**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

| **ý** |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**  |
|------------|--------|-----------------------------------------------------------------------------------------------------|
|       |   |                                                                                                |
|       |   | **FOR THE QUARTERLY PERIOD ENDED  SEPTEMBER 27, 2003**                                         |
|       |   |                                                                                                |
| **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.**

(Exactname of registrant as specified in its charter)

 

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

 

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

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements during the past 90 days.

Yes ý     Noo

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

Yes ý     Noo

 
| Number of shares  of Common Stock issued and outstanding as of October 31, 2003: |   | Class A  |   | 477,953   |   |
|---------------------------------------------------------------------------------------|--------|----------|--------|-----------|--------|
|                                                                                  |   | Ordinary |   | 8,463,494 |   |
|                                                                                  |   | Total    |   | 8,941,447 |   |

 

 

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

**FORM 10-Q**

**INDEX**

 
| **PART  I.** | **UNAUDITED  FINANCIAL INFORMATION**                                                                                                  |
|--------------|---------------------------------------------------------------------------------------------------------------------------------------|
|         |                                                                                                                                  |
| **Item 1.**  | **Condensed Consolidated Financial  Statements:**                                                                                     |
|         |                                                                                                                                  |
|         | Condensed  Consolidated Statements of Income  Three months and nine months ended September 28, 2002 and  September 27, 2003 |
|         |                                                                                                                                  |
|         | Condensed Consolidated  Balance Sheets  December 31, 2002 and September 27, 2003                                            |
|         |                                                                                                                                  |
|         | Condensed  Consolidated Statements of Cash Flows  Nine months ended September 28, 2002 and September 27, 2003               |
|         |                                                                                                                                  |
|         | Notes  to Condensed Consolidated Financial Statements                                                                                 |
|         |                                                                                                                                  |
| **Item 2.**  | **Management’s Discussion and  Analysis of Financial Condition and Results of Operations**                                       |
|         |                                                                                                                                  |
| **Item 3.**  | **Quantitative and Qualitative Disclosures about  Market Risk**                                                                       |
|         |                                                                                                                                  |
| **Item 4.**  | **Controls and Procedures**                                                                                                           |
|         |                                                                                                                                  |
| **PART II.** | **OTHER INFORMATION**                                                                                                                 |
|         |                                                                                                                                  |
| **Item 6.**  | **Exhibits and Reports on Form 8-K**                                                                                                  |
|         |                                                                                                                                  |
|         | **Signatures**                                                                                                                        |

 

2

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| **ITEM 1****. ** | **CONDENSED CONSOLIDATED FINANCIAL  STATEMENTS** |
|-----------------------|--------------------------------------------------|

 

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

**CONDENSED CONSOLIDATED STATEMENTS OFINCOME**

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

** **
|                              |   | **Three  Months Ended**      |   | **Nine  Months Ended**       |   |
|-----------------------------------|--------|------------------------------|--------|------------------------------|--------|
|                              |   | **September 28,  2002** |   | **September 27,  2003** |   | **September 28,  2002** |   | **September 27,  2003** |   |
|                              |   |                         |   |                         |   |   |   |   |   |
| Net sales                         |   | $                            | 75,320 |                         | $      | 82,546 |   | $ | 241,728 |   | $ | 243,090 |   |
| Cost of sales                     |   | 54,019                       |   | 59,655                       |   | 170,679 |   | 176,654 |   |
|                              |   |                         |   |                         |   |   |   |   |   |
| Gross Profit                      |   | 21,301                       |   | 22,891                       |   | 71,049 |   | 66,436 |   |
|                              |   |                         |   |                         |   |   |   |   |   |
| Operating  expenses:              |   |                         |   |                         |   |   |   |   |   |
| Sales and marketing               |   | 9,497                        |   | 9,383                        |   | 30,127 |   | 31,340 |   |
| General and  administrative       |   | 5,286                        |   | 5,480                        |   | 16,215 |   | 16,969 |   |
| Amortization                      |   | 288                          |   | 288                          |   | 866 |   | 865 |   |
| Other operating  expense          |   | 204                          |   | 110                          |   | 611 |   | 418 |   |
| Facility  rationalization charges |   | —                       |   | 2,075                        |   | — |   | 2,075 |   |
| Total operating  expenses         |   | 15,275                       |   | 17,336                       |   | 47,819 |   | 51,667 |   |
|                              |   |                         |   |                         |   |   |   |   |   |
| Income from  operations           |   | 6,026                        |   | 5,555                        |   | 23,230 |   | 14,769 |   |
|                              |   |                         |   |                         |   |   |   |   |   |
| Interest  expense, net            |   | 3,555                        |   | 3,189                        |   | 10,345 |   | 9,168 |   |
| Other income,  net                |   | (390                         | )      | (699                         | )      | (1,933 | ) | (2,032 | ) |
|                              |   |                         |   |                         |   |   |   |   |   |
| Income before  income taxes       |   | 2,861                        |   | 3,065                        |   | 14,818 |   | 7,633 |   |
|                              |   |                         |   |                         |   |   |   |   |   |
| Provision for  income taxes       |   | 670                          |   | 1,227                        |   | 4,860 |   | 2,952 |   |
|                              |   |                         |   |                         |   |   |   |   |   |
| Net income                        |   | $                            | 2,191  |                         | $      | 1,838 |   | $ | 9,958 |   | $ | 4,681 |   |
|                              |   |                         |   |                         |   |   |   |   |   |
| Earnings per  share:              |   |                         |   |                         |   |   |   |   |   |
| Basic and  Diluted                |   | $                            | 0.25   |                         | $      | 0.21 |   | $ | 1.12 |   | $ | 0.53 |   |
|                              |   |                         |   |                         |   |   |   |   |   |
| Weighted average  shares:         |   |                         |   |                         |   |   |   |   |   |
| Basic                             |   | 8,894,580                    |   | 8,930,613                    |   | 8,867,595 |   | 8,914,363 |   |
| Diluted                           |   | 8,894,620                    |   | 8,931,709                    |   | 8,892,453 |   | 8,914,712 |   |

 

See notes to condensedconsolidated financial statements.

 

3

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

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(In Thousands)**

** **
|                                                                                                                          |   | **December 31,  2002** |    | **September 27,  2003** |   |
|-------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|------------------------------|--------|
|                                                                                                                          |   |                        |    |                         |   |
| ASSETS:                                                                                                                       |   |                        |    |                         |   |
| Current assets:                                                                                                               |   |                        |    |                         |   |
| Cash                                                                                                                          |   | $                           | 19,099  |                         | $      | 18,713 |   |
| Accounts, notes  and leases receivable, net of allowance for bad debts of $11,389 and $10,831  in 2002 and 2003, respectively |   | 77,421                      |    | 94,638                       |   |
| Inventories                                                                                                                   |   | 163,090                     |    | 161,182                      |   |
| Prepaid expenses  and other current assets                                                                                    |   | 5,227                       |    | 4,578                        |   |
| Deferred tax  assets                                                                                                          |   | 7,012                       |    | 7,690                        |   |
| Total current  assets                                                                                                         |   | 271,849                     |    | 286,801                      |   |
|                                                                                                                          |   |                        |    |                         |   |
| Property, plant  and equipment, net of accumulated depreciation of $55,151 and $62,733 in 2002  and 2003, respectively        |   | 102,567                     |    | 97,897                       |   |
| Trademarks                                                                                                                    |   | 9,651                       |    | 9,965                        |   |
| Goodwill                                                                                                                      |   | 29,539                      |    | 30,540                       |   |
| Other  intangibles, net                                                                                                       |   | 6,936                       |    | 6,105                        |   |
| Other assets                                                                                                                  |   | 7,692                       |    | 7,789                        |   |
|                                                                                                                          |   |                        |    |                         |   |
| TOTAL ASSETS                                                                                                                  |   | $                           | 428,234 |                         | $      | 439,097 |   |
|                                                                                                                          |   |                        |    |                         |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                    |   |                        |    |                         |   |
| Current  liabilities:                                                                                                         |   |                        |    |                         |   |
| Current portion  of long-term debt                                                                                            |   | $                           | 8,055   |                         | $      | 9,159 |   |
| Accounts payable                                                                                                              |   | 9,888                       |    | 8,452                        |   |
| Other current  liabilities                                                                                                    |   | 35,264                      |    | 39,186                       |   |
| Total current  liabilities                                                                                                    |   | 53,207                      |    | 56,797                       |   |
|                                                                                                                          |   |                        |    |                         |   |
| Long-term debt                                                                                                                |   | 192,581                     |    | 187,627                      |   |
| Deferred tax  liabilities                                                                                                     |   | 22,709                      |    | 24,084                       |   |
| Other  non-current liabilities                                                                                                |   | 23,931                      |    | 26,219                       |   |
| Total  liabilities                                                                                                            |   | 292,428                     |    | 294,727                      |   |
|                                                                                                                          |   |                        |    |                         |   |
| Commitments and  contingent liabilities                                                                                       |   |                        |    |                         |   |
|                                                                                                                          |   |                        |    |                         |   |
| Stockholders’  equity:                                                                                                   |   |                        |    |                         |   |
| Common stock                                                                                                                  |   | 9                           |    | 9                            |   |
| Additional  paid-in capital                                                                                                   |   | 73,172                      |    | 73,673                       |   |
| Retained  earnings                                                                                                            |   | 91,620                      |    | 96,301                       |   |
| Accumulated  other comprehensive loss, net                                                                                    |   | (13,142                     | )       | (9,760                       | )      |
| Treasury stock,  at cost                                                                                                      |   | (15,853                     | )       | (15,853                      | )      |
| Total  stockholders’ equity                                                                                              |   | 135,806                     |    | 144,370                      |   |
|                                                                                                                          |   |                        |    |                         |   |
| TOTAL LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                              |   | $                           | 428,234 |                         | $      | 439,097 |   |

 

See notes to condensedconsolidated financial statements.

 

4

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

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(In Thousands)**

** **
|                                                                          |   | **Nine  Months Ended**       |   |
|-------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                          |   | **September 28,  2002** |   | **September 27,  2003** |   |
| Cash flows from  operating activities:                                        |   |                         |   |   |   |
| Net income                                                                    |   | $                            | 9,958  |   | $ | 4,681 |   |
| Adjustments to  reconcile net income to cash flows from operating activities: |   |                         |   |   |   |
| Depreciation and  amortization                                                |   | 8,337                        |   | 8,214 |   |
| Deferred tax  expense (benefit)                                               |   | (308                         | )      | 231 |   |
| Other                                                                         |   | 298                          |   | 235 |   |
| Facility  rationalization charges                                             |   | —                       |   | 2,075 |   |
| Changes in  operating assets and liabilities:                                 |   |                         |   |   |   |
| Accounts, notes  and leases receivable                                        |   | (16,656                      | )      | (16,512 | ) |
| Inventories                                                                   |   | (621                         | )      | 3,846 |   |
| Prepaid expenses  and other current assets                                    |   | (237                         | )      | 416 |   |
| Accounts payable                                                              |   | (951                         | )      | (1,708 | ) |
| Other current  liabilities                                                    |   | (1,895                       | )      | 3,877 |   |
| Cash flows from  operating activities                                         |   | (2,075                       | )      | 5,355 |   |
|                                                                          |   |                         |   |   |   |
| Cash flows from  investing activities:                                        |   |                         |   |   |   |
| Capital  expenditures                                                         |   | (3,626                       | )      | (2,752 | ) |
| Proceeds from  disposals of fixed assets                                      |   | 4                            |   | 4 |   |
| Changes in other  assets                                                      |   | 211                          |   | 372 |   |
| Cash flows from  investing activities                                         |   | (3,411                       | )      | (2,376 | ) |
|                                                                          |   |                         |   |   |   |
| Cash flows from  financing activities:                                        |   |                         |   |   |   |
| Gross borrowings  under lines of credit                                       |   | 89,978                       |   | 8,465 |   |
| Gross repayments  under lines of credit                                       |   | (81,866                      | )      | (7,523 | ) |
| Repayments of  long-term debt                                                 |   | (4,753                       | )      | (4,874 | ) |
| Proceeds from  issuance of stock                                              |   | 994                          |   | 501 |   |
| Cash flows from  financing activities                                         |   | 4,353                        |   | (3,431 | ) |
|                                                                          |   |                         |   |   |   |
| Effect of  foreign exchange rate changes on cash                              |   | (34                          | )      | 66 |   |
|                                                                          |   |                         |   |   |   |
| Decrease in cash                                                              |   | (1,167                       | )      | (386 | ) |
| Cash, beginning  of period                                                    |   | 5,545                        |   | 19,099 |   |
|                                                                          |   |                         |   |   |   |
| Cash, end of  period                                                          |   | $                            | 4,378  |   | $ | 18,713 |   |
|                                                                          |   |                         |   |   |   |
| Supplemental  Cash Flow Information                                           |   |                         |   |   |   |
| Interest paid                                                                 |   | $                            | 8,259  |   | $ | 7,719 |   |
| Taxes paid                                                                    |   | $                            | 8,526  |   | $ | 6,443 |   |

 

See notes to condensedconsolidated financial statements.

 

5

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

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**SEPTEMBER 27, 2003**

**(Tabular Amounts In Thousands ExceptShare and Per Share Data)**

 

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

 

The accompanyingcondensed consolidated financial statements of Steinway Musical Instruments,Inc. and subsidiaries (the “Company”) for the three months and nine monthsended September 28, 2002 and September 27, 2003 are unaudited.  In the opinion of management, these statementshave been prepared on the same basis as the audited consolidated financialstatements as of and for the year ended December 31, 2002, and include alladjustments which are of a normal and recurring nature, necessary for the fairpresentation of financial position, results of operations and cash flows forthe interim period.  You should read thecondensed consolidated financial statements in conjunction with theconsolidated financial statements and notes thereto contained in the Company’sAnnual Report on Form 10-K for the fiscal year ended December 31, 2002filed with the Securities and Exchange Commission.  The results of operations for the three months and nine monthsended September 27, 2003 are not necessarily indicative of the resultsthat may be expected for the entire year.

 

Throughout this report“we”, “us”, and “our” refer to Steinway Musical Instruments, Inc. andsubsidiaries taken as a whole. Effective January 1, 2003, we combined the operations of The SelmerCompany, Inc. (“Selmer”) and United Musical Instruments, Inc. (“UMI”) intoConn-Selmer, Inc. (“Conn-Selmer”). References to Selmer and UMI occur in connection with events orcircumstances prior to the merger.

 

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

 

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

 

*Stock-based Compensation* - We have an employee stock purchaseplan (“Purchase Plan”) and a stock option plan (“Stock Plan”).  As permitted under accounting principlesgenerally accepted in the United States of America, we have elected to continueto follow the intrinsic value method in accounting for our stock-based employeecompensation arrangements.

 

6

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The following table illustrates the effect on net income and earningsper share if we had applied the fair value method to measure stock-basedemployee compensation:

 
|                                                                                                                                          |   | **Three  Months Ended**      |       | **Nine  Months Ended**       |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|------------------------------|------------|
|                                                                                                                                          |   | **September 28,  2002** |       | **September 27,  2003** |       | **September 28,  2002** |   | **September 27,  2003** |   |
|                                                                                                                                          |   |                         | ** ** |                         | ** ** |   | ** ** |   | ** ** |
| Net income, as  reported                                                                                                                      |   | $                            | 2,191      |                         | $          | 1,838 |   | $ | 9,958 |   | $ | 4,681 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair-value based  method for all awards, net of related tax effects |   | (176                         | )          | (189                         | )          | (381 | ) | (625 | ) |
|                                                                                                                                          |   |                         |       |                         |       |   |   |   |   |
| Pro forma net  income                                                                                                                         |   | $                            | 2,015      |                         | $          | 1,649 |   | $ | 9,577 |   | $ | 4,056 |   |
| Earnings per  share:                                                                                                                          |   |                         |       |                         |       |   |   |   |   |
| As reported  Basic and Diluted                                                                                                                |   | $                            | 0.25       |                         | $          | 0.21 |   | $ | 1.12 |   | $ | 0.53 |   |
| Pro forma Basic  and Diluted                                                                                                                  |   | $                            | 0.23       |                         | $          | 0.18 |   | $ | 1.08 |   | $ | 0.45 |   |

 

We measured the fairvalue of options on their grant date, including the valuation of the optionfeature implicit in our Purchase Plan using the Black-Scholes option-pricingmodel.  Key assumptions used to applythis pricing model are as follows:

 
|                                                |   | **Three  Months Ended**      |   | **Nine  Months Ended**       |   |
|-----------------------------------------------------|--------|------------------------------|--------|------------------------------|--------|
|                                                |   | **September 28,  2002** |   | **September 27,  2003** |   | **September 28,  2002** |   | **September 27,  2003** |   |
| Range of risk-free  interest rates                  |   | 1.86%-3.56%                  |   | 1.26%-1.86%                  |   | 1.86%-3.56% |   | 1.26%-3.12% |   |
| Range of  expected life of option grants (in years) |   | 1 to 6                       |   | 1 to 6                       |   | 1 to 6 |   | 1 to 6 |   |
| Expected  volatility of underlying stock            |   | 25.7%                        |   | 26.5%                        |   | 25.7% |   | 26.5% |   |

 

The weighted average fair value of options on their grant date is asfollows:

 
|          |   | **Three  Months Ended**      |   | **Nine  Months Ended**       |   |
|---------------|--------|------------------------------|--------|------------------------------|--------|
|          |   | **September 28,  2002** |   | **September 27,  2003** |   | **September 28,  2002** |   | **September 27,  2003** |   |
|          |   |                         |   |                         |   |   |   |   |   |
| Stock Plan    |   | $                            | 6.30   |                         | $      | — |   | $ | 6.30 |   | $ | 4.77 |   |
| Purchase Plan |   | $                            | 4.67   |                         | $      | 4.48 |   | $ | 4.54 |   | $ | 4.64 |   |

 

It should be notedthat the Black-Scholes option-pricing model was designed to value readilytradable options with relatively short lives and no vesting restrictions.  In addition, option valuation models requirethe input of highly subjective assumptions including the expected pricevolatility.  Because the options grantedare not tradable and have contractual lives of up to ten years, and becausechanges in the subjective input assumptions can materially affect the fairvalue estimate, in our opinion, the existing models do not provide a reliablemeasure of the fair value of the options issued under either the Stock Plan orPurchase Plan.

 

7

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*Income per Common Share –*We compute basic income per shareusing the weighted average number of common shares outstanding during eachperiod.  Diluted income per common sharereflects the effect of our outstanding options using the treasury stock method,except when such items would be antidilutive.

 

A reconciliation of theweighted average shares used for the basic and diluted computations is asfollows:

 
|                             |   | **Three  Months Ended**      |   | **Nine  Months Ended**       |   |
|----------------------------------|--------|------------------------------|--------|------------------------------|--------|
|                             |   | **September 28,  2002** |   | **September 27,  2003** |   | **September 28,  2002** |   | **September 27,  2003** |   |
| Weighted average shares:         |   |                         |   |                         |   |   |   |   |   |
| For basic income per share       |   | 8,894,580                    |   | 8,930,613                    |   | 8,867,595 |   | 8,914,363 |   |
| Dilutive effect of stock options |   | 40                           |   | 1,096                        |   | 24,858 |   | 349 |   |
| For diluted income per share     |   | 8,894,620                    |   | 8,931,709                    |   | 8,892,453 |   | 8,914,712 |   |

 

Options topurchase 1,068,500 shares of common stock at prices ranging from $18.84 to$21.94 per share and options to purchase 991,800 shares of common stock atprices ranging from $18.55 to $21.94 per share were outstanding during thequarters ended September 28, 2002 and September 27, 2003,respectively, but were not included in the computation of diluted net incomeper share because the exercise prices of the options were greater than theaverage market price of the common shares.

 

Options topurchase 47,500 shares of common stock at prices ranging from $20.75 to $21.94per share and options to purchase 991,800 shares of common stock at pricesranging from $18.55 to $21.94 per share were outstanding during the nine monthsended September 28, 2002 and September 27, 2003, respectively, butwere not included in the computation of diluted net income per share becausethe exercise prices of the options were greater than the average market priceof the common shares.

 

*Comprehensive Income –*Othercomprehensive income is comprised of foreign currency translation adjustments,additional minimum pension liabilities, and unrealized gains and losses oncertain long-term assets.  Totalcomprehensive income is as follows:

 
|                                   |   | **Three  Months Ended**      |   | **Nine  Months Ended**       |   |
|----------------------------------------|--------|------------------------------|--------|------------------------------|--------|
|                                   |   | **September 28,  2002** |   | **September 27,  2003** |   | **September 28,  2002** |   | **September 27,  2003** |   |
|                                   |   |                         |   |                         |   |   |   |   |   |
| Net income                             |   | $                            | 2,191  |                         | $      | 1,838 |   | $ | 9,958 |   | $ | 4,681 |   |
| Other comprehensive income (loss), net |   | (335                         | )      | 497                          |   | 3,165 |   | 3,382 |   |
| Total comprehensive income             |   | $                            | 1,856  |                         | $      | 2,335 |   | $ | 13,123 |   | $ | 8,063 |   |

 

8

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*New Accounting Pronouncements –*InApril 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 onDerivative Instruments and Hedging Activities.” SFAS 149 amends SFAS 133 toconform and incorporate derivative implementation issues and subsequentlyissued accounting guidance. SFAS 149 clarifies under what circumstances acontract with an initial net investment meets the characteristic of aderivative, and clarifies when a derivative contains a financing component thatwarrants special reporting in the statement of cash flows.  SFAS 149 also amends other existingpronouncements, resulting in more consistent reporting of contracts that arederivatives in their entirety or that contain embedded derivatives that warrantspecial accounting.  SFAS 149 iseffective for contracts entered into or modified after June 30, 2003, andshould be applied prospectively. However, certain SFAS 133 implementationissues that were effective for all fiscal quarters prior to June 15, 2003,should continue to be applied in accordance with their respective effectivedates. The adoption of SFAS 149 did not have a material effect on our financialposition, results of operations or cash flows.

 

In May 2003,the FASB issued SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity.” SFAS 150 establishesstandards for how an issuer classifies and measures certain freestandingfinancial instruments with characteristics of both liabilities and equity. SFAS150 requires that an issuer classify a financial instrument that is within itsscope as a liability (or asset in some circumstances). We were required toadopt SFAS 150 effective June 29, 2003. The adoption of SFAS 150 did nothave a material effect on our financial position, results of operations or cashflows.

* *

*Reclassifications*– Certain prior year amounts have been reclassified to conform to the currentyear presentation.

 

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

 

Inventories consist ofthe following:

 
|            |   | **December 31,  2002** |    | **September 27,  2003** |   |
|-----------------|--------|-----------------------------|---------|------------------------------|--------|
|            |   |                        |    |                         |   |
| Raw materials   |   | $                           | 21,568  |                         | $      | 18,649 |   |
| Work in process |   | 56,019                      |    | 58,057                       |   |
| Finished goods  |   | 85,503                      |    | 84,476                       |   |
| Total           |   | $                           | 163,090 |                         | $      | 161,182 |   |

 

**(4)****              Goodwill, Trademarks, and Other IntangibleAssets**

 

We ceased torecord amortization expense on our goodwill and trademark assets onJanuary 1, 2002.  We test ourgoodwill and trademark assets for impairment annually, or on an interim basisif events or circumstances indicate that the fair value of an asset hasdecreased below its carrying value.  AtJuly 27, 2003 we evaluated our goodwill and trademark assets anddetermined that the fair value had not decreased below the carrying value and,accordingly, no impairment adjustments have been made.

 

9

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The changes in net carrying amounts of goodwill and trademarks are asfollows:

 
|                                 |   | **Piano  Segment** |   | **Band and  Orchestral  Segment** |   |
|--------------------------------------|--------|--------------------|--------|-----------------------------------|--------|
|                                 |   |               |   |                              |   |
| Goodwill:                            |   |               |   |                              |   |   |   |
| Beginning balance December  31, 2002 |   | $                  | 20,984 |                              | $      | 8,555 |   |
| Foreign currency  translation impact |   | 1,001              |   | —                            |   |
| Ending Balance September  27, 2003   |   | $                  | 21,985 |                              | $      | 8,555 |   |
|                                 |   |               |   |                              |   |
| Trademarks:                          |   |               |   |                              |   |   |   |
| Beginning balance December  31, 2002 |   | $                  | 6,980  |                              | $      | 2,671 |   |
| Foreign currency  translation impact |   | 314                |   | —                            |   |
| Ending Balance September  27, 2003   |   | $                  | 7,294  |                              | $      | 2,671 |   |

 

We also carry certainintangible assets that are amortized, which consist of the following:

 
|                           |   | **December 31,  2002** |   | **September 27,  2003** |   |
|--------------------------------|--------|-----------------------------|--------|------------------------------|--------|
|                           |   |                        |   |                         |   |
| Gross deferred financing costs |   | $                           | 10,751 |                         | $      | 10,753 |   |
| Accumulated amortization       |   | (3,951                      | )      | (4,781                       | )      |
| Deferred financing costs, net  |   | $                           | 6,800  |                         | $      | 5,972 |   |
|                           |   |                        |   |                         |   |
| Gross covenants not to compete |   | $                           | 750    |                         | $      | 805 |   |
| Accumulated amortization       |   | (614                        | )      | (672                         | )      |
| Covenants not to compete, net  |   | $                           | 136    |                         | $      | 133 |   |

 

The weightedaverage amortization period for deferred financing costs is 8.75 years, and theweighted average amortization period of covenants not to compete is 8.5years.  Total amortization expense is asfollows:

 
|                 |   | **Three  Months Ended**      |   | **Nine  Months Ended**       |   |
|----------------------|--------|------------------------------|--------|------------------------------|--------|
|                 |   | **September 28,  2002** |   | **September 27,  2003** |   | **September 28,  2002** |   | **September 27,  2003** |   |
|                 |   |                         |   |                         |   |   |   |   |   |
| Amortization expense |   | $                            | 288    |                         | $      | 288 |   | $ | 866 |   | $ | 865 |   |
|                      |        |                              |        |                              |        |  |  |  |  |  |  |  |  |

 

The following table showsthe estimated amortization expense for the remainder of 2003 and the next fivesucceeding fiscal years:

 

Estimatedamortization expense:

 
| 2003 |   | $     | 289    |   |
|------|--------|-------|--------|--------|
| 2004 |   | 1,043 |   |
| 2005 |   | 987   |   |
| 2006 |   | 952   |   |
| 2007 |   | 952   |   |
| 2008 |   | 807   |   |

 

10

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**(5)****              Other CurrentLiabilities**

** **
|                                 |   | **Period  Ended**           |   |
|--------------------------------------|--------|-----------------------------|--------|
|                                 |   | **December 31,  2002** |   | **September 27,  2003** |   |
|                                 |   |                        |   |   |   |
| Accrued payroll and related benefits |   | $                           | 15,287 |   | $ | 17,016 |   |
| Current portion of pension liability |   | 4,111                       |   | 2,800 |   |
| Accrued warranty expense             |   | 2,357                       |   | 2,487 |   |
| Accrued interest                     |   | 2,720                       |   | 5,885 |   |
| Deferred income                      |   | 3,536                       |   | 4,888 |   |
| Other accrued expenses               |   | 7,253                       |   | 6,110 |   |
| Total                                |   | $                           | 35,264 |   | $ | 39,186 |   |

 

Accrued warranty expense is generally recorded at thetime of sale for instruments which have a warranty period ranging from five toten years.  The accrued expense recordedis based on a percentage of sales and is adjusted periodically following ananalysis of warranty activity.  Accruedwarranty expense for instruments that have a warranty period of one year isrecorded based on warranty return trends.

 

The accruedwarranty expense activity for the year ended December 31, 2002 and ninemonths ended September 27, 2003 is as follows:

 
|                      |   | **Period  Ended**           |   |
|---------------------------|--------|-----------------------------|--------|
|                      |   | **December 31,  2002** |   | **September 27,  2003** |   |
|                      |   |                        |   |   |   |
| Accrued warranty expense: |   |                        |   |   |   |
| Beginning balance         |   | $                           | 2,221  |   | $ | 2,357 |   |
| Additions                 |   | 950                         |   | 848 |   |
| Claims and reversals      |   | (814                        | )      | (718 | ) |
| Ending balance            |   | $                           | 2,357  |   | $ | 2,487 |   |

 

**(6)**              **Stockholders’ Equity**

 

Our common stock is comprised of two classes: Class Aand Ordinary.  With the exception ofdisparate voting power, both classes are substantially identical.  Each share of Class A common stock entitlesthe holder to 98 votes.  Holders ofOrdinary common stock are entitled to one vote per share.  Class A common stock shall automaticallyconvert to Ordinary common stock if, at any time, the Class A common stock isnot owned by an original Class A holder. The Chairman and Chief Executive Officer own 100% of the Class A commonshares, representing approximately 85% of the combined voting power of theClass A common stock and Ordinary common stock.

 

11

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**(7)****              FacilityRationalization Charges**

 

On August 7, 2003 we announced that we will beclosing our woodwind manufacturing facility in Nogales, Arizona.  The manufacturing operations for this facility,which is a component of the band and orchestral segment, will cease in thefourth quarter of 2003. Approximately 90 positions will be eliminated.

 

As a result of this closing, we recorded charges of$0.3 million in severance expenses as a component of cost of goods sold and$2.1 million in impairment charges in the third quarter.  The impairment charges were reported as aseparate component of operating expenses labeled “facility rationalizationcharges” and relate to building, land, and equipment.  The impairment costs associated with the land and building werecalculated based on the excess of the carrying value over quoted marketprices.  The equipment impairmentcharges were based on our ability to utilize the equipment at other facilitieswith unusable equipment valued at zero.

 

We expect to incur additional severance and inventorywrite-down expenses in the fourth quarter as we continue our facilityrationalization project.

 

**(8)****              Other Income, Net**

 

Other income, netconsists of the following:

 
|                              |   | **Three  Months Ended**      |   | **Nine  Months Ended**       |   |
|-----------------------------------|--------|------------------------------|--------|------------------------------|--------|
|                              |   | **September 28,  2002** |   | **September 27,  2003** |   | **September 28,  2002** |   | **September 27,  2003** |   |
|                              |   |                         |   |                         |   |   |   |   |   |
| West 57th building income         |   | $                            | (1,164 | )                            | $      | (1,164 | ) | $ | (3,491 | ) | $ | (3,490 | ) |
| West 57th building expenses       |   | 813                          |   | 813                          |   | 2,437 |   | 2,441 |   |
| Foreign exchange (gain) loss, net |   | 88                           |   | (63                          | )      | (386 | ) | (453 | ) |
| Miscellaneous                     |   | (127                         | )      | (285                         | )      | (493 | ) | (530 | ) |
| Other income, net                 |   | $                            | (390   | )                            | $      | (699 | ) | $ | (1,933 | ) | $ | (2,032 | ) |

 

**(9)****              Commitmentsand Contingent Liabilities**

 

We are involved incertain legal proceedings regarding environmental matters, which are describedbelow.  Further, in the ordinary courseof business, we are party to various legal actions that we believe are routinein nature and incidental to the operation of our business.  While the outcome of such actions cannot bepredicted with certainty, we believe that, based on our experience in dealingwith these matters, their ultimate resolution will not have a material adverseimpact on our business, financial condition, or results of operations orprojects.

 

We operate manufacturingfacilities at certain locations where hazardous substances (includingchlorinated solvents) were used.  Webelieve that an entity that formerly operated one such facility may havereleased hazardous substances at such location, which we leased throughJuly 2001.  We did not contributeto such release.  Further, we have acontractual indemnity from certain stockholders of such entity.  This facility is not the subject of a legalproceeding that involves us, nor, to our knowledge, is the facility subject toinvestigation.  However, no assurancecan be given that legal proceedings will not arise in the future and that suchindemnitors would make the payments described in the indemnity.

 

12

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We operate othermanufacturing facilities which were previously owned by Philips ElectronicsNorth America Corporation (“Philips”). Philips agreed to indemnify us for any and all losses, damages,liabilities and claims relating to environmental matters resulting from certainactivities of Philips occurring prior to December 29, 1988 (the“Environmental Indemnity Agreement”). Philips has fully performed its obligations under the Environmental IndemnityAgreement, which terminates on December 29, 2008.  Four matters covered by the EnvironmentalIndemnity Agreement are currently pending. Philips has entered into Consent Orders with the Environmental ProtectionAgency (“EPA”) for one site and the North Carolina Department of Environment,Health and Natural Resources for a second site, whereby Philips has agreed topay required response costs.  OnOctober 22, 1998, we were joined as defendant in an action involving asite formerly occupied by a business we acquired in Illinois.  Philips has accepted the defense of thisaction pursuant to the terms of the Environmental Indemnity Agreement.  For the fourth site, the EPA has notified usit intends to carry out the final remediation itself.  The EPA estimates that this remedy has a present net cost ofapproximately $14.5 million.  Over 40persons or entities have been named by the EPA as potentially responsibleparties at this site.  This matter hasbeen tendered to Philips pursuant to the Environmental IndemnityAgreement.  Our potential liability atany of these sites is affected by several factors including, but not limitedto, the method of remediation, our portion of the materials in the siterelative to the other named parties, the number of parties participating, andthe financial capabilities of the other potentially responsible parties oncethe relative share has been determined. No assurance can be given, however, that additional environmental issueswill not require additional, currently unanticipated investigation, assessmentor remediation expenditures or that Philips will make payments that it isobligated to make under the Environmental Indemnity Agreement.

 

We are also continuing anexisting environmental remediation program at a facility acquired in 2000.  Wecurrently estimate that this project will take eighteen years to complete, at atotal cost of approximately $1.0 million. We have accrued approximately $0.6 million for the estimated remainingcost of this remediation program, which represents the present value total costusing a discount rate of 4.75%.  Asummary of expected future payments associated with this project is as follows:

 
|       |   | **Environmental  Payments** |   |
|------------|--------|-----------------------------|--------|
| 2003       |   | $                           | 26     |   |
| 2004       |   | 72                          |   |
| 2005       |   | 72                          |   |
| 2006       |   | 72                          |   |
| 2007       |   | 51                          |   |
| Thereafter |   | 656                         |   |
| Total      |   | $                           | 949    |   |

 

The matters described aboveand our other liabilities and compliance costs arising under environmental lawsare not expected to have a material impact on our capital expenditures,earnings or competitive position. However, some risk of environmental liability is inherent in the natureof our current and former businesses and we might, in the future, incurmaterial costs to meet current or more stringent compliance, cleanup or otherobligations pursuant to environmental laws.

 

13

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**(10)****       SegmentInformation**

 

We have identifiedtwo distinct and reportable segments: the piano segment and the band andorchestral instrument segment.  Thesesegments were selected based upon the way management oversees and evaluates theresults of each operation.  Managementand the chief operating decision maker use income from operations as ameaningful measurement of profit or loss for the segments.  Income from operations for the reportablesegments includes certain corporate costs allocated to the segments basedprimarily on revenue, as well as intercompany profit.  Amounts reported as “Other & Elim” include those corporatecosts that were not allocated to the reportable segments and the remainingintercompany profit elimination.

 

The followingtables present information about our operating segments for the three month andnine month periods ended September 28, 2002 and September 27, 2003:

 
|                            |   | **Piano  Segment** |   | **Band and  Orchestral Segment** |   | **Other  &  Elim** |   | **Consol  Total** |   |
|---------------------------------|--------|--------------------|--------|----------------------------------|--------|------------------------|--------|-------------------|--------|
| **Three  months ended 2002**    |   | **U.S.**           |   | **Germany**                      |   | **Other**              |   | **Total**         |   | **U.S.** |   | **Other** |   | **Total** |   |   |   |
| Net sales to external customers |   | $                  | 24,049 |                             | $      | 6,956                  |   | $                 | 4,535  |   | $ | 35,540 |   | $ | 38,524 |   | $ | 1,256 |   | $ | 39,780 |   | $ | — |   | $ | 75,320 |   |
| Income from operations          |   | 2,739              |   | (169                             | )      | 454                    |   | 3,024             |   | 3,343 |   | 50 |   | 3,393 |   | (391 | ) | 6,026 |   |
|                            |   |               |   |                             |   |                   |   |              |   |   |   |   |   |   |   |   |   |   |   |
|                            |   | **Piano  Segment** |   | **Band and  Orchestral Segment** |   | **Other  &  Elim** |   | **Consol  Total** |   |
| **Three  months ended 2002**    |   | **U.S.**           |   | **Germany**                      |   | **Other**              |   | **Total**         |   | **U.S.** |   | **Other** |   | **Total** |   |   |   |
| Net sales to external customers |   | $                  | 27,213 |                             | $      | 9,502                  |   | $                 | 5,605  |   | $ | 42,320 |   | $ | 38,938 |   | $ | 1,288 |   | $ | 40`,226 |   | $ | — |   | $ | 82,546 |   |
| Income from operations          |   | 3,176              |   | 839                              |   | 614                    |   | 4,629             |   | 1,474 |   | 55 |   | 1,529 |   | (603 | ) | 5,555 |   |
|                            |   |               |   |                             |   |                   |   |              |   |   |   |   |   |   |   |   |   |   |   |
|                            |   | **Piano  Segment** |   | **Band and  Orchestral Segment** |   | **Other  &  Elim** |   | **Consol  Total** |   |
| **Three months  ended 2002**    |   | **U.S.**           |   | **Germany**                      |   | **Other**              |   | **Total**         |   | **U.S.** |   | **Other** |   | **Total** |   |   |   |
| Net sales to external customers |   | $                  | 72,531 |                             | $      | 23,540                 |   | $                 | 14,187 |   | $ | 110,258 |   | $ | 128,331 |   | $ | 3,139 |   | $ | 131,470 |   | $ | — |   | $ | 241,728 |   |
| Income from operations          |   | 8,923              |   | 1,720                            |   | 1,910                  |   | 12,553            |   | 12,101 |   | 103 |   | 12,204 |   | (1,527 | ) | 23,230 |   |
|                            |   |               |   |                             |   |                   |   |              |   |   |   |   |   |   |   |   |   |   |   |
|                            |   | **Piano  Segment** |   | **Band and  Orchestral Segment** |   | **Other  &  Elim** |   | **Consol  Total** |   |
| **Three  months ended 2002**    |   | **U.S.**           |   | **Germany**                      |   | **Other**              |   | **Total**         |   | **U.S.** |   | **Other** |   | **Total** |   |   |   |
| Net sales to external customers |   | $                  | 73,598 |                             | $      | 29,530                 |   | $                 | 16,437 |   | $ | 119,565 |   | $ | 120,178 |   | $ | 3,347 |   | $ | 123,525 |   | $ | — |   | $ | 243,090 |   |
| Income from operations          |   | 5,594              |   | 2,801                            |   | 1,864                  |   | 10,259            |   | 6,056 |   | 102 |   | 6,158 |   | (1,648 | ) | 14,769 |   |

 

14

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**(11)****       Summary of Guarantees**

 

During 2001, wecompleted a $150.0 million 8.75% Senior Note offering.  At the end of 2002, we repurchased $4.7million of these Senior Notes.

 

Our paymentobligations under the 8.75% Senior Notes are fully and unconditionallyguaranteed on a joint and several basis by Conn-Selmer, Steinway, and certainother of our direct and indirect wholly-owned subsidiaries, each a Guarantor(the “Guarantor Subsidiaries”).  Thesesubsidiaries represent all of our (the “Issuer”) operations conducted in theUnited States.  The remainingsubsidiaries, which do not guarantee the 8.75% Senior Notes, represent non-U.S.operations (the “Non Guarantor Subsidiaries”).

 

The followingcondensed consolidating supplementary data presents the financial position,results of operations, and cash flows of the Guarantor Subsidiaries and the NonGuarantor Subsidiaries.  Separatecomplete financial statements of the respective Guarantors would not provideadditional material information that would be useful in assessing the financialcomposition of the Guarantor Subsidiaries. No single Guarantor Subsidiary has any significant legal restrictions onthe ability of investors or creditors to obtain access to its assets in eventof default on the guarantee other than its subordination to seniorindebtedness.

 

Investments insubsidiaries are recorded on the cost method for purposes of the supplementalconsolidating presentation.  Earnings ofsubsidiaries are therefore not reflected in the parent company’s investment accountsand earnings.  The principal eliminationentries eliminate investments in subsidiaries and intercompany balances andtransactions.

 

15

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATING STATEMENTS OFINCOME**

**THREE MONTHS ENDED SEPTEMBER 28,2002**

**(In Thousands)**

 
|                                     |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net sales                                |   | $                    | — |                        | $      | 64,322                           |   | $                          | 13,140 |             | $      | (2,142 | ) | $ | 75,320 |   |
| Cost of sales                            |   | —               |   | 47,034                      |   | 9,137                            |   | (2,152                     | )      | 54,019           |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Gross profit                             |   | —               |   | 17,288                      |   | 4,003                            |   | 10                         |   | 21,301           |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Operating  expenses:                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Sales and  marketing                     |   | —               |   | 7,062                       |   | 2,451                            |   | (16                        | )      | 9,497            |   |
| General and  administrative              |   | 1,139                |   | 3,153                       |   | 994                              |   | —                     |   | 5,286            |   |
| Amortization                             |   | 113                  |   | 174                         |   | 1                                |   | —                     |   | 288              |   |
| Other operating  (income) expense        |   | (829                 | )      | 795                         |   | 222                              |   | 16                         |   | 204              |   |
| Total operating  expenses                |   | 423                  |   | 11,184                      |   | 3,668                            |   | —                     |   | 15,275           |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Income (loss)  from operations           |   | (423                 | )      | 6,104                       |   | 335                              |   | 10                         |   | 6,026            |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Interest  (income) expense, net          |   | (274                 | )      | 3,752                       |   | 77                               |   | —                     |   | 3,555            |   |
| Other income,  net                       |   | —               |   | (249                        | )      | (141                             | )      | —                     |   | (390             | )      |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Income (loss)  before income taxes       |   | (149                 | )      | 2,601                       |   | 399                              |   | 10                         |   | 2,861            |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Provision for  (benefit of) income taxes |   | (4                   | )      | 537                         |   | 113                              |   | 24                         |   | 670              |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net income  (loss)                       |   | $                    | (145   | )                           | $      | 2,064                            |   | $                          | 286    |             | $      | (14 | ) | $ | 2,191 |   |

 

16

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATING STATEMENTS OFINCOME**

**THREE MONTHS ENDED SEPTEMBER 27,2003**

**(In Thousands)**

 
|                                     |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net sales                                |   | $                    | — |                        | $      | 67,660                           |   | $                          | 17,240 |             | $      | (2,354 | ) | $ | 82,546 |   |
| Cost of sales                            |   | —               |   | 50,267                      |   | 11,613                           |   | (2,225                     | )      | 59,655           |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Gross profit                             |   | —               |   | 17,393                      |   | 5,627                            |   | (129                       | )      | 22,891           |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Operating  expenses:                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Sales and  marketing                     |   | —               |   | 6,797                       |   | 2,602                            |   | (16                        | )      | 9,383            |   |
| General and  administrative              |   | 1,095                |   | 3,103                       |   | 1,282                            |   | —                     |   | 5,480            |   |
| Amortization                             |   | 113                  |   | 174                         |   | 1                                |   | —                     |   | 288              |   |
| Other operating  (income) expense        |   | (768                 | )      | 628                         |   | 234                              |   | 16                         |   | 110              |   |
| Facility  rationalization charges        |   | —               |   | 2,075                       |   | —                           |   | —                     |   | 2,075            |   |
| Total operating  expenses                |   | 440                  |   | 12,777                      |   | 4,119                            |   | —                     |   | 17,336           |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Income (loss)  from operations           |   | (440                 | )      | 4,616                       |   | 1,508                            |   | (129                       | )      | 5,555            |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Interest  (income) expense, net          |   | (376                 | )      | 3,478                       |   | 87                               |   | —                     |   | 3,189            |   |
| Other (income)  expense, net             |   | 8                    |   | (553                        | )      | (154                             | )      | —                     |   | (699             | )      |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Income (loss)  before income taxes       |   | (72                  | )      | 1,691                       |   | 1,575                            |   | (129                       | )      | 3,065            |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Provision for  (benefit of) income taxes |   | (25                  | )      | 107                         |   | 1,202                            |   | (57                        | )      | 1,227            |   |
|                                     |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net income  (loss)                       |   | $                    | (47    | )                           | $      | 1,584                            |   | $                          | 373    |             | $      | (72 | ) | $ | 1,838 |   |

 

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATING STATEMENTS OFINCOME**

**NINE MONTHS ENDED SEPTEMBER 28,2002**

**(In Thousands)**

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

 

18

----

 

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

**CONDENSED CONSOLIDATING STATEMENTS OFINCOME**

**NINE MONTHS ENDED SEPTEMBER 27,2003**

**(In Thousands)**

 
|                                     |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                                     |   |                 |   |                        |   |                             |       |                       |       |             |       |
| Net sales                                |   | $                    | — |                        | $      | 199,927                          |       | $                          | 51,463     |             | $          | (8,300 | ) | $ | 243,090 |   |
| Cost of sales                            |   | —               |   | 151,028                     |   | 33,684                           |       | (8,058                     | )          | 176,654          |       |
|                                     |   |                 |   |                        |   |                             |       |                       |       |             |       |
| Gross profit                             |   | —               |   | 48,899                      |   | 17,779                           |       | (242                       | )          | 66,436           |       |
|                                     |   |                 |   |                        |   |                             |       |                       |       |             |       |
| Operating expenses:                      |   |                 |   |                        |   |                             |       |                       |       |             |       |
| Sales and marketing                      |   | —               |   | 22,855                      |   | 8,549                            |       | (64                        | )          | 31,340           |       |
| General and  administrative              |   | 3,382                |   | 9,786                       |   | 3,801                            |       | —                     |       | 16,969           |       |
| Amortization                             |   | 339                  |   | 523                         |   | 3                                |       | —                     |       | 865              |       |
| Other operating  (income) expense        |   | (2,368               | )      | 2,063                       |   | 659                              |       | 64                         |       | 418              |       |
| Facility rationalization  charges        |   | —               |   | 2,075                       |   | —                           |       | —                     |       | 2,075            |       |
| Total operating  expenses                |   | 1,353                |   | 37,302                      |   | 13,012                           |       | —                     |       | 51,667           |       |
|                                     |   |                 |   |                        |   |                             |       |                       |       |             |       |
| Income (loss) from  operations           |   | (1,353               | )      | 11,597                      |   | 4,767                            |       | (242                       | )          | 14,769           |       |
|                                     |   |                 |   |                        |   |                             |       |                       |       |             |       |
| Interest (income)  expense, net          |   | (1,129               | )      | 10,091                      |   | 206                              |       | —                     |       | 9,168            |       |
| Other (income) expense,  net             |   | 8                    |   | (1,750                      | )      | (290                             | )          | —                     |       | (2,032           | )          |
|                                     |   |                 |   |                        |   |                             |       |                       |       |             |       |
| Income (loss) before  income taxes       |   | (232                 | )      | 3,256                       |   | 4,851                            |       | (242                       | )          | 7,633            |       |
|                                     |   |                 |   |                        |   |                             |       |                       |       |             |       |
| Provision for (benefit  of) income taxes |   | (81                  | )      | 1,478                       |   | 1,658                            |       | (103                       | )          | 2,952            |       |
|                                     |   |                 |   |                        |   |                             |       |                       |       |             |       |
| Net income (loss)                        |   | $                    | (151   | )                           | $      | 1,778                            |       | $                          | 3,193      |             | $          | (139 | ) | $ | 4,681 |   |

 

19

----

 

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

**CONDENSED CONSOLIDATING BALANCE SHEETS**

**DECEMBER 31, 2002**

**(In Thousands)**

 
|                                             |   | **Issuer of  Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
| ASSETS                                           |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Current  assets:                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash                                             |   | $                    | — |                        | $      | 1,871                            |   | $                          | 6,031  |             | $      | 11,197 |   | $ | 19,099 |   |
| Accounts,  notes and leases receivable, net      |   | —               |   | 65,690                      |   | 11,809                           |   | (78                        | )      | 77,421           |   |
| Inventories                                      |   | —               |   | 133,782                     |   | 30,289                           |   | (981                       | )      | 163,090          |   |
| Prepaid  expenses and other current assets       |   | 643                  |   | 3,678                       |   | 906                              |   | —                     |   | 5,227            |   |
| Deferred  tax assets                             |   | —               |   | 6,146                       |   | 5,036                            |   | (4,170                     | )      | 7,012            |   |
| Total  current assets                            |   | 643                  |   | 211,167                     |   | 54,071                           |   | 5,968                      |   | 271,849          |   |
|                                             |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Property,  plant and equipment, net              |   | 159                  |   | 87,980                      |   | 14,428                           |   | —                     |   | 102,567          |   |
| Investment  in subsidiaries                      |   | 71,143               |   | 255,666                     |   | —                           |   | (326,809                   | )      | —           |   |
| Trademarks                                       |   | —               |   | 6,280                       |   | 3,371                            |   | —                     |   | 9,651            |   |
| Goodwill                                         |   | —               |   | 18,795                      |   | 10,744                           |   | —                     |   | 29,539           |   |
| Other  intangibles, net                          |   | 3,749                |   | 3,178                       |   | 9                                |   | —                     |   | 6,936            |   |
| Other  assets                                    |   | 865                  |   | 6,393                       |   | 434                              |   | —                     |   | 7,692            |   |
| TOTAL  ASSETS                                    |   | $                    | 76,559 |                        | $      | 589,459                          |   | $                          | 83,057 |             | $      | (320,841 | ) | $ | 428,234 |   |
|                                             |   |                 |   |                        |   |                             |   |                       |   |             |   |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY       |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Current  liabilities:                            |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Current  portion of long-term debt               |   | $                    | — |                        | $      | 6,454                            |   | $                          | 1,601  |             | $      | — |   | $ | 8,055 |   |
| Accounts  payable                                |   | 98                   |   | 6,933                       |   | 2,935                            |   | (78                        | )      | 9,888            |   |
| Other  current liabilities                       |   | (14,195              | )      | 40,559                      |   | 13,343                           |   | (4,443                     | )      | 35,264           |   |
| Total  current liabilities                       |   | (14,097              | )      | 53,946                      |   | 17,879                           |   | (4,521                     | )      | 53,207           |   |
|                                             |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Long-term  debt                                  |   | 145,398              |   | 35,986                      |   | —                           |   | 11,197                     |   | 192,581          |   |
| Intercompany                                     |   | (109,830             | )      | 105,963                     |   | 3,867                            |   | —                     |   | —           |   |
| Deferred  tax liabilities                        |   | —               |   | 16,164                      |   | 6,545                            |   | —                     |   | 22,709           |   |
| Other  non-current liabilities                   |   | 252                  |   | 9,458                       |   | 14,221                           |   | —                     |   | 23,931           |   |
| Total  liabilities                               |   | 21,723               |   | 221,517                     |   | 42,512                           |   | 6,676                      |   | 292,428          |   |
|                                             |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Stockholders’  equity                       |   | 54,836               |   | 367,942                     |   | 40,545                           |   | (327,517                   | )      | 135,806          |   |
|                                             |   |                 |   |                        |   |                             |   |                       |   |             |   |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY |   | $                    | 76,559 |                        | $      | 589,459                          |   | $                          | 83,057 |             | $      | (320,841 | ) | $ | 428,234 |   |

 

20

----

 

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

**CONDENSED CONSOLIDATING BALANCE SHEETS**

**SEPTEMBER 27, 2003**

**(In Thousands)**

 
|                                             |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
| ASSETS                                           |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Current  assets:                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash                                             |   | $                    | — |                        | $      | 1,369                            |   | $                          | 2,601  |             | $      | 14,743 |   | $ | 18,713 |   |
| Accounts,  notes and leases receivable, net      |   | —               |   | 81,449                      |   | 13,177                           |   | 12                         |   | 94,638           |   |
| Inventories                                      |   | —               |   | 126,227                     |   | 36,178                           |   | (1,223                     | )      | 161,182          |   |
| Prepaid  expenses and other current assets       |   | 311                  |   | 2,776                       |   | 1,491                            |   | —                     |   | 4,578            |   |
| Deferred  tax assets                             |   | —               |   | 6,141                       |   | 5,263                            |   | (3,714                     | )      | 7,690            |   |
| Total  current assets                            |   | 311                  |   | 217,962                     |   | 58,710                           |   | 9,818                      |   | 286,801          |   |
|                                             |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Property,  plant and equipment, net              |   | 162                  |   | 82,507                      |   | 15,228                           |   | —                     |   | 97,897           |   |
| Investment  in subsidiaries                      |   | 71,143               |   | 234,621                     |   | —                           |   | (305,764                   | )      | —           |   |
| Trademarks                                       |   | —               |   | 6,280                       |   | 3,685                            |   | —                     |   | 9,965            |   |
| Goodwill                                         |   | —               |   | 18,795                      |   | 11,745                           |   | —                     |   | 30,540           |   |
| Other  intangibles, net                          |   | 3,410                |   | 2,688                       |   | 7                                |   | —                     |   | 6,105            |   |
| Other  assets                                    |   | 1,074                |   | 6,153                       |   | 562                              |   | —                     |   | 7,789            |   |
| TOTAL  ASSETS                                    |   | $                    | 76,100 |                        | $      | 569,006                          |   | $                          | 89,937 |             | $      | (295,946 | ) | $ | 439,097 |   |
|                                             |   |                 |   |                        |   |                             |   |                       |   |             |   |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY       |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Current  liabilities:                            |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Current  portion of long-term debt               |   | $                    | — |                        | $      | 6,534                            |   | $                          | 2,625  |             | $      | — |   | $ | 9,159 |   |
| Accounts  payable                                |   | 424                  |   | 4,639                       |   | 3,389                            |   | —                     |   | 8,452            |   |
| Other  current liabilities                       |   | (11,277              | )      | 40,214                      |   | 14,305                           |   | (4,056                     | )      | 39,186           |   |
| Total  current liabilities                       |   | (10,853              | )      | 51,387                      |   | 20,319                           |   | (4,056                     | )      | 56,797           |   |
|                                             |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Long-term  debt                                  |   | 145,369              |   | 27,515                      |   | —                           |   | 14,743                     |   | 187,627          |   |
| Intercompany                                     |   | (114,143             | )      | 110,139                     |   | 3,992                            |   | 12                         |   | —           |   |
| Deferred  tax liabilities                        |   | —               |   | 16,473                      |   | 7,611                            |   | —                     |   | 24,084           |   |
| Other  non-current liabilities                   |   | 461                  |   | 9,803                       |   | 15,955                           |   | —                     |   | 26,219           |   |
| Total  liabilities                               |   | 20,834               |   | 215,317                     |   | 47,877                           |   | 10,699                     |   | 294,727          |   |
|                                             |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Stockholders’  equity                       |   | 55,266               |   | 353,689                     |   | 42,060                           |   | (306,645                   | )      | 144,370          |   |
|                                             |   |                 |   |                        |   |                             |   |                       |   |             |   |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY |   | $                    | 76,100 |                        | $      | 569,006                          |   | $                          | 89,937 |             | $      | (295,946 | ) | $ | 439,097 |   |

 

21

----

 

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

**CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS**

**NINE MONTHS ENDED SEPTEMBER 28,2002**

**(In Thousands)**

 
|                                                                                 |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
| Cash  flows from operating activities:                                               |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net  income (loss)                                                                   |   | $                    | (466   | )                           | $      | 8,254                            |   | $                          | 2,297  |             | $      | (127 | ) | $ | 9,958 |   |
| Adjustments  to reconcile net income (loss) to cash flows from operating activities: |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Depreciation  and amortization                                                       |   | 385                  |   | 6,787                       |   | 1,165                            |   | —                     |   | 8,337            |   |
| Deferred  tax benefit                                                                |   | —               |   | (173                        | )      | (135                             | )      | —                     |   | (308             | )      |
| Other                                                                                |   | —               |   | 161                         |   | 137                              |   | —                     |   | 298              |   |
| Changes  in operating assets and liabilities:                                        |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Accounts,  notes and leases receivable                                               |   | —               |   | (17,578                     | )      | 770                              |   | 152                        |   | (16,656          | )      |
| Inventories                                                                          |   | —               |   | 2,501                       |   | (3,276                           | )      | 154                        |   | (621             | )      |
| Prepaid  expenses and other current assets                                           |   | (13                  | )      | (329                        | )      | 138                              |   | (33                        | )      | (237             | )      |
| Accounts  payable                                                                    |   | 65                   |   | (1,396                      | )      | 532                              |   | (152                       | )      | (951             | )      |
| Other  current liabilities                                                           |   | 4,556                |   | (3,767                      | )      | (2,657                           | )      | (27                        | )      | (1,895           | )      |
| Cash  flows from operating activities                                                |   | 4,527                |   | (5,540                      | )      | (1,029                           | )      | (33                        | )      | (2,075           | )      |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash  flows from investing activities:                                               |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Capital  expenditures                                                                |   | —               |   | (3,280                      | )      | (346                             | )      | —                     |   | (3,626           | )      |
| Proceeds  from disposal of fixed assets                                              |   |                 |   | 4                           |   |                             |   |                       |   | 4                |   |
| Changes  in other assets                                                             |   | (104                 | )      | 282                         |   | —                           |   | 33                         |   | 211              |   |
| Cash  flows from investing activities                                                |   | (104                 | )      | (2,994                      | )      | (346                             | )      | 33                         |   | (3,411           | )      |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash  flows from financing activities:                                               |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Gross  borrowings under lines of credit                                              |   | 34                   |   | 84,744                      |   | 5,200                            |   | —                     |   | 89,978           |   |
| Gross  repayments under lines of credit                                              |   | —               |   | (77,804                     | )      | (3,418                           | )      | (644                       | )      | (81,866          | )      |
| Repayment  of long-term debt                                                         |   | —               |   | (4,753                      | )      | —                           |   | —                     |   | (4,753           | )      |
| Proceeds  from issuance of stock                                                     |   | 994                  |   | —                      |   | —                           |   | —                     |   | 994              |   |
| Intercompany  transactions                                                           |   | (5,451               | )      | 6,735                       |   | (1,284                           | )      | —                     |   | —           |   |
| Cash  flows from financing activities                                                |   | (4,423               | )      | 8,922                       |   | 498                              |   | (644                       | )      | 4,353            |   |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Effect  of exchange rate changes on cash                                             |   | —               |   | —                      |   | (34                              | )      | —                     |   | (34              | )      |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Decrease  in cash                                                                    |   | —               |   | 388                         |   | (911                             | )      | (644                       | )      | (1,167           | )      |
| Cash,  beginning of period                                                           |   |                 |   | 1,672                       |   | 3,229                            |   | 644                        |   | 5,545            |   |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash,  end of period                                                                 |   | $                    | — |                        | $      | 2,060                            |   | $                          | 2,318  |             | $      | — |   | $ | 4,378 |   |

 

22

----

 

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

**CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS**

**NINE MONTHS ENDED SEPTEMBER 27,2003**

**(In Thousands)**

 
|                                                                                 |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
| Cash  flows from operating activities:                                               |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net  income (loss)                                                                   |   | $                    | (151   | )                           | $      | 1,778                            |   | $                          | 3,193  |             | $      | (139 | ) | $ | 4,681 |   |
| Adjustments  to reconcile net income (loss) to cash flows from operating activities: |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Depreciation  and amortization                                                       |   | 382                  |   | 6,656                       |   | 1,176                            |   | —                     |   | 8,214            |   |
| Deferred  tax benefit                                                                |   | —               |   | (176                        | )      | 407                              |   | —                     |   | 231              |   |
| Other                                                                                |   | 8                    |   | 105                         |   | 122                              |   | —                     |   | 235              |   |
| Facility  rationalization charges                                                    |   | —               |   | 2,075                       |   | —                           |   | —                     |   | 2,075            |   |
| Changes  in operating assets and liabilities:                                        |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Accounts,  notes and leases receivable                                               |   | —               |   | (15,849                     | )      | (573                             | )      | (90                        | )      | (16,512          | )      |
| Inventories                                                                          |   | —               |   | 6,836                       |   | (3,232                           | )      | 242                        |   | 3,846            |   |
| Prepaid  expenses and other current assets                                           |   | 123                  |   | 855                         |   | (562                             | )      | —                     |   | 416              |   |
| Accounts  payable                                                                    |   | 326                  |   | (2,294                      | )      | 182                              |   | 78                         |   | (1,708           | )      |
| Other  current liabilities                                                           |   | 3,127                |   | 490                         |   | 363                              |   | (103                       | )      | 3,877            |   |
| Cash  flows from operating activities                                                |   | 3,815                |   | 476                         |   | 1,076                            |   | (12                        | )      | 5,355            |   |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash  flows from investing activities:                                               |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Capital  expenditures                                                                |   | (54                  | )      | (2,035                      | )      | (663                             | )      | —                     |   | (2,752           | )      |
| Proceeds  from disposal of fixed assets                                              |   | —               |   | 4                           |   | —                           |   | —                     |   | 4                |   |
| Capital  contribution to subsidiary                                                  |   | —               |   | (513                        | )      | 513                              |   | —                     |   | —           |   |
| Changes  in other assets                                                             |   | 80                   |   | 292                         |   | —                           |   | —                     |   | 372              |   |
| Cash  flows from investing activities                                                |   | 26                   |   | (2,252                      | )      | (150                             | )      | —                     |   | (2,376           | )      |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash  flows from financing activities:                                               |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Gross  borrowings under lines of credit                                              |   | —               |   | 5,119                       |   | 3,346                            |   | —                     |   | 8,465            |   |
| Gross  repayments under lines of credit                                              |   | (29                  | )      | (8,636                      | )      | (2,404                           | )      | 3,546                      |   | (7,523           | )      |
| Repayment  of long-term debt                                                         |   | —               |   | (4,874                      | )      | —                           |   | —                     |   | (4,874           | )      |
| Proceeds  from issuance of stock                                                     |   | 501                  |   | —                      |   | —                           |   | —                     |   | 501              |   |
| Intercompany  transactions                                                           |   | (4,313               | )      | 9,665                       |   | (5,364                           | )      | 12                         |   | —           |   |
| Cash  flows from financing activities                                                |   | (3,841               | )      | 1,274                       |   | (4,422                           | )      | 3,558                      |   | (3,431           | )      |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Effect  of exchange rate changes on cash                                             |   | —               |   | —                      |   | 66                               |   | —                     |   | 66               |   |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Decrease  in cash                                                                    |   | —               |   | (502                        | )      | (3,430                           | )      | 3,546                      |   | (386             | )      |
| Cash,  beginning of period                                                           |   | —               |   | 1,871                       |   | 6,031                            |   | 11,197                     |   | 19,099           |   |
|                                                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash,  end of period                                                                 |   | $                    | — |                        | $      | 1,369                            |   | $                          | 2,601  |             | $      | 14,743 |   | $ | 18,713 |   |

 

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**(12)****       Subsequent Events**

 

OnOctober 3, 2003 we announced that we will be closing one of our ourwoodwind manufacturing facilities in Elkhart, Indiana and transferringproduction to other company-owned facilities. We expect to complete the transfer of production during the secondquarter of 2004.  This closure impactsapproximately 100 active employees.

 

In connection with this closure, we expectto incur charges of $4.0 to $5.0 million. We estimate that the cash portion of these charges will approximate $2.5to $3.0 million and consist primarily of severance expense.  The remaining charges are predominantly forinventory write-downs and asset impairment costs.

 

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

 

**Introduction**

 

We area world leader in the design, manufacture, marketing, and distribution of highquality musical instruments.  Our pianodivision concentrates on the high-end grand piano segment of the industry,handcrafting Steinway pianos in New York and Germany.  We also offer upright pianos and two mid-priced lines of pianosunder the Boston and Essex brand names. Moreover, we are the largest domestic producer of band and orchestralinstruments and offer a complete line of brasswind, woodwind, percussion andstringed instruments and related accessories with well-known brand names suchas Bach, C.G. Conn, King, and Ludwig. We sell our products through dealers and distributors worldwide.  Our piano customer base consists ofprofessional artists, amateur pianists, and institutions such as concert halls,universities, and music schools.  Ourband and orchestral instrument customer base consists primarily of middle schooland high school students, but also includes adult amateur and professionalmusicians.

 

**Critical Accounting Policies**

 

The nature of our business - the productionand sale of musical instruments - is such that it rarely involves applicationof highly complex or subjective accounting principles.  The accounting policies that are subject tosignificant management estimates are those normally found in traditionalbusinesses and include inventory reserves, accounts receivable reserves,reserves on notes receivable, and warranty reserves.  We have significant experience and data on which to base theseestimates.  Historical information isadjusted for specific uncertainties, such as new product introductions, andcontemporaneous information, such as price fluctuations.  Management regularly performs assessments ofthe underlying assumptions and believes that they provide a reasonable basisfor the estimates contained in our financial statements.

 

**Forward-Looking Statements**

 

Certainstatements contained in this document are “forward-looking statements” withinthe meaning of Section 21E of the Securities and Exchange Act of 1934, asamended.  These forward-lookingstatements represent our present expectations or beliefs concerning futureevents.  We caution that such statementsare necessarily based on certain assumptions which are subject to risks anduncertainties which could cause actual results to differ materially from thoseindicated herein.  These risk factorsinclude, but are not limited to, changes in general economic conditions, geopolitical events, increasedcompetition, work stoppages and slowdowns, exchange rate fluctuations,variations in the mix of products sold, fluctuations in effective tax ratesresulting from shifts in sources of income, and the ability to successfullyintegrate and operate acquired businesses. Further information on these risk factors is included in our AnnualReport on Form 10-K for the year ended December 31, 2002, our FinalProspectus filed in August 1996, and Registration Statement No. 333-62790filed in June 2001, particularly in the sections entitled “RiskFactors.”  We encourage you to readthose descriptions carefully.  Wecaution investors not to place undue reliance on the forward-looking statementscontained in this report.  Thesestatements, like all statements contained in this report, speak only as of thedate of this report (unless another date is indicated) and we undertake noobligation to update or revise the statements except as required by law.

 

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**Resultsof Operations**

 

*Three Months Ended September 27, 2003 Compared to ThreeMonths Ended September 28, 2002*

 

*Net Sales -*Netsales increased $7.2 million (10%) to $82.5 million. The majority of thisincrease was attributable to piano sales, which improved $6.8 million (19%) to$42.3 million.  This increase was due toa positive foreign exchange impact of $1.4 million and a 15% increase in Steinway grand unitshipments.  An increase in Bostonproduct shipments of 8% also contributed to the sales improvement.  Band and orchestral instrument salesimproved $0.4 million (1%), despite an overall unit decrease of 13%.  A shift towards higher priced andprofessional level instruments was the primary cause of the increase.

 

*G**ross Profit -* Gross profit increased by$1.6 million (7%) to $22.9 million on a gross margin decrease from 28.3% to27.7%.  Piano margins decreased from32.5% in 2002 to 31.7% in 2003 due primarily to unfavorable exchange rates onour Boston piano purchases.  Underabsorptionof overhead at our domestic manufacturing facility was also a contributingfactor. Band and orchestral instrument margins decreased from 24.5% in 2002 to23.5% in 2003.  This decrease was due to$0.3 million of severance costs associated with the pending closing of our Nogales, Arizonawoodwind facility and the underabsorption of overhead at due to lowerproduction levels of student instruments. $0.3 million in increased pension expense in the current period alsonegatively contributed to the margin.

 

*Operating Expenses*– Overall operating expenses increased by $2.1 million (13%) to $17.3 millionin the third quarter due to $0.3 million in negative foreign exchange impactand $2.1 million in building and equipment impairment costs associated with theupcoming closing of our Nogales, Arizona woodwind manufacturing facility.  Excluding these costs, operating expensesdecreased slightly.

 

*Other Expense, Net -*Otherexpenses decreased $0.7 million to $2.5 million in the current period.  Net interest expense decreased $0.4 millionas a result lower borrowings on our line of credit and interest savings ($0.1million) associated with our debt buyback of $4.7 million in December 2002. A shift from foreign exchange losses in the prior period to foreignexchange gains in the current period also contributed to the net decrease inexpenses.

 

*Income Taxes**–*Our effective tax rate is highlydependent upon our ability to utilize foreign tax credits.  The amount of such credits is based on theratio of foreign source to total income computed solely on a tax , as opposedto book, reporting basis.  We file ourtax returns for the previous year in September and have nine months ofcurrent year information on which to base our full year estimate.  Accordingly, the third quarter is the period in which we have the mostcomprehensive and comparative data to use when adjusting our estimates for thefull year.  This year our third quarteradjustment was driven by an unfavorable shift in the ratio of foreign sourceincome to domestic income, due in part by an increase in foreign-based assetsgenerated mostly through the strengthening of foreign currencies.  As a result, our effective tax rateincreased from 23.4% in the prior year period to 40%.

 

*Nine Months Ended September 27, 2003 Compared to NineMonths Ended September 28, 2002*

 

*Net Sales*-**Net sales increased $1.4 million (1%) to$243.1 million in the first nine months of 2003. Piano sales increased $9.3million (8%) despite an overall unit shipment decrease of 4%, primarily as aresult of a positive foreign exchange impact of $6.6 million.  The remaining sales increase resulted from afavorable shift in mix towards retail units. Band and orchestral instrument sales decreased $7.9 million (6%) on anoverall unit decrease of 11%.  The delayin availability of product resulting from the union strikes at our LaGrange,Illinois and Eastlake, Ohio plants (settled in March and May,respectively)

 

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negatively impacted instrument shipments into thethird quarter.  Band sales continued tobe adversely impacted by lower priced products imported from Asia.  However, this impact was minimized byimproved shipments of fill-in orders to dealers requiring additional instrumentstock for the 2003 fall rental season.

 

G*ross Profit-* Gross profit decreased by $4.6 million (7%) to $66.4 million on agross margin decrease from 29.4% to 27.3%. Piano margins decreased from 34.8% in 2002 to 32.6% in 2003 as a resultof lower production levels and underabsorption of overhead at our domesticmanufacturing facility, compounded by the impact of unfavorable foreignexchange rates on Boston inventory purchases. Band and orchestral instrumentmargins decreased from 24.9% in 2002 to 22.3% in 2003.  This decrease was due to three main factors:costs of $1.9 million paid to employees in accordance with the terms of laborcontracts which expired, $1.3 million in unabsorbed overhead and lost profitresulting from the work stoppages at two of our plants, and $0.3 million inseverance costs associated with the pending closure of our Nogales, Arizonawoodwind manufacturing facility.

 

*Operating Expenses*– Overall operating expenses increased by $3.8 million (8%) to $51.7 million inthe first nine months of 2003. Approximately $1.6 million of the increase is attributable to foreignexchange, $1.0 million is due to the costs associated with the 150thanniversary celebration of our piano division, and $2.1 million resulted fromthe building and equipment impairment charges associated with our Nogales,Arizona facility.  Excluding theseitems, operating expenses decreased compared to the prior period.

 

*Other Expense, net -*Otherexpenses decreased by $1.3 million (15%) to $7.1 million, primarily as a resultof lower net interest expense of $1.2 million. Limited borrowings on our lines of credit, our debt buyback of $4.7million in December 2002, and the resultant lower interest expensecontributed $0.8 million to the decrease. Increased interest income of $0.4 million, resulting from our internalfinancing of notes receivable that had historically been sold to a third partyalso contributed to the net decrease.

 

*Income Taxes* – Oureffective tax rate increased from 32.8% to 38.7% based on forecasted foreignsource income and lower estimated foreign tax credit utilization in 2003.

 

**Liquidity and Capital Resources**

 

Wehave relied primarily upon cash provided by operations, supplemented asnecessary by seasonal borrowings under our working capital line, to finance ouroperations, repay long-term indebtedness and fund capital expenditures.

 

Cashused in operations in the first nine months of 2002 was $2.1 million, comparedto cash provided by operations in the first nine months of 2003 of $5.4million.  The significant increase incash flows occurred despite a $5.3 million decrease in net income to date,which was caused in part by the non-cash facility rationalization charge takenin the third quarter.  An increase intax and other accruals resulting from a change in timing of payments, andeffective inventory management also contributed to the improved operationalcash flow.

 

Cashused in investing activities decreased from $3.4 million to $2.4 million in thecurrent period as a result of the decrease in capital expenditures from $3.6million to $2.8 million.  Capitalexpenditures were used primarily for the purchase of new machinery andequipment and production and retail facility improvements.  In 2003, we expect to spend approximately$4.5 to $5.0 million for capital projects, consisting mainly of retail facilitybuild-outs, machinery and process improvements, and equipment replacement.

 

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Cashprovided by financing activities in the first nine months of 2002 was $4.4 million,compared to cash used for financing activities in the first nine months of 2003of $3.4 million.  This shift isprimarily a result of the decreased use of our domestic revolving line ofcredit in the current period.

 

## **Borrowing Availability and Activities**

 

Ourreal estate term loan, acquisition term loan and domestic seasonal borrowingrequirements are accommodated through a committed credit facility with asyndicate of domestic lenders (the “Credit Facility”).  The Credit Facility provides us with a potentialborrowing capacity of up to $85.0 million in revolving credit loans, based oneligible accounts receivable and inventory balances.  The acquisition term loan and revolving credit loan portions ofthe Credit Facility bear interest at average 30-day LIBOR plus 1.75%, and thereal estate term loan bears interest at average 30-day LIBOR plus 1.5%.  The Credit facility expires onSeptember 14, 2008.  As ofSeptember 27, 2003, there were no revolving credit loans outstanding andavailability based on eligible accounts receivable and inventory balances, netof letter of credit deductions of $4.5 million, was approximately $80.5million.  Open account loans withforeign banks also provide for borrowings by Steinway’s foreign subsidiaries ofup to €17.6 million ($20.2 million at the September 27, 2003 exchangerate).  We had $2.6 million in foreignloans outstanding as of September 27, 2003.

 

Ourlong-term financing consists primarily of $145.3 million of 8.75% Senior Notesand $48.8 million of term loans outstanding under the Credit Facility. Our debtagreements contain covenants that place certain restrictions on us, includingour ability to incur additional indebtedness, to make investments in otherentities and to pay cash dividends.  Wewere in compliance with all such covenants as of September 27, 2003.

 

Weexpect to continue to focus on managing working capital, repaying debt,maintaining and expanding market share, and improving productionefficiency.  In the next nine to twelvemonths, we intend to complete the project of scaling back the number of banddivision production facilities.  We willclose our Nogales, Arizona and one of our Elkhart, Indiana woodwind plants andconsolidate the manufacturing of many products into our existing productionfacilities.  We believe the cash impactof our facility rationalization project will range from $4.0 to $5.0 millionand will not materially impact our liquidity. We are not aware of any other trends, demands, commitments, or costs ofresources that are expected to materially impact liquidity or capitalresources.  Therefore, we believe thatcash on hand, together with cash flows anticipated from operations andavailable borrowings under the Credit Facility, will be adequate to meetexisting debt service requirements, fund continuing capital requirements andsatisfy working capital and general corporate needs for the next twelve months.

 

Wehave reserved 721,750 shares of our existing treasury stock to be utilized forthe exercise of stock options our Amended and Restated 1996 Stock Plan.  These options will have no impact on ourcash flow or the number of shares outstanding unless and until the options areexercised.

 

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**ContractualObligations**

 

The followingtable provides a summary of our contractual obligations at September 27,2003.

 
|                             |   | **Payments due by period (amounts in 000s)** |    |
|----------------------------------|--------|----------------------------------------------|---------|
| **Contractual Obligations**      |   | **Total**                                    |    | **Less than  1 year** |   | **1 - 3 years** |   | **3 - 5 years** |   | **More than  5 years** |   |
|                             |   |                                         |    |   |   |   |   |   |   |   |   |
| Long-term  debt (1)              |   | $                                            | 196,786 |   | $ | 9,159 |   | $ | 14,984 |   | $ | 16,700 |   | $ | 155,943 |   |
| Operating  leases (2)            |   | 276,013                                      |    | 5,006 |   | 8,080 |   | 6,878 |   | 256,049 |   |
| Purchase  obligations (3)        |   | 3,610                                        |    | 3,173 |   | 227 |   | 210 |   | — |   |
| Other  long-term liabilities (4) |   | 31,154                                       |    | 3,896 |   | 6,466 |   | 8,170 |   | 12,622 |   |
| Total                            |   | $                                            | 507,563 |   | $ | 21,234 |   | $ | 29,757 |   | $ | 31,958 |   | $ | 424,614 |   |

 

**Notesto Contractual Obligations:**

 

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(1) The nature of our long-term debt obligations isdescribed more fully in the “Borrowing Availability and Activities”section of “Liquidity and Capital Resources.”

(2) Approximately $260.2 million of our operatinglease obligations is attributable to the ninety-nine year land lease associatedwith the purchase of Steinway Hall; the remainder is attributable to theleasing of other facilities and equipment.

(3) Purchase obligations consist of firm purchasecommitments for raw materials and equipment.

(4) Our other long-term liabilities consist primarilyof pension obligations and employment agreement obligations.

 

**NewAccounting Pronouncements**

 

InApril 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 onDerivative Instruments and Hedging Activities.” SFAS 149 amends SFAS 133 toconform and incorporate derivative implementation issues and subsequentlyissued accounting guidance. SFAS 149 clarifies under what circumstances acontract with an initial net investment meets the characteristic of aderivative, and clarifies when a derivative contains a financing component thatwarrants special reporting in the statement of cash flows.  SFAS 149 also amends other existingpronouncements, resulting in more consistent reporting of contracts that arederivatives in their entirety or that contain embedded derivatives that warrantspecial accounting.  SFAS 149 is effectivefor contracts entered into or modified after June 30, 2003, and should beapplied prospectively. However, certain SFAS 133 implementation issues thatwere effective for all fiscal quarters prior to June 15, 2003, shouldcontinue to be applied in accordance with their respective effective dates. Theadoption of SFAS 149 did not have a material effect on our financial position,results of operations or cash flows.

 

InMay 2003, the FASB issued SFAS No. 150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity.” SFAS 150establishes standards for how an issuer classifies and measures certainfreestanding financial instruments with characteristics of both liabilities andequity. SFAS 150 requires that an issuer classify a financial instrument that iswithin its scope as a liability (or asset in some circumstances). We wererequired to adopt SFAS 150 effective June 29, 2003. The adoption of SFAS150 did not have a material effect on our financial position, results ofoperations or cash flows.

 

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

 

**We are exposed to market riskassociated with changes in foreign currency exchange rates and interestrates.  We mitigate our foreign currencyexchange rate risk by maintaining foreign currency cash balances and holdingforward foreign currency contracts. These contracts are used as a hedge against intercompany transactionsand are not used for trading or speculative purposes.  The fair value of the forward foreign currency exchange contractsis sensitive to changes in foreign currency exchange rates.  The impact of an adverse change in foreigncurrency exchange rates would not be materially different than that disclosedin the our Annual Report on Form 10-K for the year ended December 31,2002.**

 

**Although the majority of ourlong-term debt is at a fixed interest rate, our revolving loans and term loansbear interest at rates that fluctuate with changes in LIBOR.  As such, our interest expense on ourrevolving loans and term loans and the fair value of our fixed long-term debtare sensitive to changes in market interest rates.  The effect of an adverse change in market interest rates on ourinterest expense and the fair value of our long-term debt would not bematerially different than that disclosed in our Annual Report on Form 10-K forthe year ended December 31, 2002.**

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

 

As ofthe end of the period covered by this report, we evaluated the effectiveness ofthe design and operation of our disclosure controls and procedures (as definedin Exchange Act Rules 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.Dana Messina, our President and Chief Executive Officer, and Dennis Hanson, ourSenior Executive Vice President and Chief Financial Officer, reviewed andparticipated in this evaluation. Based on this evaluation, Messrs. Messina andHanson concluded that, as of the Evaluation Date, our disclosure controls wereeffective.  As of the end of the periodcovered by this report, there have not been any significant changes in ourinternal accounting controls or in other factors that could significantlyaffect those controls.

 

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

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

 

(a)          Exhibits

 

31.1        Certification of thePrincipal Executive Officer pursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

31.2        Certification of thePrincipal Financial Officer pursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

32.1        Certificationof the Principal Executive Officer pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2        Certificationof the Principal Financial Officer pursuant to 18 U.S. C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)         Reports on Form 8-K

 

During the quarter endedSeptember 27, 2003, we filed or furnished the following reports on Form8-K:

 

(i)             OnAugust 7, 2003, the Company filed a Current Report on Form 8-K thatincluded a press release issued on the same day announcing its results for thesecond quarter and six months ended June 28, 2003.

 

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Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrants have duly caused this reportto be signed on their behalf by the undersigned, thereunto duly authorized.

 

 
|                         | STEINWAY MUSICAL  INSTRUMENTS, INC.                           |
|------------------------------|---------------------------------------------------------------|
|                         |                                                          |
|                         |  /s/ Dana D. Messina                                     |   |
|                         | Dana D. Messina                                               |
|                         | Director, President and  Chief Executive Officer              |
|                         |                                                          |
|                         |  /s/ Dennis M. Hanson                                    |   |
|                         | Dennis M. Hanson                                              |
|                         | Senior Executive Vice  President and  Chief Financial Officer |
|                         |                                                          |
|                         |                                                          |
| Date: November 7,  2003 |                                                          |

 

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