid principal of $250,000.  Asof June 30, 2005 there was accrued interest of $20,548 due Mr. Dolanfor this note.

 

**Item 13. Exhibits and Reports on Form 8-K.**

 
| a.                  |   | Exhibit Index                                                                |                                 |   |
|---------------------|--------|-----------------------------------------------------------------------------------|--------------------------------------|--------|
|                |   |                                                                              |
| Exhibit Number |   |                                                                              |
|                |   |                                                                              |
| 2                   |   | (i)                                                                               | Articles  of Incorporation           |   | * |
|                |   | (ii)                                                                              | Bylaws                               |   | * |
|                |   |                                                                              |                                 |   |
| 6                   |   | Material  Contracts                                                               |                                 |   |
|                |   |                                                                              |                                 |   |
|                |   | (i)                                                                               | Lease  – Naples, Florida        |   | * |
|                |   | (ii)                                                                              | Monthly  Rental Agreement- Las Vegas |   | * |
|                |   | (iii)                                                                             | Demand  note issued to Richard Dolan |   | * |
|                |   |                                                                              |                                 |   |
| 31.1                |   | Certifications  (of Chief Financial Officer)                                      |                                 |   |
|                |   |                                                                              |                                 |   |
| 31.2                |   | Certifications  (of Chief Executive Officer)                                      |                                 |   |
|                |   |                                                                              |                                 |   |
| 32.1                |   | Certification  of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 |                                 |   |
|                |   |                                                                              |                                 |   |
| 32.2                |   | Certification  of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 |                                 |   |
|                     |        |                                                                                   |                                      |        |  |  |

 

OnMay 17, 2004, Company filed a report on Form 8-K disclosing in Item 5that in the 3rdquarter of the fiscal year ending June 30, 2005, the Company discoveredthat in August 2004, a default judgment in the amount of approximately$478,000 plus interest had been entered against it in United States BankruptcyCourt, Southern District of Ohio, Western Division.

 

**Item 14. Principal Accountant Fees and Services**

 

The Board of Directors, upon recommendation of the Audit Committee, appointed the firm of Altschuler, Melvoin & Glasser LLP (“AM&G”) certified public accountants for fiscal 2005.

 

----

* Incorporated by referencefrom Company's Form 10SB Amendment 3 dated May 21, 2001.

 

30

----

 

AM&Ghas a continuing relationship with American Express Tax and Business Services,Inc.  (TBS)  from which it leases auditing staff who arefull time, permanent employees of TBS and through which its partners providenon-audit services.  As a result of thisarrangement, AM&G has no full time employees and therefore, none of the auditservices performed were provided by permanent full-time employees ofAM&G.  AM&G manages andsupervises the audit and audit staff, and is exclusively responsible for theopinion rendered in connection with its examination.  On October 1, 2005 American Express Taxand Business Services, Inc, was acquired by RSM McGladrey.

 

Auditfees

 

Auditfees relate to audit work performed on the financial statements as well as workthat generally only he independent auditor can reasonably be expected toprovide including discussions surrounding the proper application of financialaccounting and/or reporting standards and reviews of the financial statementsincluded in quarterly reports filed on Form 10-Q.  Fees billed for professional audit servicesrendered amounted to approximately $73,000 and $80,000 for the fiscal yearsended June 30, 2005 and 2004, respectively.

 

*Auditrelated fees*

 

None

 

*TaxFees*

 

Taxcompliance services were provided by TBS for which fees amounted toapproximately $15,000 and $9,000 for the fiscal years ended June 30, 2005and 2004, respectively.

 

*Allother fees*

 

Duringthe year ended June  30, 2005, AM&G and TBS did not perform anymanagement consulting services for the Company.

 

*Preapprovalof Policies and Procedures by Audit Committee.*

 

The accountants provide a quote for services to the auditcommittee before work begins for the fiscal year.  After discussion the audit committee thenmakes a recommendation to the board on whether to accept the proposal.

 

*Percentageof services approved by Audit Committee.*

 

All services were approved by the audit committee.

 

31

----

 

**SIGNATURES**

 

In accordance with therequirements of the Exchange Act, the Company caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
|   | QRS  Music Technologies, Inc.     |
|--------|----------------------------------------|
|   |                                   |
|   | Date:                                  | 10/12/05 |   |
|   |                                   |   |
|   | /s/ Ann A. Jones                       |   |
|   |                                   |   |   |   |
|   | Ann  A. Jones, Chief Financial Officer |   |
|        |                                        |  |  |  |  |

 

32

----