**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**FOR THE QUARTERLY PERIODENDED JUNE 30, 2006**

 

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**COMMISSION FILE NUMBER001-11911**

 

**STEINWAY MUSICAL INSTRUMENTS, INC.**

(Exact name of registrant as specified in its charter)

 

| **DELAWARE**                              |   | **35-1910745**       |
|-------------------------------------------|--------|----------------------|
| (State or Other  Jurisdiction of          |   | (I.R.S. Employer     |
| Incorporation or  Organization)           |   | Identification  No.) |
|                                      |   |                 |
| **800  South Street, Suite 305**          |   |                 |
| **Waltham,  Massachusetts**               |   | **02453**            |
| (Address of  Principal Executive Offices) |   | (Zip Code)           |

 

Registrant’s telephonenumber including area code:     **(781) 894-9770**

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements during thepast 90 days.

Yes x  Noo

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  Seedefinition of “accelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):
| Large accelerated filer o | Accelerated filer x | Non-accelerated filer o |
|---------------------------|---------------------|-------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yes o  Nox
| Number of shares of Common  Stock issued and outstanding as of August 6, 2006: |   | Class A  |   | 477,952   |   |
|--------------------------------------------------------------------------------|--------|----------|--------|-----------|--------|
|                                                                           |   | Ordinary |   | 7,884,152 |   |
|                                                                           |   | Total    |   | 8,362,104 |   |

 

 

----

 

**STEINWAY MUSICALINSTRUMENTS, INC. AND SUBSIDIARIESFORM 10-QINDEX**
| **PART I.**  | **UNAUDITED  FINANCIAL INFORMATION**                                                                     | ** ** |
|--------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **   | ** **                                                                                               | ** ** |
| **Item 1.**  | **Consolidated and Condensed  Consolidated Financial Statements:**                                       | ** ** |
|         |                                                                                                     |       |
|         | Consolidated Statements of Operations  Three months and six months ended June 30, 2006 and June 30, 2005 |       |
|         |                                                                                                     |       |
|         | Condensed Consolidated  Balance Sheets June 30, 2006 and December 31, 2005                               |       |
|         |                                                                                                     |       |
|         | Consolidated Statements of  Cash Flows Six months ended June 30, 2006 and June 30, 2005                  |       |
|         |                                                                                                     |       |
|         | Consolidated Statement of  Stockholders’ Equity Six months ended June 30, 2006                      |       |
|         |                                                                                                     |       |
|         | Notes to Consolidated and  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 4.**  | **Submission of Matters to a  Vote of Security Holders**                                                 | ** ** |
|         | ** **                                                                                               | ** ** |
| **Item 6.**  | **Exhibits**                                                                                             | ** ** |
| ** **   | ** **                                                                                               | ** ** |
| ** **   | **Signatures**                                                                                           |       |

 

2

----

**ITEM 1**                       CONSOLIDATEDAND CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

**STEINWAY MUSICAL INSTRUMENTS,INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSUnaudited(In Thousands Except Share and Per Share Amounts)**
| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales                          |       | $                                                   | 92,423     |                                              | $          | 89,761 |   | $ | 187,617 |   | $ | 181,103 |   |
| Cost of sales                      |       | 69,274                                              |       | 63,635                                            |       | 138,476 |   | 129,280 |   |
|                               |       |                                                |       |                                              |       |   |   |   |   |
| Gross profit                       |       | 23,149                                              |       | 26,126                                            |       | 49,141 |   | 51,823 |   |
|                               |       |                                                |       |                                              |       |   |   |   |   |
| Operating expenses:                |       |                                                |       |                                              |       |   |   |   |   |
| Sales and  marketing               |       | 11,063                                              |       | 11,049                                            |       | 22,733 |   | 22,182 |   |
| Provision for  doubtful accounts   |       | 4,505                                               |       | 83                                                |       | 4,562 |   | 222 |   |
| General and  administrative        |       | 7,811                                               |       | 6,960                                             |       | 16,189 |   | 13,935 |   |
| Amortization of  intangible assets |       | 197                                                 |       | 284                                               |       | 426 |   | 566 |   |
| Other operating (income)  expenses |       | (32                                                 | )          | 23                                                |       | 115 |   | 133 |   |
| Total operating  expenses          |       | 23,544                                              |       | 18,399                                            |       | 44,025 |   | 37,038 |   |
|                               |       |                                                |       |                                              |       |   |   |   |   |
| (Loss) income from  operations     |       | (395                                                | )          | 7,727                                             |       | 5,116 |   | 14,785 |   |
|                               |       |                                                |       |                                              |       |   |   |   |   |
| Other (income) expense,  net       |       | (695                                                | )          | 33                                                |       | (1,446 | ) | (406 | ) |
| Loss on extinguishment  of debt    |       | 3,063                                               |       | —                                            |       | 9,674 |   | — |   |
| Interest income                    |       | (880                                                | )          | (723                                              | )          | (2,607 | ) | (1,693 | ) |
| Interest expense                   |       | 4,032                                               |       | 4,389                                             |       | 8,507 |   | 8,528 |   |
| Total non-operating  expenses      |       | 5,520                                               |       | 3,699                                             |       | 14,128 |   | 6,429 |   |
|                               |       |                                                |       |                                              |       |   |   |   |   |
| (Loss) income before  income taxes |       | (5,915                                              | )          | 4,028                                             |       | (9,012 | ) | 8,356 |   |
|                               |       |                                                |       |                                              |       |   |   |   |   |
| Income tax (benefit)  provision    |       | (5,054                                              | )          | 1,610                                             |       | (6,309 | ) | 3,340 |   |
|                               |       |                                                |       |                                              |       |   |   |   |   |
| Net (loss) income                  |       | $                                                   | (861       | )                                                 | $          | 2,418 |   | $ | (2,703 | ) | $ | 5,016 |   |
|                               |       |                                                |       |                                              |       |   |   |   |   |
| (Loss) earnings per  share:        |       |                                                |       |                                              |       |   |   |   |   |
| Basic                              |       | $                                                   | (0.10      | )                                                 | $          | 0.30 |   | $ | (0.33 | ) | $ | 0.62 |   |
| Diluted                            |       | $                                                   | (0.10      | )                                                 | $          | 0.29 |   | $ | (0.33 | ) | $ | 0.61 |   |
|                               |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average  shares:          |       |                                                |       |                                              |       |   |   |   |   |
| Basic                              |       | 8,331,652                                           |       | 8,052,418                                         |       | 8,242,011 |   | 8,041,649 |   |
| Diluted                            |       | 8,331,652                                           |       | 8,276,096                                         |       | 8,242,011 |   | 8,259,070 |   |

 

See notes to consolidated and condensed consolidatedfinancial statements.

3

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETSUnaudited(In Thousands)**
| ** **                                                                                                                                         | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                                                                                                                               |       |                    |       |                        |       |
| Assets                                                                                                                                             |       |                    |       |                        |       |
| Current assets:                                                                                                                                    |       |                    |       |                        |       |
| Cash                                                                                                                                               |       | $                       | 21,118     |                        | $          | 34,952 |   |
| Accounts, notes and other receivables, net of  allowances of $18,899 and $12,323 in 2006 and 2005, respectively |       | 90,307                  |       | 81,880                      |       |
| Inventories                                                                                                                                        |       | 155,284                 |       | 159,310                     |       |
| Prepaid expenses and other current assets                                                                                                          |       | 11,669                  |       | 11,653                      |       |
| Deferred tax assets                                                                                                                                |       | 18,383                  |       | 7,936                       |       |
| Total current  assets                                                                                                                              |       | 296,761                 |       | 295,731                     |       |
|                                                                                                                                               |       |                    |       |                        |       |
| Property, plant  and equipment, net of accumulated depreciation of  $81,306 and $75,734 in 2006 and 2005, respectively         |       | 96,448                  |       | 96,664                      |       |
| Trademarks                                                                                                                                         |       | 13,540                  |       | 13,233                      |       |
| Goodwill                                                                                                                                           |       | 31,062                  |       | 30,088                      |       |
| Other intangibles,  net                                                                                                                            |       | 4,623                   |       | 4,128                       |       |
| Other assets                                                                                                                                       |       | 15,661                  |       | 15,811                      |       |
|                                                                                                                                               |       |                    |       |                        |       |
| Total assets                                                                                                                                       |       | $                       | 458,095    |                        | $          | 455,655 |   |
|                                                                                                                                               |       |                    |       |                        |       |
| Liabilities and  stockholders’ equity                                                                                                         |       |                    |       |                        |       |
| Current  liabilities:                                                                                                                              |       |                    |       |                        |       |
| Current portion of long-term debt                                                                                                                  |       | $                       | 5,960      |                        | $          | 12,977 |   |
| Accounts payable                                                                                                                                   |       | 15,222                  |       | 13,805                      |       |
| Other current liabilities                                                                                                                          |       | 47,131                  |       | 45,099                      |       |
| Total current  liabilities                                                                                                                         |       | 68,313                  |       | 71,881                      |       |
|                                                                                                                                               |       |                    |       |                        |       |
| Long-term debt                                                                                                                                     |       | 187,544                 |       | 191,715                     |       |
| Deferred tax  liabilities                                                                                                                          |       | 15,823                  |       | 15,326                      |       |
| Other  non-current liabilities                                                                                                                     |       | 30,443                  |       | 27,903                      |       |
| Total liabilities                                                                                                                                  |       | 302,123                 |       | 306,825                     |       |
|                                                                                                                                               |       |                    |       |                        |       |
| Commitments and  contingent liabilities                                                                                                            |       |                    |       |                        |       |
|                                                                                                                                               |       |                    |       |                        |       |
| Stockholders’  equity:                                                                                                                        |       |                    |       |                        |       |
| Common stock                                                                                                                                       |       | 10                      |       | 10                          |       |
| Additional paid-in capital                                                                                                                         |       | 88,804                  |       | 83,062                      |       |
| Retained earnings                                                                                                                                  |       | 123,676                 |       | 126,379                     |       |
| Accumulated other comprehensive loss                                                                                                               |       | (9,082                  | )          | (13,185                     | )          |
| Treasury stock, at cost                                                                                                                            |       | (47,436                 | )          | (47,436                     | )          |
| Total  stockholders’ equity                                                                                                                   |       | 155,972                 |       | 148,830                     |       |
|                                                                                                                                               |       |                    |       |                        |       |
| Total liabilities and  stockholders’ equity                                                                                                   |       | $                       | 458,095    |                        | $          | 455,655 |   |

 

See notes to consolidated and condensed consolidatedfinancial statements.

4

----

 

**STEINWAY MUSICAL INSTRUMENTS,INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSUnaudited(In Thousands)**
| ** **                                                                           | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                               |       |                                              |       |   |   |
| Net (loss) income                                                                    |       | $                                                 | (2,703     | ) | $ | 5,016 |   |
| Adjustments to reconcile net (loss) income to cash flows  from operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                        |       | 5,439                                             |       | 5,739 |   |
| Amortization of bond discount                                                        |       | 57                                                |       | — |   |
| Amortization of bond premium                                                         |       | (42                                               | )          | (126 | ) |
| Loss on extinguishment of debt                                                       |       | 9,674                                             |       | — |   |
| Stock-based compensation expense                                                     |       | 566                                               |       | — |   |
| Excess tax benefits from stock-based awards                                          |       | (417                                              | )          | — |   |
| Tax benefit from stock option exercises                                              |       | 917                                               |       | 99 |   |
| Deferred tax benefit                                                                 |       | (10,227                                           | )          | (279 | ) |
| Provision for doubtful accounts                                                      |       | 4,562                                             |       | 222 |   |
| Other                                                                                |       | (85                                               | )          | (118 | ) |
| Changes in operating assets and liabilities:                                         |       |                                              |       |   |   |
| Accounts, notes and other receivables                                                |       | (11,582                                           | )          | (3,443 | ) |
| Inventories                                                                          |       | 6,020                                             |       | (13,145 | ) |
| Prepaid expenses and other assets                                                    |       | (423                                              | )          | 2,821 |   |
| Accounts payable                                                                     |       | 1,014                                             |       | (1,097 | ) |
| Other liabilities                                                                    |       | 1,619                                             |       | (5,786 | ) |
| Cash flows from  operating activities                                                |       | 4,389                                             |       | (10,097 | ) |
|                                                                                 |       |                                              |       |   |   |
| Cash flows from  investing activities:                                               |       |                                              |       |   |   |
| Capital expenditures                                                                 |       | (2,565                                            | )          | (2,349 | ) |
| Proceeds from disposals of property, plant and  equipment                            |       | 331                                               |       | 1,353 |   |
| Cash flows from  investing activities                                                |       | (2,234                                            | )          | (996 | ) |
|                                                                                 |       |                                              |       |   |   |
| Cash flows from  financing activities:                                               |       |                                              |       |   |   |
| Borrowings under lines of credit                                                     |       | 37,401                                            |       | 70,708 |   |
| Repayments under lines of credit                                                     |       | (37,779                                           | )          | (64,200 | ) |
| Debt issuance costs                                                                  |       | (4,145                                            | )          | — |   |
| Proceeds from issuance of debt                                                       |       | 173,676                                           |       | — |   |
| Repayments of long-term debt                                                         |       | (183,331                                          | )          | (4,090 | ) |
| Premium paid on extinguishment of debt                                               |       | (7,740                                            | )          | — |   |
| Proceeds from issuance of common stock                                               |       | 4,259                                             |       | 656 |   |
| Excess tax benefits from stock-based awards                                          |       | 417                                               |       | — |   |
| Cash flows from  financing activities                                                |       | (17,242                                           | )          | 3,074 |   |
|                                                                                 |       |                                              |       |   |   |
| Effect of  foreign exchange rate changes on cash                                     |       | 1,253                                             |       | (1,611 | ) |
|                                                                                 |       |                                              |       |   |   |
| Decrease in cash                                                                     |       | (13,834                                           | )          | (9,630 | ) |
| Cash, beginning  of period                                                           |       | 34,952                                            |       | 27,372 |   |
|                                                                                 |       |                                              |       |   |   |
| Cash, end of  period                                                                 |       | $                                                 | 21,118     |   | $ | 17,742 |   |
|                                                                                 |       |                                              |       |   |   |
| Supplemental  Cash Flow Information                                                  |       |                                              |       |   |   |
| Interest paid                                                                        |       | $                                                 | 7,163      |   | $ | 9,517 |   |
| Taxes paid                                                                           |       | $                                                 | 3,249      |   | $ | 6,694 |   |

 

See notes to consolidated and condensed consolidatedfinancial statements.

5

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITYUnaudited(In Thousands Except Share Data)**
| ** **                                              | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|---------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|---------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
|                                                    |       |              |       |                             |       |                   |       |                                        |       |                |       |                                  |       |
| Balance, January  1, 2006                               |       | $                 | 10         |                             | $          | 83,062                 |       | $                                           | 126,379    |                | $          | (13,185                               | )          | $ | (47,436 | ) | $ | 148,830 |   |
| Comprehensive  loss:                                    |       |              |       |                             |       |                   |       |                                        |       |                |       |                                  |       |
| Net loss                                                |       |              |       |                             |       | (2,703                 | )          |                                        |       |                |       | (2,703                                | )          |
| Foreign currency translation adjustment                 |       |              |       |                             |       |                   |       | 4,111                                       |       |                |       | 4,111                                 |       |
| Holding loss on marketable securities, net              |       |              |       |                             |       |                   |       | (8                                          | )          |                |       | (8                                    | )          |
| Total  comprehensive income                             |       |              |       |                             |       |                   |       |                                        |       |                |       | 1,400                                 |       |
| Exercise of  options for 221,973 shares of common stock |       | —            |       | 4,259                            |       |                   |       |                                        |       |                |       | 4,259                                 |       |
| Stock-based  compensation                               |       |              |       | 566                              |       |                   |       |                                        |       |                |       | 566                                   |       |
| Tax benefit of  options exercised                       |       |              |       | 917                              |       |                   |       |                                        |       |                |       | 917                                   |       |
| Balance, June 30, 2006                                  |       | $                 | 10         |                             | $          | 88,804                 |       | $                                           | 123,676    |                | $          | (9,082                                | )          | $ | (47,436 | ) | $ | 155,972 |   |

 

See notes to consolidated and condensed consolidatedfinancial statements.

6

----

**STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED AND CONDENSED CONSOLIDATEDFINANCIAL STATEMENTSJUNE 30, 2006Unaudited(Tabular Amounts In Thousands Except Share, Per Share, Option, and Per OptionData)**

**(1)           Basis of Presentation**

The accompanying consolidated and condensed consolidated financialstatements of Steinway Musical Instruments, Inc. and subsidiaries (the “Company”)for the three months and six months ended June 30, 2006 and 2005 areunaudited.  In the opinion of management,these statements have been prepared on the same basis as the auditedconsolidated financial statements as of and for the year ended December 31,2005, and include all adjustments which are of a normal and recurring nature,necessary for the fair presentation of financial position, results ofoperations and cash flows for the interim periods.  We encourage you to read the consolidated andcondensed consolidated financial statements in conjunction with the risk factors,consolidated financial statements and notes thereto contained in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2005 filed with theSecurities and Exchange Commission (“SEC”). The results of operations for the three months and six months ended June30, 2006 are not necessarily indicative of the results that may be expected forthe entire year.

Throughout this report “we,” “us,” and “our” refer to Steinway MusicalInstruments, Inc. and subsidiaries taken as a whole.

**(2)           Summary of Significant AccountingPolicies**

**Principlesof Consolidation***-*Ourconsolidated financial statements include the accounts of all direct andindirect subsidiaries, all of which are wholly-owned, including The SteinwayPiano Company, Inc. (“Steinway”) and Conn-Selmer, Inc. (“Conn-Selmer”).  Intercompany balances have been eliminated inconsolidation.

**Use ofEstimates****- Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America necessarily requires us tomake estimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of revenues and expensesduring the reporting period.  Actual resultscould differ from those estimates.

**IncomeTaxes** - We provide for income taxes using an asset andliability approach.  We compute deferredincome tax assets and liabilities for differences between the financialstatement and tax bases of assets and liabilities that will result in taxableor deductible amounts in the future based on enacted tax laws and ratesapplicable to the periods in which the differences are expected to affecttaxable income.  We establish valuationallowances when necessary to reduce deferred tax assets to the amount that morelikely than not will be realized.

**Stock-basedCompensation** - We have an employee stock purchase plan (“PurchasePlan”) and a stock award plan (“Stock Plan”). Prior to January 1, 2006, we used the intrinsic-value method ofaccounting for our stock-based employee compensation arrangements. EffectiveJanuary 1, 2006, we adopted Statement of Financial Accounting Standard (SFAS)No. 123R, “Share-Based Payment” using the modified prospective applicationmethod.  Under this transition method, weare required to record

7

----

 

compensation cost for allawards granted after the date of adoption and for the unvested portion of thepreviously granted awards that remain outstanding at the date of adoption.  We are not required to restate prior periodresults.

**(Loss) Earnings per Common Share -**We compute basic (loss) earnings pershare using the weighted-average number of common shares outstanding duringeach period.  Diluted (loss) earnings percommon share reflects the effect of our outstanding options using the treasurystock method, except when such options would be antidilutive.

Areconciliation of the weighted-average shares used for the basic and dilutedcomputations is as follows:
|                                   | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Weighted-average  shares:         |       |                                                |       |                                              |       |   |   |   |   |
| For basic  earnings per share     |       | 8,331,652                                           |       | 8,052,418                                         |       | 8,242,011 |   | 8,041,649 |   |
| Dilutive effect  of stock options |       | —                                              |       | 223,678                                           |       | — |   | 217,421 |   |
| For diluted  earnings per share   |       | 8,331,652                                           |       | 8,276,096                                         |       | 8,242,011 |   | 8,259,070 |   |

 

We did not include 628,200 outstanding options topurchase shares of common stock in the computation of diluted loss per commonshare for the three and six months ended June 30, 2006 because their impactwould have been antidilutive.  Alloutstanding options were included in the computation of diluted net earningsper common share for the three and six months ended June 30, 2005 because theexercise prices of the outstanding options were less than the average marketprice of our common shares.

**Accumulated Other ComprehensiveIncome (Loss)** -Comprehensive income (loss) is comprised of foreign currency translationadjustments, additional minimum pension liabilities, and unrealized gains andlosses on available-for-sale (“AFS”) marketable securities.  The components of accumulated othercomprehensive loss are as follows:
|                           | ** ** | **Foreign Currency  Translation  Adjustment** | ** ** | **Unrealized  Holding Gain on  AFS Securities** | ** ** | **Tax Impact of  Unrealized  Holding Gain on  AFS Securities** | ** ** | **Additional  Minimum  Pension Liability** | ** ** | **Tax Impact of  Additional  Minimum  Pension Liability** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** |
|---------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------------------------------|------------|---------------------------------------------|------------|
|                      |       |                                               |       |                                                           |       |                                                                                    |       |                                            |       |                                                                     |       |                                        |       |
| Balance,  January 1, 2006 |       | $                                                  | (2,631     | )                                                              | $          | 213                                                                                     |       | $                                               | (85        | )                                                                        | $          | (17,424                                     | )          | $ | 6,742 |   | $ | (13,185 | ) |
| Activity                  |       | 4,111                                              |       | (13                                                            | )          | 5                                                                                       |       | —                                          |       | —                                                                   |       | 4,103                                       |       |
| Balance,  June 30, 2006   |       | $                                                  | 1,480      |                                                           | $          | 200                                                                                     |       | $                                               | (80        | )                                                                        | $          | (17,424                                     | )          | $ | 6,742 |   | $ | (9,082 | ) |

 

**Recent Accounting Pronouncements****-** InJune 2006, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 48 (“FIN48”), “Accounting for Uncertainty in IncomeTaxes - an interpretation of FASB Statement No. 109.” FIN 48 clarifies therecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting ininterim periods, disclosure and transition. FIN 48 is effective for fiscalyears

8

----

 

beginning afterDecember 15, 2006. We are evaluating the impact that this statement willhave on our financial position or result of operations.

*Reclassification*—We havereclassified our prior year provision for doubtful accounts and related cashflow effects to conform to the current year presentation. The provision fordoubtful accounts was included in operating expenses within “Sales andmarketing” in the prior year. The cash flow effects of changes in the provisionfor doubtful accounts were included in the “Other” line item on our prior yearcash flow.

**(3)           Inventories**
|                 | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------|------------|-------------------------|------------|-----------------------------|------------|
| Raw materials   |       | $                       | 20,504     |                        | $          | 23,218 |   |
| Work-in-process |       | 43,953                  |       | 47,511                      |       |
| Finished goods  |       | 90,827                  |       | 88,581                      |       |
|            |       | $                       | 155,284    |                        | $          | 159,310 |   |

 

**(4)           Goodwill, Trademarks, and OtherIntangible Assets**

Intangible assets other than goodwill andindefinite-lived trademarks are amortized on a straight-line basis over theirestimated useful lives.  Deferredfinancing costs are amortized over the repayment periods of the underlyingdebt.  We test our goodwill andindefinite-lived trademark assets for impairment annually, or on an interimbasis if events or circumstances indicate that the fair value of an asset hasdecreased below its carrying value.  Thechanges in carrying amounts of goodwill and trademarks are as follows:
|                                      | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|
| Goodwill:                            |       |                   |       |                  |       |      |       |
| Balance, January  1, 2006            |       | $                      | 21,533     |                  | $          | 8,555     |       | $ | 30,088 |   |
| Foreign currency  translation impact |       | 974                    |       | —                |       | 974       |       |
| Balance, June  30, 2006              |       | $                      | 22,507     |                  | $          | 8,555     |       | $ | 31,062 |   |
|                                 |       |                   |       |                  |       |      |       |
| Trademarks:                          |       |                   |       |                  |       |      |       |
| Balance, January  1, 2006            |       | $                      | 7,409      |                  | $          | 5,824     |       | $ | 13,233 |   |
| Foreign currency  translation impact |       | 307                    |       | —                |       | 307       |       |
| Balance, June  30, 2006              |       | $                      | 7,716      |                  | $          | 5,824     |       | $ | 13,540 |   |

 

9

----

 

We also carry certain intangible assets that are amortized.  Once fully amortized, these assets areremoved from both the gross and accumulated amortization balance.  These assets consist of the following:
|                                 | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                            |       |                    |       |                        |       |
| Gross deferred  financing costs |       | $                       | 5,260      |                        | $          | 8,467 |   |
| Accumulated  amortization       |       | (949                    | )          | (4,701                      | )          |
| Deferred  financing costs, net  |       | $                       | 4,311      |                        | $          | 3,766 |   |
|                            |       |                    |       |                        |       |
| Gross covenants  not to compete |       | $                       | 500        |                        | $          | 500 |   |
| Accumulated  amortization       |       | (188                    | )          | (138                        | )          |
| Covenants not to  compete, net  |       | $                       | 312        |                        | $          | 362 |   |

 

**Thechange in gross deferred financing costs and related accumulated amortizationduring the six months ended June 30, 2006 is primarily attributable to thewrite-off of the assets associated with our term loan which we repaid, theextinguishment of our 8.75% Senior Notes, and the recording of a new deferredfinancing costs associated with the issuance of our 7.00% Senior Notes.  These events are described more fully in Note6.**

**Theweighted-average amortization period for deferred financing costs is 8 years,and the weighted-average amortization period of covenants not to compete is 5years.  Total amortization expense, whichincludes amortization of deferred financing costs, is as follows:**
|                       | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **            | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                  |       |                                                |       |                                              |       |   |   |   |   |
| Amortization  expense |       | $                                                   | 197        |                                              | $          | 284 |   | $ | 426 |   | $ | 566 |   |
|                       |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

 

The following table shows the total estimatedamortization expense for 2006 and the next five succeeding fiscal years:
| Estimated amortization expense: | ** ** | **Amount** | ** ** |
|-------------------------------------------|------------|------------|------------|
|                                      |       |       |       |
| 2006                                      |       | $          | 809        |   |
| 2007                                      |       | 766        |       |
| 2008                                      |       | 730        |       |
| 2009                                      |       | 598        |       |
| 2010                                      |       | 519        |       |
| 2011                                      |       | 515        |       |
|                                           |            |            |            |  |

 

10

----

 

**(5)****                                 OtherCurrent Liabilities**
|                                       | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Accrued payroll  and related benefits |       | $                       | 18,564     |                        | $          | 17,622 |   |
| Current portion  of pension liability |       | 3,813                   |       | 3,441                       |       |
| Accrued warranty  expense             |       | 1,894                   |       | 1,857                       |       |
| Accrued interest                      |       | 4,356                   |       | 3,134                       |       |
| Deferred income                       |       | 5,402                   |       | 5,482                       |       |
| Environmental  liabilities            |       | 3,719                   |       | 3,820                       |       |
| Other accrued  expenses               |       | 9,383                   |       | 9,743                       |       |
| Total                                 |       | $                       | 47,131     |                        | $          | 45,099 |   |

 

Accrued warranty expense is recorded at the time ofsale for instruments that have a warranty period ranging from one to tenyears.  The accrued expense recorded isgenerally calculated on a ratio of warranty costs to sales based on ourwarranty history and is adjusted periodically following an analysis of actualwarranty claims.

The accrued warranty expense activity for the sixmonths ended June 30, 2006 and 2005, and the year ended December 31, 2005 is asfollows:
|                                      | ** ** | **June 30,  2006** | ** ** | **June 30,  2005** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------|------------|-------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Beginning  balance                   |       | $                       | 1,857      |                    | $          | 2,139                       |       | $ | 2,139 |   |
| Additions                            |       | 534                     |       | 542                     |       | 858                         |       |
| Claims and  reversals                |       | (550                    | )          | (480                    | )          | (1,045                      | )          |
| Foreign currency  translation impact |       | 53                      |       | (81                     | )          | (95                         | )          |
| Ending balance                       |       | $                       | 1,894      |                    | $          | 2,120                       |       | $ | 1,857 |   |

 

11

----

 

**(6)           Long-Term Debt**

Duringthe six months ended June 30, 2006, we significantly restructured our long-termdebt.  We repaid our larger, higherinterest term loan, which had an outstanding balance of $16.6 million atDecember 31, 2005.  We also issued $175.0million of 7.00% Senior Notes and extended a tender offer to purchase the$166.2 million of our outstanding 8.75% Senior Notes.  We issued our new 7.00% Senior Notes at99.2435%, and received proceeds of $170.2 million, net of associated fees.  We used the proceeds from this issuance toextinguish $114.6 million of the 8.75% Senior Notes pursuant to our tenderoffer in the first quarter of 2006.  Theremaining proceeds, supplemented by borrowings on our line of credit, were usedto exercise our right to call the remaining $51.6 million of 8.75% Senior Noteson April 17, 2006.  As a result of theseactivities, our long-term debt at June 30, 2006 consists of the following:
|                                        | ** ** | **June 30, 2006** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| Term loans                             |       | $                           | 14,874     |   |
| 7.00% Senior  Notes                    |       | 175,000                     |       |
| Unamortized bond  discount             |       | (1,267                      | )          |
| Open account  loans, payable on demand |       | 4,897                       |       |
| Total                                  |       | 193,504                     |       |
| Less: current  portion                 |       | (5,960                      | )          |
| Long-term debt                         |       | $                           | 187,544    |   |
|                                   |       |                        |       |

 

Inconjunction with our debt restructuring activities, we recorded a net loss onextinguishment of debt of $9.7 million in the period ended June 30, 2006, whichconsists of the following:
|                                                          | ** ** | **June 30, 2006** | ** ** |
|----------------------------------------------------------|------------|-----------------------------|------------|
| Deferred  financing costs write-off - term loan          |       | $                           | 977        |   |
| Deferred  financing costs write-off - 8.75% Senior Notes |       | 2,247                       |       |
| Premiums  pursuant to the tender offer and call          |       | 7,740                       |       |
| Bond premium  write-off                                  |       | (1,290                      | )          |
| Total net loss on  extinguishment of debt                |       | $                           | 9,674      |   |

 

Scheduled paymentsof long-term debt are as follows:
|                    | ** ** | **June 30,  2006** | ** ** |
|--------------------|------------|-------------------------|------------|
| Remainder of  2006 |       | $                       | 5,415      |   |
| 2007               |       | 1,107                   |       |
| 2008               |       | 13,249                  |       |
| 2009               |       | —                  |       |
| 2010               |       | —                  |       |
| Thereafter         |       | 175,000                 |       |
| Total              |       | $                       | 194,771    |   |

 

12

----

 

**(7)           Stockholders’ Equity and Stock-basedCompensation Arrangements**

Our common stock is comprised of two classes: Class A andOrdinary.  With the exception ofdisparate voting power, both classes are substantially identical.  Each share of Class A common stock entitlesthe holder to 98 votes.  Holders ofOrdinary common stock are entitled to one vote per share.  Class A common stock shall automaticallyconvert to Ordinary common stock if, at any time, the Class A common stock isnot owned by an original Class A holder. As of June 30, 2006 our Chairman and Chief Executive Officer owned 100%of the Class A common shares, representing approximately 86% of the combinedvoting power of the Class A common stock and Ordinary common stock.

**Employee Stock Purchase Plan** - We have an employee stock purchaseplan under which substantially all employees may purchase Ordinary common stockthrough payroll deductions at a purchase price equal to 85% of the lower of thefair market values as of the beginning or end of each twelve-month offeringperiod.  Stock purchases under thePurchase Plan are limited to 5% of an employee’s annual base earnings.  We have reserved 500,000 shares for issuanceunder this plan and we may grant options to purchase shares up to ten yearsfrom the plan’s commencement.  This planexpired on July 31, 2006.  Ourstockholders approved a new Purchase Plan effective August 1, 2006 during ourannual stockholders meeting.  Thecharacteristics of the plan were not changed. Our Board of Directors has authorized an aggregate of 400,000 shares ofcommon stock for issuance under this plan.

**Stock Plan** - The 1996 stockplan, as amended, provides for the granting of up to 1,500,000 stock options(including incentive stock options and non-qualified stock options), stockappreciation rights and other stock awards to certain key employees,consultants and advisors through July 31, 2006. Our stock options generally have five year vesting terms and ten yearoption terms.  Upon option exercise, weissue shares of Ordinary common stock, and we will continue to issue sharesuntil we have reached our registered share limitation.  At that time, we will issue shares out oftreasury stock.  We have reserved 721,750treasury stock shares under the 1996 stock plan for this purpose.  Our stockholders approved a new “2006 StockPlan” effective August 1, 2006 during our annual stockholders meeting.  The characteristics of the plan were notchanged.  Our Board of Directors hasauthorized an aggregate of 1,000,000 shares of common stock for issuance underthis plan.

EffectiveJanuary 1, 2006, we adopted Statement of Financial Accounting Standards(“SFAS”) No. 123R, “Share-Based Payment” to account for our stock compensationarrangements, using the modified prospective application transitionmethod.  Accordingly, we did not restatethe results of prior periods.  Prior toJanuary 1, 2006, we applied Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees” and did not recognize anycompensation expense associated with employee stock options because theexercise price was equal to the market price at the date of option grant.  SFAS No. 123R requires that stock-basedcompensation cost be recognized over the period from the date of grant to thedate when the award is no longer contingent upon the employee providingadditional service.

As of June 30, 2006, thecompensation cost that has been charged against income for these plans was $0.3million and $0.6 million for the three and six months ended June 30, 2006,respectively.  The income tax benefitrecognized in the income statement for share-based compensation arrangementswas less than $0.1 million for the three and six months ended June 30,2006.  Basic and diluted loss per shareincludes $0.03 and $0.06 of stock-based compensation cost for the three and sixmonths ended June 30, 2006, respectively.

 

13

----

 

The following table illustrates the effect on netincome and earnings per share as if we had applied the fair value method ofStatement of Financial Accounting Standards (SFAS) No. 123, “Accounting forStock-Based Compensation” (SFAS 123), prior to January 1, 2006:
| ** **                                                                                                                                                                                                                        | ** ** | **Three Months Ended  June 30, 2005** | ** ** | **Six Months Ended  June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
|                                                                                                                                                                                                                              |       |                                                      |       |                                                    |       |
| Net income, as  reported                                                                                                                                                                                                          |       | $                                                         | 2,418      |                                                    | $          | 5,016 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair-value based  method for all awards, net of related tax effects of $35 and $71 for the three  and six months ended June 30, 2005, respectively |       | (220                                                      | )          | (472                                                    | )          |
|                                                                                                                                                                                                                              |       |                                                      |       |                                                    |       |
| Pro forma net  income                                                                                                                                                                                                             |       | $                                                         | 2,198      |                                                    | $          | 4,544 |   |
|                                                                                                                                                                                                                              |       |                                                      |       |                                                    |       |
| Earnings per  share:                                                                                                                                                                                                              |       |                                                      |       |                                                    |       |
| Basic - as reported                                                                                                                                                                                                               |       | $                                                         | 0.30       |                                                    | $          | 0.62 |   |
| Basic - pro forma                                                                                                                                                                                                                 |       | $                                                         | 0.27       |                                                    | $          | 0.57 |   |
|                                                                                                                                                                                                                              |       |                                                      |       |                                                    |       |
| Diluted - as reported                                                                                                                                                                                                             |       | $                                                         | 0.29       |                                                    | $          | 0.61 |   |
| Diluted - pro  forma                                                                                                                                                                                                              |       | $                                                         | 0.27       |                                                    | $          | 0.56 |   |

 

We measured thefair value of options on their grant date, including the valuation of theoption feature implicit in our Purchase Plan, using the Black-Scholesoption-pricing model.  The risk-freeinterest rate is based on the weighted-average of U.S. Treasury rates over theexpected life of the stock option or the contractual life of the option featurein the Purchase Plan. The expected life of a stock option is based onhistorical data of similar option holders. We have segregated our employees into two groups based on historicalexercise and termination behavior. The expected life of the option feature inthe Purchase Plan is the same as its contractual life.  Expected volatility is based on historicalvolatility of our stock over its expected life, as our options are not readilytradable.

 

14

----

 

Key assumptionsused to apply this pricing model to the option feature in the Purchase Plan areas follows:
| ** **                                                                        | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Risk-free  interest rate                                                          |       | 3.80%                                           |       | 2.04%                                         |       | 3.80% |   | 2.04% |   |
| Weighted-average  expected life of option feature in the Purchase Plan (in years) |       | 1.00                             |       | 1.00                                |       | 1.00   |   | 1.00   |   |
| Expected volatility of  underlying stock                                          |       | 22.79%                                          |       | 26.83%                                        |       | 22.79% |   | 26.83% |   |

 

The weighted average fair value of the option feature in the PurchasePlan is as follows:

 
| ** **                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                       | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Option feature  in Purchase Plan |       | $                                               | 7.25       |                                          | $          | 7.33 |   | $ | 7.25 |   | $ | 7.33 |   |
|                                  |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

 

There were nostock option awards issued during the six months ended June 30, 2005.  During the six months ended June 30, 2006, wegranted stock options awards and applied a risk-free interest rate of 4.98%, aweighted-average expected life in years of 7.12, and an expected volatility of24.43% to the Black-Scholes option-pricing model.  The weighted average fair value of optionsgranted during the three and six months ended June 30, 2006 was $10.95.

The following table sets forth information regardingthe Purchase Plan:

|                                 | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Remaining  Contractual  Life  (in years)** | ** ** |
|---------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|---------------------------------------------------|------------|
| Outstanding at  January 1, 2006 |       | 9,476                       |       | $                                       | 25.42      |                                              |       |   |
| Shares  subscribed              |       | 11,203                      |       | 25.42                                   |       |                                              |       |
| Exercised                       |       | —                      |       | —                                  |       |                                              |       |
| Canceled                        |       | (1,238                      | )          | 25.42                                   |       |                                              |       |
| Outstanding at June 30,  2006   |       | 19,441                      |       | $                                       | 25.42      |                                              | 0.1        |   |

 

15

----

 

The followingtable sets forth information regarding the Stock Plan:
| ** **                      | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Remaining  Contractual  Life  (in years)** | ** ** | **Aggregate  Intrinsic  Value   (not in 000s)** | ** ** |
|---------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------------------|------------|
| Outstanding at  January 1, 2006 |       | 826,773                     |       | $                                       | 20.33      |                                              |       |                                                           |       |   |
| Granted                         |       | 25,000                      |       | 27.66                                   |       |                                              |       |                                                           |       |
| Exercised                       |       | (221,973                    | )          | 19.19                                   |       |                                              |       |                                                           |       |
| Forfeited                       |       | (1,600                      | )          | 19.04                                   |       |                                              |       |                                                           |       |
| Outstanding at  June 30, 2006   |       | 628,200                     |       | $                                       | 21.03      |                                              | 6.7        |                                                           | $          | 2,395,321 |   |
|                            |       |                        |       |                                    |       |                                              |       |                                                           |       |
| Exercisable at June 30,  2006   |       | 273,500                     |       | $                                       | 19.89      |                                              | 5.9        |                                                           | $          | 1,269,879 |   |

 

The total intrinsic value of the options exercisedduring the six months ended June 30, 2006 and 2005 was $2.6 million and $0.3million, respectively.

As of June 30, 2006, there was $1.9 million ofunrecognized compensation cost related to nonvested share-based compensationarrangements granted under the Stock Plan. This compensation cost is expected to be recognized over a period of 2.4years.

As reported in the statement of cash flows, cashreceived from option exercises under the Stock Plan for the period ended June30, 2006 was $4.3 million.  SFAS No. 123Rrequires that cash flows from tax benefits resulting from tax deductions inexcess of the compensation cost recognized for stock-based awards under a fairvalue basis (excess tax benefits) be classified as a cash flow from financingactivities.  Prior to the adoption ofSFAS No. 123R, such excess tax benefits were classified as operating cashflows.  Accordingly, $0.9 million of taxbenefit from stock option exercises is presented as a cash inflow fromoperating activities and $0.4 million of excess tax benefits has beenclassified as an outflow from operating activities and an inflow from financingactivities in the statement of cash flows.

**(8)           Other (Income) Expense, Net**
| ** **                            | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                  |       |                                                |       |                                              |       |   |   |   |   |
| West 57th  building income            |       | $                                                   | (1,163     | )                                                 | $          | (1,163 | ) | $ | (2,327 | ) | $ | (2,327 | ) |
| West 57th  building expenses          |       | 820                                                 |       | 816                                               |       | 1,638 |   | 1,631 |   |
| Foreign exchange  (gains) losses, net |       | (322                                                | )          | 457                                               |       | (672 | ) | 442 |   |
| Miscellaneous                         |       | (30                                                 | )          | (77                                               | )          | (85 | ) | (152 | ) |
| Other (income) expense,  net          |       | $                                                   | (695       | )                                                 | $          | 33 |   | $ | (1,446 | ) | $ | (406 | ) |

 

16

----

 

**(9)           Commitments and Contingent Liabilities**

Weare involved in certain legal proceedings regarding environmental matters,which are described below.  Further, inthe ordinary course of business, we are party to various legal actions that webelieve are routine in nature and incidental to the operation of ourbusiness.  While the outcome of suchactions cannot be predicted with certainty, we believe that, based on ourexperience in dealing with these matters, their ultimate resolution will nothave a material adverse impact on our business, financial condition, results ofoperations or prospects.

Certainenvironmental laws, such as the Comprehensive Environmental Response,Compensation, and Liability Act, as amended (“CERCLA”), impose strict,retroactive, joint and several liability upon persons responsible for releasesof hazardous substances, which liability is broadly construed.  Under CERCLA and other laws, we may haveliability for investigation and cleanup costs and other damages relating to ourcurrent or former properties, or third-party sites to which we sent wastes fordisposal.  Our potential liability at anyof these sites is affected by many factors including, but not limited to, themethod of remediation, our portion of the hazardous substances at the siterelative to that of other parties, the number of responsible parties, thefinancial capabilities of other parties, and contractual rights andobligations.

Inthis regard, we operate certain manufacturing facilities which were previouslyowned by Philips Electronics North America Corporation (“Philips”).  When we purchased these facilities, Philipsagreed to indemnify us for certain environmental matters resulting fromactivities of Philips occurring prior to December 29, 1988 (the “EnvironmentalIndemnity Agreement”).  To date, Philipshas fully performed its obligations under the Environmental IndemnityAgreement, which terminates on December 29, 2008; however, we cannot provideassurance that it will continue to do so in the future.  Four matters covered by the EnvironmentalIndemnity Agreement are currently pending. Philips has entered into Consent Orders with the EnvironmentalProtection Agency (“EPA”) for one site and the North Carolina Department ofEnvironment, Health and Natural Resources for a second site, whereby Philips hasagreed to pay required response costs. On October 22, 1998, we were joined as defendant in an action involvinga third site formerly occupied by a business we acquired in Illinois.  Philips has accepted the defense of thisaction pursuant to the terms of the Environmental Indemnity Agreement.  At the fourth site, which is a third-partywaste disposal site, the EPA has named over 40 persons or entities aspotentially responsible parties (“PRP”), including four Conn-Selmer predecessorentities.  The four entities have beeninvolved as members of PRP group in the ongoing negotiations with the siteowners, the largest contributor, and the EPA in an attempt to reach asettlement and release PRP group members from further potential liability.  We expect a decision on the proposedsettlement to be reached within the next six to twelve months.  For two of these predecessor entities, whichwere previously owned by Philips, this matter has been tendered to Philipspursuant to the Environmental Indemnity Agreement.  With respect to the other two entities, basedon current information concerning estimated cleanup costs at the site, and ourshare of liability, we do not believe our liability will be material.

In addition, we arecontinuing an existing environmental remediation plan at a facility we acquiredin 2000.  We estimate our costs, whichapproximate $0.9 million, over a 15 year period.  We have accrued approximately $0.7 millionfor the estimated remaining cost of this remediation program, which representsthe present value total cost using a discount rate of 4.54%.

 

17

----

 

A summary of expected payments associated with thisproject is as follows:

|            | ** ** | **Environmental  Payments** | ** ** |
|------------|------------|-----------------------------|------------|
| 2006       |       | $                           | 62         |   |
| 2007       |       | 84                          |       |
| 2008       |       | 56                          |       |
| 2009       |       | 56                          |       |
| 2010       |       | 56                          |       |
| Thereafter |       | 555                         |       |
|       |       | $                           | 869        |   |

 

In2004, we acquired two manufacturing facilities from G. Leblanc Corporation, nowGrenadilla, Inc. (“Grenadilla”), for which environmental remediation plans hadalready been established.  In connectionwith the acquisition, we assumed the existing accrued liability ofapproximately $0.8 million for the cost of these remediation activities.  Based on a review of past and ongoinginvestigatory and remedial work by our environmental consultants, and discussionswith state regulatory officials, as well as recent sampling, we estimate theremaining costs of such remedial plans at $3.1 million.  Pursuant to the purchase and sale agreement,we have sought indemnification from Grenadilla for anticipated costs above theoriginal estimate in the amount of $2.5 million.  We filed a claim against the escrow andrecorded a corresponding receivable for this amount in prepaid expenses andother current assets in the consolidated balance sheet.  However, we cannot be assured that we will beable to recover such costs from Grenadilla.

Based on our pastexperience and currently available information, the matters described above andour other liabilities and compliance costs arising under environmental laws arenot expected to have a material impact on our capital expenditures, earnings orcompetitive position in an individual year. However, some risk of environmental liability is inherent in the natureof our current and former business and we may, in the future, incur materialcosts to meet current or more stringent compliance, cleanup, or otherobligations pursuant to environmental laws.

 

18

----

 

**(10)         Retirement Plans**

We have defined benefit pension plans covering themajority of our employees, including certain employees in Germany and theU.K.  The components of net periodicpension cost for these plans are as follows:
| ** **                          | ** ** | **Domestic Plans**                             | ** ** | **Foreign Plans**                              | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                          | ** ** | **Three Months Ended June 30,** | ** ** | **Three Months Ended June 30,** | ** ** |
| ** **                          | ** ** | **2006**                                            | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost                        |       | $                                                   | 190        |                                                | $          | 126 |   | $ | 215 |   | $ | 171 |   |
| Interest cost                       |       | 690                                                 |       | 566                                                 |       | 366 |   | 330 |   |
| Expected return  on plan assets     |       | (1,018                                              | )          | (782                                                | )          | (77 | ) | (73 | ) |
| Amortization of  prior service cost |       | 105                                                 |       | 76                                                  |       | — |   | — |   |
| Amortization of  net loss           |       | 146                                                 |       | 114                                                 |       | — |   | 1 |   |
| Net periodic  benefit cost          |       | $                                                   | 113        |                                                | $          | 100 |   | $ | 504 |   | $ | 429 |   |

 
| ** **                          | ** ** | **Domestic Plans**                           | ** ** | **Foreign Plans**                            | ** ** |
|-------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **Six Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
| ** **                          | ** ** | **2006**                                          | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost                        |       | $                                                 | 433        |                                              | $          | 252 |   | $ | 422 |   | $ | 339 |   |
| Interest cost                       |       | 1,475                                             |       | 1,132                                             |       | 717 |   | 655 |   |
| Expected return  on plan assets     |       | (2,169                                            | )          | (1,564                                            | )          | (151 | ) | (148 | ) |
| Amortization of  prior service cost |       | 215                                               |       | 152                                               |       | — |   | — |   |
| Amortization of  net loss           |       | 322                                               |       | 228                                               |       | — |   | 1 |   |
| Net periodic benefit  cost          |       | $                                                 | 276        |                                              | $          | 200 |   | $ | 988 |   | $ | 847 |   |

 

We provide postretirement health care and life insurance benefits toeligible hourly retirees and their dependents. The components of net periodic postretirement benefit cost for thesebenefits are as follows:
| ** **                             | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost                           |       | $                                                   | 13         |                                              | $          | 9 |   | $ | 25 |   | $ | 20 |   |
| Interest cost                          |       | 34                                                  |       | 29                                                |       | 68 |   | 65 |   |
| Amortization of  transition obligation |       | 8                                                   |       | 10                                                |       | 17 |   | 23 |   |
| Amortization of  net loss              |       | 12                                                  |       | —                                            |       | 25 |   | — |   |
| Net postretirement  benefit cost       |       | $                                                   | 67         |                                              | $          | 48 |   | $ | 135 |   | $ | 108 |   |

 

Based on federal laws andregulations, we are not required to make a contribution to our domestic pensionplan in 2006 and, through June 30, 2006, we have not made any contributions tothis plan.  Nevertheless, we expect tocontribute approximately $1.5 million to our domestic pension plan in thecurrent year.  Our anticipatedcontributions to the pension plan of our U.K. subsidiary approximate $0.2million for the current year.  As of June30, 2006, we have made contributions of $0.1 million to this plan.  The pension plans of our German subsidiariesdo not hold any assets and pay participant benefits as incurred.  Expected 2006 benefit payments under theseplans are $1.1 million.  For the sixmonths ended June 30, 2006, we have made benefit payments of $0.5 million underthese plans.

 

19

----

 

**(11)         Segment Information**

We have identified two reportable segments: the piano segment and theband & orchestral instrument segment. We consider these two segments reportable as they are managed separatelyand the operating results of each segment are separately reviewed and evaluatedby our senior management on a regular basis. Management and the chief operating decision maker use income fromoperations as a meaningful measurement of profit or loss for the segments.  Income from operations for the reportablesegments includes certain corporate costs allocated to the segments basedprimarily 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.

The following tables present information about our operating segmentsfor the three months and six months ended June 30, 2006 and 2005:
| **Three months ended 2006** | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| ** **                                 | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to  external customers           |       | $                      | 29,912     |                  | $          | 14,436    |       | $          | 7,316      |   | $ | 51,664 |   | $ | 38,958 |   | $ | 1,801 |   | $ | 40,759 |   | $ | — |   | $ | 92,423 |   |
| Income (loss)  from operations             |       | 2,246                  |       | 3,528                 |       | 284       |       | 6,058      |       | (5,933 | ) | 46 |   | (5,887 | ) | (566 | ) | (395 | ) |
|                                            |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **Three months ended 2005** | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| ** **                                 | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to  external customers           |       | $                      | 25,489     |                  | $          | 13,739    |       | $          | 7,165      |   | $ | 46,393 |   | $ | 41,767 |   | $ | 1,601 |   | $ | 43,368 |   | $ | — |   | $ | 89,761 |   |
| Income (loss)  from operations             |       | 1,872                  |       | 3,142                 |       | 271       |       | 5,285      |       | 3,449 |   | (217 | ) | 3,232 |   | (790 | ) | 7,727 |   |
|                                            |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **Six months ended 2006** | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| ** **                               | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to  external customers         |       | $                      | 54,567     |                  | $          | 24,124    |       | $          | 15,101     |   | $ | 93,792 |   | $ | 90,216 |   | $ | 3,609 |   | $ | 93,825 |   | $ | — |   | $ | 187,617 |   |
| Income (loss) from  operations           |       | 2,669                  |       | 5,107                 |       | 733       |       | 8,509      |       | (1,653 | ) | (40 | ) | (1,693 | ) | (1,700 | ) | 5,116 |   |
|                                          |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **Six months ended 2005** | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| ** **                               | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to  external customers         |       | $                      | 51,406     |                  | $          | 24,053    |       | $          | 14,709     |   | $ | 90,168 |   | $ | 87,518 |   | $ | 3,417 |   | $ | 90,935 |   | $ | — |   | $ | 181,103 |   |
| Income (loss) from  operations           |       | 4,350                  |       | 5,348                 |       | 822       |       | 10,520     |       | 6,163 |   | (271 | ) | 5,892 |   | (1,627 | ) | 14,785 |   |
|                                          |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

20

----

 

**(12)**                          Summaryof Guarantees

Our payment obligations under our 7.00% Senior Notes arefully and unconditionally guaranteed on a joint and several basis byConn-Selmer, Steinway, and certain other 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 either Notes,represent non-U.S. operations (the “Non Guarantor Subsidiaries”).

**The following condensedconsolidating supplementary data illustrates the financial position, results ofoperations, and cash flows of the Guarantor Subsidiaries and the Non GuarantorSubsidiaries.  Separate complete financialstatements of the respective Guarantors would not provide additional materialinformation that would be useful in assessing the financial composition of theGuarantor Subsidiaries.  No singleGuarantor Subsidiary had any significant legal restrictions on the ability ofinvestors or creditors to obtain access to its assets in event of default onthe guarantee other than its subordination to senior indebtedness.**

We record investments in subsidiaries on the costmethod for purposes of the supplemental consolidating presentation.  Earnings of subsidiaries are therefore notreflected in the parent company’s investment accounts and earnings.  The principal elimination entries eliminateinvestments in subsidiaries and intercompany balances and transactions.

21

----

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIESCONSOLIDATING STATEMENTS OF OPERATIONSTHREE MONTHS ENDED JUNE 30, 2006Unaudited(In Thousands)**
| ** **                         | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|---------------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                         | —     |                        | $          | 71,063                           |       | $                          | 24,327     |             | $          | (2,967 | ) | $ | 92,423 |   |
| Cost of sales                      |       | —                    |       | 57,023                      |       | 15,250                           |       | (2,999                     | )          | 69,274           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —                    |       | 14,040                      |       | 9,077                            |       | 32                         |       | 23,149           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Operating expenses:                |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Sales and  marketing               |       | —                    |       | 7,957                       |       | 3,106                            |       | —                     |       | 11,063           |       |
| Provision for  doubtful accounts   |       | —                    |       | 4,480                       |       | 25                               |       | —                     |       | 4,505            |       |
| General and  administrative        |       | 1,755                     |       | 4,240                       |       | 1,816                            |       | —                     |       | 7,811            |       |
| Amortization of  intangible assets |       | 137                       |       | 57                          |       | 3                                |       | —                     |       | 197              |       |
| Other operating  (income) expense  |       | (1,326                    | )          | 951                         |       | 343                              |       | —                     |       | (32              | )          |
| Total operating  expenses          |       | 566                       |       | 17,685                      |       | 5,293                            |       | —                     |       | 23,544           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| (Loss) income from  operations     |       | (566                      | )          | (3,645                      | )          | 3,784                            |       | 32                         |       | (395             | )          |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Other income, net                  |       | —                    |       | (618                        | )          | (77                              | )          | —                     |       | (695             | )          |
| Loss on extinguishment  of debt    |       | 3,063                     |       | —                      |       | —                           |       | —                     |       | 3,063            |       |
| Interest income                    |       | (4,796                    | )          | (764                        | )          | (86                              | )          | 4,766                      |       | (880             | )          |
| Interest expense                   |       | 3,318                     |       | 5,342                       |       | 138                              |       | (4,766                     | )          | 4,032            |       |
| Total non-operating  expenses      |       | 1,585                     |       | 3,960                       |       | (25                              | )          | —                     |       | 5,520            |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| (Loss) income before  income taxes |       | (2,151                    | )          | (7,605                      | )          | 3,809                            |       | 32                         |       | (5,915           | )          |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Income tax (benefit)  provision    |       | (6,156                    | )          | (548                        | )          | 1,637                            |       | 13                         |       | (5,054           | )          |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Net (loss) income                  |       | $                         | 4,005      |                        | $          | (7,057                           | )          | $                          | 2,172      |             | $          | 19 |   | $ | (861 | ) |

 

22

----

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIESCONSOLIDATING STATEMENTS OF OPERATIONSTHREE MONTHS ENDED JUNE 30, 2005Unaudited(In Thousands)**
| ** **                         | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|---------------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                         | —     |                        | $          | 70,113                           |       | $                          | 23,403     |             | $          | (3,755 | ) | $ | 89,761 |   |
| Cost of sales                      |       | —                    |       | 52,435                      |       | 14,944                           |       | (3,744                     | )          | 63,635           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —                    |       | 17,678                      |       | 8,459                            |       | (11                        | )          | 26,126           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Operating  expenses:               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Sales and marketing                |       | —                    |       | 7,644                       |       | 3,405                            |       | —                     |       | 11,049           |       |
| Provision for doubtful accounts    |       | —                    |       | 75                          |       | 8                                |       | —                     |       | 83               |       |
| General and administrative         |       | 1,891                     |       | 3,557                       |       | 1,512                            |       | —                     |       | 6,960            |       |
| Amortization of intangible assets  |       | 116                       |       | 162                         |       | 6                                |       | —                     |       | 284              |       |
| Other operating (income) expense   |       | (1,217                    | )          | 849                         |       | 391                              |       | —                     |       | 23               |       |
| Total operating  expenses          |       | 790                       |       | 12,287                      |       | 5,322                            |       | —                     |       | 18,399           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| (Loss) income  from operations     |       | (790                      | )          | 5,391                       |       | 3,137                            |       | (11                        | )          | 7,727            |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Other income,  net                 |       | —                    |       | (58                         | )          | 91                               |       | —                     |       | 33               |       |
| Interest income                    |       | (3,667                    | )          | (6,312                      | )          | (71                              | )          | 9,327                      |       | (723             | )          |
| Interest expense                   |       | 3,856                     |       | 9,779                       |       | 81                               |       | (9,327                     | )          | 4,389            |       |
| Total  non-operating expenses      |       | 189                       |       | 3,409                       |       | 101                              |       | —                     |       | 3,699            |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| (Loss) income  before income taxes |       | (979                      | )          | 1,982                       |       | 3,036                            |       | (11                        | )          | 4,028            |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Income tax  (benefit) provision    |       | 354                       |       | (36                         | )          | 1,299                            |       | (7                         | )          | 1,610            |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Net (loss)  income                 |       | $                         | (1,333     | )                           | $          | 2,018                            |       | $                          | 1,737      |             | $          | (4 | ) | $ | 2,418 |   |

 

23

----

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIESCONSOLIDATING STATEMENTS OF OPERATIONSSIX MONTHS ENDED JUNE 30, 2006Unaudited(In Thousands)**
| ** **                         | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|---------------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                         | —     |                        | $          | 148,401                          |       | $                          | 44,380     |             | $          | (5,164 | ) | $ | 187,617 |   |
| Cost of sales                      |       | —                    |       | 115,455                     |       | 28,238                           |       | (5,217                     | )          | 138,476          |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —                    |       | 32,946                      |       | 16,142                           |       | 53                         |       | 49,141           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Operating  expenses:               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Sales and marketing                |       | —                    |       | 16,658                      |       | 6,075                            |       | —                     |       | 22,733           |       |
| Provision for doubtful accounts    |       | —                    |       | 4,541                       |       | 21                               |       | —                     |       | 4,562            |       |
| General and administrative         |       | 4,227                     |       | 8,472                       |       | 3,490                            |       | —                     |       | 16,189           |       |
| Amortization of intangible assets  |       | 275                       |       | 145                         |       | 6                                |       | —                     |       | 426              |       |
| Other operating (income) expense   |       | (2,802                    | )          | 2,151                       |       | 766                              |       | —                     |       | 115              |       |
| Total operating  expenses          |       | 1,700                     |       | 31,967                      |       | 10,358                           |       | —                     |       | 44,025           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| (Loss) income  from operations     |       | (1,700                    | )          | 979                         |       | 5,784                            |       | 53                         |       | 5,116            |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Other income,  net                 |       | (16                       | )          | (1,197                      | )          | (233                             | )          | —                     |       | (1,446           | )          |
| Loss on extinguishment  of debt    |       | 8,697                     |       | 977                         |       | —                           |       | —                     |       | 9,674            |       |
| Interest income                    |       | (9,774                    | )          | (2,198                      | )          | (165                             | )          | 9,530                      |       | (2,607           | )          |
| Interest expense                   |       | 7,223                     |       | 10,537                      |       | 277                              |       | (9,530                     | )          | 8,507            |       |
| Total  non-operating expenses      |       | 6,130                     |       | 8,119                       |       | (121                             | )          | —                     |       | 14,128           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| (Loss) income before  income taxes |       | (7,830                    | )          | (7,140                      | )          | 5,905                            |       | 53                         |       | (9,012           | )          |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Income tax  (benefit) provision    |       | (8,490                    | )          | (503                        | )          | 2,663                            |       | 21                         |       | (6,309           | )          |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Net (loss)  income                 |       | $                         | 660        |                        | $          | (6,637                           | )          | $                          | 3,242      |             | $          | 32 |   | $ | (2,703 | ) |

 

24

----

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIESCONSOLIDATING STATEMENTS OF OPERATIONSSIX MONTHS ENDED JUNE 30, 2005Unaudited(In Thousands)**
| ** **                         | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|---------------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                         | —     |                        | $          | 144,716                          |       | $                          | 44,366     |             | $          | (7,979 | ) | $ | 181,103 |   |
| Cost of sales                      |       | —                    |       | 109,002                     |       | 28,315                           |       | (8,037                     | )          | 129,280          |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —                    |       | 35,714                      |       | 16,051                           |       | 58                         |       | 51,823           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Operating  expenses:               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Sales and marketing                |       | —                    |       | 15,779                      |       | 6,403                            |       | —                     |       | 22,182           |       |
| Provision for doubtful accounts    |       | —                    |       | 258                         |       | (36                              | )          | —                     |       | 222              |       |
| General and administrative         |       | 3,662                     |       | 7,169                       |       | 3,104                            |       | —                     |       | 13,935           |       |
| Amortization of intangible assets  |       | 233                       |       | 324                         |       | 9                                |       | —                     |       | 566              |       |
| Other operating (income) expense   |       | (2,268                    | )          | 1,674                       |       | 727                              |       | —                     |       | 133              |       |
| Total operating  expenses          |       | 1,627                     |       | 25,204                      |       | 10,207                           |       | —                     |       | 37,038           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| (Loss) income  from operations     |       | (1,627                    | )          | 10,510                      |       | 5,844                            |       | 58                         |       | 14,785           |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Other income,  net                 |       | (8                        | )          | (474                        | )          | 76                               |       | —                     |       | (406             | )          |
| Loss on  extinguishment of debt    |       | —                    |       | —                      |       | —                           |       | —                     |       | —           |       |
| Interest income                    |       | (7,332                    | )          | (12,262                     | )          | (161                             | )          | 18,062                     |       | (1,693           | )          |
| Interest expense                   |       | 7,714                     |       | 18,721                      |       | 155                              |       | (18,062                    | )          | 8,528            |       |
| Total  non-operating expenses      |       | 374                       |       | 5,985                       |       | 70                               |       | —                     |       | 6,429            |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| (Loss) income  before income taxes |       | (2,001                    | )          | 4,525                       |       | 5,774                            |       | 58                         |       | 8,356            |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Income tax  (benefit) provision    |       | 891                       |       | (66                         | )          | 2,464                            |       | 51                         |       | 3,340            |       |
|                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Net (loss) income                  |       | $                         | (2,892     | )                           | $          | 4,591                            |       | $                          | 3,310      |             | $          | 7 |   | $ | 5,016 |   |

 

25

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIESCONDENSED CONSOLIDATING BALANCE SHEETSJUNE 30, 2006Unaudited(In Thousands)**
| ** **                                       | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| ASSETS                                           |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Current assets:                                  |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Cash                                             |       | $                         | —     |                        | $          | 42,278                           |       | $                          | 14,894     |             | $          | (36,054 | ) | $ | 21,118 |   |
| Accounts, notes and other receivables, net       |       | —                    |       | 81,250                      |       | 9,057                            |       | —                     |       | 90,307           |       |
| Inventories                                      |       | —                    |       | 112,109                     |       | 43,928                           |       | (753                       | )          | 155,284          |       |
| Prepaid expenses and other current assets        |       | 3,535                     |       | 6,684                       |       | 1,450                            |       | —                     |       | 11,669           |       |
| Deferred tax assets                              |       | 9,444                     |       | 9,882                       |       | 6,447                            |       | (7,390                     | )          | 18,383           |       |
| Total current  assets                            |       | 12,979                    |       | 252,203                     |       | 75,776                           |       | (44,197                    | )          | 296,761          |       |
|                                             |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Property, plant  and equipment, net              |       | 216                       |       | 77,775                      |       | 18,457                           |       | —                     |       | 96,448           |       |
| Investment in  subsidiaries                      |       | 69,643                    |       | 115,054                     |       | (2,082                           | )          | (182,615                   | )          | —           |       |
| Trademarks                                       |       | —                    |       | 9,319                       |       | 4,221                            |       | —                     |       | 13,540           |       |
| Goodwill                                         |       | —                    |       | 17,973                      |       | 13,089                           |       | —                     |       | 31,062           |       |
| Other  intangibles, net                          |       | 3,964                     |       | 596                         |       | 63                               |       | —                     |       | 4,623            |       |
| Other assets                                     |       | 4,424                     |       | 8,379                       |       | 2,858                            |       | —                     |       | 15,661           |       |
| TOTAL ASSETS                                     |       | $                         | 91,226     |                        | $          | 481,299                          |       | $                          | 112,382    |             | $          | (226,812 | ) | $ | 458,095 |   |
|                                             |       |                      |       |                        |       |                             |       |                       |       |             |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY       |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Current  liabilities:                            |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Current portion of long-term debt                |       | $                         | —     |                        | $          | 1,063                            |       | $                          | 4,897      |             | $          | — |   | $ | 5,960 |   |
| Accounts payable                                 |       | 399                       |       | 11,018                      |       | 3,805                            |       | —                     |       | 15,222           |       |
| Other current liabilities                        |       | 5,969                     |       | 25,205                      |       | 16,244                           |       | (287                       | )          | 47,131           |       |
| Total current  liabilities                       |       | 6,368                     |       | 37,286                      |       | 24,946                           |       | (287                       | )          | 68,313           |       |
|                                             |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Long-term debt                                   |       | 173,733                   |       | 49,865                      |       | —                           |       | (36,054                    | )          | 187,544          |       |
| Intercompany                                     |       | (180,512                  | )          | 178,894                     |       | 1,520                            |       | 98                         |       | —           |       |
| Deferred tax  liabilities                        |       | 80                        |       | 17,698                      |       | 5,435                            |       | (7,390                     | )          | 15,823           |       |
| Other  non-current liabilities                   |       | 1,356                     |       | 4,269                       |       | 24,818                           |       | —                     |       | 30,443           |       |
| Total  liabilities                               |       | 1,025                     |       | 288,012                     |       | 56,719                           |       | (43,633                    | )          | 302,123          |       |
|                                             |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Stockholders’  equity                       |       | 90,201                    |       | 193,287                     |       | 55,663                           |       | (183,179                   | )          | 155,972          |       |
|                                             |       |                      |       |                        |       |                             |       |                       |       |             |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY |       | $                         | 91,226     |                        | $          | 481,299                          |       | $                          | 112,382    |             | $          | (226,812 | ) | $ | 458,095 |   |

 

26

----

**STEINWAY MUSICAL INSTRUMENTS,INC. AND SUBSIDIARIESCONDENSED CONSOLIDATING BALANCE SHEETSDECEMBER 31, 2005Unaudited(In Thousands)**

 
| ** **                                      | ** ** | **Issuer  Of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                                            |       |                      |       |                        |       |                             |       |                       |       |             |       |
| ASSETS                                          |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Current assets:                                 |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Cash                                            |       | $                         | —     |                        | $          | 48,790                           |       | $                          | 14,190     |             | $          | (28,028 | ) | $ | 34,952 |   |
| Accounts, notes and  other receivables, net     |       | —                    |       | 71,702                      |       | 10,178                           |       | —                     |       | 81,880           |       |
| Inventories                                     |       | —                    |       | 121,712                     |       | 39,279                           |       | (1,681                     | )          | 159,310          |       |
| Prepaid expenses and  other current assets      |       | 3,947                     |       | 6,875                       |       | 831                              |       | —                     |       | 11,653           |       |
| Deferred tax assets                             |       | —                    |       | 9,267                       |       | 6,059                            |       | (7,390                     | )          | 7,936            |       |
| Total current assets                            |       | 3,947                     |       | 258,346                     |       | 70,537                           |       | (37,099                    | )          | 295,731          |       |
|                                            |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Property, plant and equipment, net              |       | 184                       |       | 79,426                      |       | 17,054                           |       | —                     |       | 96,664           |       |
| Investment in subsidiaries                      |       | 69,643                    |       | 115,083                     |       | —                           |       | (184,726                   | )          | —           |       |
| Trademarks                                      |       | —                    |       | 9,319                       |       | 3,800                            |       | 114                        |       | 13,233           |       |
| Goodwill                                        |       | —                    |       | 17,973                      |       | 12,115                           |       | —                     |       | 30,088           |       |
| Other intangibles, net                          |       | 2,341                     |       | 1,718                       |       | 69                               |       | —                     |       | 4,128            |       |
| Other assets                                    |       | 4,151                     |       | 9,180                       |       | 2,480                            |       | —                     |       | 15,811           |       |
| TOTAL ASSETS                                    |       | $                         | 80,266     |                        | $          | 491,045                          |       | $                          | 106,055    |             | $          | (221,711 | ) | $ | 455,655 |   |
|                                            |       |                      |       |                        |       |                             |       |                       |       |             |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY       |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Current liabilities:                            |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Current portion of  long-term debt              |       | $                         | —     |                        | $          | 7,822                            |       | $                          | 5,155      |             | $          | — |   | $ | 12,977 |   |
| Accounts payable                                |       | 464                       |       | 9,598                       |       | 3,743                            |       | —                     |       | 13,805           |       |
| Other current  liabilities                      |       | 4,876                     |       | 24,608                      |       | 15,923                           |       | (308                       | )          | 45,099           |       |
| Total current liabilities                       |       | 5,340                     |       | 42,028                      |       | 24,821                           |       | (308                       | )          | 71,881           |       |
|                                            |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Long-term debt                                  |       | 167,526                   |       | 52,217                      |       | —                           |       | (28,028                    | )          | 191,715          |       |
| Intercompany                                    |       | (177,624                  | )          | 179,433                     |       | (1,674                           | )          | (135                       | )          | —           |       |
| Deferred tax liabilities                        |       | 85                        |       | 17,768                      |       | 4,863                            |       | (7,390                     | )          | 15,326           |       |
| Other non-current liabilities                   |       | 1,132                     |       | 4,161                       |       | 22,610                           |       | —                     |       | 27,903           |       |
| Total liabilities                               |       | (3,541                    | )          | 295,607                     |       | 50,620                           |       | (35,861                    | )          | 306,825          |       |
|                                            |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Stockholders’ equity                       |       | 83,807                    |       | 195,438                     |       | 55,435                           |       | (185,850                   | )          | 148,830          |       |
|                                            |       |                      |       |                        |       |                             |       |                       |       |             |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |       | $                         | 80,266     |                        | $          | 491,045                          |       | $                          | 106,055    |             | $          | (221,711 | ) | $ | 455,655 |   |

 

27

----

** **

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIESCONSOLIDATING STATEMENTS OF CASH FLOWSSIX MONTHS ENDED JUNE 30, 2006Unaudited(In Thousands)**
| ** **                                                                           | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| Cash flows from  operating activities:                                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Net (loss) income                                                                    |       | $                         | 660        |                        | $          | (6,637                           | )          | $                          | 3,242      |             | $          | 32 |   | $ | (2,703 | ) |
| Adjustments to  reconcile net (loss) income to cash flows from operating activities: |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Depreciation and  amortization                                                       |       | 319                       |       | 4,202                       |       | 918                              |       | —                     |       | 5,439            |       |
| Amortization of  bond discount                                                       |       | 57                        |       | —                      |       | —                           |       | —                     |       | 57               |       |
| Amortization of  bond premium                                                        |       | (42                       | )          | —                      |       | —                           |       | —                     |       | (42              | )          |
| Loss on  extinguishment of debt                                                      |       | 8,697                     |       | 977                         |       | —                           |       | —                     |       | 9,674            |       |
| Stock-based  compensation expense                                                    |       | 208                       |       | 323                         |       | 35                               |       | —                     |       | 566              |       |
| Excess tax  benefits from stock-based awards                                         |       | (417                      | )          | —                      |       | —                           |       | —                     |       | (417             | )          |
| Tax benefit from  stock option exercises                                             |       | 917                       |       | —                      |       | —                           |       | —                     |       | 917              |       |
| Deferred tax  benefit                                                                |       | (9,449                    | )          | (685                        | )          | (93                              | )          | —                     |       | (10,227          | )          |
| Provision for  doubtful accounts                                                     |       | —                    |       | 4,541                       |       | 21                               |       | —                     |       | 4,562            |       |
| Other                                                                                |       | —                    |       | (82                         | )          | (3                               | )          | —                     |       | (85              | )          |
| Changes in  operating assets and liabilities:                                        |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Accounts, notes  and other receivables                                               |       | —                    |       | (13,269                     | )          | 1,687                            |       | —                     |       | (11,582          | )          |
| Inventories                                                                          |       | —                    |       | 8,939                       |       | (2,641                           | )          | (278                       | )          | 6,020            |       |
| Prepaid expenses  and other assets                                                   |       | 132                       |       | 172                         |       | (727                             | )          | —                     |       | (423             | )          |
| Accounts payable                                                                     |       | (66                       | )          | 1,277                       |       | (197                             | )          | —                     |       | 1,014            |       |
| Other  liabilities                                                                   |       | 1,317                     |       | 705                         |       | (424                             | )          | 21                         |       | 1,619            |       |
| Cash flows from  operating activities                                                |       | 2,333                     |       | 463                         |       | 1,818                            |       | (225                       | )          | 4,389            |       |
|                                                                                 |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  investing activities:                                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Capital  expenditures                                                                |       | (76                       | )          | (2,138                      | )          | (351                             | )          | —                     |       | (2,565           | )          |
| Proceeds from  disposal of fixed assets                                              |       | —                    |       | 327                         |       | 4                                |       | —                     |       | 331              |       |
| Cash flows from  investing activities                                                |       | (76                       | )          | (1,811                      | )          | (347                             | )          | —                     |       | (2,234           | )          |
|                                                                                 |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  financing activities:                                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Borrowings under  lines of credit                                                    |       | —                    |       | 34,746                      |       | 10,681                           |       | (8,026                     | )          | 37,401           |       |
| Repayments under  lines of credit                                                    |       | —                    |       | (26,720                     | )          | (11,059                          | )          | —                     |       | (37,779          | )          |
| Debt issuance  costs                                                                 |       | (4,145                    | )          | —                      |       | —                           |       | —                     |       | (4,145           | )          |
| Proceeds from  issuance of debt                                                      |       | 173,676                   |       | —                      |       | —                           |       | —                     |       | 173,676          |       |
| Repayments of  long-term debt                                                        |       | (166,194                  | )          | (17,137                     | )          | —                           |       | —                     |       | (183,331         | )          |
| Premium paid on  extinguishment of debt                                              |       | (7,740                    | )          | —                      |       | —                           |       | —                     |       | (7,740           | )          |
| Proceeds from  issuance of common stock                                              |       | 4,259                     |       | —                      |       | —                           |       | —                     |       | 4,259            |       |
| Excess tax  benefits from stock-based awards                                         |       | 417                       |       | —                      |       | —                           |       | —                     |       | 417              |       |
| Intercompany  transactions                                                           |       | (2,530                    | )          | 3,947                       |       | (1,642                           | )          | 225                        |       | —           |       |
| Cash flows from financing  activities                                                |       | (2,257                    | )          | (5,164                      | )          | (2,020                           | )          | (7,801                     | )          | (17,242          | )          |
|                                                                                 |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Effect of exchange rate  changes on cash                                             |       | —                    |       | —                      |       | 1,253                            |       | —                     |       | 1,253            |       |
|                                                                                 |       |                      |       |                        |       |                             |       |                       |       |             |       |
| (Decrease) increase in  cash                                                         |       | —                    |       | (6,512                      | )          | 704                              |       | (8,026                     | )          | (13,834          | )          |
| Cash, beginning of year                                                              |       | —                    |       | 48,790                      |       | 14,190                           |       | (28,028                    | )          | 34,952           |       |
|                                                                                 |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Cash, end of period                                                                  |       | $                         | —     |                        | $          | 42,278                           |       | $                          | 14,894     |             | $          | (36,054 | ) | $ | 21,118 |   |

 

28

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIESCONSOLIDATING STATEMENTS OF CASH FLOWSSIX MONTHS ENDED JUNE 30, 2005Unaudited(In Thousands)**
| ** **                                                                           | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| Cash flows from  operating activities:                                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Net (loss)  income                                                                   |       | $                         | (2,892     | )                           | $          | 4,591                            |       | $                          | 3,310      |             | $          | 7 |   | $ | 5,016 |   |
| Adjustments to  reconcile net (loss) income to cash flows from operating activities: |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Depreciation and amortization                                                        |       | 275                       |       | 4,488                       |       | 976                              |       | —                     |       | 5,739            |       |
| Amortization of bond premium                                                         |       | (126                      | )          | —                      |       | —                           |       | —                     |       | (126             | )          |
| Tax benefit from stock option exercises                                              |       | 99                        |       | —                      |       | —                           |       | —                     |       | 99               |       |
| Deferred tax benefit                                                                 |       | (13                       | )          | (122                        | )          | (144                             | )          | —                     |       | (279             | )          |
| Provision for doubful accounts                                                       |       | —                    |       | 258                         |       | (36                              | )          | —                     |       | 222              |       |
| Other                                                                                |       | —                    |       | (160                        | )          | 42                               |       | —                     |       | (118             | )          |
| Changes in operating assets and liabilities:                                         |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Accounts, notes and other receivables                                                |       | —                    |       | (6,149                      | )          | 2,706                            |       | —                     |       | (3,443           | )          |
| Inventories                                                                          |       | —                    |       | (9,471                      | )          | (3,616                           | )          | (58                        | )          | (13,145          | )          |
| Prepaid expenses and other assets                                                    |       | 360                       |       | 3,365                       |       | (904                             | )          | —                     |       | 2,821            |       |
| Accounts payable                                                                     |       | (444                      | )          | (910                        | )          | 257                              |       | —                     |       | (1,097           | )          |
| Other liabilities                                                                    |       | (2,688                    | )          | (2,578                      | )          | (571                             | )          | 51                         |       | (5,786           | )          |
| Cash flows from  operating activities                                                |       | (5,429                    | )          | (6,688                      | )          | 2,020                            |       | —                     |       | (10,097          | )          |
|                                                                                 |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  investing activities:                                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Capital expenditures                                                                 |       | (75                       | )          | (1,720                      | )          | (554                             | )          | —                     |       | (2,349           | )          |
| Proceeds from disposal of fixed assets                                               |       | —                    |       | 954                         |       | 399                              |       | —                     |       | 1,353            |       |
| Cash flows from  investing activities                                                |       | (75                       | )          | (766                        | )          | (155                             | )          | —                     |       | (996             | )          |
|                                                                                 |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  financing activities:                                               |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Borrowings under lines of credit                                                     |       | —                    |       | 69,664                      |       | 2,153                            |       | (1,109                     | )          | 70,708           |       |
| Repayments under lines of credit                                                     |       | —                    |       | (61,317                     | )          | (2,883                           | )          | —                     |       | (64,200          | )          |
| Repayments of term-loan debt                                                         |       | —                    |       | (4,090                      | )          | —                           |       | —                     |       | (4,090           | )          |
| Proceeds from issuance of stock                                                      |       | 656                       |       | —                      |       | —                           |       | —                     |       | 656              |       |
| Intercompany transactions                                                            |       | 4,848                     |       | (4,505                      | )          | (343                             | )          | —                     |       | —           |       |
| Cash flows from  financing activities                                                |       | 5,504                     |       | (248                        | )          | (1,073                           | )          | (1,109                     | )          | 3,074            |       |
|                                                                                 |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Effect of  exchange rate changes on cash                                             |       | —                    |       | —                      |       | (1,611                           | )          | —                     |       | (1,611           | )          |
|                                                                                 |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Decrease in cash                                                                     |       | —                    |       | (7,702                      | )          | (819                             | )          | (1,109                     | )          | (9,630           | )          |
| Cash, beginning  of year                                                             |       | —                    |       | 44,990                      |       | 14,238                           |       | (31,856                    | )          | 27,372           |       |
|                                                                                 |       |                      |       |                        |       |                             |       |                       |       |             |       |
| Cash, end of  period                                                                 |       | $                         | —     |                        | $          | 37,288                           |       | $                          | 13,419     |             | $          | (32,965 | ) | $ | 17,742 |   |

 

29

----

 
| **ITEM 2** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|------------|-------------------------------------------------------------------------------------------------|
| ** ** | **(Tabular Amounts in Thousands Except Share and  Per Share Data)**                             |

 

**Introduction**

**We are a world leader in thedesign, manufacture, marketing, and distribution 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 upright pianos and two mid-priced lines of pianos underthe Boston and Essex brand names.  We arealso the largest domestic producer of band and orchestral instruments and offera complete line of brass, woodwind, percussion and string instruments andrelated accessories with well-known brand names such as Bach, Selmer, C.G.Conn, Leblanc, King, and Ludwig.  We sellour products through dealers and distributors worldwide. Our piano customerbase consists of professional artists, amateur pianists, and institutions suchas concert halls, universities, and music schools.  Our band and orchestral instrument customerbase consists primarily of middle school and high school students, but alsoincludes adult amateur and professional musicians.**

**CriticalAccounting Policies**

The Securities and Exchange Commission (“SEC”) hasissued disclosure guidance for “critical accounting policies.” The SEC defines “criticalaccounting policies” as those that require application of management’s mostdifficult, subjective or complex judgments, often as a result of the need tomake estimates about the effect of matters that are inherently uncertain andmay change in subsequent periods.

Management is required to make certain estimates andassumptions during the preparation of the consolidated financial statements.These estimates and assumptions impact the reported amount of assets andliabilities and disclosures of contingent assets and liabilities as of the dateof the consolidated financial statements. Estimates and assumptions arereviewed periodically and the effects of revisions are reflected in theconsolidated financial statements in the period they are determined to benecessary. Actual results could differ from those estimates.

The significant accounting policies are described inNote 2 of the Notes to Consolidated Financial Statements included in theCompany’s 2005 Annual Report on Form 10-K. Not all of these significantaccounting policies require management to make difficult, subjective or complexjudgments or estimates. However, management considers the following to becritical accounting policies based on the definition above.

**Accounts Receivable**

We establish reserves for accounts receivable andnotes receivable (including recourse reserves when our customers have financednotes receivable with a third party).  Wereview overall collectibility trends and customer characteristics such as debtleverage, solvency, and outstanding balances in order to develop our reserveestimates.  Historically, a large portionof our sales have been generated by our top 15 customers.  As a result, we experience some inherentconcentration of credit risk in our accounts receivable due to its compositionand the relative proportion of large customer receivables to the total. This isespecially true at our band division, which characteristically has the majorityof our consolidated accounts receivable balance.  We consider the credit health and solvency ofour customers when developing our receivable reserve estimates.

30

----

 

**Inventory**

We establish inventory reserves for items such aslower-of-cost-or-market and obsolescence. We review inventory levels on a detailed basis, concentrating on the ageand amounts of raw materials, work-in-process, and finished goods, as well asrecent usage and sales dates and quantities to help develop our estimates.Ongoing changes in our business strategy, including a shift from batchprocessing to single piece production flow, coupled with increased offshoresourcing, could affect our ability to realize the current cost of ourinventory, and are considered by management when developing our estimates. Wealso establish reserves for anticipated book-to-physical adjustments based uponour historical level of adjustments from our annual physical inventories.  We cost our inventory using standardcosts.  Accordingly, variances betweenactual and standard costs that are not abnormal in nature are capitalized intoinventory and released based on calculated inventory turns.

**Workers’ Compensation and Self-Insured HealthClaims**

We establish workers’ compensation and self-insuredhealth claims reserves based on our trend analysis of data provided by thirdparty administrators regarding historical claims and anticipated future claims.

**Warranty**

We establish reserves for warranty claims based on ouranalysis of historical claims data, recent claims trends, and the variouslengths of time for which we warranty our products.

**Long-lived Assets**

Wereview long-lived assets, such as property, plant, and equipment, forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. We measure recoverabilityby comparing the carrying amount of the asset to the estimated future cashflows the asset is expected to generate.

Wetest our goodwill and indefinite-lived trademark assets for impairment annuallyor on an interim basis if events or circumstances indicate that the fair valueof an asset may have decreased below its carrying value.  Our assessment is based on several analyses,including multi-year cash flows and comparison of estimated fair values to ourmarket capitalization.

**Pensions and Other Post RetirementBenefit Costs**

We make certain assumptions when calculating ourbenefit obligations and expenses.  Webase our selection of assumptions, such as discount rates and long-term ratesof return, on information provided by our actuaries, investment advisors,investment committee, current rate trends, and historical trends for ourpension asset portfolio.  Our benefitobligations and expenses can fluctuate significantly based on the assumptionsmanagement selects.

**Income Taxes**

Our effective tax rate at an interim period is basedupon an estimate of expected foreign source income to U.S. income and ourcorresponding ability to utilize foreign tax credits effectively.  We consider shifts in sources of income whendeveloping our estimated effective tax rate.

31

----

 

A valuation allowance has been recorded for certaindeferred tax assets related to foreign tax credit carryforwards and state netoperating loss carryforwards.  Whenassessing the realizability of deferred tax assets, we consider whether it ismore likely than not that the deferred tax assets will be fully realized. Theultimate realization of these assets is dependent upon many factors, includingthe ratio of foreign source income to overall income and generation ofsufficient future taxable income in the states for which we have losscarryforwards.  When establishing oradjusting valuation allowances, we consider these factors, as well asanticipated trends in foreign source income and tax planning strategies whichmay impact future realizability of these assets.

**Stock-based Compensation**

We grant stock-basedcompensation awards which generally vest over a specified period.  When determining the fair value of stockoptions and subscriptions to purchase shares under the Purchase Plan, we usethe Black-Scholes option valuation model, which requires input of certainmanagement assumptions, including dividend yield, expected volatility,risk-free interest rate, expected life of stock options granted during theperiod, and the life applicable to the Purchase Plan subscriptions.  The estimated fair value of the options andsubscriptions to purchase shares, and the resultant stock-based compensationexpense can fluctuate based on the assumptions used by management.

**Environmental Liabilities**

We make certain assumptions when calculating ourenvironmental liabilities.  We base ourselection of assumptions, such as cost and length of time for remediation, ondata provided by our environmental consultants, as well as information providedby regulatory authorities. We also make certain assumptions regarding theindemnifications we have received from others, including whether remediationcosts are within the scope of the indemnification, the indemnifier’s ability toperform under the agreement, and whether past claims have been successful.  Our environmental obligations and expensescan fluctuate significantly based on management’s assumptions.

We believe the assumptions made by management providea reasonable basis for the estimates reflected in our financial statements.

**Forward-LookingStatements**

Certain statements contained in this document are “forward-lookingstatements” within the meaning of Section 21E of the Securities and ExchangeAct of 1934, as amended.  Theseforward-looking statements represent our present expectations or beliefsconcerning future events.  We cautionthat such statements are necessarily based on certain assumptions which aresubject to risks and uncertainties which could cause actual results to differmaterially from those indicated in this report. These risk factors include, but are not limited to, the following:  changes in general economic conditions;geopolitical events; increased competition; work stoppages and slowdowns;exchange rate fluctuations; variations in the mix of products sold; marketacceptance of new product and distribution strategies; ability of suppliers tomeet demand; fluctuations in effective tax rates resulting from shifts insources of income; and the ability to successfully integrate and operateacquired businesses.  Further informationon these risk factors is included in Item 1A of our Annual Report on Form 10-Kfor the year ended December 31, 2005.  Weencourage you to read those descriptions carefully.  We caution investors not to place unduereliance on the forward-looking statements contained in this report.  These statements, like all statements containedin this report, speak only as of the date of this report (unless another dateis indicated) and we undertake no obligation to update or revise the statementsexcept as required by law.

32

----

 

**Results of Operations**

Three Months EndedJune 30, 2006 Compared to Three Months Ended June 30, 2005
| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** | ** ** | ** ** | **Change** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                         | ** ** | **2006**                                            | ** ** | ** ** | ** ** | **2005**   | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Net sales                          |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Band                               |       | $                                                   | 40,759     |       |       |       | $          | 43,368 |   |   |   | (2,609 | ) | (6.0 | ) |
| Piano                              |       | 51,664                                              |       |       |       | 46,393     |       |   |   | 5,271 |   | 11.4 |   |
| Total sales                        |       | 92,423                                              |       |       |       | 89,761     |       |   |   | 2,662 |   | 3.0 |   |
|                               |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Cost of sales                      |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Band                               |       | 35,324                                              |       |       |       | 33,709     |       |   |   | 1,615 |   | 4.8 |   |
| Piano                              |       | 33,950                                              |       |       |       | 29,926     |       |   |   | 4,024 |   | 13.4 |   |
| Total cost of  sales               |       | 69,274                                              |       |       |       | 63,635     |       |   |   | 5,639 |   | 8.9 |   |
|                               |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Gross profit                       |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Band                               |       | 5,435                                               |       | 13.3%      |       | 9,659      |       | 22.3% |   | (4,224 | ) | (43.7 | ) |
| Piano                              |       | 17,714                                              |       | 34.3%      |       | 16,467     |       | 35.5% |   | 1,247 |   | 7.6 |   |
| Total gross  profit                |       | 23,149                                              |       |       |       | 26,126     |       |   |   | (2,977 | ) | (11.4 | ) |
|                               |       | 25.0%                                               |       |       |       | 29.1%      |       |   |   |   |   |   |   |
|                               |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Operating  expenses                |       | 23,544                                              |       |       |       | 18,399     |       |   |   | 5,145 |   | 28.0 |   |
|                               |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| (Loss) income  from operations     |       | (395                                                | )          |       |       | 7,727      |       |   |   | (8,122 | ) | (105.1 | ) |
|                               |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Other (income)  expense, net       |       | (695                                                | )          |       |       | 33         |       |   |   | (728 | ) | (2,206.1 | ) |
| Loss on  extinguishment of debt    |       | 3,063                                               |       |       |       | —     |       |   |   | 3,063 |   | 100.0 |   |
| Net interest  expense              |       | 3,152                                               |       |       |       | 3,666      |       |   |   | (514 | ) | (14.0 | ) |
| Non-operating  expenses            |       | 5,520                                               |       |       |       | 3,699      |       |   |   | 1,821 |   | 49.2 |   |
|                               |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| (Loss) income  before income taxes |       | (5,915                                              | )          |       |       | 4,028      |       |   |   | (9,943 | ) | (246.8 | ) |
|                               |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Income tax  (benefit) provision    |       | (5,054                                              | )          | 85.4%      |       | 1,610      |       | 40.0% |   | (6,664 | ) | (413.9 | ) |
|                               |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Net (loss) income                  |       | $                                                   | (861       | )          |       |       | $          | 2,418 |   |   |   | (3,279 | ) | (135.6 | ) |

 

33

----

 

**Overview***-*Salesat our piano division improved significantly during the quarter. We re-launchedour Essex piano line in June 2006 and received a positive response from ourdealers.  Our domestic piano operationsexperienced increases in both wholesale and retail sales volume, and ouroverseas operations remained stable with sales and margins on par with theyear-ago period.  Band division revenuesand gross profit were negatively impacted by the strike at our Elkhart, Indianabrass instrument manufacturing facility. While professional brass instrument sales were adversely affected by thestrike, improved sales of student level instruments and percussion producthelped to offset its impact.  We areactively working towards resolving the strike.

**Net Sales** -**The increasein net sales of $2.7 million resulted from improved performance in the pianosegment.  Piano sales increased $5.3million or 11% due primarily to a 15% increase in total domestic unitsshipped.  A special promotional programwas offered to domestic dealers in conjunction with the Essex re-launch thathelped drive a $3.1 million increase in Steinway grand pianos sold atwholesale.  Overseas piano salesincreased $1.2 million primarily due to continued wholesale demand in theEuropean market.  Band division salesdecreased $2.6 million due primarily to an estimated $4.9 million in lowershipments caused by the strike at our Elkhart brass instrument facility.  The strike impact was partially offset by a$1.5 million increase in sales of percussion instruments and a $1.2 millionincrease in sales of student instruments generated through promotional programstargeted towards available inventory.

**Gross Profit***-*Gross profit decreased $3.0 million driven by a decrease in our band divisiongross profit of $4.2 million.  Anestimated $3.0 million was due to the strike at the Elkhart brass instrumentfacility consisting of an estimated $1.8 million in lost profit and $1.2million in unabsorbed overhead.  We alsoadjusted our inventory reserves upward by $2.3 million to properly reflect thenet realizable value of our inventory. The increase in reserves resulted from the streamlining of our productoffering and our on going migration from batch processing to one-pieceproduction flow.  These two initiativeshave helped reduced our raw material and work in process inventory over thepast year and increased our exposure to excess and obsolete inventory.  The decrease in band division gross profitwas somewhat offset by $0.5 million in lower charges associated with theLeblanc inventory step-up and reduced medical costs.  The piano segment gross profit increased $1.2million primarily due to increased sales volume.  This increase was offset by unabsorbedoverhead of $0.4 million from a one week shutdown at our domestic manufacturingfacility and increased cash discounts due to the special promotional programoffered to domestic dealers associated with the Essex re-launch.

**Operating Expenses** - Operatingexpenses increased $5.1 million due largely to an increase of $4.4 million inour provision for doubtful accounts. This increase in reserve primarily resulted from the bankruptcy of oneof our major band division customers in July 2006.  The re-launch of our Essex line increasedoperating expenses $0.4 million and the remaining increase of $0.3 million isattributable to stock based compensation.

**Non-operating Expenses** -Non-operating expenses increased $1.8 million due to the loss on extinguishmentof debt of $3.1 million resulting from the call of our remaining $51.6 millionof 8.75% Senior Notes.  This loss wascomprised of $2.3 in call premiums and $0.8 million write-off of bond relateddeferred financing fees and was partially offset by an increase in otherincome.

Otherincome, net increased $0.7 million due to foreign exchange gains.  Net interest expense decreased $0.5 milliondue to a reduced interest rate on outstanding Senior Notes from 8.75% to 7.00%.

34

----

 

**Income Taxes** -**Our effective rate has increased from the year ago perioddue to the significant shift in the ratio of foreign source income to worldwideincome. This shift is due largely to the adverse impact of the loss onextinguishment of our 8.75% Senior Notes, the additional reserve charges takenin the second quarter, and the estimated loss in income due to the strike atour Elkhart brass facility. We anticipate that virtually all of ourconsolidated income for the year will be derived from subsidiaries which aretaxed both domestically and in their local country. Accordingly, we expect togenerate significantly more foreign taxes than we will be able to utilize ascredits against U.S. tax liabilities and our higher effective rate reflectsthis double taxation. Although we continue to investigate acceptable taxplanning strategies in an effort to reduce our rate, we currently expect oureffective tax rate for 2006 to be 70%.

**Results of Operations**

Six Months EndedJune 30, 2006 Compared to Six Months Ended June 30, 2005
| ** **                         | ** ** | **Period Ended June 30,** | ** ** | ** ** | ** ** | **Change** | ** ** |
|------------------------------------|------------|------------------------------------------|------------|------------|------------|------------|------------|
| ** **                         | ** ** | **2006**                                 | ** ** | ** ** | ** ** | **2005**   | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Net sales                          |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Band                               |       | $                                        | 93,825     |       |       |       | $          | 90,935 |   |   |   | 2,890 |   | 3.2 |   |
| Piano                              |       | 93,792                                   |       |       |       | 90,168     |       |   |   | 3,624 |   | 4.0 |   |
| Total sales                        |       | 187,617                                  |       |       |       | 181,103    |       |   |   | 6,514 |   | 3.6 |   |
|                               |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Cost of sales                      |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Band                               |       | 76,329                                   |       |       |       | 71,523     |       |   |   | 4,806 |   | 6.7 |   |
| Piano                              |       | 62,147                                   |       |       |       | 57,757     |       |   |   | 4,390 |   | 7.6 |   |
| Total cost of  sales               |       | 138,476                                  |       |       |       | 129,280    |       |   |   | 9,196 |   | 7.1 |   |
|                               |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Gross profit                       |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Band                               |       | 17,496                                   |       | 18.6%      |       | 19,412     |       | 21.3% |   | (1,916 | ) | (9.9 | ) |
| Piano                              |       | 31,645                                   |       | 33.7%      |       | 32,411     |       | 35.9% |   | (766 | ) | (2.4 | ) |
| Total gross  profit                |       | 49,141                                   |       |       |       | 51,823     |       |   |   | (2,682 | ) | (5.2 | ) |
|                               |       | 26.2%                                    |       |       |       | 28.6%      |       |   |   |   |   |   |   |
|                               |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Operating  expenses                |       | 44,025                                   |       |       |       | 37,038     |       |   |   | 6,987 |   | 18.9 |   |
|                               |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Income from  operations            |       | 5,116                                    |       |       |       | 14,785     |       |   |   | (9,669 | ) | (65.4 | ) |
|                               |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Other income,  net                 |       | (1,446                                   | )          |       |       | (406       | )          |   |   | (1,040 | ) | 256.2 |   |
| Loss on  extinguishment of debt    |       | 9,674                                    |       |       |       | —     |       |   |   | 9,674 |   | 100.0 |   |
| Net interest  expense              |       | 5,900                                    |       |       |       | 6,835      |       |   |   | (935 | ) | (13.7 | ) |
| Non-operating  expenses            |       | 14,128                                   |       |       |       | 6,429      |       |   |   | 7,699 |   | 119.8 |   |
|                               |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| (Loss) income  before income taxes |       | (9,012                                   | )          |       |       | 8,356      |       |   |   | (17,368 | ) | (207.9 | ) |
|                               |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Income tax  (benefit) provision    |       | (6,309                                   | )          | 70.0%      |       | 3,340      |       | 40.0% |   | (9,649 | ) | (288.9 | ) |
|                               |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Net (loss) income                  |       | $                                        | (2,703     | )          |       |       | $          | 5,016 |   |   |   | (7,719 | ) | (153.9 | ) |

 

35

----

 

**Overview***-*Salesat our piano and band divisions increased during the period.  The piano division’s improved domesticSteinway sales at both retail and wholesale offset a decrease in domesticBoston product sales. Piano division margin deteriorated due to plant shutdownat our domestic manufacturing facility. Band division unit volume and sales increased despite the impact of thestrike at our Elkhart brass instrument facility.  Band margin improvements made during thefirst quarter were more than offset during the second quarter by unabsorbedoverhead from the strike, higher inventory reserves and additional salesdiscounts.

**Net Sales***-*Theincrease in net sales of $6.5 million was driven by increases in both our bandand piano divisions.  The increase inband division sales of $2.9 million was driven by an increase in studentwoodwind product and percussion instruments. Availability of student woodwind product and the introduction of newpercussion product into existing channels and entry into new channels helped tosupport this growth.  First quarterpromotions geared towards professional and step-up brass instruments offset anestimated $4.9 million impact of the strike at our Elkhart brass instrumentsfacility during the second quarter.  Ourpiano division sales increase of $3.6 million was driven by a $2.5 millionincrease in domestic Steinway grand sales at wholesale, boosted by a salesincentive offered to dealers as part of the June Essex re-launch.  Domestic Steinway grand piano sales at retailincreased $1.5 million based on a 15% increase in unit shipments, which helpedto offset a decrease of $0.9 million in domestic Boston product sales todealers.  Total overseas piano salesincreased $0.8 million as an overall 11% increase in unit shipments waspartially offset by an unfavorable foreign currency translation of $1.8million.

**Gross Profit***-*Gross profit decreased by $2.7 million from deterioration in both the band andpiano division margins.  Our banddivision gross margin declined from 21.3% to 18.6% as a result of a $2.3million charge to inventory reserves during the second quarter and a $1.3million increase in cash discounts.  Themajority of sales growth experienced during the period resulted from customers utilizingcash discounts.  Gross margin was alsonegatively impacted by the strike at the Elkhart brass instrument facilityduring the second quarter.  Thedeterioration was minimized by $1.1 million in lower charges associated withLeblanc inventory step-up.  The bandgross profit also benefited from increased sales, a reduction in propertytaxes, and reduced medical costs. Our piano division gross profit decreased $0.8million, despite increased sales, as a result of three weeks of production shutdownat our domestic piano manufacturing facility resulting in $1.3 million ofunabsorbed overhead.

**Operating Expenses** - Operatingexpenses increased $7.0 million due largely to an increase of $4.3 million inour provision for doubtful accounts. Stock based compensation cost for the period was $0.6 million, legalfees at our band division increased $0.6 million, and bonus expense increased$0.5 million.  Operating expenseassociated with the re-launch of our Essex line, recruiting, and commissionsaccounted for the remaining increase. 

**Non-operating Expenses** -Non-operating expenses increased $7.7 million due largely to the loss onextinguishment of debt of $9.7 million resulting from the refinancing of our8.75% Senior Notes and the early repayment of our acquisition term loan.  This net loss was comprised of $7.7 millionin premiums paid to bondholders, the write-off of term loan related deferredfinancing fees of $1.0, and the write-off of bond related deferred financingfees of $2.2 million, which were offset in part by the write-off of bondpremium of $1.3 million.

Otherincome, net increased $1.0 million due to foreign exchange gains.  Net interest expense decreased $0.9 milliondue to the reduction in interest rates on our outstanding Senior Notes from 8.75%to 7.00% for a portion of the period. The remaining decrease was due to interest earned for two months on$51.6 million in residual proceeds from the issuance of our 7.00% Senior Notes.

36

----

 

**Income Taxes** -**Our effective rate has increased from the year ago perioddue to the significant shift in the ratio of foreign source income to worldwideincome. This shift is due largely to the adverse impact of the loss onextinguishment of our 8.75% Senior Notes, the additional reserve charges takenin the second quarter, and the estimated loss in income due to the strike atour Elkhart brass facility. We anticipate that virtually all of ourconsolidated income for the year will be derived from subsidiaries which aretaxed both domestically and in their local country. Accordingly, we expect togenerate significantly more foreign taxes than we will be able to utilize ascredits against U.S. tax liabilities and our higher effective rate reflectsthis double taxation. Although we continue to investigate acceptable taxplanning strategies in an effort to reduce our rate, we currently expect oureffective tax rate for 2006 to be 70%.

**Liquidity andCapital Resources**

**We have relied primarily upon cashprovided by operations, supplemented as necessary by seasonal borrowings underour working capital line, to finance our operations, repay long-termindebtedness and fund capital expenditures.**

Our statements ofcash flows for the six months ended June 30, 2006 and 2005 are summarized asfollows:
| ** **                                                                          | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
| Net (loss) income:                                                                  |       | $        | (2,703     | )        | $          | 5,016      |       | $ | (7,719 | ) |
| Changes in  operating assets and liabilities                                        |       | (3,352   | )          | (20,650  | )          | 17,298     |       |
| Other  adjustments to reconcile net (loss) income to cash from operating activities |       | 10,444   |       | 5,537    |       | 4,907      |       |
| Cash flows from  operating activities                                               |       | 4,389    |       | (10,097  | )          | 14,486     |       |
|                                                                                |       |     |       |     |       |       |       |
| Cash flows from  investing activities                                               |       | (2,234   | )          | (996     | )          | (1,238     | )          |
|                                                                                |       |     |       |     |       |       |       |
| Cash flows from  financing activities                                               |       | (17,242  | )          | 3,074    |       | (20,316    | )          |
|                                                                                     |            |          |            |          |            |            |            |  |  |  |

 

Cash flows generated from operating activitiesincreased $14.5 million due to changes in working capital accounts.  Cash provided by inventory increased $19.2million due to increased domestic sales, combined with reduced production atboth our Elkhart brass instrument facility and our domestic piano manufacturingfacility.  Cash used for accountsreceivable increased $8.1 million primarily as a result of increasedsales.  An increase in our band divisionaged receivable balance and improved June sales by our domestic piano divisionwere also factors behind the change.

The use of cash for investing activities increased$1.2 million despite consistent capital expenditures each period, as webenefited from an additional $1.0 million of proceeds from disposals ofproperty in the prior period.

Cash used by financing activities increased $20.3million due to our bond refinancing, which generated proceeds of $173.7million, offset by the extinguishment of $166.2 million of our 8.75% SeniorNote debt and the repayment of our acquisition term loan of $16.6 million.  Premiums paid on the extinguishment of debtof $7.7 million and costs related to the transaction of $4.1 million alsooffset our bond refinancing proceeds. Additional proceeds from the issuance of stock contributed $3.6 millionin

37

----

 

the current period;however $7.2 million of net borrowings on our domestic revolver and $4.1million in debt repayments in the prior period offset any cash proceedsreceived from the stock issuance.

**BorrowingActivities and Availability -**Duringthe period we restructured our long-term debt and issued $175.0 million of7.00% Senior Notes due 2014.  We used theproceeds from this issuance to repay $114.6 million of the 8.75% Senior Notespursuant to our tender offer.  Theremaining proceeds, supplemented by borrowings on our line of credit, were usedto exercise our right to call the remaining $51.6 million of 8.75% SeniorNotes.  This resulted in a loss onextinguishment of $8.7 million, comprised of $7.7 million in premiums paid toexisting holders of 8.75% Senior Notes, $1.3 million of bond premium write-off,and $2.3 million in the write-off of associated deferred financing costs. Werecorded interest on both the 8.75% Senior Notes and the 7.00% Senior Notes forthe February - April timeframe during which both series of notes wereoutstanding. This double interest expense was partially offset by interestincome on the unused debt issuance proceeds during the first quarter, and isnot material to our liquidity.  We expectinterest payment savings of approximately $2.3 million per year based on thedifference in interest rates on the Senior Notes.

Our real estate term loan and domestic seasonalborrowing requirements are accommodated through a committed credit facilitywith a syndicate of domestic lenders (the “Credit Facility”).  The Credit Facility provides us with apotential borrowing capacity of $85.0 million in revolving credit loans, andexpires on September 14, 2008. Borrowings are collateralized by our domesticaccounts receivable, inventory, and fixed assets.  As of June 30, 2006, there were no revolvingcredit loans outstanding and availability based on eligible accounts receivableand inventory balances was approximately $83.6 million, net of letters ofcredit. The real estate term loan is payable in monthly installments of $0.2million and includes interest at average 30-day London Interbank Offered Rate (“LIBOR”)(5.23% at June 30, 2006) plus 1.5%.  Thisterm loan is secured by all of our interests in the Steinway Hallproperty.  The acquisition term loan wasrepaid during the first quarter of 2006. All of our borrowings under the Credit Facility are secured by a firstlien on our domestic inventory, receivables, and fixed assets.

We also have certain non-domestic credit facilitiesoriginating from two German banks that provide for borrowings by foreignsubsidiaries of up to €17.7 million ($22.7 million at the June 30, 2006 exchange rate), netof borrowing restrictions of €0.7 million ($0.9 million at the June 30, 2006 exchange rate) and arepayable on demand.  These borrowings are collateralized by most of theassets of the borrowing subsidiaries.  A portion of the loans can beconverted into a maximum of £0.5 million ($0.9 million at the June 30, 2006 exchange rate) for useby our U.K. branch and ¥300 million ($2.6 million at the June 30, 2006 exchange rate) for use by our Japanesesubsidiary. Our Chinese subsidiary also has the ability to convert theequivalent of up to €1.8 million into U.S. dollars or Chinese yuan ($2.3million at the June 30, 2006exchange rate). Euro loans bear interest at rates of Euro Interbank OfferedRate (“EURIBOR”) plus a margin determined at the time of borrowing. Marginsfluctuate based on the loan amount and the borrower’s bank rating. Theremaining demand borrowings bear interest at fixed margins at rates of LIBORplus 1% for British pound loans (6.5% at June30, 2006), LIBOR plus 1% for U.S. dollar loans of our Chinese subsidiary(6.1% to 6.3% at June 30, 2006),and Tokyo Interbank Offered Rate (“TIBOR”) plus 0.8% for Japanese yen loans(1.0% at June 30, 2006). We had$1.8 million outstanding as of June 30,2006 on these credit facilities.

Our Japanese subsidiary also maintains a separate revolvingloan agreement that provides additional borrowing capacity of up to ¥460million ($4.0 million at theJune 30, 2006 exchange rate) based on eligible inventory balances. Therevolving loan agreement bears interest at an average 30-day TIBOR rate plus0.8% (1.0% at June 30, 2006) andexpires on January 31, 2010.  As of June 30, 2006, we had $3.1 million outstanding on this revolvingloan agreement.

38

----

 

At June30, 2006, our total outstanding indebtedness amounted to $194.8 million,consisting of $175.0 million of 7.00% Senior Notes, $14.9 million on the realestate term loan, and $4.9 million of notes payable to foreign banks.

All of our debt agreements contain covenants thatplace certain restrictions on us, including our ability to incur additional indebtedness,to make investments in other entities and to pay cash dividends. We were incompliance with all such covenants as of June 30, 2006 and do not anticipate any compliance issues in2006.

Our bond indenture contains limitations, based on netincome (among other things), on the amount of discretionary repurchases we maymake of our Ordinary common stock.  Ourintent and ability to repurchase additional Ordinary common stock eitherdirectly from shareholders or on the open market is directly affected by thislimitation.

We have reserved 721,750 shares of our existingtreasury stock to be utilized for the exercise of outstanding stock optionsunder our Amended and Restated 1996 Stock Plan. As of June 30, 2006, we estimate 530,350 shares of reserved treasurystock will be utilized.  These optionshave no impact on our cash flow or the number of shares outstanding unless anduntil the options are exercised.

We experience long production and inventory turnovercycles, which we constantly monitor since fluctuations in demand can have asignificant impact on these cycles.  Wewere able to effectively utilize cash flow from operations to fund our capitalrequirements and pay off our seasonal borrowings on our domestic line ofcredit.

Three weeks of additional shutdown at our domesticpiano manufacturing facility and the strike at the Elkhart brass instrumentfacility has had an adverse impact on operations, however, we do not anticipateany material changes to liquidity as a result of these events.

Other than the restructuring of our long-term debt asdescribed above, we do not have any current plans or intentions that will havea material impact on our liquidity in 2006, although we may consideracquisitions that may require funding from operations or from our creditfacilities.  Other than those described,we are not aware of any trends, demands, commitments, or costs of resourcesthat are expected to materially impact our liquidity or capital resources.  Accordingly, we believe that cash on hand,together with cash flows anticipated from operations and available borrowingsunder the Credit Facility, will be adequate to meet our debt servicerequirements, fund continuing capital requirements and satisfy our workingcapital and general corporate needs through 2006.

39

----

 

**Contractual Obligations -**The following table provides a summary of our contractual obligationsat June 30, 2006.
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **More than  5 years** | ** ** |
|                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-term debt  (1)              |       | $                                         | 290,766    |   | $ | 19,251 |   | $ | 39,348 |   | $ | 24,500 |   | $ | 207,667 |   |
| Capital leases                   |       | 59                                        |       | 13 |   | 31 |   | 15 |   | — |   |
| Operating leases  (2)            |       | 267,559                                   |       | 5,098 |   | 8,102 |   | 7,940 |   | 246,419 |   |
| Purchase  obligations (3)        |       | 16,028                                    |       | 15,857 |   | 157 |   | 14 |   | — |   |
| Other long-term  liabilities (4) |       | 30,220                                    |       | 3,651 |   | 3,539 |   | 3,357 |   | 19,673 |   |
| Total                            |       | $                                         | 604,632    |   | $ | 43,870 |   | $ | 51,177 |   | $ | 35,826 |   | $ | 473,759 |   |

----

**Notes toContractual Obligations:**

(1)             Long-term debtrepresents long-term debt obligations, the fixed interest on our Notes, and thevariable interest on our other loans.  Weestimated the future variable interest obligation using the applicable June 30,2006 rates.  The nature of our long-termdebt obligations, including changes to our long-term debt structure, isdescribed more fully in the “Borrowing Availability and Activities” section of “Liquidityand Capital Resources.”

(2)             Approximately $254.3million of our operating lease obligations are attributable to the ninety-nineyear land lease associated with the purchase of Steinway Hall; the remainder isattributable to the leasing of other facilities and equipment.

(3)             Purchase obligationsconsist of firm purchase commitments for raw materials, finished goods, andequipment.

(4)             Ourother long-term liabilities consist primarily of the long-term portion of ourpension obligations, which are described in Note 10 in the Notes toConsolidated Financial Statements included within this filing, and obligationsunder employee and consultant agreements.

40

----

 

**Recent AccountingPronouncements**

In June 2006, the FinancialAccounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”), “Accountingfor Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109.”FIN 48 clarifies the recognition threshold and measurement attribute for thefinancial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. FIN 48 also provides guidance onderecognition, classification, interest andpenalties, accounting in interim periods, disclosure and transition. FIN 48 iseffective for fiscal years beginning after December 15, 2006. We are evaluatingthe impact that this statement will have on our financial position or resultsof operations.

**ITEM 3**                                        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk associated with changesin foreign currency exchange rates and interest rates.  We mitigate a portion of our foreign currencyexchange rate risk by maintaining foreign currency cash balances and holdingoption and forward foreign currency contracts. They are not designated as hedges for accounting purposes.  These contracts relate primarily tointercompany transactions and are not used for trading or speculativepurposes.  The fair value of the optionand forward foreign currency exchange contracts is sensitive to changes inforeign currency exchange rates.  Theimpact of an adverse change in foreign currency exchange rates would not bematerially different than that disclosed in our Annual Report on Form 10-K forthe year ended December 31, 2005.

Our revolving loans and term loans bear interest atrates that fluctuate with changes in LIBOR, TIBOR, and EURIBOR.  As such, our interest expense on ourrevolving loans and term loans and the fair value of our fixed long-term debtare sensitive to changes in market interest rates.  The effect of an adverse change in marketinterest rates on our interest expense would not be materially different thanthat disclosed in our Annual Report on Form 10-K for the year ended December31, 2005.

The majority of our long-term debt is at a fixedinterest rate.  Therefore, the associatedinterest expense is not sensitive to fluctuations in market interestrates.  However, the fair value of ourfixed interest debt would be sensitive to market rate changes.  Such fair value changes may affect ourdecision whether to retain, replace, or retire this debt.

**ITEM 4**                                        CONTROLS ANDPROCEDURES

As of the end of the period covered by this report, weevaluated the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)). Our disclosure controls and procedures are the controls and otherprocedures that we designed to ensure that we record, process, summarize andreport in a timely manner the information we must disclose in reports that wefile with or submit to the SEC. Our Chief Executive Officer and Chief FinancialOfficer reviewed and participated in this evaluation. Based on this evaluationthe Chief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective.  In designing the Company’s disclosurecontrols and procedures, the Company’s management recognizes that any controls,no matter how well designed and operated, can only provide reasonable, notabsolute, assurance of achieving the desired control objectives.

41

----

 

During the quarter covered by this report, there wereno significant changes in our internal controls that materially affected, orare reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

**PART II****                                  ****OTHER INFORMATION**

**ITEM 4**                                        SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

At the Company’s Annual Meeting of Shareholders heldon May 17, 2006, the Board of Directors was re-elected in its entirety.  The votes cast for each nominee were asfollows:
|                      | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|----------------------|------------|------------|------------|--------------|------------|
|                 |       |       |       |         |       |
| Kyle Kirkland        |       | 51,909,466 |       | 2,274,021    |       |
| Dana D. Messina      |       | 51,916,558 |       | 2,266,929    |       |
| John M. Stoner,  Jr. |       | 51,487,375 |       | 2,696,112    |       |
| Bruce A. Stevens     |       | 51,904,430 |       | 2,279,057    |       |
| A. Clinton Allen     |       | 53,929,479 |       | 254,008      |       |
| Rudolph K. Kluiber   |       | 53,929,479 |       | 254,008      |       |
| Peter McMillan       |       | 53,937,230 |       | 246,257      |       |

 

The proposal to ratify Deloitte & Touche LLP toserve as the Company’s independent registered public accounting firm for thefiscal year ending December 31, 2006 was approved with 54,155,110 votes castfor, 28,277 against, and 100 abstentions.

The proposal to approve the Company’s 2006 StockCompensation Plan effective August 1, 2006 was approved with 50,126,079 votescast for, 2,102,753 against, 416,894 abstentions, and 1,537,761 withheld.  The 2006 stock plan is identical to theexisting 1996 stock plan except our Board of Directors has authorized anaggregate of 1,000,000 shares of common stock for issuance under this plan.

The proposal to approve the Company’s 2006 EmployeeStock Purchase Plan effective August 1, 2006 was approved with 52,157,591 votescast for, 71,243 against, 416,892 abstentions, and 1,537,761 withheld.  The new plan is identical to the existingplan except our Board of Directors has authorized an aggregate of 400,000shares of common stock for issuance under this plan.

**ITEM 6**                                        EXHIBITS
| (i)          Exhibits |
|--------------------------------------------------------------------|
|                                                               |
|                                                               | 4.1 |   | Tenth Amendment and consent to the Second Amended  and Restated Credit Agreement dated as of May 1, 2006 by and among  Conn-Selmer, Inc. f/k/a The Selmer Company, Inc. and surviving corporation of  the merger of United Musical Instruments USA, Inc. and United Instruments  Holdings with and into Conn-Selmer, Inc., Steinway, Inc., as borrowers; those  signatories identified as guarantors, the lenders, and GMAC Commercial  Finance LLC (successor by merger to GMAC Commercial Credit LLC), as  administrative agent. |
|                                                               |   |   |   |
|                                                               | 31.1 |   | Certification of the Principal Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |

 

42

----

 
|        | 31.2   |   | Certification of the Principal Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                 |
|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                        |
|   | 32.1   |   | Certification of the Principal Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|   |   |   |                                                                                                                                                        |
|   | 32.2   |   | Certification of the Principal Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

43

----

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused 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:  August 9, 2006 |                                             |

 

44

----