**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

| **ý**                                             | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                   |
| **FOR THE QUARTERLY PERIOD ENDED SEPTEMBER  28, 2002** |
|                                                   |
| **o**                                                  | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                   |
|                                                   |
| **COMMISSION FILE NUMBER 001-11911**                   |

 

 

**STEINWAY MUSICAL INSTRUMENTS, INC.**

(Exact name of registrant asspecified in its charter)

 

| **DELAWARE**                                                                                       |   | **35-1910745**                        |
|----------------------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization)                                    |   | (I.R.S. Employer  Identification No.) |
|                                                                                               |   |                                  |
| **800 South Street, Suite 305  Waltham, Massachusetts**                                            |   | **02453**                             |
| (Address of Principal Executive Offices)                                                           |   | (Zip Code)                            |
|                                                                                               |   |                                  |
| Registrant’s telephone number including area  code:    **(781) 894-9770** |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements during the past 90 days.   Yes ý    No o

 
| Number of shares of Common Stock issued and outstanding as of  November 1, 2002: |   | Class A  |   | 477,953   |
|----------------------------------------------------------------------------------|--------|----------|--------|-----------|
|                                                                             |   | Ordinary |   | 8,482,285 |
|                                                                             |   | Total    |   | 8,906,238 |

 

 

----

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**FORM10-Q**

**INDEX**

 
| **PART I.**  | **FINANCIAL  INFORMATION**                                                                                                |
|--------------|---------------------------------------------------------------------------------------------------------------------------|
|         |                                                                                                                      |
| **Item 1.**  | **Condensed  Consolidated Financial Statements:**                                                                         |
|         |                                                                                                                      |
|         | Condensed Consolidated Statements of Income  Three months and nine months ended September 29, 2001 and September 28, 2002 |
|         |                                                                                                                      |
|         | Condensed Consolidated Balance Sheets  December 31, 2001 and September 28, 2002                                           |
|         |                                                                                                                      |
|         | Condensed Consolidated Statements of Cash  Flows  Nine months ended September 29, 2001 and September 28, 2002             |
|         |                                                                                                                      |
|         | Notes to Condensed Consolidated Financial  Statements                                                                     |
|         |                                                                                                                      |
| **Item 2.**  | **Management’s Discussion and Analysis of Financial Condition and  Results of Operations**                           |
|         |                                                                                                                      |
| **Item  3.** | **Quantitative and Qualitative Disclosures about  Market Risk**                                                           |
|         |                                                                                                                      |
| **Item 4.**  | **Controls and Procedures**                                                                                               |
|         |                                                                                                                      |
| **PART II.** | **OTHER INFORMATION**                                                                                                     |
|         |                                                                                                                      |
| **Item 6.**  | **Exhibits and Reports on Form 8-K**                                                                                      |
|         |                                                                                                                      |
|         | **Signatures**                                                                                                            |

 

2

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF INCOME**

**(In Thousands Except Share and Per ShareAmounts)**

**(Unaudited)**

 
|                                                                               |   | **Three  Months Ended**  |   | **Nine Months  Ended**   |   |
|------------------------------------------------------------------------------------|--------|--------------------------|--------|--------------------------|--------|
|                                                                               |   | **September  29,  2001** |   | **September  28,  2002** |   | **September  29,  2001** |   | **September  28,  2002** |   |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Net sales                                                                          |   | $                        | 82,885 |                     | $      | 75,320 |   | $ | 268,127 |   | $ | 241,728 |   |
| Cost of sales                                                                      |   | 58,576                   |   | 54,019                   |   | 185,045 |   | 170,679 |   |
| Gross Profit                                                                       |   | 24,309                   |   | 21,301                   |   | 83,082 |   | 71,049 |   |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Operating expenses:                                                                |   |                     |   |                     |   |   |   |   |   |
| Sales and marketing                                                                |   | 9,544                    |   | 9,497                    |   | 31,739 |   | 30,127 |   |
| General and administrative                                                         |   | 5,548                    |   | 5,286                    |   | 16,319 |   | 16,215 |   |
| Amortization                                                                       |   | 1,044                    |   | 288                      |   | 3,203 |   | 866 |   |
| Other operating expense                                                            |   | 148                      |   | 204                      |   | 623 |   | 611 |   |
| Total operating expenses                                                           |   | 16,284                   |   | 15,275                   |   | 51,884 |   | 47,819 |   |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Income from operations                                                             |   | 8,025                    |   | 6,026                    |   | 31,198 |   | 23,230 |   |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Interest expense, net                                                              |   | 4,416                    |   | 3,555                    |   | 13,482 |   | 10,345 |   |
| Other income, net                                                                  |   | (692                     | )      | (390                     | )      | (1,086 | ) | (1,933 | ) |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Income before income taxes                                                         |   | 4,301                    |   | 2,861                    |   | 18,802 |   | 14,818 |   |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Provision for income taxes                                                         |   | 1,787                    |   | 670                      |   | 7,387 |   | 4,860 |   |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Net income before extraordinary loss                                               |   | 2,514                    |   | 2,191                    |   | 11,415 |   | 9,958 |   |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Extraordinary loss on early extinguishment  of debt (net of tax benefit of $2,662) |   | —                   |   | —                   |   | 3,950 |   | — |   |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Net income                                                                         |   | $                        | 2,514  |                     | $      | 2,191 |   | $ | 7,465 |   | $ | 9,958 |   |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Earnings per share:                                                                |   |                     |   |                     |   |   |   |   |   |
| Basic earnings per share before  extraordinary loss                                |   | $                        | 0.28   |                     | $      | 0.25 |   | $ | 1.28 |   | $ | 1.12 |   |
| Extraordinary loss on early extinguishment  of debt                                |   | —                   |   | —                   |   | (0.44 | ) | — |   |
| Basic earnings per share                                                           |   | $                        | 0.28   |                     | 0.25   |   | $ | 0.84 |   | 1.12 |   |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Diluted earnings per share before  extraordinary loss                              |   | $                        | 0.28   |                     | $      | 0.25 |   | $ | 1.28 |   | $ | 1.12 |   |
| Extraordinary loss on early extinguishment  of debt                                |   | —                   |   | —                   |   | (0.44 | ) | — |   |
| Diluted earnings per share                                                         |   | $                        | 0.28   |                     | 0.25   |   | $ | 0.84 |   | 1.12 |   |
|                                                                               |   |                     |   |                     |   |   |   |   |   |
| Weighted average shares:                                                           |   |                     |   |                     |   |   |   |   |   |
| Basic                                                                              |   | 8,947,342                |   | 8,894,580                |   | 8,936,781 |   | 8,867,595 |   |
| Diluted                                                                            |   | 8,947,342                |   | 8,894,620                |   | 8,936,781 |   | 8,892,453 |   |

 

See notes to condensed consolidated financialstatements.

 

3

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCESHEETS**

**(In Thousands)**

**(Unaudited)**

 
|                                                                                                                          |   | **December  31,  2001** |    | **September  28,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|--------------------------|--------|
|                                                                                                                          |   |                    |    |                     |   |
| ASSETS:                                                                                                                       |   |                    |    |                     |   |
| Current assets:                                                                                                               |   |                    |    |                     |   |
| Cash                                                                                                                          |   | $                       | 5,545   |                     | $      | 4,378 |   |
| Accounts, notes and leases receivable, net  of allowance for bad debts of $10,909 and $11,933 in 2001 and 2002,  respectively |   | 82,188                  |    | 99,478                   |   |
| Inventories                                                                                                                   |   | 161,124                 |    | 163,864                  |   |
| Prepaid expenses and other current assets                                                                                     |   | 4,484                   |    | 4,788                    |   |
| Deferred tax assets                                                                                                           |   | 5,636                   |    | 5,910                    |   |
| Total current assets                                                                                                          |   | 258,977                 |    | 278,418                  |   |
|                                                                                                                          |   |                    |    |                     |   |
| Property, plant and equipment, net of  accumulated depreciation of $45,105 and $52,812 in 2001 and 2002,  respectively        |   | 104,011                 |    | 101,987                  |   |
| Other assets, net                                                                                                             |   | 13,993                  |    | 12,773                   |   |
| Trademarks                                                                                                                    |   | 9,142                   |    | 9,429                    |   |
| Goodwill                                                                                                                      |   | 27,917                  |    | 28,831                   |   |
|                                                                                                                          |   |                    |    |                     |   |
| TOTAL ASSETS                                                                                                                  |   | $                       | 414,040 |                     | $      | 431,438 |   |
|                                                                                                                          |   |                    |    |                     |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                     |   |                    |    |                     |   |
| Current liabilities:                                                                                                          |   |                    |    |                     |   |
| Current portion of long-term debt                                                                                             |   | $                       | 7,446   |                     | $      | 9,361 |   |
| Accounts payable                                                                                                              |   | 7,682                   |    | 6,921                    |   |
| Other current liabilities                                                                                                     |   | 34,095                  |    | 32,495                   |   |
| Total current liabilities                                                                                                     |   | 49,223                  |    | 48,777                   |   |
|                                                                                                                          |   |                    |    |                     |   |
| Long-term debt                                                                                                                |   | 203,757                 |    | 205,267                  |   |
| Deferred tax liabilities                                                                                                      |   | 27,118                  |    | 27,430                   |   |
| Other liabilities                                                                                                             |   | 13,571                  |    | 15,476                   |   |
| Total liabilities                                                                                                             |   | 293,669                 |    | 296,950                  |   |
|                                                                                                                          |   |                    |    |                     |   |
| Commitments and contingent liabilities                                                                                        |   |                    |    |                     |   |
|                                                                                                                          |   |                    |    |                     |   |
| Stockholders’ equity:                                                                                                    |   |                    |    |                     |   |
| Common stock                                                                                                                  |   | 9                       |    | 9                        |   |
| Additional paid-in capital                                                                                                    |   | 72,178                  |    | 73,172                   |   |
| Retained earnings                                                                                                             |   | 76,711                  |    | 86,669                   |   |
| Accumulated other comprehensive income                                                                                        |   | (12,674                 | )       | (9,509                   | )      |
| Treasury stock, at cost                                                                                                       |   | (15,853                 | )       | (15,853                  | )      |
| Total stockholders’ equity                                                                                               |   | 120,371                 |    | 134,488                  |   |
|                                                                                                                          |   |                    |    |                     |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                               |   | $                       | 414,040 |                     | $      | 431,438 |   |

 

See notes to condensed consolidated financial statements.

 

4

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In Thousands)**

**(Unaudited)**

 
|                                                                          |   | **Nine  Months Ended**   |   |
|-------------------------------------------------------------------------------|--------|--------------------------|--------|
|                                                                          |   | **September  29,  2001** |   | **September  28,  2002** |   |
| Cash flows from operating activities:                                         |   |                     |   |   |   |
| Net income                                                                    |   | $                        | 7,465  |   | $ | 9,958 |   |
| Adjustments to reconcile net income to cash  flows from operating activities: |   |                     |   |   |   |
| Depreciation and amortization                                                 |   | 10,369                   |   | 8,337 |   |
| Early extinguishment of debt                                                  |   | 3,950                    |   | — |   |
| Deferred tax benefit                                                          |   | (1,003                   | )      | (308 | ) |
| Other                                                                         |   | 472                      |   | 298 |   |
| Changes in operating assets and  liabilities:                                 |   |                     |   |   |   |
| Accounts, notes and leases receivable                                         |   | (17,720                  | )      | (16,656 | ) |
| Inventories                                                                   |   | (12,783                  | )      | (621 | ) |
| Prepaid expenses and other current assets                                     |   | (331                     | )      | (237 | ) |
| Accounts payable                                                              |   | (3,387                   | )      | (951 | ) |
| Other current liabilities                                                     |   | 2,502                    |   | (1,895 | ) |
| Cash flows from operating activities                                          |   | (10,466                  | )      | (2,075 | ) |
|                                                                          |   |                     |   |   |   |
| Cash flows from investing activities:                                         |   |                     |   |   |   |
| Capital expenditures                                                          |   | (4,478                   | )      | (3,626 | ) |
| Proceeds from disposals of fixed assets                                       |   | 221                      |   | 4 |   |
| Changes in other assets                                                       |   | 63                       |   | 211 |   |
| Cash flows from investing activities                                          |   | (4,194                   | )      | (3,411 | ) |
|                                                                          |   |                     |   |   |   |
| Cash flows from financing activities:                                         |   |                     |   |   |   |
| Net borrowings (repayments) under lines of  credit                            |   | (13,233                  | )      | 8,112 |   |
| Proceeds from issuance of long-term debt                                      |   | 150,000                  |   | — |   |
| Repayments of long-term debt                                                  |   | (117,512                 | )      | (4,753 | ) |
| Debt issuance costs                                                           |   | (4,478                   | )      | — |   |
| Proceeds from issuance of stock                                               |   | 454                      |   | 994 |   |
| Purchase of treasury stock                                                    |   | (336                     | )      | — |   |
| Cash flows from financing activities                                          |   | 14,895                   |   | 4,353 |   |
|                                                                          |   |                     |   |   |   |
| Effect of foreign exchange rate changes on  cash                              |   | 133                      |   | (34 | ) |
|                                                                          |   |                     |   |   |   |
| Increase (decrease) in cash                                                   |   | 368                      |   | (1,167 | ) |
| Cash, beginning of period                                                     |   | 4,989                    |   | 5,545 |   |
|                                                                          |   |                     |   |   |   |
| Cash, end of period                                                           |   | $                        | 5,357  |   | $ | 4,378 |   |
|                                                                          |   |                     |   |   |   |
| Supplemental Cash Flow Information                                            |   |                     |   |   |   |
| Interest paid                                                                 |   | $                        | 11,815 |   | $ | 8,259 |   |
| Taxes paid                                                                    |   | $                        | 9,293  |   | $ | 8,526 |   |

 

See notes to condensed consolidated financialstatements.

 

5

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**SEPTEMBER 28, 2002**

**(In Thousands Except Share and Per ShareData)**

**(Unaudited)**

 

**(1)****         Basisof Presentation**

 

Theaccompanying condensed consolidated financial statements of Steinway MusicalInstruments, Inc. and subsidiaries (the “Company”) for the three months andnine months ended September 29, 2001 and September 28, 2002 are unaudited.  In the opinion of management, thesestatements have been prepared on the same basis as the audited consolidatedfinancial statements as of and for the year ended December 31, 2001, andinclude all adjustments which are of a normal and recurring nature, necessaryfor the fair presentation of financial position, results of operations and cashflows for the interim period.  Thecondensed consolidated financial statements should be read in conjunction withthe consolidated financial statements and notes thereto contained in theCompany’s Annual Report on Form 10-K for the fiscal year ended December 31,2001 filed with the Securities and Exchange Commission.  The results of operations for the threemonths and nine months ended September 28, 2002 are not necessarily indicativeof the results that may be expected for the entire year.

 

Throughoutthis form “we”, “us”, and “our” refer to Steinway Musical Instruments, Inc. andsubsidiaries taken as a whole.

 

**(2)****         Summaryof Significant Accounting Policies**

 

*Principles of Consolidation -*Our consolidated financial statementsinclude the accounts of our direct and indirect wholly owned subsidiaries,including The Steinway Piano Company, Inc. (“Steinway”), The Selmer Company,Inc. (“Selmer”), and United Musical Instruments Holdings, Inc. (“UMI”).  Significant intercompany balances have beeneliminated in consolidation.

 

*Income per Common Share*–**Basic income per share is computed usingthe weighted average number of common shares outstanding during eachperiod.  Diluted income per common sharereflects the effect of our outstanding options using the treasury stock method,except when such items would be antidilutive. A reconciliation of the weighted average shares used for the basic anddiluted computations for the three month and nine month periods ended September29, 2001 and September 28, 2002 is as follows:

 
|                             |   | **Three  months ended** |   | **Nine  months ended** |   |
|----------------------------------|--------|-------------------------|--------|------------------------|--------|
|                             |   | **2001**                |   | **2002**               |   | **2001** |   | **2002** |   |
| Weighted average shares:         |   |                    |   |                   |   |   |   |   |   |
| For basic income per share       |   | 8,947,342               |   | 8,894,580              |   | 8,936,781 |   | 8,867,595 |   |
| Dilutive effect of stock options |   | —                  |   | 40                     |   | — |   | 24,858 |   |
| For diluted income per share     |   | 8,947,342               |   | 8,894,620              |   | 8,936,781 |   | 8,892,453 |   |

 

6

----

 

*Comprehensive Income*–**Other comprehensive income is comprised of foreign currencytranslation adjustments, additional minimum pension liabilities, and unrealizedgains and losses on certain long-term assets. Total comprehensive income for the three month and nine month periodsended September 29, 2001 and September 28, 2002 is as follows:

 
|                              |   | **Three  months ended** |   | **Nine  months ended** |   |
|-----------------------------------|--------|-------------------------|--------|------------------------|--------|
|                              |   | **2001**                |   | **2002**               |   | **2001** |   | **2002** |   |
|                              |   |                    |   |                   |   |   |   |   |   |
| Net income                        |   | $                       | 2,514  |                   | $      | 2,191 |   | $ | 7,465 |   | $ | 9,958 |   |
| Other comprehensive income (loss) |   | 1,999                   |   | (335                   | )      | (883 | ) | 3,165 |   |
| Total comprehensive income        |   | $                       | 4,513  |                   | $      | 1,856 |   | $ | 6,582 |   | $ | 13,123 |   |

 

*New Accounting Pronouncements*– On January 1, 2002 we adopted SFASNo. 142, “Goodwill and Intangible Assets,” which supersedes APB Opinion No. 17,“Intangible Assets.”  SFAS No. 142eliminates the requirement to amortize goodwill and indefinite-lived assets. IfSFAS No. 142 had applied at the beginning of 2001 to goodwill and trademarkassets, the result would have been to increase pretax income for the threemonths ended September 29, 2001 by approximately $0.8 million and related netincome by approximately $0.5 million, or $.06 per share.  For the nine months ended September 29, 2001,the result would have been to increase pretax income by approximately $2.3million and related net income by approximately $1.6 million, or $.18 pershare.  Changes in the balances reportedfor goodwill and trademarks are the result of currency translation.

 

In June 2001, the FASB issued SFAS No. 143,“Accounting for Asset Retirement Obligations.” SFAS No. 143 addresses financial accounting and reporting forobligations associated with the retirement of tangible long-lived assets andthe associated asset retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15,2002.  We do not expect the adoption ofSFAS No. 143 to have a material impact on our financial position or results ofoperations.

 

On January 1, 2002, we adopted SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” whichaddresses the financial accounting and reporting for the impairment or disposalof long-lived assets.  SFAS No. 144supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to Be Disposed Of,” and also supersedes theaccounting and certain reporting provisions of APB Opinion No. 30, “Reportingthe Results of Operations-Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions,” for the disposal of a segment of a business.  The adoption of SFAS No. 144 did not have amaterial impact on our financial position or results of operations.

 

On April 30, 2002, the FASB issued SFAS No.145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASBStatement No. 13, and Technical Corrections,” which addresses, among otherthings, the treatment of gains and losses resulting from the earlyextinguishment of debt.  SFAS No. 145rescinds SFAS No. 4, “Reporting Gains and Losses from Early Extinguishment ofDebt,” which required

 

7

----

 

that all gains and losses from theextinguishment of debt be aggregated and, if material, reported as anextraordinary item.  SFAS No. 145requires that these gains and losses be classified as extraordinary only ifthey meet the criteria set forth in APB Opinion No. 30.  SFAS No. 145 also amends SFAS No. 13,“Accounting for Leases” to require that certain lease modifications that haveeconomic effects similar to sale-leaseback transactions be accounted for in thesame manner as such transactions.  Theprovisions of SFAS No. 145 related to the rescission of SFAS No. 4 areeffective for fiscal years beginning after May 15, 2002.  The provisions related to the amendment ofSFAS No. 13 are effective for transactions occurring after May 15, 2002.  SFAS No. 145 will require that upon adoptionwe restate our previously released financial statements to reflect the loss onextinguishment of debt in 2001 as an element of operating income; it will notchange the amount of the loss recorded or, other than this reclassification,have a material impact on our financial position or results of operations.

 

On July 30, 2002 the FASB issued SFAS No.146, “Accounting for Costs Associated with Exit or Disposal Activities.”  SFAS No. 146 requires costs associated withexit or disposal activities to be recognized when the costs are incurred,rather than at a date of commitment to an exit or disposal plan.  The provisions of SFAS No. 146 are effectivefor disposal activities initiated after December 31, 2002.  We do not expect SFAS No. 146 to have amaterial impact on our financial position or results of operations.

 

*Reclassifications* – Certain prior year amountshave been reclassified to conform to the current year presentation.

 

**(3)****   Inventories**

 

Inventories consist of the following:

 
|            |   | **December  31,  2001** |    | **September  28,  2002** |   |
|-----------------|--------|-------------------------|---------|--------------------------|--------|
|            |   |                    |    |                     |   |
| Raw materials   |   | $                       | 20,948  |                     | $      | 18,465 |   |
| Work in process |   | 52,967                  |    | 60,973                   |   |
| Finished goods  |   | 87,209                  |    | 84,426                   |   |
| Total           |   | $                       | 161,124 |                     | $      | 163,864 |   |

 

8

----

 

**(4)****   Other(Income) Expense, Net**

 

Other (income) expense, net consists of thefollowing:

 
|                              |   | **Three  months ended**  |   | **Nine  months ended**   |   |
|-----------------------------------|--------|--------------------------|--------|--------------------------|--------|
|                              |   | **September  29,  2001** |   | **September  28,  2002** |   | **September  29,  2001** |   | **September  28,  2002** |   |
|                              |   |                     |   |                     |   |   |   |   |   |
| West 57th Building income         |   | $                        | (1,164 | )                        | $      | (1,164 | ) | $ | (3,491 | ) | $ | (3,491 | ) |
| West 57th building expenses       |   | 810                      |   | 813                      |   | 2,434 |   | 2,437 |   |
| Foreign exchange (gain) loss, net |   | (51                      | )      | 88                       |   | 453 |   | (386 | ) |
| Miscellaneous                     |   | (287                     | )      | (127                     | )      | (482 | ) | (493 | ) |
| Other income, net                 |   | $                        | (692   | )                        | $      | (390 | ) | $ | (1,086 | ) | $ | (1,933 | ) |

 

**(5)****   Commitmentsand Contingent Liabilities**

 

Certainenvironmental matters are pending against one of our subsidiaries, which mightresult in monetary damages, the amount of which, if any, cannot be determinedat the present time.  PhilipsElectronics, a previous owner of one of our subsidiaries, has agreed to hold usharmless from any financial liability arising from these environmental matterswhich were pending as of December 29, 1988. Management believes that these matters will not have a material adverseimpact on our results of operations or financial condition.

 

**(6)****   SegmentInformation**

 

We haveidentified two distinct and reportable segments: the piano segment and the bandand orchestral instrument segment. These segments were selected based upon the way in which managementoversees and evaluates the results of each operation.  In the past, we have reported net income by segment as ourmeasure of profit or loss. These amounts included intercompany allocations ofitems such as interest and taxes not completely under the control of thesegment. Income from operations is now utilized by management and by the chiefoperating decision maker as a more meaningful measurement of profit or loss forthe segments.  Income from operationsfor the reportable segments includes certain corporate costs allocated to thesegments based primarily on revenue, as well as intercompany profit.  Amounts reported as “Other & Elim”include those corporate costs that were not allocated to the reportablesegments and the remaining intercompany profit elimination.

 

9

----

 

The following tables present informationabout our operating segments for the three month and nine month periods endedSeptember 29, 2001 and September 28, 2002:

 
| **Three  months ended 2001**     |   | **Piano Segment**  |   | **Band and Orchestral Segment**  |   | **Other****& Elim** |   | **Consol****Total** |   |
|----------------------------------|--------|--------------------|--------|----------------------------------|--------|-------------------------|--------|---------------------|--------|
|                             |   | **U.S.**           |   | **Germany**                      |   | **Other**               |   | **Total**           |   | **U.S.** |   | **Other** |   | **Total** |   |   |   |
| Net sales to external  customers |   | $                  | 24,018 |                             | $      | 8,939                   |   | $                   | 4,765  |   | $ | 37,722 |   | $ | 44,101 |   | $ | 1,062 |   | $ | 45,163 |   | $ | — |   | $ | 82,885 |   |
| Income from operations           |   | 1,565              |   | 994                              |   | 670                     |   | 3,229               |   | 4,978 |   | 29 |   | 5,007 |   | (211 | ) | 8,025 |   |
|                             |   |               |   |                             |   |                    |   |                |   |   |   |   |   |   |   |   |   |   |   |
| **Three  months ended 2002**     |   | **Piano  Segment** |   | **Band and  Orchestral Segment** |   | **Other  & Elim**   |   | **Consol  Total**   |   |
|                             |   | **U.S.**           |   | **Germany**                      |   | **Other**               |   | **Total**           |   | **U.S.** |   | **Other** |   | **Total** |   |   |   |
| Net sales to external  customers |   | $                  | 24,049 |                             | $      | 6,956                   |   | $                   | 4,535  |   | $ | 35,540 |   | $ | 38,524 |   | $ | 1,256 |   | $ | 39,780 |   | $ | — |   | $ | 75,320 |   |
| Income from operations           |   | 2,739              |   | (169                             | )      | 454                     |   | 3,024               |   | 3,343 |   | 50 |   | 3,393 |   | (391 | ) | 6,026 |   |
|                             |   |               |   |                             |   |                    |   |                |   |   |   |   |   |   |   |   |   |   |   |
| **Nine months  ended 2001**      |   | **Piano  Segment** |   | **Band and  Orchestral Segment** |   | **Other  & Elim**   |   | **Consol  Total**   |   |
|                             |   | **U.S.**           |   | **Germany**                      |   | **Other**               |   | **Total**           |   | **U.S.** |   | **Other** |   | **Total** |   |   |   |
| Net sales to external  customers |   | $                  | 78,340 |                             | $      | 26,231                  |   | $                   | 16,593 |   | $ | 121,164 |   | $ | 143,675 |   | $ | 3,288 |   | $ | 146,963 |   | $ | — |   | $ | 268,127 |   |
| Income from operations           |   | 8,183              |   | 3,099                            |   | 3,235                   |   | 14,517              |   | 17,418 |   | 51 |   | 17,469 |   | (788 | ) | 31,198 |   |
|                             |   |               |   |                             |   |                    |   |                |   |   |   |   |   |   |   |   |   |   |   |
| **Nine months  ended 2002**      |   | **Piano  Segment** |   | **Band and  Orchestral Segment** |   | **Other  & Elim**   |   | **Consol  Total**   |   |
|                             |   | **U.S.**           |   | **Germany**                      |   | **Other**               |   | **Total**           |   | **U.S.** |   | **Other** |   | **Total** |   |   |   |
| Net sales to external  customers |   | $                  | 72,531 |                             | $      | 23,540                  |   | $                   | 14,187 |   | $ | 110,258 |   | $ | 128,331 |   | $ | 3,139 |   | $ | 131,470 |   | $ | — |   | $ | 241,728 |   |
| Income from operations           |   | 8,923              |   | 1,720                            |   | 1,910                   |   | 12,553              |   | 12,101 |   | 103 |   | 12,204 |   | (1,527 | ) | 23,230 |   |

 

**(7)****                     Summaryof Guarantees**

 

On April 19, 2001, we completed a $150.0million 8.75% Senior Note offering.  Theproceeds of the offering were used to redeem all of the then outstanding 11%Senior Subordinated Notes, with the balance used to pay down the domesticrevolving credit facility.

 

Our payment obligations under the 8.75%Senior Notes are fully and unconditionally guaranteed on a joint and severalbasis by Selmer, Steinway, UMI and certain of our direct and indirectwholly-owned subsidiaries, each a Guarantor (the “Guarantor Subsidiaries”).  These subsidiaries represent all of our (the“Issuer”) operations conducted in the United States.  The remaining subsidiaries, which do not guarantee the 8.75%Senior Notes, represent non-U.S. operations (the “Non Guarantor Subsidiaries”).

 

The following condensed consolidating supplementarydata illustrates the composition of the combined Guarantors.  Separate complete financial statements ofthe respective Guarantors would not provide additional material informationthat would be useful in assessing the financial composition of the

 

10

----

 

Guarantors. No single Guarantor has any significant legal restrictions on theability of investors or creditors to obtain access to its assets in event ofdefault on the Guarantee other than its subordination to senior indebtedness.

 

Investments in subsidiaries are recorded onthe cost method for purposes of the supplemental consolidatingpresentation.  Earnings of subsidiariesare therefore not reflected in the parent company’s investment accounts andearnings.  The principal eliminationentries eliminate investments in subsidiaries and intercompany balances andtransactions.

 

11

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATING STATEMENTS OF INCOME**

**NINE MONTHS ENDED SEPTEMBER 28, 2002**

**(In Thousands)**

**(Unaudited)**

 
|                                    |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|-----------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
|                                    |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net sales                               |   | $                    | — |                        | $      | 207,386                          |   | $                          | 42,112 |             | $      | (7,770 | ) | $ | 241,728 |   |
| Cost of sales                           |   | —               |   | 150,699                     |   | 27,596                           |   | (7,616                     | )      | 170,679          |   |
|                                    |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Gross profit                            |   | —               |   | 56,687                      |   | 14,516                           |   | (154                       | )      | 71,049           |   |
|                                    |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Operating expenses:                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Sales and marketing                     |   | —               |   | 23,230                      |   | 6,929                            |   | (32                        | )      | 30,127           |   |
| General and administrative              |   | 3,391                |   | 9,621                       |   | 3,203                            |   | —                     |   | 16,215           |   |
| Amortization                            |   | 339                  |   | 524                         |   | 3                                |   | —                     |   | 866              |   |
| Other operating (income) expense        |   | (2,290               | )      | 2,221                       |   | 648                              |   | 32                         |   | 611              |   |
| Total operating expenses                |   | 1,440                |   | 35,596                      |   | 10,783                           |   | —                     |   | 47,819           |   |
|                                    |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Income (loss) from operations           |   | (1,440               | )      | 21,091                      |   | 3,733                            |   | (154                       | )      | 23,230           |   |
|                                    |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Interest (income) expense, net          |   | (822                 | )      | 10,955                      |   | 212                              |   | —                     |   | 10,345           |   |
| Other income, net                       |   | —               |   | (1,761                      | )      | (172                             | )      | —                     |   | (1,933           | )      |
|                                    |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Income (loss) before income taxes       |   | (618                 | )      | 11,897                      |   | 3,693                            |   | (154                       | )      | 14,818           |   |
|                                    |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Provision for (benefit of) income taxes |   | (152                 | )      | 3,643                       |   | 1,396                            |   | (27                        | )      | 4,860            |   |
|                                    |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net income (loss)                       |   | $                    | (466   | )                           | $      | 8,254                            |   | $                          | 2,297  |             | $      | (127 | ) | $ | 9,958 |   |

 

12

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATING BALANCE SHEETS**

**SEPTEMBER 28, 2002**

**(In Thousands)**

**(Unaudited)**

 
|                                            |   | **Issuer   of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|-------------------------------------------------|--------|-----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
| ASSETS                                          |   |                  |   |                        |   |                             |   |                       |   |             |   |
| Current assets:                                 |   |                  |   |                        |   |                             |   |                       |   |             |   |
| Cash                                            |   | $                     | — |                        | $      | 2,060                            |   | $                          | 2,318  |             | $      | — |   | $ | 4,378 |   |
| Accounts, notes and leases receivable, net      |   | —                |   | 89,752                      |   | 10,000                           |   | (274                       | )      | 99,478           |   |
| Inventories                                     |   | —                |   | 133,911                     |   | 30,994                           |   | (1,041                     | )      | 163,864          |   |
| Prepaid expenses and other current assets       |   | 298                   |   | 3,746                       |   | 744                              |   | —                     |   | 4,788            |   |
| Deferred tax assets                             |   | —                |   | 5,532                       |   | 4,861                            |   | (4,483                     | )      | 5,910            |   |
| Total current assets                            |   | 298                   |   | 235,001                     |   | 48,917                           |   | (5,798                     | )      | 278,418          |   |
|                                            |   |                  |   |                        |   |                             |   |                       |   |             |   |
|                                            |   |                  |   |                        |   |                             |   |                       |   |             |   |
| Property, plant and equipment, net              |   | 170                   |   | 88,281                      |   | 13,536                           |   | —                     |   | 101,987          |   |
| Investment in subsidiaries                      |   | 71,143                |   | 255,666                     |   | —                           |   | (326,809                   | )      | —           |   |
| Other assets, net                               |   | 4,705                 |   | 7,832                       |   | 236                              |   | —                     |   | 12,773           |   |
| Trademarks                                      |   | —                |   | 6,280                       |   | 3,149                            |   | —                     |   | 9,429            |   |
| Goodwill                                        |   | —                |   | 18,795                      |   | 10,036                           |   | —                     |   | 28,831           |   |
|                                            |   |                  |   |                        |   |                             |   |                       |   |             |   |
| TOTAL ASSETS                                    |   | $                     | 76,316 |                        | $      | 611,855                          |   | $                          | 75,874 |             | $      | (332,607 | ) | $ | 431,438 |   |
|                                            |   |                  |   |                        |   |                             |   |                       |   |             |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY       |   |                  |   |                        |   |                             |   |                       |   |             |   |
| Current liabilities:                            |   |                  |   |                        |   |                             |   |                       |   |             |   |
| Current portion of long-term debt               |   | $                     | — |                        | $      | 6,352                            |   | $                          | 3,009  |             | $      | — |   | $ | 9,361 |   |
| Accounts payable                                |   | 149                   |   | 4,684                       |   | 2,362                            |   | (274                       | )      | 6,921            |   |
| Other current liabilities                       |   | (11,141               | )      | 37,434                      |   | 11,630                           |   | (5,428                     | )      | 32,495           |   |
| Total current liabilities                       |   | (10,992               | )      | 48,470                      |   | 17,001                           |   | (5,702                     | )      | 48,777           |   |
|                                            |   |                  |   |                        |   |                             |   |                       |   |             |   |
| Long-term debt                                  |   | 150,054               |   | 55,213                      |   | —                           |   | —                     |   | 205,267          |   |
| Intercompany                                    |   | (117,888              | )      | 113,983                     |   | 3,905                            |   | —                     |   | —           |   |
| Deferred tax liabilities                        |   | —                |   | 20,702                      |   | 6,728                            |   | —                     |   | 27,430           |   |
| Other liabilities                               |   | 230                   |   | 2,158                       |   | 13,088                           |   | —                     |   | 15,476           |   |
| Total liabilities                               |   | 21,404                |   | 240,526                     |   | 40,722                           |   | (5,702                     | )      | 296,950          |   |
|                                            |   |                  |   |                        |   |                             |   |                       |   |             |   |
| Stockholders’ equity                       |   | 54,912                |   | 371,329                     |   | 35,152                           |   | (326,905                   | )      | 134,488          |   |
|                                            |   |                  |   |                        |   |                             |   |                       |   |             |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |   | $                     | 76,316 |                        | $      | 611,855                          |   | $                          | 75,874 |             | $      | (332,607 | ) | $ | 431,438 |   |

 

13

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATING STATEMENTS OF CASHFLOWS**

**NINE MONTHS ENDED SEPTEMBER 28, 2002**

**(In Thousands)**

**(Unaudited)**

 
|                                                                                 |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
| Cash flows from operating  activities:                                               |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net income (loss)                                                                    |   | $                    | (466   | )                           | $      | 8,254                            |   | $                          | 2,297  |             | $      | (127 | ) | $ | 9,958 |   |
| Adjustments to reconcile net income (loss) to cash  flows from operating activities: |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Depreciation and amortization                                                        |   | 385                  |   | 6,787                       |   | 1,165                            |   | —                     |   | 8,337            |   |
| Deferred tax benefit                                                                 |   | —               |   | (173                        | )      | (135                             | )      | —                     |   | (308             | )      |
| Other                                                                                |   | —               |   | 161                         |   | 137                              |   | —                     |   | 298              |   |
| Changes in operating assets and liabilities:                                         |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Accounts, notes and leases receivable                                                |   | —               |   | (17,578                     | )      | 770                              |   | 152                        |   | (16,656          | )      |
| Inventories                                                                          |   | —               |   | 2,501                       |   | (3,276                           | )      | 154                        |   | (621             | )      |
| Prepaid expenses and other current assets                                            |   | (13                  | )      | (329                        | )      | 138                              |   | (33                        | )      | (237             | )      |
| Accounts payable                                                                     |   | 65                   |   | (1,396                      | )      | 532                              |   | (152                       | )      | (951             | )      |
| Other current liabilities                                                            |   | 4,556                |   | (3,767                      | )      | (2,657                           | )      | (27                        | )      | (1,895           | )      |
| Cash flows from operating activities                                                 |   | 4,527                |   | (5,540                      | )      | (1,029                           | )      | (33                        | )      | (2,075           | )      |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash flows from investing activities:                                                |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Capital expenditures                                                                 |   | —               |   | (3,280                      | )      | (346                             | )      | —                     |   | (3,626           | )      |
| Proceeds from disposal of fixed assets                                               |   | —               |   | 4                           |   | —                           |   | —                     |   | 4                |   |
| Changes in other assets                                                              |   | (104                 | )      | 282                         |   | —                           |   | 33                         |   | 211              |   |
| Cash flows from investing activities                                                 |   | (104                 | )      | (2,994                      | )      | (346                             | )      | 33                         |   | (3,411           | )      |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash flows from financing activities:                                                |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net borrowings (repayments) under lines of credit                                    |   | 34                   |   | 6,940                       |   | 1,782                            |   | (644                       | )      | 8,112            |   |
| Repayment of long-term debt                                                          |   | —               |   | (4,753                      | )      | —                           |   | —                     |   | (4,753           | )      |
| Proceeds from issuance of stock                                                      |   | 994                  |   | —                      |   | —                           |   | —                     |   | 994              |   |
| Intercompany transactions                                                            |   | (5,451               | )      | 6,735                       |   | (1,284                           | )      | —                     |   | —           |   |
| Cash flows from financing activities                                                 |   | (4,423               | )      | 8,922                       |   | 498                              |   | (644                       | )      | 4,353            |   |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Effect of exchange rate changes on cash                                              |   | —               |   | —                      |   | (34                              | )      | —                     |   | (34              | )      |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Increase (decrease) in cash                                                          |   | —               |   | 388                         |   | (911                             | )      | (644                       | )      | (1,167           | )      |
| Cash, beginning of period                                                            |   | —               |   | 1,672                       |   | 3,229                            |   | 644                        |   | 5,545            |   |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash, end of period                                                                  |   | $                    | — |                        | $      | 2,060                            |   | $                          | 2,318  |             | $      | — |   | $ | 4,378 |   |

 

14

----

 
| **ITEM 2** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**(Dollars in  thousands)** |
|------------|------------------------------------------------------------------------------------------------------------------------------|

 

**Introduction**

 

We, through our operating subsidiaries, are a worldleader in the design, manufacture and marketing of high quality musicalinstruments.  Our piano divisionconcentrates on the high-end grand piano segment of the industry, handcraftingSteinway pianos in New York and Germany. We also offer vertical pianos and two mid-priced lines of pianos underthe Boston and Essex brand names. Moreover, we are the largest domestic producer of band and orchestralinstruments and offer a complete line of brasswind, woodwind, percussion andstringed instruments and related accessories with well known brand names suchas Bach, C.G. Conn, King, and Ludwig. We sell our products through dealers and distributors worldwide.  Our piano customer base consists ofprofessional artists, amateur pianists, and institutions such as concert halls,universities, and music schools.  Ourband and orchestral instrument customer base consists primarily of middleschool and high school students, but also includes adult amateur andprofessional musicians.

 

**Critical Accounting Policies**

 

The nature of our business - the production and saleof musical instruments - is such that it rarely involves application of highlycomplex or subjective accounting principles. The accounting policies that are subject to significant managementestimates are those normally found in traditional businesses and include inventoryreserves, accounts receivable reserves, reserves on notes receivable (includingrecourse reserves when notes had been sold to third parties), and warrantyreserves.  We have significantexperience and data on which to base these estimates.  Historical information is adjusted for specific uncertainties,such as new product introductions, and contemporaneous information, such asprice fluctuations.  Managementregularly performs assessments of the underlying assumptions and believes thatthey provide a reasonable basis for the estimates contained in our financialstatements.

 

**Forward-Looking Statements**

 

Certain statements contained in this document are“forward-looking statements” within the meaning of Section 21E of theSecurities and Exchange Act of 1934, as amended.  These forward-looking statements represent our presentexpectations or beliefs concerning future events.  We caution that such statements are necessarily based on certainassumptions which are subject to risks and uncertainties which could causeactual results to differ materially from those indicated herein.  These risk factors include, but are notlimited to, changes in general economic conditions, increased competition, workstoppages and slowdowns, exchange rate fluctuations, variations in the mix ofproducts sold, fluctuations in effective tax rates resulting from shifts insources of income, and the ability to successfully integrate and operateacquired businesses.  Furtherinformation on these risk factors is included in our Annual Report on Form 10-Kfor the year ended December 31, 2001 and our Final Prospectus filed in August1996.

 

15

----

 

**Results of Operations**

 

*Three Months Ended September 28, 2002Compared to Three Months Ended September 29, 2001*

 

*Net Sales -*Netsales decreased $7.6 million (9%) to $75.3 million in the third quarter of2002. Piano sales decreased $2.2 million (6%) to $35.5 million, primarily as aresult of the 14% decrease in Steinway shipments.  This decrease in Steinway shipments was due to the economic slowdown,which continues to affect the high-end piano markets both domestically andabroad.  However, this was mitigatedsomewhat by a 14% increase in shipments of Boston product lines (Boston andEssex pianos), which resulted from the continued resurgence of the mid-pricedpiano market.  Band and orchestralinstrument sales decreased $5.4 million (12%) to $39.8 million on an overallunit decrease of 12%.  Fiscalconstraints on school budgets and instrument dealers coupled with competitivepricing offered by many offshore manufacturers resulted in fewer instrumentorders and sales in the current period.

 

G*ross Profit-* Gross profit decreased by $3.0 million (12%) to $21.3million.  Gross margins decreased from29.3% in 2001 to 28.3% in 2002.  Pianomargins decreased slightly from 32.7% in 2001 to 32.5% in 2002, primarily as aresult of a shift in mix to the lower margin Boston products.  Band and orchestral instrument marginsdecreased from 26.5% in 2001 to 24.5% in 2002. This drop was primarily due to under absorption of overhead resultingfrom decreased production levels, which were reduced in line with currentdemand.  Although we completed ourmanufacturing revitalization project in June 2002, residual inefficiencies fromthe resulting retraining processes continued to impact margins during the thirdquarter.

 

*Operating Expenses*- Overall operating expenses decreased by $1.0 million (6%) to $15.3 million inthe third quarter.  $0.3 million of thisdecrease is attributable to increased fiscal constraints on non-mandatorymarketing and administrative expenses. The remaining decrease is due to the adoption of SFAS No. 142, whichresulted in a decrease in amortization expense of approximately $0.8 million.

 

*Other Expenses, net-*Other expenses decreased by $0.6 million (15%) to$3.2 million. Lower average outstanding debt balances resulted in a reductionof net interest expense of $0.9 million. A foreign exchange loss of $0.1 million, as compared to a foreignexchange gain of $0.1 million in the prior period, also contributed to thechange.

 

*Income Taxes*- Our effective tax rate decreased from 41.5% in 2001 to 23.4% in 2002.  Following completion of our tax filings for2001, we have been able to more effectively gauge our ability to absorb foreigntax credits. As a result of the expected ratio of foreign source income todomestic income in the current year, we anticipate an effective rate of 30% forfiscal year 2002.  The rate of 23.4% wasrecorded in the current period in order to achieve the targeted rate for fiscalyear 2002.

 

*Nine Months Ended September 28, 2002 Comparedto Nine Months Ended September 29, 2001*

 

*Net Sales -*Netsales decreased $26.4 million (10%) to $241.7 million in the first threequarters of 2002. Piano sales decreased $10.9 million (9%) to $110.3 million onan 18% decrease in Steinway shipments, which was partially offset by an 11%increase in Boston product line shipments. The decrease in Steinway shipments, which was relatively consistentdomestically and overseas with units down 18% and 16% respectively, wasprimarily a result of the continued economic slowdown.  However, Boston product continued to farewell domestically, with units up 20%, driving the overall increase in Bostonproduct shipments.  Band and orchestralinstrument sales decreased $15.5 million (11%) to $131.5 million on an overallunit decrease of 14%.  Fiscalconstraints on school budgets and instrument

 

16

----

 

dealers has resulted in fewerbackground instrument sales, and inventory and rental pool replacement sales inthe current period.  On certaininstruments we continue to face pricing competition from offshore instrumentmanufacturers, which also contributed to the decrease.

 

G*ross Profit-* Gross profit decreased by $12.0 million (15%) to $71.0million.  Gross margins decreased from31.0% in 2001 to 29.4% in 2002.  Pianomargins decreased from 35.6% in 2001 to 34.8% in 2002 primarily as a result ofthe under absorption of overhead associated with the periodic shutdowns at ourpiano manufacturing facilities.  Theincreased proportion of Boston product sold and the lower proportion of concertgrands sold abroad also contributed to the decrease in gross margin.  Band and orchestral instrument marginsdecreased from 27.2% in 2001 to 24.9% in 2002. This change was due to under absorption of overhead resulting fromreduced production consistent with current demand levels.  The temporary inefficiencies caused by theimplementation of the manufacturing revitalization project and the correspondingretraining processes were also a factor.

 

*Operating Expenses*- Overall operating expenses decreased by $4.1 million (8%) to $47.8 million inthe current period.  $1.6 million ofthis decrease is attributable to reduced sales and marketing expenses due tomore selective promotional events, streamlined advertising, and increasedfiscal constraints on non-mandatory marketing costs.  The remaining decrease is primarily due to the adoption of SFASNo. 142, which resulted in a decrease in amortization expense of approximately$2.3 million.

* *

*Other Expense, net -*Other expenses decreased by $4.0 million (32%) to $8.4million. Lower average outstanding debt balances resulting from working capitalmanagement and lower interest rates on our borrowings resulted in a decrease innet interest expense of $3.1 million. We also recorded foreign exchange gains of $0.4 million in the currentperiod, as compared to a recorded loss of approximately $0.5 million in theprior year period, which contributed to the decrease.

 

*Income Taxes*- Our effective tax rate decreased from 39.3% in 2001 to 32.8% in 2002 as aresult of our expected increased utilization of foreign tax credits in thecurrent year. We anticipate an effective rate of 30% for fiscal year 2002.

 

**Liquidity and Capital Resources**

 

We have reliedprimarily upon cash provided by operations, supplemented as necessary byseasonal borrowings under our working capital line, to finance our operations,repay long-term indebtedness and fund capital expenditures.

 

Cash used inoperations in the first nine months of 2002 was $2.1million, compared to cashused in operations of $10.5 million in the first nine months of 2001.  Prior to 2002, we sold notes receivablegenerated by our band and orchestral instruments segment to third-partyfinancing companies.  We havediscontinued this practice primarily because of our improved operating cashflow position.  Had we continued ourhistorical practice of selling notes receivable, cash flow from operationswould have improved by approximately $7.1 million, net of tax, during thenine-months ended September 28, 2002. This represents the estimated proceeds wewould have received from such sales, as well as notes we repurchased from thethird-party at the termination of the agreement.  Management’s control of working capital and the reduction ofinventory in the current year period contributed significantly to theoperational cash flow improvement in the current period.

 

17

----

 

Capital expendituresof $4.5 million and $3.6 million in the first three quarters of 2001 and 2002,respectively, were used primarily for the purchase of new machinery andequipment, production facility improvements, and EPA compliance projects.  In 2002, we expect to spend approximately$5-6 million for capital projects, consisting mainly of production efficiencyand equipment modernization projects.

 

Our realestate term loan, acquisition term loan and domestic seasonal borrowingrequirements are accommodated through a committed credit facility with asyndicate of domestic lenders (the “Credit Facility”).  The Credit Facility provides us with apotential borrowing capacity of up to $85.0 million in revolving credit loans,based on eligible accounts receivable and inventory balances.  The acquisition term loan and revolvingcredit loan portions of the Credit Facility bear interest at average 30-dayLIBOR plus 1.75%, and the real estate term loan bears interest at average30-day LIBOR plus 1.5%.  The Creditfacility expires on September 14, 2008. As of September 28, 2002, revolving credit loans outstanding wereapproximately $6.3 million and availability based on eligible accountsreceivable and inventory balances, net of letter of credit deductions of $0.7million, was approximately $78.0 million. Open account loans with foreign banks also provide for borrowings bySteinway’s foreign subsidiaries of up to €17.6 million ($17.3 million at theSeptember 28, 2002 exchange rate).  Wehad $3.0 million in foreign loans outstanding as of September 28, 2002.

 

Our long-termfinancing consists primarily of $150.0 million of 8.75% Senior Notes and $55.3million of term loans outstanding under the Credit Facility.  On April 19, 2001, we completed a $150.0million senior note offering at 8.75%. The proceeds of the offering were used to redeem $110.0 million ofpreviously outstanding Senior Subordinated Notes, with the balance paying downthe Credit Facility.  The earlyretirement of the Senior Subordinated Notes, which were redeemed on June 1,2001 at 102.75% of the principal amount, generated an extraordinary charge ofapproximately $4.0 million, net of tax of $2.7 million.  Our debt agreements contain restrictivecovenants that place certain restrictions on us, including restrictions on ourability to incur additional indebtedness, to make investments in other entitiesand to pay cash dividends.  We are incompliance with all such covenants.

 

Managementexpects to continue its focus on maintaining sufficient, but not excessive,inventory levels, repaying debt, maintaining and expanding market share, andimproving production efficiency.  We arenot aware of any other trends, demands, commitments, or costs of resources thatare expected to materially impact liquidity or capital resources.  Therefore, management believes that cash onhand, together with cash flows anticipated from operations and availableborrowings under the Credit Facility, will be adequate to meet existing debtservice requirements, fund continuing capital requirements and satisfy workingcapital and general corporate needs through 2002.

 

Management hasreserved 721,750 shares of our existing treasury stock to be utilized for theissuance of stock options under our Amended and Restated 1996 Stock Plan.  These options will have no impact on ourcash flow or the number of shares outstanding unless and until the options areexercised.

 

**New Accounting Pronouncements**

 

On January 1,2002 we adopted SFAS No. 142, “Goodwill and Intangible Assets,” whichsupersedes APB Opinion No. 17, “Intangible Assets.” SFAS No. 142 eliminates therequirement to amortize goodwill and indefinite-lived assets. If SFAS No. 142had applied at the beginning of 2001 to goodwill and trademark assets, theresult would have been to increase pretax income for the three months endedSeptember 29, 2001 by approximately $0.8 million and related net income byapproximately $0.5 million, or $.06 per share. For the nine months ended September 29, 2001, the result would have beento

 

18

----

 

increase pretax income byapproximately $2.3 million and related net income by approximately $1.6million, or $.18 per share.  Changes inthe balances reported for goodwill and trademarks are the result of currency translation.

 

In June 2001,the FASB issued SFAS No. 143, “Accounting for Asset RetirementObligations.”  SFAS No. 143 addressesfinancial accounting and reporting for obligations associated with theretirement of tangible long-lived assets and the associated asset retirementcosts.  SFAS No. 143 is effective forfiscal years beginning after June 15, 2002. We do not expect the adoption of SFAS No. 143 to have a material impacton our financial position or results of operations.

 

On January 1,2002, we adopted SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets,” which addresses the financial accounting and reporting forthe impairment or disposal of long-lived assets.  SFAS No. 144 supersedes SFAS No. 121, “Accounting for theImpairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,”and also supersedes the accounting and certain reporting provisions of APBOpinion No. 30, “Reporting the Results of Operations-Reporting the Effects ofDisposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions,” for the disposal of a segmentof a business.  The adoption of SFAS No.144 did not have a material impact on our financial position or results ofoperations.

 

On April 30,2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44,and 64, Amendment of FASB Statement No. 13, and Technical Corrections,” whichaddresses, among other things, the treatment of gains and losses resulting fromthe early extinguishment of debt.  SFASNo. 145 rescinds SFAS No. 4, “Reporting Gains and Losses from EarlyExtinguishment of Debt,” which required that all gains and losses from theextinguishment of debt be aggregated and, if material, reported as anextraordinary item.  SFAS No. 145 requiresthat these gains and losses be classified as extraordinary only if they meetthe criteria set forth in APB Opinion No. 30. SFAS No. 145 also amends SFAS No.13, “Accounting for Leases” to require that certain lease modifications thathave economic effects similar to sale-leaseback transactions be accounted forin the same manner as such transactions. The provisions of SFAS No. 145 related to the rescission of SFAS No. 4are effective for fiscal years beginning after May 15, 2002.  The provisions related to the amendment ofSFAS No. 13 are effective for transactions occurring after May 15, 2002.  SFAS No. 145 will require that upon adoptionwe restate our previously released financial statements to reflect the loss onextinguishment of debt in 2001 as an element of operating income; it will notchange the amount of the loss recorded or, other than this reclassification, tohave a material impact on our financial position or results of operations.

 

On July 30,2002 the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exitor Disposal Activities.”  SFAS No. 146requires costs associated with exit or disposal activities to be recognizedwhen the costs are incurred, rather than at a date of commitment to an exit ordisposal plan.  The provisions of SFASNo. 146 are effective for disposal activities initiated after December 31,2002.  We do not expect SFAS No. 146 tohave a material effect on our financial position or results of operations.

 

19

----

 
| **ITEM 3** | **QUANTITATIVE AND QUALITATIVE DISCLOSURES  ABOUT MARKET RISK** |
|------------|-----------------------------------------------------------------|

 

We are exposedto market risk associated with changes in foreign currency exchange rates andinterest rates.  We mitigate our foreigncurrency exchange rate risk by maintaining foreign currency cash balances andholding forward foreign currency contracts. These contracts are used as a hedge against intercompany transactionsand are not used for trading or speculative purposes.  The fair value of the forward foreign currency exchange contractsis sensitive to changes in foreign currency exchange rates.  The impact of an adverse change in foreigncurrency exchange rates would not be materially different than that disclosedin the our Annual Report on Form 10-K for the year ended December 31, 2001.

 

Although themajority of our long-term debt is at a fixed interest rate, our revolving loansand term loans bear interest at rates that fluctuate with changes inLIBOR.  As such, our interest expense onour revolving loans and term loans and the fair value of its fixed long-termdebt are sensitive to changes in market interest rates.  The effect of an adverse change in marketinterest rates on our interest expense and the fair value of our long-term debtwould not be materially different than that disclosed in our Annual Report onForm 10-K for the year ended December 31, 2001.

 
| **ITEM 4** | **CONTROLS AND PROCEDURES** |
|------------|-----------------------------|

 

(a) Disclosure Controls and Procedures

 

Within 90 daysbefore filing this report, we evaluated the effectiveness of the design andoperation of our disclosure controls and procedures. Our disclosure controlsand procedures are the controls and other procedures that we designed to ensurethat we record, process, summarize and report in a timely manner theinformation we must disclose in reports that we file with or submit to the SEC.Mr. Messina, our President and Chief Executive Officer, and Mr. Hanson, ourSenior Executive Vice President and Chief Financial Officer, reviewed andparticipated in this evaluation. Based on this evaluation, Messrs. Messina andHanson concluded that, as of the date of their evaluation, our disclosurecontrols were effective.

 

(b) Internal Controls

 

Since the dateof the evaluation described above, there have not been any significant changesin our internal accounting controls or in other factors that couldsignificantly affect those controls.

 
| **PART II** | **OTHER INFORMATION** |
|-------------|-----------------------|

 
| **ITEM 6** | **EXHIBITS AND  REPORTS ON FORM 8-K** |
|------------|---------------------------------------|

 
| (a)    | Exhibits                                                                                                |
|--------|---------------------------------------------------------------------------------------------------------|
|   |                                                                                                    |
|   | 99.1 Certifying letter, Dana Messina,  President and Chief Executive Officer                            |
|   | 99.2 Certifying  letter, Dennis M. Hanson, Senior Executive Vice President and Chief Financial  Officer |
|   |                                                                                                    |
| (b)    | Reports on  Form 8-K                                                                                    |
|   |                                                                                                    |
|   | We did not  file any reports on Form 8-K during the quarter ended September 28, 2002.                   |

 

20

----

 

SIGNATURES

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrants have dulycaused this report to be signed on their behalf by the undersigned, thereuntoduly authorized.

 

 
|                          | STEINWAY MUSICAL INSTRUMENTS, INC.              |
|-------------------------------|-------------------------------------------------|
|                          |                                            |
|                          | /s/ Dana D. Messina                             |   |
|                          | Dana D. Messina                                 |
|                          | Director, President and Chief Executive Officer |
|                          |                                            |
|                          | /s/ Dennis M. Hanson                            |   |
|                          | Dennis M. Hanson                                |
|                          | Senior Executive Vice President and             |
|                          | Chief Financial Officer                         |
|                          |                                            |
| Date:  November 11, 2002 |                                            |

 

21

----

 

I, Dana D. Messina, certifythat:

 

1. I have reviewed thisquarterly report on Form 10-Q of Steinway Musical Instruments, Inc.;

 

2. Based on my knowledge, thisquarterly report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3. Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4. The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

a) designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) evaluated the effectivenessof the registrant’s disclosure controls and procedures as of a date within 90days prior to the filing date of this quarterly report (the “Evaluation Date”);and

 

c) presented in this quarterlyreport our conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s othercertifying officers and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a) all significant deficienciesin the design or operation of internal controls which could adversely affectthe registrant’s ability to record, process, summarize and report financialdata and have identified for the registrant’s auditors any material weaknessesin internal controls; and

 

b) any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6. The registrant’s othercertifying officers and I have indicated in this quarterly report whether ornot there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

 
| Date:  November 11, 2002 |                                             |
|-------------------------------|--------------------------------------------------|
|                          |                                             |
|                          | /s/ Dana D. Messina                              |   |
|                          |                                             |
|                          | Dana D. Messina                                  |
|                          | Director, President and Chief  Executive Officer |

 

22

----

 

I, Dennis M. Hanson, certifythat:

 

1. I have reviewed thisquarterly report on Form 10-Q of Steinway Musical Instruments, Inc.;

 

2. Based on my knowledge, thisquarterly report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3. Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4. The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

a) designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) evaluated the effectivenessof the registrant’s disclosure controls and procedures as of a date within 90days prior to the filing date of this quarterly report (the “Evaluation Date”);and

 

c) presented in this quarterlyreport our conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s othercertifying officers and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a) all significant deficienciesin the design or operation of internal controls which could adversely affectthe registrant’s ability to record, process, summarize and report financialdata and have identified for the registrant’s auditors any material weaknessesin internal controls; and

 

b) any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6. The registrant’s othercertifying officers and I have indicated in this quarterly report whether ornot there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

 
| Date:  November 11, 2002 |                                                         |
|-------------------------------|--------------------------------------------------------------|
|                          | /s/ Dennis M. Hanson                                         |   |
|                          |                                                         |
|                          | Dennis M. Hanson                                             |
|                          | Senior Executive Vice President and  Chief Financial Officer |

 

23

----