**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 
| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|------------|------------|---------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | **FOR THE QUARTERLY PERIOD ENDED  MARCH 31, 2008**                                                 |
| ** ** | ** ** | ** **                                                                                              |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**COMMISSIONFILE NUMBER 001-11911**

 

**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 by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements duringthe past 90 days.Yes x    No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer  o                     |   | Accelerated filer x          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

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

Yes o    No x

 

Number of sharesof Common Stock issued and outstanding as of May 5, 2008:

 
|   | Class A |   | 477,952   |   |
|--------|--------------|--------|-----------|--------|
|   | Ordinary     |   | 8,104,728 |   |
|   | Total        |   | 8,582,680 |   |

 

** **

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**STEINWAY MUSICALINSTRUMENTS, INC. AND SUBSIDIARIES**

**FORM 10-Q**

**INDEX**

 
| **PART I.**  | **UNAUDITED  FINANCIAL INFORMATION**                                                                  |       |
|-------------------|-------------------------------------------------------------------------------------------------------|------------|
| ** **        | ** **                                                                                            |       |
| **Item 1.**       | **Condensed  Consolidated Financial Statements:**                                                     | ** ** |
| ** **        | ** **                                                                                            | ** ** |
|              | Condensed  Consolidated Statements of Operations Three Months Ended March 31, 2008  and 2007     | 3          |
|              |                                                                                                  |       |
|              | Condensed  Consolidated Balance Sheets March 31, 2008 and December 31, 2007                 | 4          |
|              |                                                                                                  |       |
|              | Condensed  Consolidated Statements of Cash Flows Three Months Ended March 31, 2008  and 2007     | 5          |
|              |                                                                                                  |       |
|              | Condensed Consolidated Statement of Stockholders’  Equity Three Months Ended March 31, 2008 | 6          |
|              |                                                                                                  |       |
|              | Notes to Condensed  Consolidated Financial Statements                                                 | 7          |
|              |                                                                                                  |       |
| **Item 2.**       | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**       | 20         |
| ** **        | ** **                                                                                            |       |
| **Item 3.**       | **Quantitative  and Qualitative Disclosures about Market Risk**                                       | 29         |
| ** **        | ** **                                                                                            |       |
| **Item 4.**       | **Controls and  Procedures**                                                                          | 29         |
| ** **        | ** **                                                                                            |       |
| **PART II.** | **OTHER INFORMATION**                                                                                 |       |
| ** **        | ** **                                                                                            |       |
| ** **        | **Exhibits**                                                                                          | 30         |
| ** **        | ** **                                                                                            |       |
| **Item 6.**       | **Signatures**                                                                                        | 31         |

 

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**ITEM 1                  CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

**Unaudited**

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

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Net sales                        |       | $                                                    | 94,186     |   | $ | 93,432 |   |
| Cost of sales                    |       | 66,794                                               |       | 66,192 |   |
|                             |       |                                                 |       |   |   |
| Gross profit                     |       | 27,392                                               |       | 27,240 |   |
|                             |       |                                                 |       |   |   |
| Operating  expenses:             |       |                                                 |       |   |   |
| Sales and  marketing             |       | 13,051                                               |       | 12,664 |   |
| Provision for  doubtful accounts |       | 353                                                  |       | 126 |   |
| General and  administrative      |       | 8,781                                                |       | 9,206 |   |
| Other operating  expenses        |       | 403                                                  |       | 877 |   |
| Total operating  expenses        |       | 22,588                                               |       | 22,873 |   |
|                             |       |                                                 |       |   |   |
| Income from  operations          |       | 4,804                                                |       | 4,367 |   |
|                             |       |                                                 |       |   |   |
| Other income,  net               |       | (37                                                  | )          | (170 | ) |
| Gain on  extinguishment of debt  |       | (636                                                 | )          | — |   |
| Interest income                  |       | (952                                                 | )          | (1,096 | ) |
| Interest expense                 |       | 3,109                                                |       | 3,248 |   |
| Total  non-operating expenses    |       | 1,484                                                |       | 1,982 |   |
|                             |       |                                                 |       |   |   |
| Income before  income taxes      |       | 3,320                                                |       | 2,385 |   |
|                             |       |                                                 |       |   |   |
| Income tax  provision            |       | 1,345                                                |       | 955 |   |
|                             |       |                                                 |       |   |   |
| Net income                       |       | $                                                    | 1,975      |   | $ | 1,430 |   |
|                             |       |                                                 |       |   |   |
| Earnings per share:              |       |                                                 |       |   |   |
| Basic                            |       | $                                                    | 0.23       |   | $ | 0.17 |   |
| Diluted                          |       | $                                                    | 0.23       |   | $ | 0.17 |   |
|                             |       |                                                 |       |   |   |
| Weighted average  shares:        |       |                                                 |       |   |   |
| Basic                            |       | 8,579,203                                            |       | 8,419,148 |   |
| Diluted                          |       | 8,654,843                                            |       | 8,579,978 |   |

 

See notes to condensed consolidated financial statements.

 

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**Unaudited**

**(In Thousands)**

 
| ** **                                                                                                              | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Assets                                                                                                                  |       |                     |       |                        |       |
| Current assets:                                                                                                         |       |                     |       |                        |       |
| Cash                                                                                                                    |       | $                        | 30,750     |                        | $          | 37,304 |   |
| Accounts, notes  and other receivables, net of allowances of $17,231   and $17,519 in 2008 and 2007, respectively       |       | 70,521                   |       | 73,131                      |       |
| Inventories, net                                                                                                        |       | 162,933                  |       | 152,451                     |       |
| Prepaid expenses  and other current assets                                                                              |       | 11,675                   |       | 11,272                      |       |
| Deferred tax  assets                                                                                                    |       | 12,931                   |       | 11,571                      |       |
| Total current  assets                                                                                                   |       | 288,810                  |       | 285,729                     |       |
|                                                                                                                    |       |                     |       |                        |       |
| Property, plant  and equipment, net of accumulated depreciation of $97,782   and $94,221 in 2008 and 2007, respectively |       | 94,158                   |       | 94,150                      |       |
| Trademarks                                                                                                              |       | 14,501                   |       | 14,119                      |       |
| Goodwill                                                                                                                |       | 34,124                   |       | 32,907                      |       |
| Other  intangibles, net                                                                                                 |       | 3,644                    |       | 3,937                       |       |
| Other assets                                                                                                            |       | 18,043                   |       | 18,014                      |       |
| Long-term  deferred tax assets                                                                                          |       | 8,427                    |       | 8,822                       |       |
|                                                                                                                    |       |                     |       |                        |       |
| Total assets                                                                                                            |       | $                        | 461,707    |                        | $          | 457,678 |   |
|                                                                                                                    |       |                     |       |                        |       |
| Liabilities and  stockholders’ equity                                                                              |       |                     |       |                        |       |
| Current  liabilities:                                                                                                   |       |                     |       |                        |       |
| Debt                                                                                                                    |       | $                        | 2,508      |                        | $          | 2,285 |   |
| Accounts payable                                                                                                        |       | 16,005                   |       | 12,381                      |       |
| Other current  liabilities                                                                                              |       | 48,449                   |       | 52,320                      |       |
| Total current  liabilities                                                                                              |       | 66,962                   |       | 66,986                      |       |
|                                                                                                                    |       |                     |       |                        |       |
| Long-term debt                                                                                                          |       | 168,305                  |       | 173,981                     |       |
| Deferred tax  liabilities                                                                                               |       | 15,017                   |       | 15,003                      |       |
| Pension and  other postretirement benefit liabilities                                                                   |       | 32,376                   |       | 30,093                      |       |
| Other  non-current liabilities                                                                                          |       | 7,889                    |       | 7,836                       |       |
| Total  liabilities                                                                                                      |       | 290,549                  |       | 293,899                     |       |
|                                                                                                                    |       |                     |       |                        |       |
| Commitments and  contingent liabilities                                                                                 |       |                     |       |                        |       |
|                                                                                                                    |       |                     |       |                        |       |
| Stockholders’  equity:                                                                                             |       |                     |       |                        |       |
| Common stock                                                                                                            |       | 11                       |       | 11                          |       |
| Additional  paid-in capital                                                                                             |       | 94,617                   |       | 94,370                      |       |
| Retained  earnings                                                                                                      |       | 114,879                  |       | 112,917                     |       |
| Accumulated  other comprehensive income                                                                                 |       | 6,868                    |       | 1,773                       |       |
| Treasury stock,  at cost                                                                                                |       | (45,217                  | )          | (45,292                     | )          |
| Total  stockholders’ equity                                                                                        |       | 171,158                  |       | 163,779                     |       |
|                                                                                                                    |       |                     |       |                        |       |
| Total  liabilities and stockholders’ equity                                                                        |       | $                        | 461,707    |                        | $          | 457,678 |   |

 

See notes to condensedconsolidated financial statements.

 

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

**Unaudited**

**(In Thousands)**

 
| ** **                                                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                    | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Cash flows from  operating activities:                                        |       |                                                 |       |   |   |
| Net income                                                                    |       | $                                                    | 1,975      |   | $ | 1,430 |   |
| Adjustments to  reconcile net income to cash flows from operating activities: |       |                                                 |       |   |   |
| Depreciation and  amortization                                                |       | 2,685                                                |       | 2,569 |   |
| Amortization of  bond discount                                                |       | 42                                                   |       | 41 |   |
| Gain on  extinguishment of debt                                               |       | (636                                                 | )          | — |   |
| Stock-based  compensation expense                                             |       | 245                                                  |       | 264 |   |
| Excess tax  benefits from stock-based awards                                  |       | (2                                                   | )          | (255 | ) |
| Tax benefit from  stock option exercises                                      |       | 2                                                    |       | 496 |   |
| Deferred tax  benefit                                                         |       | (1,297                                               | )          | (1,352 | ) |
| Provision for  doubtful accounts                                              |       | 353                                                  |       | 126 |   |
| Purchase of  trading securities, net                                          |       | (212                                                 | )          | (206 | ) |
| Other                                                                         |       | 449                                                  |       | (29 | ) |
| Changes in  operating assets and liabilities:                                 |       |                                                 |       |   |   |
| Accounts, notes  and other receivables                                        |       | 3,170                                                |       | 696 |   |
| Inventories                                                                   |       | (7,079                                               | )          | (11,148 | ) |
| Prepaid expenses  and other assets                                            |       | (207                                                 | )          | 322 |   |
| Accounts payable                                                              |       | 3,412                                                |       | (209 | ) |
| Other  liabilities                                                            |       | (5,179                                               | )          | (4,737 | ) |
| Cash flows from  operating activities                                         |       | (2,279                                               | )          | (11,992 | ) |
|                                                                          |       |                                                 |       |   |   |
| Cash flows from  investing activities:                                        |       |                                                 |       |   |   |
| Capital  expenditures                                                         |       | (1,071                                               | )          | (844 | ) |
| Proceeds from  disposals of property, plant and equipment                     |       | 311                                                  |       | 15 |   |
| Cash flows from  investing activities                                         |       | (760                                                 | )          | (829 | ) |
|                                                                          |       |                                                 |       |   |   |
| Cash flows from  financing activities:                                        |       |                                                 |       |   |   |
| Borrowings under  lines of credit                                             |       | 1,657                                                |       | 23,302 |   |
| Repayments under  lines of credit                                             |       | (1,739                                               | )          | (9,147 | ) |
| Repayment of  long-term debt, net of discount                                 |       | (4,981                                               | )          | — |   |
| Proceeds from  issuance of common stock                                       |       | 62                                                   |       | 2,497 |   |
| Dividends paid                                                                |       | —                                               |       | (25,187 | ) |
| Excess tax  benefits from stock-based awards                                  |       | 2                                                    |       | 255 |   |
| Cash flows from  financing activities                                         |       | (4,999                                               | )          | (8,280 | ) |
|                                                                          |       |                                                 |       |   |   |
| Effect of  foreign exchange rate changes on cash                              |       | 1,484                                                |       | 141 |   |
|                                                                          |       |                                                 |       |   |   |
| Decrease in cash                                                              |       | (6,554                                               | )          | (20,960 | ) |
| Cash, beginning  of period                                                    |       | 37,304                                               |       | 30,409 |   |
|                                                                          |       |                                                 |       |   |   |
| Cash, end of  period                                                          |       | $                                                    | 30,750     |   | $ | 9,449 |   |
|                                                                          |       |                                                 |       |   |   |
| Supplemental  Cash Flow Information                                           |       |                                                 |       |   |   |
| Interest paid                                                                 |       | $                                                    | 6,142      |   | $ | 6,188 |   |
| Taxes paid                                                                    |       | $                                                    | 3,334      |   | $ | 3,571 |   |

 

See notes to condensedconsolidated financial statements.

 

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

**Unaudited**

**(In Thousands Except Share Data)**

** **
| ** **                                            | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’   Equity** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|-----------------------------------------------|------------|---------------------|------------|---------------------------------------------|------------|
|                                                  |       |              |       |                             |       |                   |       |                                          |       |                |       |                                        |       |
| Balance,  January 1, 2008                        |       | $                 | 11         |                             | $          | 94,370                 |       | $                                             | 112,917    |                | $          | 1,773                                       |       | $ | (45,292 | ) | $ | 163,779 |   |
| Comprehensive  income:                                |       |              |       |                             |       |                   |       |                                          |       |                |       |                                        |       |
| Net income                                            |       |              |       |                             |       | 1,975                  |       |                                          |       |                |       | 1,975                                       |       |
| Foreign currency  translation adjustments             |       |              |       |                             |       |                   |       | 5,095                                         |       |                |       | 5,095                                       |       |
| Total  comprehensive income                           |       |              |       |                             |       |                   |       |                                          |       |                |       | 7,070                                       |       |
| Exercise of  3,200 options for shares of common stock |       |              |       |                             |       | (13                    | )          |                                          |       | 75                  |       | 62                                          |       |
| Stock-based  compensation                             |       |              |       | 245                              |       |                   |       |                                          |       |                |       | 245                                         |       |
| Tax benefit of  options exercised                     |       |              |       | 2                                |       |                   |       |                                          |       |                |       | 2                                           |       |
| Balance,  March 31, 2008                         |       | $                 | 11         |                             | $          | 94,617                 |       | $                                             | 114,879    |                | $          | 6,868                                       |       | $ | (45,217 | ) | $ | 171,158 |   |

 

See notes to condensedconsolidated financial statements.

 

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**STEINWAY MUSICAL INSTRUMENTS,INC. AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED**

**FINANCIAL STATEMENTS**

**MARCH 31, 2008**

**Unaudited**

**(Tabular Amounts In Thousands Except Share, Per Share, Option, and PerOption Data)**

 

**(1)           Basis ofPresentation**

 

Theaccompanying consolidated and condensed consolidated financial statements ofSteinway Musical Instruments, Inc. and subsidiaries (the “Company”) forthe three months ended March 31, 2008 and 2007 are unaudited. In theopinion of management, these statements have been prepared on the same basis asthe audited consolidated financial statements as of and for the year ended December 31,2007, 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 thecondensed consolidated financial statements in conjunction with the riskfactors, consolidated financial statements and notes thereto contained in theCompany’s Annual Report on Form 10-K for the year ended December 31,2007 filed with the Securities and Exchange Commission (“SEC”). The results ofoperations for the three months ended March 31, 2008 are not necessarilyindicative of the results that may be expected for the entire year.

 

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

 

**(2)           Summary ofSignificant Accounting Policies**

 

**Principles of Consolidation** - Our consolidated financial statements include the accounts of alldirect and indirect subsidiaries, all of which are wholly owned, including thepiano (“Steinway”) and band (“Conn-Selmer”) divisions. Intercompany balanceshave been eliminated in consolidation.

 

**Use of Estimates****- The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America necessarily requires us to makeestimates 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 results could differ from those estimates.

 

**Income Taxes**- We provide for income taxes using an asset and liability approach. We computedeferred income tax assets and liabilities for differences between thefinancial statement and tax bases of assets and liabilities that will result intaxable or 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 valuation allowances when necessary to reducedeferred tax assets to the amount that more likely than not will be realized.

 

We provide reserves for potential payments of tax to various taxauthorities related to uncertain tax positions and other issues. Prior to 2007,these reserves were recorded when management determined that it was probablethat a loss would be incurred related to these matters and the amount of theloss was reasonably determinable. In 2007, we adopted Financial AccountingStandards Board (“FASB”) Interpretation No. 48, “Accounting forUncertainty in Income Taxes – an interpretation of FASB Statement No. 109”(“FIN 48”). As a result, reserves recorded subsequent to adoption arebased on a determination of whether and how much of a tax benefit taken in ourtax filings or positions is more likely than not to be realized, assuming thatthe matter in question will be raised by the tax authorities. Potentialinterest and penalties associated with such uncertain tax positions are 

 

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recorded as a component of income tax expense. At adoption date,we made a comprehensive review of our uncertain tax positions. We believeappropriate provisions for outstanding issues have been made.

 

Inconjunction with the adoption of FIN 48, we began reporting income tax-relatedinterest and penalties as a component of income tax expense. Prior to adoption,such interest was reported in interest expense. We file income tax returns atthe U.S. federal, state, and local levels, as well as in several foreignjurisdictions. With few exceptions, our returns are no longer subject toexaminations for years before 2004.

 

Therehave been no material changes to the liability for uncertain tax positions.Although we believe our tax estimates are appropriate, the final determinationof tax audits and any related litigation could result in favorable or unfavorablechanges in our estimates.

 

**Stock-based Compensation** -We record compensation cost on a straight-line basis over the award’srequisite service period for all share-based awards granted. We estimate thefair value of our stock option awards (less estimated forfeitures) and employeestock purchase plan rights on the date of grant using the Black-Scholes optionvaluation model.

 

**Earningsper Common Share**- We compute earnings per share using the weighted-average number of commonshares outstanding during each period. Diluted earnings per common sharereflects the effect of our outstanding options using the treasury stock 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 March 31,** | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Weighted-average  shares:                            |       |      |       |      |       |
| For basic  earnings per share                        |       | 8,579,203 |       | 8,419,148 |       |
| Dilutive effect  of stock options                    |       | 75,640    |       | 160,830   |       |
| For diluted  earnings per share                      |       | 8,654,843 |       | 8,579,978 |       |

 

Wedid not include 214,400 and 20,000 outstanding options to purchase shares ofcommon stock in the computation of diluted earnings per common share for thethree months ended March 31, 2008 and 2007, respectively, because theirexercise prices were more than the average market price of our common shares,and therefore antidilutive.

 

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**AccumulatedOther Comprehensive Income** - Accumulated other comprehensive income is comprisedof foreign currency translation adjustments and pension and otherpost-retirement benefits. The components of accumulated other comprehensiveincome are as follows:

 
| ** **                    | ** ** | **Foreign Currency  Translation  Adjustments** | ** ** | **Pension & Other  Post-Retirement  Benefits** | ** ** | **Tax Impact of  Pension & Other  Post-Retirement  Benefits** | ** ** | **Accumulated Other  Comprehensive  Income** | ** ** |
|-------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| Balance  January 1, 2008 |       | $                                                   | 9,041      |                                                         | $          | (11,616                                                                               | )          | $                                                 | 4,348      |   | $ | 1,773 |   |
| Activity                      |       | 5,095                                               |       | —                                                       |       | —                                                                                |       | 5,095                                             |       |
| Balance  March 31, 2008  |       | $                                                   | 14,136     |                                                         | $          | (11,616                                                                               | )          | $                                                 | 4,348      |   | $ | 6,868 |   |

 

**Recent Accounting Pronouncements****-**On January 1,2008, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities—includingan amendment of FASB Statement No. 115,” (“SFAS 159”). SFAS 159 permitsentities to choose to measure many financial instruments and certain otherassets and liabilities at fair value on an instrument-by-instrument basis (thefair value option) with changes in fair value reported in earnings. We alreadyrecord marketable securities at fair value in accordance with SFAS No. 115,“Accounting for Certain Investments in Debt and Equity Securities,” andderivative contracts and hedging activities at fair value in accordance withSFAS No. 133, “Accounting for Derivative Instruments and HedgingActivities,” as amended. The adoption of SFAS 159 had no impact on ourconsolidated financial position and results of operations as management did notelect the fair value option for any other financial instruments or certainother assets and liabilities.

 

In September 2006, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157defines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements. On January 1, 2008, weadopted SFAS 157, which did not have an impact on our consolidated financialstatements. In February 2008, the FASB delayed the effective date of SFAS157 for all nonrecurring fair value measurements of nonfinancial assets andnonfinancial liabilities. We will comply with this component of SFAS 157 January 1,2009. We are currently evaluating these requirements of SFAS 157 and have notyet determined the impact its adoption will have on our consolidated financialstatements.

 

InDecember 2007, the FASB issued SFAS No. 141R, “Business Combinations,”a revision to SFAS No. 141, “Business Combinations” (“ SFAS 141R”),which provides revised guidance for recognition and measurement of identifiableassets and goodwill acquired, liabilities assumed, and any noncontrollinginterest in the acquiree at fair value.  The Statement alsoestablishes disclosure requirements to enable the evaluation of the nature andfinancial effects of a business combination. SFAS 141R is required to beapplied prospectively to business combinations for which the acquisition dateis on or after the beginning of the first annual reporting period beginning onor after December 15, 2008. We will comply with SFAS 141R January 1,2009.  We are currently evaluating the potential impact, if any, of theadoption of SFAS 141R on our consolidated financial statements.

 

InDecember 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements – an amendment of ARB No. 51”(“SFAS 160”). This Statement establishes accounting and reportingstandards for ownership interests in subsidiaries held by parties other thanthe parent. Specifically, SFAS 160 requires the presentation ofnoncontrolling interests as equity in the Consolidated Statement of FinancialPosition, and separate identification and presentation in the ConsolidatedStatement of Operations of net income attributable to the entity and thenoncontrolling interest. It also establishes accounting and reportingstandards regarding deconsolidation and changes in a parent’s ownershipinterest. We will be required to comply with SFAS 160 

 

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January 1, 2009.  The provisions of SFAS 160 are generallyrequired to be applied prospectively, except for the presentation anddisclosure requirements, which must be applied retrospectively. We arecurrently evaluating the potential impact, if any, of the adoption of SFAS 160on our consolidated financial statements.

 

InMarch 2008, the FASB issued SFAS No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133”(“SFAS 161”). This Statement amends and expands the disclosurerequirements for derivative instruments and hedging activities, with the intentto provide users of financial statements with an enhanced understanding of howand why an entity uses derivative instruments, how derivative instruments andrelated hedged items are accounted for, and how derivative instruments andrelated hedged items affect an entity’s financial statements. We willcomply with SFAS 161 January 1, 2009.

 

**(3)           Inventories**

 
| ** **      | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------|------------|--------------------------|------------|-----------------------------|------------|
| Raw materials   |       | $                        | 19,488     |                        | $          | 18,615 |   |
| Work-in-process |       | 52,193                   |       | 51,402                      |       |
| Finished goods  |       | 91,252                   |       | 82,434                      |       |
|            |       | $                        | 162,933    |                        | $          | 152,451 |   |

 

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

 

Intangibleassets other than goodwill and indefinite-lived trademarks are amortized on astraight-line basis over their estimated useful lives. Deferred financing costsare amortized over the repayment periods of the underlying debt. We test ourgoodwill and indefinite-lived trademark assets for impairment annually, or onan interim basis if events or circumstances indicate that the fair value of anasset has decreased below its carrying value. At July 31, 2007, weevaluated these assets and determined that the fair value had not decreasedbelow the carrying value and, accordingly, no impairments have been recognized.No other events or circumstances have occurred subsequent to our annualimpairment date which have indicated that these assets may potentially beimpaired. The changes in carrying amounts of goodwill and trademarks are asfollows:

 
| ** **                           | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|
| Goodwill:                            |       |                   |       |                  |       |      |       |
| Balance,  January 1, 2008       |       | $                      | 24,352     |                  | $          | 8,555     |       | $ | 32,907 |   |
| Foreign currency  translation impact |       | 1,217                  |       | —                |       | 1,217     |       |
| Balance,  March 31, 2008        |       | $                      | 25,569     |                  | $          | 8,555     |       | $ | 34,124 |   |
|                                 |       |                   |       |                  |       |      |       |
| Trademarks:                          |       |                   |       |                  |       |      |       |
| Balance,  January 1, 2008       |       | $                      | 8,295      |                  | $          | 5,824     |       | $ | 14,119 |   |
| Foreign currency  translation impact |       | 382                    |       | —                |       | 382       |       |
| Balance,  March 31, 2008        |       | $                      | 8,677      |                  | $          | 5,824     |       | $ | 14,501 |   |

 

10

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Wealso carry certain intangible assets that are amortized. Once fully amortized,these assets are removed from both the gross and accumulated amortizationbalance. These assets consist of the following:

 
| ** **                       | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                             |       |                     |       |                        |       |
| Gross deferred  financing costs: |       | $                        | 5,630      |                        | $          | 5,755 |   |
| Accumulated  amortization        |       | (2,123                   | )          | (1,980                      | )          |
| Deferred  financing costs, net   |       | $                        | 3,507      |                        | $          | 3,775 |   |
|                             |       |                     |       |                        |       |
| Gross covenants  not to compete: |       | $                        | 500        |                        | $          | 500 |   |
| Accumulated  amortization        |       | (363                     | )          | (338                        | )          |
| Covenants not to  compete, net   |       | $                        | 137        |                        | $          | 162 |   |

 

Deferred financing costswere impacted by our purchase of $5.8 million of our Senior Notes in March 2008.This repurchase is described more fully in Note 6. The weighted-averageamortization period for deferred financing costs is six years, and theweighted-average amortization period of covenants not to compete is five years.Total amortization expense, which includes amortization of deferred financingcosts, is as follows:

 
| **Three Months Ended March 31,** | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Amortization  expense                                |       | $        | 198        |     | $          | 196 |   |
|                                                      |            |          |            |          |            |  |  |

 

Thefollowing table shows the total estimated amortization expense for theremainder of 2008 and beyond:

 
| **Estimated amortization expense:** | ** ** | **Amount** | ** ** |
|-----------------------------------------------|------------|------------|------------|
|                                          |       |       |       |
| Remainder of  2008                            |       | $          | 580        |   |
| 2009                                          |       | 732        |       |
| 2010                                          |       | 649        |       |
| 2011                                          |       | 608        |       |
| 2012                                          |       | 497        |       |
| 2013 and  thereafter                          |       | 578        |       |
| Total                                         |       | $          | 3,644      |   |

 

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**(5)****                                ****Other Current Liabilities**

 
| ** **                                                               | ** ** | **March 31,  2008** | ** ** | **December 31,**

**2007** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------|------------|---------------------------------|------------|
| Accrued payroll  and related benefits                                    |       | $                        | 17,540     |                            | $          | 16,721 |   |
| Current portion  of pension and other postretirement benefit liabilities |       | 1,416                    |       | 1,440                           |       |
| Accrued warranty  expense                                                |       | 1,532                    |       | 1,541                           |       |
| Accrued interest                                                         |       | 961                      |       | 4,049                           |       |
| Deferred income                                                          |       | 11,222                   |       | 10,224                          |       |
| Environmental  liabilities                                               |       | 2,612                    |       | 2,648                           |       |
| Income and other  taxes payable                                          |       | 5,419                    |       | 6,139                           |       |
| Other accrued  expenses                                                  |       | 7,747                    |       | 9,558                           |       |
| Total                                                                    |       | $                        | 48,449     |                            | $          | 52,320 |   |

 

Accrued warranty expense is recorded at the time ofsale for instruments that have a warranty period ranging from one to ten years.The accrued expense recorded is generally calculated on a ratio of warrantycosts to sales based on our warranty history and is adjusted periodicallyfollowing an analysis of actual warranty claims.

 

The accrued warranty expense activity for the three months ended March 31,2008 and 2007, and the year ended December 31, 2007 is as follows:

 
| ** **                           | ** ** | **March 31,  2008** | ** ** | **March 31,  2007** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------|------------|--------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Beginning  balance                   |       | $                        | 1,541      |                     | $          | 1,888                       |       | $ | 1,888 |   |
| Additions                            |       | 262                      |       | 8                        |       | 798                         |       |
| Claims and  reversals                |       | (307                     | )          | (240                     | )          | (1,200                      | )          |
| Foreign currency  translation impact |       | 36                       |       | (8                       | )          | 55                          |       |
| Ending balance                       |       | $                        | 1,532      |                     | $          | 1,648                       |       | $ | 1,541 |   |

 

**(6)           Long-Term Debt**

 

Ourlong-term debt consists of the following:

 
| ** **                             | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| 7.00% Senior  Notes                    |       | $                        | 169,250    |                        | $          | 175,000 |   |
| Unamortized bond  discount             |       | (945                     | )          | (1,019                      | )          |
| Domestic line of  credit               |       | —                   |       | —                      |       |
| Open account loans,  payable on demand |       | 2,508                    |       | 2,285                       |       |
| Total                                  |       | 170,813                  |       | 176,266                     |       |
| Less: current  portion                 |       | (2,508                   | )          | (2,285                      | )          |
| Long-term debt                         |       | $                        | 168,305    |                        | $          | 173,981 |   |

 

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Scheduled payments ofdebt are as follows:

 
| ** **         | ** ** | **March 31,  2008** | ** ** |
|--------------------|------------|--------------------------|------------|
| Remainder of  2008 |       | $                        | 2,508      |   |
| 2009               |       | —                   |       |
| 2010               |       | —                   |       |
| 2011               |       | —                   |       |
| 2012               |       | —                   |       |
| Thereafter         |       | 169,250                  |       |
| Total              |       | $                        | 171,758    |   |

 

In March 2008, we repurchased $5.8 million of our Senior Notes ata price of 86.625 plus interest. As a result, we recorded a net gain onextinguishment of debt of $0.6 million. A summary of the transaction is asfollows:

 
| **Three Months Ended March 31,** | ** ** | **2008** | ** ** |
|------------------------------------------------------|------------|----------|------------|
| Principal  repurchased                               |       | $        | 5,750      |   |
| Accrued interest                                     |       | 19       |       |
| Subtotal                                             |       | 5,769    |       |
| Less:                                                |       |     |       |
| Cash paid                                            |       | (5,000   | )          |
| Deferred  financing costs write-off                  |       | (101     | )          |
| Bond discount  write-off                             |       | (32      | )          |
| Net gain on  extinguishment of debt                  |       | $        | 636        |   |

 

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

 

Our common stockis comprised of two classes: Class A and Ordinary. With the exception ofdisparate voting power, both classes are substantially identical. Each share ofClass A common stock entitles the holder to 98 votes. Holders of Ordinarycommon stock are entitled to one vote per share. Each share of Class Acommon stock shall automatically convert to Ordinary common stock if, at anytime, that share of Class A common stock is not owned by an original Class Aholder. As of March 31, 2008 our Chairman and our Chief Executive Officercollectively owned 100% of the Class A common shares, representingapproximately 85% of the combined voting power of the Class A common stockand Ordinary common stock.

 

**EmployeeStock Purchase Plan** - We have an employee stock purchase planunder 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 the Purchase Plan are limited to 5% of anemployee’s annual base earnings. We have reserved 400,000 shares of commonstock for issuance under this plan.

 

**Stock Plans** -The 2006 Stock Plan provides for the granting of 1,000,000 stock options(including incentive stock options and non-qualified stock options), stockappreciation rights and other stock awards to certain key

 

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employees,consultants and advisors. Our stock options generally have five-year vestingterms and ten-year option terms.

 

We had reserved 721,750 treasury stock shares to issue under our 1996Stock Plan, once we reached our registered share limitation. This plan hasexpired but still has vested and unvested options outstanding. In early 2007 wereached our registered share limitation and have since issued 95,674 shares oftreasury stock to cover options exercised, with 414,076 remaining optionsoutstanding. Since in most instances the average cost of the treasury stockexceeded the price of the options exercised, the difference between theproceeds received and the average cost of the treasury stock issued resulted ina reduction of retained earnings. This reduction was less than $0.1 million forthe three months ended March 31, 2008 and $0.1 million for the threemonths ended March 31, 2007.

 

The compensation cost andthe income tax benefit recognized for these plans is as follows:

 
| **Three Months Ended March 31,**                | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Compensation  cost included in basic and   diluted income per share |       | $        | 0.03       |     | $          | 0.03 |   |
| Stock-based  compensation expense                                   |       | 245      |       | 264      |       |
| Income tax  benefit                                                 |       | 27       |       | 42       |       |
|                                                                     |            |          |            |          |            |  |  |

 

We measured the fair value of options on their grant date, includingthe valuation of the option feature implicit in our Purchase Plan, using theBlack-Scholes option-pricing model. The risk-free interest rate is based on theweighted-average of U.S. Treasury rates over the expected life of the stockoption or the contractual life of the option feature in the Purchase Plan. Theexpected life of a stock option is based on historical data of similar optionholders. 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 isbased on historical volatility of our stock over the expected life of theoption, as our options are not readily tradable.

 

Keyassumptions used to apply this pricing model to the 2006 Stock Plan are asfollows:

 
| **Three Months Ended March 31,**         | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
| Risk-free  interest rate                                     |       | 2.9%     |       | 4.6%     |       |
| Weighted-average  expected life of option feature (in years) |       | 7.1      |       | 8.1      |       |
| Expected  volatility of underlying stock                     |       | 25.9%    |       | 25.2%    |       |
| Expected  dividends                                          |       | n/a      |       | n/a      |       |
| Weighted-average  fair value of option feature               |       | $10.01   |       | $13.66   |       |

 

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Thefollowing table sets forth information regarding the Stock Plans:

 
| ** **                           | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Remaining  Contractual  Life  (in years)** | ** ** | **Aggregate  Intrinsic  Value  (not in 000s)** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------------|------------|
| Outstanding at  January 1, 2008 |       | 544,576                     |       | $                                       | 23.78      |                                              |       |                                                     |       |   |
| Granted                              |       | 32,500                      |       | 28.90                                   |       |                                              |       |                                                     |       |
| Exercised                            |       | (3,200                      | )          | 19.04                                   |       |                                              |       |                                                     |       |
| Forfeited                            |       | (3,400                      | )          | 31.55                                   |       |                                              |       |                                                     |       |
| Outstanding at  March 31, 2008  |       | 570,476                     |       | $                                       | 24.05      |                                              | 6.2        |                                                     | $          | 3,198,006 |   |
|                                 |       |                        |       |                                    |       |                                              |       |                                                     |       |
| Exercisable at  March 31, 2008  |       | 361,056                     |       | $                                       | 21.02      |                                              | 4.9        |                                                     | $          | 2,930,146 |   |

 

The total intrinsic value of the options exercised during the threemonths ended March 31, 2008 and 2007 was less than $0.1 million and $1.6million, respectively.

 

As of March 31, 2008, there was $2.0 million of unrecognizedcompensation cost related to nonvested share-based compensation arrangementsgranted under the Stock Plan. This compensation cost is expected to berecognized over a period of 3.6 years.

 

Thefollowing tables set forth information regarding the Purchase Plan:

 
| **Three Months Ended March 31,**         | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
| Risk-free  interest rate                                     |       | 4.8%     |       | 5.1%     |       |
| Weighted-average  expected life of option feature (in years) |       | 1.0      |       | 1.0      |       |
| Expected  volatility of underlying stock                     |       | 25.8%    |       | 24.7%    |       |
| Expected  dividends                                          |       | n/a      |       | n/a      |       |
| Weighted-average  fair value of option feature               |       | $8.69    |       | $6.22    |       |

 
| ** **                           | ** ** | **Number  of Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Remaining  Contractual  Life  (in years)** | ** ** | **Aggregate  Intrinsic  Value  (not in 000s)** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------------|------------|
| Outstanding at  January 1, 2008 |       | 10,441                      |       | $                                       | 28.73      |                                              |       |                                                     |       |   |
| Shares  subscribed                   |       | 6,694                       |       | 28.73                                   |       |                                              |       |                                                     |       |
| Exercised                            |       | —                      |       | —                                  |       |                                              |       |                                                     |       |
| Canceled,  forfeited, or expired     |       | (500                        | )          | 28.73                                   |       |                                              |       |                                                     |       |
| Outstanding at  March 31, 2008  |       | 16,635                      |       | $                                       | 28.73      |                                              | 0.3        |                                                     | $          | 72,030 |   |
|                                      |            |                             |            |                                         |            |                                                   |            |                                                          |            |  |  |

 

As reported in the consolidated statements of cash flows, cash receivedfrom option exercises under the Stock Plan for the periods ended March 31,2008 and 2007 was $0.1 million and $2.5 million, respectively. SFAS 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 

 

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as a cash flow from financing activities. Accordingly, for the periodsended March 31, 2008 and 2007, less than $0.1 million and $0.3 million,respectively, of excess tax benefits has been classified as an outflow fromoperating activities and an inflow from financing activities in the statementof cash flows. For the periods ended March 31, 2008 and 2007, less than$0.1 million and $0.5 million, respectively, of tax benefit from stock optionexercises is presented as a cash inflow from operating activities.

 

**(8)           Facility Rationalization - Band**

 

As part of our effort to reduce excess manufacturingcapacity in our band segment, in December 2007 we announced the pendingclosure of our Kenosha, Wisconsin woodwind manufacturing facility, which weexpect to cease operations in June 2008. This facility’s production iscurrently being relocated to our Elkhart, Indiana woodwind manufacturingfacility. In February 2008, management decided to terminate production ofmusical instrument cases, which were manufactured in a leased facility in NorthCarolina. The remaining production and assembly work occurring in that facilitywas not impacted by this termination, which occurred in April 2008.

 

As a result of these events, we previously recorded$0.1 million in facility impairment charges as a component of operatingexpenses and less than $0.1 million in severance costs as a component of costof goods sold for the year ended December 31, 2007. We recorded $0.4million in severance costs during the first quarter, and expect an additional$0.2 million during the second quarter of 2008. The severance liability andrelated activity associated with the band segment’s facility rationalizationproject are as follows:

 
| **Three Months Ended March 31,** | ** ** | **2008** | ** ** |
|------------------------------------------------------|------------|----------|------------|
| January 1,  2008                                |       | $        | 39         |   |
| Additions  charged to cost of sales                  |       | 367      |       |
| Payments                                             |       | —   |       |
| March 31,  2008                                 |       | $        | 406        |   |

 

We also recorded $0.1million of inventory write-down charges related to musical instrument cases inthe first quarter of 2008.

 

**(9)           OtherIncome, Net**

 
| **Three Months Ended March 31,** | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                 |       |     |       |     |       |
| West 57th  building income                           |       | $        | (1,163     | )        | $          | (1,163 | ) |
| West 57th  building expenses                         |       | 821      |       | 811      |       |
| Foreign exchange  (gains) losses, net                |       | (47      | )          | 235      |       |
| Miscellaneous                                        |       | 352      |       | (53      | )          |
| Other income,  net                                   |       | $        | (37        | )        | $          | (170 | ) |

 

**(10)         Commitments and Contingent Liabilities**

 

We are involved in certain legal proceedings regarding environmentalmatters, which are described below. Further, in the ordinary course ofbusiness, we are party to various legal actions that we believe are routine innature and incidental to the operation of our business. While the outcome ofsuch actions 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.

 

Certain environmental laws, such as the Comprehensive EnvironmentalResponse, Compensation, and Liability Act, as amended (“CERCLA”), imposestrict, retroactive, joint and several liability upon persons 

 

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responsible for releases of hazardous substances, which liability isbroadly construed. Under CERCLA and other laws, we may have liability forinvestigation and cleanup costs and other damages relating to our current orformer properties, or third-party sites to which we sent wastes for disposal.Our potential liability at any of these sites is affected by many factorsincluding, but not limited to, the method of remediation, our portion of thehazardous substances at the site relative to that of other parties, the numberof responsible parties, the financial capabilities of other parties, andcontractual rights and obligations.

 

In this regard, we operate certain manufacturing facilities which werepreviously owned by Philips Electronics North America Corporation (“Philips”).When we purchased these facilities, Philips agreed to indemnify us for certainenvironmental matters resulting from activities of Philips occurring prior to December 29,1988 (the “Environmental Indemnity Agreement”). To date, Philips has fullyperformed its obligations under the Environmental Indemnity Agreement, whichterminates on December 29, 2008, however, we cannot assure investors thatit will continue to do so in the future. Four matters covered by theEnvironmental Indemnity Agreement are currently pending. Philips has enteredinto Consent Orders with the Environmental Protection Agency (“EPA”) for onesite and the North Carolina Department of Environment, Health and NaturalResources for a second site, whereby Philips has agreed to pay requiredresponse costs. On October 22, 1998, we were joined as defendant in anaction involving a third site formerly occupied by a business we acquired inIllinois. Philips has accepted the defense of this action pursuant to the termsof the Environmental Indemnity Agreement. At the fourth site, which is a third-partywaste disposal site, four Conn-Selmer predecessor entities are among thepotentially responsible parties (“PRP”) group. The PRP group has recentlyentered into a Consent Order with the EPA, the site owners, and the largestcontributor. For two of the Conn-Selmer predecessor entities, which werepreviously owned by Philips, this matter was tendered to Philips pursuant tothe Environmental Indemnity Agreement. Philips is a party to the Consent Orderand has paid its share of the liability. The four Conn-Selmer predecessorentities paid approximately $0.1 million in 2006 and settled this claim exceptfor the possibility of a contingent remedial action, should any additionalenvironmental issues be discovered. We believe the likelihood of a contingencyassessment to be remote and, our share of the liability, if any, would not bematerial.

 

In addition, weare continuing an existing environmental remediation plan at a facility weacquired in 2000 and subsequently sold. We estimate our costs, whichapproximate $0.8 million, over a 13-year period. We have accrued approximately$0.6 million for the estimated remaining cost of this remediation program, whichrepresents the present value total cost using a discount rate of 4.54%. Asummary of expected payments associated with this project is as follows:

 
| ** **         | ** ** | **Environmental  Payments** | ** ** |
|--------------------|------------|-----------------------------|------------|
| Remainder of  2008 |       | $                           | 36         |   |
| 2009               |       | 61                          |       |
| 2010               |       | 61                          |       |
| 2011               |       | 61                          |       |
| 2012               |       | 61                          |       |
| Thereafter         |       | 484                         |       |
| Total              |       | $                           | 764        |   |

 

We received notification from the Arizona Department of EnvironmentalQuality (“ADEQ”) that, among other things, the required periodic reportsrelated to this environmental remediation effort were not filed timely for 1999-2005and, therefore, ADEQ has proposed a fine of $0.8 million. Since the violationsare limited to administrative items, and research indicates that fines paid toADEQ for similar violations (those with no

 

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environmental harm) were less than $0.1 million, we believe this matterwill be settled for $0.1 million and have included this amount in accountspayable.

 

In 2004, we acquired two manufacturing facilities from G. LeblancCorporation, now Grenadilla, Inc. (“Grenadilla”), for which environmentalremediation plans had already been established. In connection with theacquisition, we assumed the existing accrued liability of approximately $0.8million for the cost of these remediation activities. Based on a review of pastand ongoing investigatory and remedial work by our environmental consultants,and discussions with state regulatory officials, as well as periodic sampling,we estimate the remaining costs of such remedial plans to be $2.0 million. Pursuantto the purchase and sale agreement, we sought indemnification from Grenadillafor anticipated costs above the original estimate in the amount of $2.5million. We filed a claim against the escrow and recorded a correspondingreceivable for this amount in prepaid expenses and other current assets in ourconsolidated balance sheet. In 2007, we reduced this receivable to $2.1 millionbased on the current estimated costs of remediation. We have reached anagreement with Grenadilla whereby environmental costs are paid directly out ofthe escrow. Should the escrow be reduced to zero, we would seek furtherindemnification from Grenadilla for these additional costs. However, we cannotbe assured that we will be able to recover such costs.

 

Based on our past experience and currently available information, thematters described above and our other liabilities and compliance costs arisingunder environmental laws are not expected to have a material impact on ourcapital expenditures, earnings or competitive position in an individual year.However, some risk of environmental liability is inherent in the nature of ourcurrent and former business and we may, in the future, incur material costs tomeet current or more stringent compliance, cleanup, or other obligations pursuantto environmental laws.

 

**(11)         Retirement Plans**

 

We have defined benefit pension plans covering the majority of ouremployees, including certain employees in Germany and the U.K. The componentsof net periodic pension cost for these plans are as follows:

** **
| ** **                                           | ** ** | **Domestic Plans** | ** ** | **Foreign Plans** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| **Three Months Ended March 31,** | ** ** | **2008**                | ** ** | **2007**               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service cost                                         |       | $                       | 147        |                   | $          | 225 |   | $ | 203 |   | $ | 198 |   |
| Interest cost                                        |       | 854                     |       | 814                    |       | 482 |   | 394 |   |
| Expected return  on plan assets                      |       | (1,296                  | )          | (1,250                 | )          | (101 | ) | (90 | ) |
| Amortization of  prior service cost                  |       | 40                      |       | 108                    |       | — |   | — |   |
| Recognized loss                                      |       | 12                      |       | 128                    |       | 24 |   | 70 |   |
| Net periodic  benefit (income) cost                  |       | $                       | (243       | )                      | $          | 25 |   | $ | 608 |   | $ | 572 |   |

 

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Weprovide postretirement health care and life insurance benefits to certaineligible hourly retirees and their dependents. The components of net periodicpostretirement benefit cost for these benefits are as follows:

 
| **Three Months Ended March 31,** | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Service cost                                         |       | $        | 2          |     | $          | 10 |   |
| Interest cost                                        |       | 27       |       | 34       |       |
| Amortization of  transition obligation               |       | —   |       | 9        |       |
| Amortization of  prior service costs                 |       | (13      | )          | —   |       |
| Recognized loss  (gain)                              |       | 8        |       | (41      | )          |
| Net  postretirement benefit cost                     |       | $        | 24         |     | $          | 12 |   |

 

We do not intend to make any contributions to our domestic pension planthis year. Our anticipated contributions to the pension plan of our U.K.subsidiary approximate $0.2 million for the current year. As of March 31,2008, we have made contributions of less than $0.1 million to this plan. Thepension plans of our German entities do not hold any assets and use operatingcash to pay participant benefits as they become due. Expected 2008 benefitpayments under these plans are $1.4 million, of which $0.3 million was paid inthe first quarter.

 

**(12)****                         ****Segment Information**

 

Wehave identified two reportable segments: the piano segment and the band &orchestral instrument segment. We consider these two segments reportable asthey are managed separately and the operating results of each segment areseparately reviewed and evaluated by our senior management on a regular basis.Management and the chief operating decision maker use income from operations asa meaningful measurement of profit or loss for the segments. Income from operationsfor the reportable segments includes certain corporate costs allocated to thesegments based primarily on revenue, as well as intercompany profit. Amountsreported as “Other & Elim” include those corporate costs that were notallocated to the reportable segments and the remaining intercompany profitelimination.

 

The following tablespresent information about our operating segments for the three months ended March 31,2008 and 2007:

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band & Orchestral Segment** | ** ** | **Other** | ** ** | ** ** | ** ** |
|----------------------------------|------------|------------------------|------------|--------------------------------------------------|------------|-----------|------------|------------|------------|
| **2008**                         | ** ** | **U.S.**               | ** ** | **Germany**                                      | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Other** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Consolidated** | ** ** |
| Net sales to  external customers |       | $                      | 27,294     |                                             | $          | 14,931    |       | $          | 12,461     |   | $ | 54,686 |   | $ | 37,380 |   | $ | 2,120 |   | $ | 39,500 |   | $ | — |   | $ | 94,186 |   |
| Income (loss)  from operations   |       | 1,288                  |       | 3,648                                            |       | 856       |       | 5,792      |       | (11 | ) | (238 | ) | (249 | ) | (739 | ) | 4,804 |   |
|                                  |            |                        |            |                                                  |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band & Orchestral Segment** | ** ** | **Other &** | ** ** | ** ** | ** ** |
|----------------------------------|------------|-------------------|------------|----------------------------------------|------------|-----------------|------------|------------|------------|
| **2007**                         | ** ** | **U.S.**          | ** ** | **Germany**                            | ** ** | **Other**       | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Other** | ** ** | **Total** | ** ** | **Elim** | ** ** | **Consolidated** | ** ** |
| Net sales to  external customers |       | $                 | 29,628     |                                   | $          | 13,510          |       | $          | 9,787      |   | $ | 52,925 |   | $ | 38,779 |   | $ | 1,728 |   | $ | 40,507 |   | $ | — |   | $ | 93,432 |   |
| Income (loss)  from operations   |       | 1,942             |       | 3,601                                  |       | 793             |       | 6,336      |       | (899 | ) | 53 |   | (846 | ) | (1,123 | ) | 4,367 |   |
|                                  |            |                   |            |                                        |            |                 |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

**Introduction**

 

We are a worldleader in the design, manufacture, marketing, and distribution of high qualitymusical instruments. Our piano division concentrates on the high-end grandpiano segment of the industry, handcrafting Steinway pianos in New York andGermany. We also offer upright pianos and two mid-priced lines of pianos underthe Boston and Essex brand names. We are also the largest domestic producer ofband and orchestral instruments and offer a complete line of brass, woodwind,percussion and string instruments and related accessories with well-known brandnames such as Bach, Selmer, C.G. Conn, Leblanc, King, and Ludwig. We sell ourproducts through dealers and distributors worldwide. Our piano customer baseconsists of professional artists, amateur pianists, and institutions such asconcert halls, universities, and music schools. Our band and orchestral instrumentcustomer base consists primarily of middle school and high school students, butalso includes adult amateur and professional musicians.

 

**CriticalAccounting Policies**

 

The Securities and Exchange Commission (“SEC”) has issued disclosureguidance 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 and assumptions duringthe preparation of the consolidated financial statements. These estimates andassumptions impact the reported amount of assets and liabilities anddisclosures of contingent assets and liabilities as of the date of theconsolidated financial statements. Estimates and assumptions are reviewedperiodically and the effects of revisions are reflected in the consolidatedfinancial statements in the period they are determined to be necessary. Actualresults could differ from those estimates.

 

The significant accounting policies are described in Note 2 of theNotes to Consolidated Financial Statements included in the Company’s 2007 AnnualReport on Form 10-K. Not all of these significant accounting policiesrequire management to make difficult, subjective or complex judgments orestimates. However, management considers the following to be criticalaccounting policies based on the definition above.

 

**AccountsReceivable**

 

We establish reserves for accounts receivable andnotes receivable. We review overall collectibility trends and customercharacteristics such as debt leverage, solvency, and outstanding balances inorder to develop our reserve estimates. Historically, a large portion of oursales at both our piano and band divisions has been generated by our top 15customers. As a result, we experience some inherent concentration of creditrisk in our accounts receivable due to its composition and the relativeproportion of large customer receivables to the total. This is especially trueat our band division, which characteristically has a majority of ourconsolidated accounts receivable balance. We consider the credit health andsolvency of our customers when developing our receivable reserve estimates.

 

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**Inventory**

 

We establish inventory reserves for items such aslower-of-cost-or-market and obsolescence. We review inventory levels on a detailedbasis, concentrating on the age and amounts of raw materials, work-in-process,and finished goods, as well as recent usage and sales dates and quantities tohelp develop our estimates. Ongoing changes in our business strategy, includinga shift from batch processing to single piece production flow, coupled withincreased offshore sourcing, could affect our ability to realize the currentcost of our inventory, and are considered by management when developing ourestimates. We also establish reserves for anticipated book-to-physicaladjustments based upon our historical level of adjustments from our annualphysical inventories. We account for our inventory using standard costs.Accordingly, variances between actual and standard costs that are not abnormalin nature are capitalized into inventory and released based on calculatedinventory turns.

 

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

 

We establish self-insured workers’ compensation andhealth claims reserves based on our trend analysis of data provided bythird-party administrators regarding historical claims and anticipated futureclaims.

 

**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**

 

We review long-lived assets,such as property, plant, and equipment, for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. We measure recoverability by comparing the carrying amount ofthe asset to the estimated future cash flows the asset is expected to generate.

 

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 mayhave decreased below its carrying value. Our assessment is based on severalanalyses, including a comparison of estimated fair values to our marketcapitalization and multi-year cash flows.

 

**Pensions and Other PostretirementBenefit Costs**

 

We make certainassumptions when calculating our benefit obligations and expenses. We base ourselection of assumptions, such as discount rates and long-term rates of return,on information provided by our actuaries, investment advisors, investmentcommittee, current rate trends, and historical trends for our pension assetportfolio. Our benefit obligations and expenses can fluctuate significantlybased on the assumptions management selects.

 

**Income Taxes**

 

We record valuation allowances for certain deferredtax assets related to foreign tax credit carryforwards and state net operatingloss carryforwards. When assessing the realizability of deferred tax assets, weconsider whether it is more likely than not that the deferred tax assets willbe fully realized. The ultimate realization of these assets is dependent uponmany factors, including the ratio of foreign source income to overall incomeand generation of sufficient future taxable income in the states for which wehave loss carryforwards. When establishing or adjusting valuation allowances,we consider these factors, as well as

 

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anticipated trends inforeign source income and tax planning strategies which may impact futurerealizability of these assets.

 

A liability has been recorded for uncertain taxpositions. When analyzing these positions, we consider the probability ofvarious outcomes which could result from examination, negotiation, orsettlement with various taxing authorities. The final outcome on thesepositions could differ significantly from our original estimates due toexpiring statues of limitations, availability of detailed historical data, theresults of audits or examinations conducted by taxing authorities or agentsthat vary from management’s anticipated results, identification of new taxcontingencies, the release of applicable administrative tax guidance,management’s decision to settle or appeal assessments, or the rendering ofcourt decisions affecting our estimates of tax liabilities, as well as otherfactors.

 

**Stock-Based Compensation**

 

We grant stock-based compensation awards whichgenerally vest over a specified period. When determining the fair value ofstock options and subscriptions to purchase shares under the Purchase Plan, weuse the 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. Theestimated fair value of the options and subscriptions to purchase shares, andthe resultant stock-based compensation expense, can fluctuate based on theassumptions used by management.

 

**Environmental Liabilities**

 

We make certain assumptions when calculating ourenvironmental liabilities. We base our selection of assumptions, such as costand length of time for remediation, on data provided by our environmentalconsultants, as well as information provided by regulatory authorities. We alsomake certain assumptions regarding the indemnifications we have received fromothers, including whether remediation costs are within the scope of theindemnification, the indemnifier’s ability to perform under the agreement, andwhether past claims have been successful. Our environmental obligations andexpenses can 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 andExchange Act of 1934, as amended. These forward-looking statements representour present expectations or beliefs concerning future events. We caution thatsuch statements are necessarily based on certain assumptions which are subjectto risks and uncertainties which could cause actual results to differmaterially from those indicated in this report. These risk factors include, butare not limited to, the following: changes in general economic conditions;recent geopolitical events; increased competition; work stoppages andslowdowns; impact of dealer consolidations on orders; ability of new workers tomeet desired production levels; exchange rate fluctuations; variations in themix of products sold; market acceptance of new product and distributionstrategies; ability of suppliers to meet demand; concentration of credit risk;fluctuations in effective tax rates resulting from shifts in sources of income;and the ability to successfully integrate and operate acquired businesses.Further information on these risk factors is included in Item 1A of our AnnualReport on Form 10-K for the year ended December 31, 2007. Weencourage you to read those descriptions carefully. We caution investors not toplace undue reliance on the forward-looking statements contained in this report.These statements, like all statements contained in this report, speak only asof the date of this report

 

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(unless another date isindicated) and we undertake no obligation to update or revise the statementsexcept as required by law.

 

**Results of Operations**

 

ThreeMonths Ended March 31, 2008 Compared to Three Months Ended March 31,2007

* *
| ** **                      | ** ** | **Three Months Ended March 31,** | ** ** | ** ** | ** ** | **Change** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2008**                                             | ** ** | ** ** | ** ** | **2007**   | ** ** | ** ** | ** ** | **$ ** | ** ** | **%** | ** ** |
|                            |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Net sales                       |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Band                            |       | $                                                    | 39,500     |       |       |       | $          | 40,507 |   |   |   | (1,007 | ) | (2.5 | ) |
| Piano                           |       | 54,686                                               |       |       |       | 52,925     |       |   |   | 1,761 |   | 3.3 |   |
| Total sales                     |       | 94,186                                               |       |       |       | 93,432     |       |   |   | 754 |   | 0.8 |   |
|                            |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Cost of sales                   |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Band                            |       | 30,975                                               |       |       |       | 32,305     |       |   |   | (1,330 | ) | (4.1 | ) |
| Piano                           |       | 35,819                                               |       |       |       | 33,887     |       |   |   | 1,932 |   | 5.7 |   |
| Total cost of  sales            |       | 66,794                                               |       |       |       | 66,192     |       |   |   | 602 |   | 0.9 |   |
|                            |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Gross profit                    |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Band                            |       | 8,525                                                |       | 21.6%      |       | 8,202      |       | 20.2% |   | 323 |   | 3.9 |   |
| Piano                           |       | 18,867                                               |       | 34.5%      |       | 19,038     |       | 36.0% |   | (171 | ) | (0.9 | ) |
| Total gross  profit             |       | 27,392                                               |       |       |       | 27,240     |       |   |   | 152 |   | 0.6 |   |
|                            |       | 29.1%                                                |       |       |       | 29.2%      |       |   |   |   |   |   |   |
|                            |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Operating  expenses             |       | 22,588                                               |       |       |       | 22,873     |       |   |   | (285 | ) | (1.2 | ) |
|                            |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Income from  operations         |       | 4,804                                                |       |       |       | 4,367      |       |   |   | 437 |   | 10.0 |   |
|                            |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Other income,  net              |       | (37                                                  | )          |       |       | (170       | )          |   |   | 133 |   | (78.2 | ) |
| Gain on  extinguishment of debt |       | (636                                                 | )          |       |       | —     |       |   |   | (636 | ) | — |   |
| Net interest  expense           |       | 2,157                                                |       |       |       | 2,152      |       |   |   | 5 |   | 0.2 |   |
| Non-operating  expenses         |       | 1,484                                                |       |       |       | 1,982      |       |   |   | (498 | ) | (25.1 | ) |
|                            |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Income before  income taxes     |       | 3,320                                                |       |       |       | 2,385      |       |   |   | 935 |   | 39.2 |   |
|                            |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Income tax  provision           |       | 1,345                                                |       | 40.5%      |       | 955        |       | 40.0% |   | 390 |   | 40.8 |   |
|                            |       |                                                 |       |       |       |       |       |   |   |   |   |   |   |
| Net income                      |       | $                                                    | 1,975      |       |       |       | $          | 1,430 |   |   |   | 545 |   | 38.1 |   |

 

**Overview***-*Piano division revenueimproved due to strong mid-priced piano line sales and consistent Steinwaygrand shipments overseas. Despite the revenue improvement, piano marginsdeteriorated due to fewer Steinway grand retail sales overseas, as well as theshift towards lower margin mid-priced pianos. The shortfall in band divisionsales was caused by backorders and delivery issues for certain student levelsourced instruments, which we expect to improve during the second quarter. Banddivision margins improved due to a shift in mix towards higher marginintermediate and professional level instruments.

 

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**Net Sales** – Despitea $1.0 million decrease in band division sales, net sales improved slightly dueto higher overseas piano division sales, which increased $4.1 million. $2.9million of this increase is attributable to foreign currency translation, whilean additional $1.5 million was generated by improved Steinway and Boston grandpiano sales in China. Domestic piano division sales decreased $2.3 million dueto fewer sales at the wholesale level, which resulted in a 21% decrease inSteinway grand piano sales. Retail sales remained strong, largely due toinstitutional sales. Although band division shipments decreased 18% due to thebackorder status of certain student instruments which we source from thirdparties, the shift in mix from lower-priced student band instruments tointermediate and professional level instruments mitigated the adverse impact onrevenue.

 

**Gross Profit***-* Gross profit remainedrelatively stable, as improved band division margins and profit offset lowermargins and profit at our piano division. Domestically, piano margins were onpar with the prior period (31.9% vs. 31.8%) due to the shift towards retailsales. Overseas margins deteriorated due to fewer retail sales and the adverseimpact of a strong euro in certain parts of Europe and Asia. The band division’sgross profit benefited from the shift in mix towards higher margin intermediateand professional level band instruments. Additionally, improved overheadabsorption at our Elkhart, Indiana brass instrument manufacturing facility morethan offset the adverse impact of production inefficiencies and $0.4 million inseverance costs associated with plant closures.

 

**Operating Expenses** – Operating expenses decreased $0.3 million despite the adverse impactof $0.5 million in foreign currency translation and $0.2 million increase inbad debt reserves. The major contributing factor to this decrease was theabsence of $0.5 million reserve against the $2.0 million escrowed deposit relatingto an asset purchase agreement, which occurred in the year-ago period.

 

**Non-operating Expenses** - Non-operating expenses decreased $0.5 million due to the $0.6million gain on extinguishment of $5.8 million of our Senior Notes. Netinterest expense remained consistent, as the debt extinguishment occurredtowards the end of the period. The $0.3 million shift from foreign exchangelosses to foreign exchange gains was offset by a shift of the same amount fromunrealized gains to unrealized losses on Supplemental Executive Retirement Planassets.

 

**Income Taxes**-**Our effective tax rate is comprised of38% associated with current year income and 2.5% relating to uncertain taxpositions. In the year-ago period, the impact of these positions was notmaterial to the effective rate.

 

**Liquidity and Capital Resources**

 

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

 

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Ourstatements of cash flows for the three months ended March 31, 2008 and2007 are summarized as follows:

 
| ** **                                                                   | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
| Net income:                                                                  |       | $        | 1,975      |     | $          | 1,430      |       | $ | 545 |   |
| Changes  in operating assets and liabilities                                 |       | (5,883   | )          | (15,076  | )          | 9,193      |       |
| Other  adjustments to reconcile net income to cash from operating activities |       | 1,629    |       | 1,654    |       | (25        | )          |
| Cash flows from  operating activities                                        |       | (2,279   | )          | (11,992  | )          | 9,713      |       |
|                                                                         |       |     |       |     |       |       |       |
| Cash flows from  investing activities                                        |       | (760     | )          | (829     | )          | 69         |       |
|                                                                         |       |     |       |     |       |       |       |
| Cash flows from  financing activities                                        |       | (4,999   | )          | (8,280   | )          | 3,281      |       |
|                                                                              |            |          |            |          |            |            |            |  |  |  |

 

Cash flowsgenerated from operating activities improved $9.7 million due to improvementsin working capital accounts, as cash provided by accounts receivable andinventory increased $2.5 million and $4.1 million, respectively.  In addition, cash generated by accountspayable increased $3.6 million, largely due to timing of payments to banddivision vendors.

 

Cash flows usedfor investing activities decreased slightly as the increase in cash used forcapital expenditures of $0.2 million was more than offset by proceeds from thesale of non-manufacturing assets overseas. We expect capital expenditures to bein the range of $5.0 to $7.0 million in 2008.

 

The use of cashfor financing activities decreased $3.3 million as compared to the year-agoperiod. In 2007, we paid $25.2 million in dividends with operating cashsupplemented by domestic line of credit borrowings. In 2008, we had no domesticline of credit borrowings, so cash used for financing activities was limited tothe extinguishment of $5.8 million of our Senior Notes.

 

**BorrowingActivities and Availability** - We have a domestic credit facility with asyndicate of domestic lenders (the “Credit Facility”). The Credit Facilityprovides us with a potential borrowing capacity of $110.0 million in revolvingcredit loans, and expires on September 29, 2011. It also provides forperiodic borrowings at either London Interbank Offering Rate (“LIBOR”) plus arange from 1.25% to 1.75%, or as-needed borrowings at an alternate base rate,plus a range from 0.00% to 0.25%; both ranges depend upon borrowingavailability at the time of borrowing. The Credit Facility is collateralized byour domestic accounts receivable, inventory, and fixed assets. As of March 31,2008, there was nothing outstanding on our Credit Facility, and borrowingavailability, net of letters of credit, was approximately $98.7 million.

 

Wealso have certain non-domestic credit facilities originating from two Germanbanks that provide for borrowings by foreign subsidiaries of up to €17.5million ($27.7 million at the March 31, 2008 exchange rate), net ofborrowing restrictions of €0.5 million ($0.9 million at the March 31, 2008exchange rate) and are payable on demand. These borrowings are collateralizedby most of the assets of the borrowing subsidiaries. A portion of the loans canbe converted into a maximum of £0.5 million ($1.0 million at the March 31,2008 exchange rate) for use by our U.K. branch and ¥300 million ($3.0 millionat the March 31, 2008 exchange rate) for use by our Japanese subsidiary.Our Chinese subsidiary also has the ability to convert the equivalent of up to €2.5million into U.S. dollars or Chinese yuan ($3.9 million at the March 31,2008 exchange rate). Euro loans bear interest at rates of Euro InterbankOffered Rate (“EURIBOR”) plus a margin determined at the time of borrowing.Margins fluctuate based on the loan amount and the borrower’s bank rating. Theremaining demand borrowings bear interest rates of LIBOR plus 0.8% for Britishpound loans, LIBOR plus 1.0% for U.S. dollar loans of our Chinese subsidiary,and Tokyo Interbank Offered Rate (“TIBOR”) plus 0.9% for Japanese yenloans.  We had no outstanding borrowingsas of March 31, 2008 on these credit facilities.

 

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OurJapanese subsidiary also maintains a separate revolving loan agreement thatprovides additional borrowing capacity of up to ¥460 million ($4.6 million atthe March 31, 2008 exchange rate) based on eligible inventory balances.The revolving loan agreement bears interest at an average 30-day TIBOR rateplus 1.0% (outstanding borrowings at 1.6% at March 31, 2008) and expireson January 31, 2010. As of March 31, 2008, we had $2.5 millionoutstanding on this revolving loan agreement.

 

At March 31,2008, our total outstanding indebtedness amounted to $171.8 million, consistingof $169.3 million of 7.00% Senior Notes and $2.5 million of notes payable toforeign banks.

 

Allof our debt agreements contain covenants that place certain restrictions on us,including our ability to incur additional indebtedness, to make investments inother entities, and limitations on cash dividend payments. We were incompliance with all such covenants as of March 31, 2008 and do notanticipate any compliance issues in the future. Our bond indenture containslimitations, based on net income (among other things), on the amount ofdiscretionary repurchases we may make of our Ordinary common stock. Our intentand ability to repurchase additional Ordinary common stock either directly fromshareholders or on the open market is directly affected by this limitation.

 

We experience long production and inventory turnovercycles, which we constantly monitor since fluctuations in demand can have asignificant impact on these cycles. We expect to effectively utilize cash flowfrom operations to fund our debt and capital requirements and pay off ourseasonal borrowings on our domestic line of credit. Currently we anticipateboth our piano and band divisions to be stable or improve throughout theperiod. Our intention is to manage accounts receivable and customer credit,reduce inventory levels, and repay credit facility borrowings.

 

We donot have any current plans or intentions that will have a material adverseimpact on our liquidity in 2008, although we may consider acquisitions that mayrequire funding from operations or from our credit facilities. Other than thosedescribed, we are not aware of any trends, demands, commitments, or costs ofresources that are expected to materially impact our liquidity or capitalresources. Accordingly, we believe that cash on hand, together with cash flowsanticipated from operations and available borrowings under the Credit Facility,will be adequate to meet our debt service requirements, fund continuing capitalrequirements and satisfy our working capital and general corporate needsthrough the remainder of 2008.

 

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**ContractualObligations** - Thefollowing table provides a summary of our contractual obligations at March 31,2008.

 
| ** **                       | ** ** | **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)               |       | $                          | 241,897    |   | $ | 14,397 |   | $ | 23,695 |   | $ | 23,695 |   | $ | 180,110 |   |
| Capital leases                   |       | 35                         |       | 16 |   | 19 |   | — |   | — |   |
| Operating leases (2)             |       | 264,804                    |       | 4,831 |   | 9,413 |   | 8,109 |   | 242,451 |   |
| Purchase obligations (3)         |       | 24,979                     |       | 24,963 |   | 16 |   | — |   | — |   |
| Other long-term  liabilities (4) |       | 40,147                     |       | 8,179 |   | 4,737 |   | 4,723 |   | 22,508 |   |
| Total                            |       | $                          | 571,862    |   | $ | 52,386 |   | $ | 37,880 |   | $ | 36,527 |   | $ | 445,069 |   |

 

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**Notes to Contractual Obligations:**

 
| (1) | Long-term debt represents long-term debt obligations, the fixed  interest on our Notes, and the variable interest on our other loans. We  estimated the future variable interest obligation using the applicable  March 31, 2008 rates. The nature of our long-term debt obligations,  including changes to our long-term debt structure, is described more fully in  the “Borrowing Availability and Activities” section of “Liquidity and Capital  Resources.”                                                             |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Approximately $250.5 million of our operating lease obligations are  attributable to the ninety-nine year land lease associated with the purchase  of Steinway Hall; the remainder is attributable to the leasing of other  facilities and equipment.                                                                                                                                                                                                                                                                                                 |
| (3) | Purchase obligations consist of firm purchase commitments for raw  materials, finished goods, and equipment.                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (4) | Our other long-term liabilities consist primarily of the long-term  portion of our pension obligations, which are described in Note 11 in the  Notes to Consolidated Financial Statements included within this filing,  liabilities relating to uncertain tax positions which are expected to be  settled within one year, and obligations under employee and consultant  agreements. We have not included $2.6 million of liabilities relating to  uncertain tax positions within this schedule due to the uncertainty of the  payment date, if any. |

 

**RecentAccounting Pronouncements**

 

On January 1, 2008, we adopted Statement ofFinancial Accounting Standards (“SFAS”) No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities—including an amendment of FASBStatement No. 115,” (“SFAS 159”). SFAS 159 permits entities to choose tomeasure many financial instruments and certain other assets and liabilities atfair value on an instrument-by-instrument basis (the fair value option) withchanges in fair value reported in earnings. We already record marketablesecurities at fair value in accordance with SFAS No. 115, “Accounting forCertain Investments in Debt and Equity Securities,” and derivative contractsand hedging activities at fair value in accordance with SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” as amended. The adoption ofSFAS 159 had no impact on our consolidated financial position and results ofoperations as management did not elect the fair value option for any otherfinancial instruments or certain other assets and liabilities.

 

In September 2006, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157defines fair value, establishes a framework for measuring fair value and expandsdisclosures about fair value measurements. On January 1, 2008, we adopted SFAS157, which did not have an impact on our consolidated financial statements. In February 2008,the FASB delayed the effective date of SFAS 157 for all nonrecurring fair valuemeasurements of nonfinancial assets and nonfinancial liabilities. We willcomply with this component of SFAS 157 January 1, 2009. We are currentlyevaluating these requirements of SFAS 157 and have not yet determined theimpact its adoption will have on our consolidated financial statements.

 

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InDecember 2007, the FASB issued SFAS No. 141R, “Business Combinations,”a revision to SFAS No. 141, “Business Combinations” (“ SFAS 141R”),which provides revised guidance for recognition and measurement of identifiableassets and goodwill acquired, liabilities assumed, and any noncontrollinginterest in the acquiree at fair value.  The Statement alsoestablishes disclosure requirements to enable the evaluation of the nature andfinancial effects of a business combination. SFAS 141R is required to beapplied prospectively to business combinations for which the acquisition dateis on or after the beginning of the first annual reporting period beginning onor after December 15, 2008. We will comply with SFAS 141R January 1,2009.  We are currently evaluating the potential impact, if any, of theadoption of SFAS 141R on our consolidated financial statements.

 

InDecember 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements – an amendment of ARB No. 51”(“SFAS 160”).  This Statement establishesaccounting and reporting standards for ownership interests in subsidiaries heldby parties other than the parent. Specifically, SFAS 160 requires thepresentation of noncontrolling interests as equity in the ConsolidatedStatement of Financial Position, and separate identification and presentationin the Consolidated Statement of Operations of net income attributable to theentity and the noncontrolling interest. It also establishes accounting andreporting standards regarding deconsolidation and changes in a parent’sownership interest. We will be required to comply with SFAS 160 January 1,2009.  The provisions of SFAS 160 are generally required to be appliedprospectively, except for the presentation and disclosure requirements, whichmust be applied retrospectively. We are currently evaluating the potentialimpact, if any, of the adoption of SFAS 160 on our consolidated financial statements.

 

InMarch 2008, the FASB issued SFAS No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133”(“SFAS 161”). This Statement amends and expands the disclosurerequirements for derivative instruments and hedging activities, with the intentto provide users of financial statements with an enhanced understanding of howand why an entity uses derivative instruments, how derivative instruments andrelated hedged items are accounted for, and how derivative instruments andrelated hedged items affect an entity’s financial statements. We willcomply with SFAS 161 January 1, 2009.

 

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**ITEM 3           QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

We are exposed to marketrisk associated with changes in foreign currency exchange rates and interestrates. We mitigate a portion of our foreign currency exchange rate risk bymaintaining foreign currency cash balances and holding option and forwardforeign currency contracts. They are not designated as hedges for accountingpurposes. These contracts relate primarily to intercompany transactions and arenot used for trading or speculative purposes. The fair value of the option andforward foreign currency exchange contracts is sensitive to changes in foreigncurrency exchange rates. The impact of an adverse change in foreign currencyexchange rates would not be materially different than that disclosed in ourAnnual Report on Form 10-K for the year ended December 31, 2007.

 

Our revolving loans bearinterest at rates that fluctuate with changes in Prime, LIBOR, TIBOR, andEURIBOR. As such, our interest expense on our revolving loans and the fairvalue of our fixed long-term debt are sensitive to changes in market interestrates. The effect of an adverse change in market interest rates on our interestexpense would not be materially different than that disclosed in our AnnualReport on Form 10-K for the year ended December 31, 2007.

 

The majority of ourlong-term debt is at a fixed interest rate. Therefore, the associated interestexpense is not sensitive to fluctuations in market interest rates. However, thefair value of our fixed interest debt would be sensitive to market ratechanges. Such fair value changes may affect our decision whether to retain,replace, or retire this debt.

 

**ITEM 4           CONTROLS AND PROCEDURES**

 

As of the end of the periodcovered by this report, we evaluated the effectiveness of the design andoperation of our disclosure controls and procedures (as defined in Exchange ActRules 13a-15(e) and 15d-15(e)). Our disclosure controls andprocedures are the controls and other procedures that we designed to ensurethat we record, process, summarize and report in a timely manner theinformation we must disclose in reports that we file with or submit to the SEC.Our Chief Executive Officer and Chief Financial Officer reviewed andparticipated in this evaluation. Based on this evaluation, the Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures were effective. In designing the Company’s disclosure controls andprocedures, the Company’s management recognizes that any controls, no matterhow well designed and operated, can only provide reasonable, not absolute,assurance of achieving the desired control objectives.

 

During the quarter coveredby this report, there were no significant changes in our internal controls thatmaterially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

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**PART II****                OTHERINFORMATION**

 

**ITEM 6              EXHIBITS**

 
| (i)    |   | Exhibits                                                                                                                                                              |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                  |
| 31.1   |   | Certification  of the Principal Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                     |
|   |   |                                                                                                                                                                  |
| 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 |

 

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**SIGNATURES**

 

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

 

 
|                    | STEINWAY  MUSICAL INSTRUMENTS, INC.              |
|-------------------------|--------------------------------------------------|
|                    |                                             |
|                    | /s/  Dana D. Messina                             |
|                    | Dana  D. Messina                                 |
|                    | Director,  President and Chief Executive Officer |
|                    |                                             |
|                    | /s/ Dennis M. Hanson                             |
|                    | Dennis M. Hanson                                 |
|                    | Senior  Executive Vice President and             |
|                    | Chief  Financial Officer                         |
|                    |                                             |
|                    |                                             |
| Date:  May 8, 2008 |                                             |

 

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