Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **x**     | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008** |
|-----------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |       |                                                                                                                                                      |   |   |
| **o****** | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                  |

 

**COMMISSION FILE NUMBER 001-11911**

 

**STEINWAY MUSICAL INSTRUMENTS,INC.**

(Exact name of registrant as specified in its charter)

 

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

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements duringthe past 90 days.

Yes  x    No  o

 

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

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

 

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

Yes  o    No  x

 

Number of shares ofCommon Stock issued and outstanding as of November 5, 2008**:**

 
|   | Class A | 477,952   |   |
|--------|--------------|-----------|--------|
|   | Ordinary     | 8,055,307 |   |
|   | Total        | 8,533,259 |   |

 

 

 

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**FORM 10-Q**

**INDEX**

 
| **PART I.**  |       | **UNAUDITED FINANCIAL INFORMATION**                                                                            |       |
|-------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|
|              |       |                                                                                                           |       |
| **Item 1.**       | ** ** | **Condensed Consolidated Financial  Statements:**                                                              | ** ** |
|              |       |                                                                                                           |       |
|              |       | Condensed Consolidated  Statements of Operations Three and nine months ended September 30, 2008  and 2007 | 3          |
|              |       |                                                                                                           |       |
|              |       | Condensed  Consolidated Balance Sheets September 30, 2008 and December 31,  2007                     | 4          |
|              |       |                                                                                                           |       |
|              |       | Condensed  Consolidated Statements of Cash Flows Nine months ended September 30,  2008 and 2007           | 5          |
|              |       |                                                                                                           |       |
|              |       | Condensed  Consolidated Statement of Stockholders’ Equity Nine months ended  September 30, 2008      | 6          |
|              |       |                                                                                                           |       |
|              |       | Notes  to Condensed Consolidated Financial Statements                                                          | 7          |
|              |       |                                                                                                           |       |
| **Item 2.**       | ** ** | **Management’s  Discussion and Analysis of Financial Conditionand Results  of Operations**                | 25         |
|              |       |                                                                                                           |       |
| **Item 3.**       | ** ** | **Quantitative  and Qualitative Disclosures about Market Risk.**                                               | 35         |
|              |       |                                                                                                           |       |
| **Item 4.**       |       | **Controls and  Procedures**                                                                                   | 36         |
|              |       |                                                                                                           |       |
| **PART II.** |       | **OTHER INFORMATION**                                                                                          |       |
|              |       |                                                                                                           |       |
| **Item 2.**       |       | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                               | 36         |
| ** **        |       | ** **                                                                                                     |       |
| **Item 6.**       |       | **Exhibits**                                                                                                   | 36         |
|              |       |                                                                                                           |       |
| ** **        | ** ** | **Signatures**                                                                                                 | 37         |

 

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**ITEM 1           CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**Unaudited**

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

 
| ** **                                       | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                        |       | $                                                        | 100,488    |                                                    | $          | 99,293 |   | $ | 293,195 |   | $ | 284,982 |   |
| Cost of sales                                    |       | 70,559                                                   |       | 71,202                                                  |       | 206,829 |   | 201,086 |   |
|                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Gross profit                                     |       | 29,929                                                   |       | 28,091                                                  |       | 86,366 |   | 83,896 |   |
|                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Operating  expenses:                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Sales and  marketing                             |       | 11,682                                                   |       | 12,037                                                  |       | 37,023 |   | 36,848 |   |
| General and  administrative                      |       | 8,701                                                    |       | 8,361                                                   |       | 26,176 |   | 25,512 |   |
| Amortization of  intangible assets               |       | 336                                                      |       | 196                                                     |       | 795 |   | 588 |   |
| Other operating  expenses                        |       | 68                                                       |       | 262                                                     |       | 537 |   | 1,297 |   |
| Facility  rationalization and impairment charges |       | 8,555                                                    |       | —                                                  |       | 9,617 |   | — |   |
| Total operating  expenses                        |       | 29,342                                                   |       | 20,856                                                  |       | 74,148 |   | 64,245 |   |
|                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Income from  operations                          |       | 587                                                      |       | 7,235                                                   |       | 12,218 |   | 19,651 |   |
|                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Other (income)  expense, net                     |       | (405                                                     | )          | 37                                                      |       | (388 | ) | (154 | ) |
| Gain on  extinguishment of debt                  |       | —                                                   |       | —                                                  |       | (636 | ) | — |   |
| Interest income                                  |       | (602                                                     | )          | (613                                                    | )          | (2,343 | ) | (2,615 | ) |
| Interest expense                                 |       | 2,980                                                    |       | 3,518                                                   |       | 9,154 |   | 10,195 |   |
| Total  non-operating expenses                    |       | 1,973                                                    |       | 2,942                                                   |       | 5,787 |   | 7,426 |   |
|                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Income (loss)  before income taxes               |       | (1,386                                                   | )          | 4,293                                                   |       | 6,431 |   | 12,225 |   |
|                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Income tax  provision (benefit)                  |       | (1,126                                                   | )          | 1,285                                                   |       | 1,671 |   | 4,634 |   |
|                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Net income  (loss)                               |       | $                                                        | (260       | )                                                       | $          | 3,008 |   | $ | 4,760 |   | $ | 7,591 |   |
|                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Earnings (loss)  per share                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                            |       | $                                                        | (0.03      | )                                                       | $          | 0.35 |   | $ | 0.56 |   | $ | 0.89 |   |
| Diluted                                          |       | $                                                        | (0.03      | )                                                       | $          | 0.35 |   | $ | 0.55 |   | $ | 0.88 |   |
|                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average  shares:                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                            |       | 8,538,264                                                |       | 8,569,253                                               |       | 8,565,928 |   | 8,503,117 |   |
| Diluted                                          |       | 8,538,264                                                |       | 8,683,025                                               |       | 8,652,571 |   | 8,641,143 |   |

 

See notes to condensedconsolidated financial statements.

 

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**Unaudited**

**(In Thousands)**

** **
| ** **                                                                                                              | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Assets                                                                                                                  |       |                         |       |                        |       |
| Current assets:                                                                                                         |       |                         |       |                        |       |
| Cash                                                                                                                    |       | $                            | 22,288     |                        | $          | 37,304 |   |
| Accounts, notes  and other receivables, net of allowances of   $16,395 and $17,519 in 2008 and 2007, respectively       |       | 77,340                       |       | 73,131                      |       |
| Inventories, net                                                                                                        |       | 161,752                      |       | 152,451                     |       |
| Prepaid expenses  and other current assets                                                                              |       | 13,335                       |       | 11,272                      |       |
| Deferred tax  assets                                                                                                    |       | 12,216                       |       | 11,571                      |       |
| Total current  assets                                                                                                   |       | 286,931                      |       | 285,729                     |       |
|                                                                                                                    |       |                         |       |                        |       |
| Property, plant  and equipment, net of accumulated depreciation of   $97,679 and $94,221 in 2008 and 2007, respectively |       | 88,014                       |       | 94,150                      |       |
| Trademarks                                                                                                              |       | 16,182                       |       | 14,119                      |       |
| Goodwill                                                                                                                |       | 23,818                       |       | 32,907                      |       |
| Other  intangibles, net                                                                                                 |       | 5,899                        |       | 3,937                       |       |
| Other assets                                                                                                            |       | 18,096                       |       | 18,014                      |       |
| Long-term  deferred tax assets                                                                                          |       | 8,415                        |       | 8,822                       |       |
|                                                                                                                    |       |                         |       |                        |       |
| Total assets                                                                                                            |       | $                            | 447,355    |                        | $          | 457,678 |   |
|                                                                                                                    |       |                         |       |                        |       |
| Liabilities and  stockholders’ equity                                                                              |       |                         |       |                        |       |
| Current  liabilities:                                                                                                   |       |                         |       |                        |       |
| Debt                                                                                                                    |       | $                            | 2,983      |                        | $          | 2,285 |   |
| Accounts payable                                                                                                        |       | 17,968                       |       | 12,381                      |       |
| Other current  liabilities                                                                                              |       | 45,456                       |       | 52,320                      |       |
| Total current  liabilities                                                                                              |       | 66,407                       |       | 66,986                      |       |
|                                                                                                                    |       |                         |       |                        |       |
| Long-term debt                                                                                                          |       | 168,385                      |       | 173,981                     |       |
| Deferred tax  liabilities                                                                                               |       | 11,240                       |       | 15,003                      |       |
| Pension and  other postretirement benefit liabilities                                                                   |       | 29,124                       |       | 30,093                      |       |
| Other  non-current liabilities                                                                                          |       | 6,592                        |       | 7,836                       |       |
| Total  liabilities                                                                                                      |       | 281,748                      |       | 293,899                     |       |
|                                                                                                                    |       |                         |       |                        |       |
| Commitments and  contingent liabilities                                                                                 |       |                         |       |                        |       |
|                                                                                                                    |       |                         |       |                        |       |
| Stockholders’  equity:                                                                                             |       |                         |       |                        |       |
| Common stock                                                                                                            |       | 11                           |       | 11                          |       |
| Additional  paid-in capital                                                                                             |       | 95,876                       |       | 94,370                      |       |
| Retained  earnings                                                                                                      |       | 117,653                      |       | 112,917                     |       |
| Accumulated  other comprehensive income (loss)                                                                          |       | (811                         | )          | 1,773                       |       |
| Treasury stock,  at cost                                                                                                |       | (47,122                      | )          | (45,292                     | )          |
| Total  stockholders’ equity                                                                                        |       | 165,607                      |       | 163,779                     |       |
|                                                                                                                    |       |                         |       |                        |       |
| Total  liabilities and stockholders’ equity                                                                        |       | $                            | 447,355    |                        | $          | 457,678 |   |

 

See notes to condensedconsolidated financial statements.

 

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**Unaudited**

**(In Thousands)**

** **
| ** **                                                                    | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                    | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| Cash flows from  operating activities:                                        |       |                                                    |       |   |   |
| Net income                                                                    |       | $                                                       | 4,760      |   | $ | 7,591 |   |
| Adjustments to  reconcile net income to cash flows from operating activities: |       |                                                    |       |   |   |
| Depreciation and  amortization                                                |       | 8,217                                                   |       | 7,839 |   |
| Amortization of  bond discount, net                                           |       | 122                                                     |       | 124 |   |
| Gain on  extinguishment of debt                                               |       | (636                                                    | )          | — |   |
| Facility  rationalization charges                                             |       | 1,062                                                   |       | — |   |
| Goodwill  impairment                                                          |       | 8,555                                                   |       | — |   |
| Stock-based compensation  expense                                             |       | 811                                                     |       | 853 |   |
| Excess tax  benefits from stock-based awards                                  |       | (4                                                      | )          | (410 | ) |
| Tax benefit from  stock option exercises                                      |       | 5                                                       |       | 735 |   |
| Deferred tax  benefit                                                         |       | (3,920                                                  | )          | (2,038 | ) |
| Other                                                                         |       | 742                                                     |       | 1,036 |   |
| Changes in  operating assets and liabilities:                                 |       |                                                    |       |   |   |
| Accounts, notes  and other receivables                                        |       | (3,494                                                  | )          | (10,705 | ) |
| Inventories                                                                   |       | (12,544                                                 | )          | (10,999 | ) |
| Prepaid expenses  and other assets                                            |       | (1,582                                                  | )          | 49 |   |
| Accounts payable                                                              |       | 5,185                                                   |       | (3,873 | ) |
| Other  liabilities                                                            |       | (9,681                                                  | )          | (1,576 | ) |
| Cash flows from  operating activities                                         |       | (2,402                                                  | )          | (11,374 | ) |
|                                                                          |       |                                                    |       |   |   |
| Cash flows from  investing activities:                                        |       |                                                    |       |   |   |
| Capital  expenditures                                                         |       | (3,834                                                  | )          | (3,644 | ) |
| Proceeds from  disposals of property, plant and equipment                     |       | 817                                                     |       | 199 |   |
| Acquisition of  businesses, net of cash acquired                              |       | (3,181                                                  | )          | — |   |
| Cash flows from  investing activities                                         |       | (6,198                                                  | )          | (3,445 | ) |
|                                                                          |       |                                                    |       |   |   |
| Cash flows from  financing activities:                                        |       |                                                    |       |   |   |
| Borrowings under  lines of credit                                             |       | 5,923                                                   |       | 148,929 |   |
| Repayments under  lines of credit                                             |       | (5,395                                                  | )          | (129,633 | ) |
| Repayments of  long-term debt, net of discount                                |       | (4,981                                                  | )          | — |   |
| Proceeds from  issuance of common stock                                       |       | 817                                                     |       | 4,137 |   |
| Purchase of  treasury stock                                                   |       | (1,981                                                  | )          | — |   |
| Dividends paid                                                                |       | —                                                  |       | (25,187 | ) |
| Excess tax  benefits from stock-based awards                                  |       | 4                                                       |       | 410 |   |
| Cash flows from  financing activities                                         |       | (5,613                                                  | )          | (1,344 | ) |
| Effect of  foreign exchange rate changes on cash                              |       | (803                                                    | )          | 742 |   |
|                                                                          |       |                                                    |       |   |   |
| Decrease in cash                                                              |       | (15,016                                                 | )          | (15,421 | ) |
| Cash, beginning  of period                                                    |       | 37,304                                                  |       | 30,409 |   |
| Cash, end of  period                                                          |       | $                                                       | 22,288     |   | $ | 14,988 |   |
|                                                                          |       |                                                    |       |   |   |
| Supplemental  Cash Flow Information                                           |       |                                                    |       |   |   |
| Interest paid                                                                 |       | $                                                       | 12,398     |   | $ | 13,269 |   |
| Taxes paid                                                                    |       | $                                                       | 11,942     |   | $ | 8,980 |   |

 

See notes to condensed consolidated financial statements.

 

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’EQUITY**

**Unaudited**

**(In Thousands Except Share Data)**

** **
| ** **                                            | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|------------------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
|                                                  |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Balance,  January 1, 2008                        |       | $                 | 11         |                             | $          | 94,370                 |       | $                                                    | 112,917    |                | $          | 1,773                                 |       | $ | (45,292 | ) | $ | 163,779 |   |
| Comprehensive  income:                                |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Net income                                            |       |              |       |                             |       | 4,760                  |       |                                                 |       |                |       | 4,760                                 |       |
| Foreign currency  translation adjustments             |       |              |       |                             |       |                   |       | (2,584                                               | )     |                |       | (2,584                                | )     |
| Total  comprehensive income                           |       |              |       |                             |       |                   |       |                                                 |       |                |       | 2,176                                 |       |
| Exercise of  6,500 options for shares of common stock |       | —            |       |                             |       | (24)                   |       |                                                 |       | 151                 |       | 127                                   |       |
| Stock-based  compensation                             |       |              |       | 811                              |       |                   |       |                                                 |       |                |       | 811                                   |       |
| Tax benefit of  options exercised                     |       |              |       | 5                                |       |                   |       |                                                 |       |                |       | 5                                     |       |
| Issuance of  29,379 shares of common stock            |       | —            |       | 690                              |       |                   |       |                                                 |       |                |       | 690                                   |       |
| Purchase of  74,700 shares of treasury stock          |       |              |       |                             |       |                   |       |                                                 |       | (1,981              | )          | (1,981                                | )     |
| Balance,  September 30, 2008                     |       | $                 | 11         |                             | $          | 95,876                 |       | $                                                    | 117,653    |                | $          | (811                                  | )          | $ | (47,122 | ) | $ | 165,607 |   |

 

See notes to condensed consolidatedfinancial statements.

 

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008**

**Unaudited**

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

 

**(1)           Basis of Presentation**

 

The accompanying condensed consolidated financialstatements of Steinway Musical Instruments, Inc. and subsidiaries (the “Company”)for the three and nine months ended September 30, 2008 and 2007 areunaudited. In the opinion of management, these statements have been prepared onthe same basis as the audited consolidated financial statements as of and forthe year ended December 31, 2007, and include all adjustments which are ofa normal and recurring nature, necessary for the fair presentation of financialposition, results of operations and cash flows for the interim periods. Weencourage you to read the condensed consolidated financial statements inconjunction with the risk factors, consolidated financial statements and notesthereto contained in the Company’s Annual Report on Form 10-K for the yearended December 31, 2007 filed with the Securities and Exchange Commission(“SEC”). The results of operations for the three and nine months ended September 30,2008 are not necessarily indicative of the results that may be expected for theentire year.

 

Throughout this report “we,” “us,” and “our” refer toSteinway Musical Instruments, Inc. and subsidiaries taken as a whole.

 

**(2)           Summary of Significant AccountingPolicies**

 

**Principles of Consolidation** -Our consolidated financial statements include the accounts of all direct andindirect subsidiaries, all of which are wholly owned, including the piano (“Steinway”),band (“Conn-Selmer”), and online music (“Arkiv”) divisions. We have includedresults for Arkiv within the piano segment elsewhere in this report.Intercompany balances have been eliminated in consolidation.

 

**Use of Estimates****- The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americanecessarily requires us to make estimates and assumptions that affect thereported amounts of assets and liabilities, the disclosure of contingent assetsand liabilities at the date of the financial statements, and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates.

 

**Income Taxes** - We provide forincome taxes using an asset and liability approach. We compute deferred incometax assets and liabilities for differences between the financial statement andtax bases of assets and liabilities that will result in taxable or deductibleamounts in the future based on enacted tax laws and rates applicable to theperiods in which the differences are expected to affect taxable income. Weestablish valuation allowances when necessary to reduce deferred tax assets tothe amount that more likely than not will be realized.

 

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

 

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recorded as a component of income taxexpense. At adoption date, we made a comprehensive review of our uncertaintax positions. We believe appropriate provisions for outstanding issues havebeen made.

 

In conjunction with theadoption of FIN 48, we began reporting income tax-related interest andpenalties as a component of income tax expense. Prior to adoption, suchinterest was reported in interest expense. We file income tax returns at the U.S. federal, state, and locallevels, as well as in several foreign jurisdictions. With few exceptions, ourreturns are no longer subject to examinations for years before 2004.

 

The liability for uncertain tax positions decreased$3.8 million in 2008 as a result of settlements with state taxing authorities.Although we believe our tax estimates are appropriate, the final determinationof tax audits and any related litigation could result in changes in ourestimates.

 

**Stock-based Compensation** - Werecord compensation cost on a straight-line basis over the award’s requisiteservice period for all share-based awards granted. We estimate the fair valueof our stock option awards (less estimated forfeitures) and employee stockpurchase plan rights on the date of grant using the Black-Scholes optionvaluation model.

 

**Earnings (loss) per Common Share** - We compute earnings (loss) per shareusing the weighted-average number of common shares outstanding during eachperiod. Diluted earnings (loss) per common share reflects the effect of ouroutstanding options using the treasury stock method, except when such options wouldbe antidilutive.

 

A reconciliationof the weighted-average shares used for the basic and diluted computations isas follows:

 
| ** **                             | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                             | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Weighted-average  shares:              |       |                                                     |       |                                                    |       |   |   |   |   |
| For basic  earnings (loss) per share   |       | 8,538,264                                                |       | 8,569,253                                               |       | 8,565,928 |   | 8,503,117 |   |
| Dilutive effect  of stock options      |       | —                                                   |       | 113,772                                                 |       | 86,643 |   | 138,026 |   |
| For diluted  earnings (loss) per share |       | 8,538,264                                                |       | 8,683,025                                               |       | 8,652,571 |   | 8,641,143 |   |

 

We did not include any of the 807,876 outstandingoptions to purchase shares of common stock in the computation of diluted lossper share for the three months ended September 30, 2008 because the impactwould have been antidilutive. We did not include 195,300 outstanding options topurchase shares of common stock in the computation of diluted earnings percommon share for the nine months ended September 30, 2008, because theirexercise prices were more than the average market price of our common shares,and therefore antidilutive. We did not include 22,500 options to purchaseshares of common stock in the computation of diluted earnings per share for thethree and nine months ended September 30, 2007, respectively, becausetheir impact would have been antidilutive.

 

We purchased 48,900 sharesof our common stock for $1.3 million during the three months ended September 30,2008. We purchased 74,700 shares of our common stock for $2.0 million duringthe nine months ended September 30, 2008 pursuant to our share repurchaseprogram. This program, which was announced in the second quarter of 2008,permits us to make discretionary purchases of up to $25.0 million.

 

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**Accumulated Other Comprehensive Income (Loss)** - Accumulated other comprehensive income(loss) is comprised of foreign currency translation adjustments and pension andother post-retirement benefits. The components of accumulated othercomprehensive income (loss) are as follows:

 
| ** **                       | ** ** | **Foreign Currency  Translation  Adjustments** | ** ** | **Pension & Other  Post-Retirement  Benefits** | ** ** | **Tax Impact of  Pension & Other  Post-Retirement  Benefits** | ** ** | **Accumulated Other  Comprehensive  Income (Loss)** | ** ** |
|----------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
|                             |       |                                                |       |                                                         |       |                                                                             |       |                                                     |       |
| Balance  January 1, 2008    |       | $                                                   | 9,041      |                                                         | $          | (11,616                                                                          | )          | $                                                        | 4,348      |   | $ | 1,773 |   |
| Activity                         |       | (2,584                                              | )          | —                                                       |       | —                                                                           |       | (2,584                                                   | )          |
| Balance  September 30, 2008 |       | $                                                   | 6,457      |                                                         | $          | (11,616                                                                          | )          | $                                                        | 4,348      |   | $ | (811 | ) |

 

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

 

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

 

In December 2007, theFASB issued SFAS No. 141R, “Business Combinations,” a revision to SFAS No. 141,“Business Combinations” (“ SFAS 141R”), which provides revised guidancefor recognition and measurement of identifiable assets and goodwill acquired,liabilities assumed, and any noncontrolling interest in the acquiree at fairvalue. SFAS 141R also establishes disclosure requirements to enable theevaluation of the nature and financial effects of a businesscombination. SFAS 141R is required to be applied prospectively to businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008. Wewill comply with SFAS 141R January 1, 2009.

 

In December 2007, theFASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements – an amendment of ARB No. 51” (“SFAS 160”). SFAS160 establishes accounting and reporting standards for ownership interests insubsidiaries held by parties other than the parent. Specifically, SFAS 160requires the presentation of noncontrolling interests as equity in theConsolidated Statement of Financial

 

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Position, and separateidentification and presentation in the Consolidated Statement of Operations ofnet income attributable to the entity and the noncontrolling interest. Italso establishes accounting and reporting standards regarding deconsolidationand changes in a parent’s ownership interest. We will be required tocomply with SFAS 160 January 1, 2009. The provisions of SFAS 160 aregenerally required to be applied prospectively, except for the presentation anddisclosure requirements, which must be applied retrospectively. We arecurrently evaluating the potential impact, if any, of the adoption of SFAS 160on our consolidated financial statements.

 

In March 2008, the FASBissued SFAS No. 161, “Disclosures about Derivative Instruments and HedgingActivities – an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS161 amends and expands the disclosure requirements for derivative instrumentsand hedging activities, with the intent to provide users of financialstatements with an enhanced understanding of how and why an entity usesderivative instruments, how derivative instruments and related hedged items areaccounted for, and how derivative instruments and related hedged items affectan entity’s financial statements. We will comply with SFAS 161 January 1,2009.

 

**(3) ****                              Acquisitions**

 

# **On May 16,2008 we acquired 100% of the membership interest in ArkivMusic, LLC (“Arkiv”),an online retailer of classical music. We have included the operating resultsand net assets of Arkiv in our financial statements since the date ofacquisition.**

# ** **

We acquired Arkiv becauseits product and customer base are complementary to ours, and we will be able tocross-market our products. Under terms of the membership purchase agreement, wedisbursed $3.0 million for the purchase price, and owe additional installmentpayments of $0.5 million in each of the next three years. In addition, we areobligated to pay an amount equal to 5% of the net operating profits of Arkiv,if any, for 2008, 2009, and 2010, the sum of which is not to exceed $2.5million. The final purchase price is dependent upon a calculation derived fromthe 2010 net operating profits which, when finalized, may result in anadditional payment of not more than $11.0 million. In the event that weterminate a particular former owner without cause and do not offer one of the otherformer owners the vacated position, we are required to make a mandatory finalpurchase price payment of $8.3 million. We are still accumulating certaininformation relative to the valuation of intangible assets that may impact thefinal purchase price allocation. Accordingly, the final purchase price allocationmay differ from the amounts presented below. The purchase price is based on thepreliminary acquisition cost determination of $4.8 million and has beenallocated to acquired assets and assumed liabilities as of May 16, 2008 asfollows:

 
| Current assets                   |   | $      | 351    |   |
|----------------------------------|--------|--------|--------|--------|
| Property, plant, and equipment   |   | 33     |   |
| Trademarks                       |   | 2,231  |   |
| Non-compete agreements           |   | 250    |   |
| Customer relationships           |   | 425    |   |
| Website and developed technology |   | 1,987  |   |
| Accounts payable                 |   | (499   | )      |
| Other current liabilities        |   | (25    | )      |
| Subtotal                         |   | 4,753  |   |
| Less: Installment payments       |   | (1,605 | )      |
| Cash acquired                    |   | (162   | )      |
| Total cash paid                  |   | $      | 2,986  |   |

 

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Subsequent footnotes providingdetails of our significant balance sheet accounts include the impact of theArkiv acquisition as of September 30, 2008.

 

On July 16, 2008, weacquired the stock of 4Real Investments, Inc., which does business as Clickpoint Software, Inc.(“Clickpoint”). Our Chairman, Kyle Kirkland, and Chief Executive Officer, DanaMessina, were shareholders of Clickpoint as of the date of acquisition. We paidapproximately $0.2 million for this acquisition, of which $0.1 million was paidto our Chairperson, $0.1 million to our Chief Executive Officer, and theresidual amount of less than $0.1 million to the remaining owners. The purchaseprice has been allocated primarily to website and developed technology.

 

**(4)****                                 Inventories**

 
| ** **      | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials   |       | $                            | 20,069     |                        | $          | 18,615 |   |
| Work-in-process |       | 47,623                       |       | 51,402                      |       |
| Finished goods  |       | 94,060                       |       | 82,434                      |       |
|            |       | $                            | 161,752    |                        | $          | 152,451 |   |

 

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

 

Intangible assets other than goodwill andindefinite-lived trademarks are amortized on a straight-line basis over theirestimated useful lives. Deferred financing costs are amortized over therepayment periods of the underlying debt. We test our goodwill andindefinite-lived trademark assets for impairment annually, or on an interimbasis if events or circumstances indicate that the fair value of an asset hasdecreased below its carrying value. We performed our annual goodwill andintangible asset impairment test as of July 31, 2008. Based on ouranalysis, it was determined that the goodwill associated with the band divisionwas impaired. This was primarily due to the decline in the estimated forecasteddiscounted cash flows expected by that division, the reasons for which arediscussed in the Managements’ Discussion and Analysis section of this document.Accordingly, we wrote off all of the $8.6 million in goodwill during theperiod. Our analysis of band division trademarks did not indicate animpairment, therefore no charge was taken against that asset, or any other intangibleassets attributable to other divisions. No other events or circumstances haveoccurred subsequent to our annual impairment date which have indicated thatthese assets may potentially be impaired.

 

Intangible assets related to the acquisitions discussedin Note 3 have been included with the piano division.

 

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Thechanges in carrying amounts of goodwill and trademarks are as follows:

 
| ** **                               | ** ** | **Piano** | ** ** | **Band** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|-----------|------------|----------|------------|-----------|------------|
| Goodwill:                                |       |      |       |     |       |      |       |
| Balance,  January 1, 2008           |       | $         | 24,352     |     | $          | 8,555     |       | $ | 32,907 |   |
| Foreign currency  translation impact     |       | (534      | )          | —   |       | (534      | )          |
| Impairment  charge                       |       | —    |       | (8,555   | )          | (8,555    | )          |
| Balance,  September 30, 2008        |       | $         | 23,818     |     | $          | —    |       | $ | 23,818 |   |
|                                     |       |      |       |     |       |      |       |
| Trademarks:                              |       |      |       |     |       |      |       |
| Balance,  January 1, 2008           |       | $         | 8,295      |     | $          | 5,824     |       | $ | 14,119 |   |
| Additions based  on preliminary purchase |       |      |       |     |       |      |       |
| price allocation  to acquired assets     |       | 2,231     |       | —   |       | 2,231     |       |
| Foreign currency  translation impact     |       | (168      | )          | —   |       | (168      | )          |
| Balance,  September 30, 2008        |       | $         | 10,358     |     | $          | 5,824     |       | $ | 16,182 |   |

 

We also carry certain intangible assets that areamortized. Once fully amortized, these assets are removed from both the grossand accumulated amortization balance. These assets consist of the following:

 
| ** **                               | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                                     |       |                         |       |                        |       |
| Gross deferred  financing costs:         |       | $                            | 5,624      |                        | $          | 5,755 |   |
| Accumulated  amortization                |       | (2,456                       | )          | (1,980                      | )          |
| Deferred  financing costs, net           |       | $                            | 3,168      |                        | $          | 3,775 |   |
|                                     |       |                         |       |                        |       |
| Gross non-compete  agreements:           |       | $                            | 750        |                        | $          | 500 |   |
| Accumulated  amortization                |       | (432                         | )          | (338                        | )          |
| Non-compete  agreements, net             |       | $                            | 318        |                        | $          | 162 |   |
|                                     |       |                         |       |                        |       |
| Gross customer  relationships:           |       | $                            | 425        |                        | $          | — |   |
| Accumulated  amortization                |       | (32                          | )          | —                      |       |
| Customer  relationships, net:            |       | $                            | 393        |                        | $          | — |   |
|                                     |       |                         |       |                        |       |
| Gross website  and developed technology: |       | $                            | 2,176      |                        | $          | — |   |
| Accumulated  amortization                |       | (156                         | )          | —                      |       |
| Website and  developed technology, net   |       | $                            | 2,020      |                        | $          | — |   |
|                                     |       |                         |       |                        |       |
| Total other  intangibles                 |       | $                            | 8,975      |                        | $          | 6,255 |   |
| Accumulated  amortization                |       | (3,076                       | )          | (2,318                      | )          |
| Other  intangibles, net                  |       | $                            | 5,899      |                        | $          | 3,937 |   |

 

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Deferredfinancing costs were impacted by our purchase of $5.8 million of our SeniorNotes in March 2008. This repurchase is described more fully in Note 7.Trademarks, non-compete agreements, customer relationships, and website anddeveloped technology were impacted by the acquisitions of Arkiv and Clickpoint,which are described more fully in Note 3. The weighted-average amortizationperiod for deferred financing costs is seven years, and the weighted-averageamortization period of all other amortizable intangibles is five years. Totalamortization expense, which includes amortization of deferred financing costs,is as follows:

 
| ** **            | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **            | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **            | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Amortization  expense |       | $                                                        | 336        |                                                    | $          | 196 |   | $ | 795 |   | $ | 588 |   |
|                       |            |                                                          |            |                                                         |            |  |  |  |  |  |  |  |  |

 

The following table showsthe total estimated amortization expense for the remainder of 2008 and beyond:

 
| Remainder of  2008   |   | $     | 335    |   |
|----------------------|--------|-------|--------|--------|
| 2009                 |   | 1,302 |   |
| 2010                 |   | 1,218 |   |
| 2011                 |   | 1,178 |   |
| 2012                 |   | 1,068 |   |
| 2013 and  thereafter |   | 798   |   |
| Total                |   | $     | 5,899  |   |

 

**(6)           Other Current Liabilities**

 
| ** **                                                               | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Accrued payroll  and related benefits                                    |       | $                            | 16,294     |                        | $          | 16,721 |   |
| Current portion  of pension and other postretirement benefit liabilities |       | 1,263                        |       | 1,440                       |       |
| Accrued warranty  expense                                                |       | 1,555                        |       | 1,541                       |       |
| Accrued interest                                                         |       | 977                          |       | 4,049                       |       |
| Deferred income                                                          |       | 9,879                        |       | 10,224                      |       |
| Environmental  liabilities                                               |       | 2,514                        |       | 2,648                       |       |
| Income and other  taxes payable                                          |       | 2,320                        |       | 6,139                       |       |
| Other accrued  expenses                                                  |       | 10,654                       |       | 9,558                       |       |
| Total                                                                    |       | $                            | 45,456     |                        | $          | 52,320 |   |

 

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

 

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The accrued warranty expense activity for the nine months ended September 30,2008 and 2007, and the year ended December 31, 2007 is as follows:

 
| ** **                           | ** ** | **September 30,  2008** | ** ** | **September 30,  2007** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------|------------|------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Beginning  balance                   |       | $                            | 1,541      |                         | $          | 1,888                       |       | $ | 1,888 |   |
| Additions                            |       | 788                          |       | 469                          |       | 798                         |       |
| Claims and  reversals                |       | (742                         | )          | (772                         | )          | (1,200                      | )          |
| Foreign currency  translation impact |       | (32                          | )          | 54                           |       | 55                          |       |
| Ending balance                       |       | $                            | 1,555      |                         | $          | 1,639                       |       | $ | 1,541 |   |

 

**(7)           Long-TermDebt**

 

Our long-term debtconsists of the following:

 
| ** **                             | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| 7.00% Senior  Notes                    |       | $                            | 169,250    |                        | $          | 175,000 |   |
| Unamortized bond  discount             |       | (865                         | )          | (1,019                      | )          |
| Open account  loans, payable on demand |       | 2,983                        |       | 2,285                       |       |
| Total                                  |       | 171,368                      |       | 176,266                     |       |
| Less: current  portion                 |       | (2,983                       | )          | (2,285                      | )          |
| Long-term debt                         |       | $                            | 168,385    |                        | $          | 173,981 |   |

 

Scheduled payments ofdebt are as follows:

 
| ** **         | ** ** | **September 30,  2008** | ** ** |
|--------------------|------------|------------------------------|------------|
| Remainder of  2008 |       | $                            | 2,983      |   |
| 2009 - 2012        |       | —                       |       |
| Thereafter         |       | 169,250                      |       |
| Total              |       | $                            | 172,233    |   |

 

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In March 2008,we repurchased $5.8 million of our Senior Notes at a price of 86.625% plusinterest. As a result, we recorded a net gain on extinguishment of debt of $0.6million. A summary of the transaction is as follows:

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

 

**(8)****                                ****Stockholders’ Equity andStock-based Compensation Arrangements**

 

Our common stock iscomprised of two classes: Class A and Ordinary. With the exception ofdisparate voting power, both classes are substantially identical. Each share ofClass A common stock entitles the holder to 98 votes. Holders of Ordinarycommon stock are entitled to one vote per share. Each share of Class Acommon stock shall automatically convert to Ordinary common stock if, at anytime, that share of Class A common stock is not owned by an original Class Aholder. As of September 30, 2008 our Chairman and our Chief ExecutiveOfficer collectively owned 100% of the Class A common shares, representingapproximately 85% of the combined voting power of the Class A common stockand Ordinary common stock.

 

**EmployeeStock Purchase Plan**- We have an employee stock purchase plan (“Purchase Plan”) under whichsubstantially all employees may purchase Ordinary common stock through payrolldeductions at a purchase price equal to 85% of the lower of the fair marketvalues as of the beginning or end of each twelve-month offering period. Stockpurchases under the Purchase Plan are limited to 5% of an employee’s annualbase earnings. We have reserved 400,000 shares of common stock for issuanceunder this plan.

 

**Stock Plans** - The 2006 StockPlan provides for the granting of 1,000,000 stock options (including incentive stock options andnon-qualified stock options), stock appreciation rights and other stock awardsto certain key employees, consultants and advisors. Our stock options generallyhave five-year vesting terms and ten-year option terms.

 

Our 1996 Stock Plan has expired but still hasvested and unvested options outstanding. We reached our registered share limitationin early 2007, and had previously reserved 721,750 treasury stock shares toissue under this plan. We have since issued 98,974 shares of treasury stock tocover options exercised, with 385,776 remaining options outstanding. Since inmost instances the average cost of the treasury stock exceeded the price of theoptions exercised, the difference between the proceeds received and the averagecost of the treasury stock issued resulted in a reduction of retained earnings.This reduction was less than $0.1 million for the three and nine months ended September 30,2008.

 

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The compensation cost and the income tax benefitrecognized for these plans is as follows:

 
| ** **                                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Compensation  cost included in basic  and diluted income (loss) per share |       | $                                                    | 0.03       |                                                | $          | 0.02 |   | $ | 0.08 |   | $ | 0.08 |   |
| Stock-based  compensation expense                                         |       | 300                                                  |       | 210                                                 |       | 811 |   | 853 |   |
| Income tax  benefit                                                       |       | 46                                                   |       | 48                                                  |       | 131 |   | 148 |   |
|                                                                           |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 

We measured thefair value of options on their grant date, including the valuation of theoption feature implicit in our Purchase Plan, using the Black-Scholesoption-pricing model. The risk-free interest rate is based on theweighted-average of U.S. Treasury rates over the expected life of the stockoption or the contractual life of the option feature in the Purchase Plan. Theexpected life of a stock option is based on historical data of similar optionholders. We have segregated our employees into two groups based on historicalexercise and termination behavior. The expected life of the option feature inthe Purchase Plan is the same as its contractual life. Expected volatility isbased on historical volatility of our stock over the expected life of theoption, as our options are not readily tradable.

 

Key assumptionsused to apply this pricing model to the 2006 Stock Plan are as follows:

 
| ** **                                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                 | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Risk free  interest rate                   |       | 3.1%                                                 |       | 4.7%                                                |       | 3.4% |   | 4.6% |   |
| Weighted average  expected life (in years) |       | 6.7                                                  |       | 7.3                                                 |       | 7.2 |   | 8.1 |   |
| Expected  volatility of underlying stock   |       | 26.0%                                                |       | 24.7%                                               |       | 25.9% |   | 25.1% |   |
| Expected  dividends                        |       | —                                               |       | —                                              |       | — |   | — |   |
| Weighted average  fair value               |       | $9.92                                                |       | $12.25                                              |       | $9.94 |   | $13.61 |   |

 

The followingtable sets forth information regarding the Stock Plans:

 
| ** **                              | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Remaining  Contractual  Life  (in years)** | ** ** | **Aggregate  Intrinsic  Value  (not in 000s)** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------------|------------|
| Outstanding at  January 1, 2008    |       | 544,576                     |       | $                                       | 23.78      |                                              |       |                                                     |       |   |
| Granted                                 |       | 302,300                     |       | 27.26                                   |       |                                              |       |                                                     |       |
| Exercised                               |       | (6,500                      | )     | 19.49                                   |       |                                              |       |                                                     |       |
| Forfeited                               |       | (32,500                     | )     | 28.61                                   |       |                                              |       |                                                     |       |
| Outstanding at  September 30, 2008 |       | 807,876                     |       | $                                       | 24.92      |                                              | 6.9        |                                                     | $          | 2,960,909 |   |
| Exercisable at  September 30, 2008 |       | 361,016                     |       | $                                       | 21.08      |                                              | 4.4        |                                                     | $          | 2,556,834 |   |

 

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The total intrinsic value of the options exercised during the ninemonths ended September 30, 2008 and 2007 was less than $0.1 million and$2.4 million, respectively.

 

As of September 30, 2008, there was $3.8 million of unrecognizedcompensation cost related to nonvested share-based compensation arrangementsgranted under the Stock Plan. This compensation cost is expected to berecognized over a period of 4.2 years.

 

The followingtables set forth information regarding the Purchase Plan:

 
| ** **                                                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Risk-free  interest rate                                     |       | 3.8%                                                 |       | 4.9%                                                |       | 4.3% |   | 5.0% |   |
| Weighted-average  expected life of option feature (in years) |       | 1.0                                                  |       | 1.0                                                 |       | 1.0 |   | 1.0 |   |
| Expected  volatility of underlying stock                     |       | 25.6%                                                |       | 25.5%                                               |       | 25.7% |   | 25.0% |   |
| Expected  dividends                                          |       | —                                               |       | —                                              |       | — |   | — |   |
| Weighted-average  fair value of option feature               |       | $7.88                                                |       | $7.98                                               |       | $8.27 |   | $6.78 |   |

 
| ** **                              | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Remaining  Contractual  Life  (in years)** | ** ** | **Aggregate  Intrinsic  Value  (not in 000s)** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------------|------------|
| Outstanding at  January 1, 2008    |       | 10,441                      |       | $                                       | 28.73      |                                              |       |                                                     |       |   |
| Shares  subscribed                      |       | 25,512                      |       | 23.46                                   |       |                                              |       |                                                     |       |
| Exercised                               |       | (29,379                     | )          | 23.49                                   |       |                                              |       |                                                     |       |
| Canceled                                |       | (1,497                      | )          | 23.49                                   |       |                                              |       |                                                     |       |
| Outstanding at  September 30, 2008 |       | 5,077                       |       | $                                       | 23.36      |                                              | 0.8        |                                                     | $          | 22,847 |   |
|                                         |            |                             |            |                                         |            |                                                   |            |                                                          |            |  |  |

 

As reported in the consolidated statements of cash flows, cash receivedfrom option exercises under the Stock Plans for the periods ended September 30,2008 and 2007 was $0.8 million and $4.1 million, respectively. Cash flows fromtax benefits resulting from tax deductions in excess of the compensation costrecognized for stock-based awards under a fair value basis (excess taxbenefits) are required to be classified as a cash flow from financingactivities. Accordingly, for the periods ended September 30, 2008 and2007, less than $0.1 million and $0.4 million, respectively, of excess taxbenefits has been classified as an outflow from operating activities and aninflow from financing activities in the statement of cash flows. For theperiods ended September 30, 2008 and 2007, less than $0.1 million and $0.7million, respectively, of tax benefit from stock option exercises is presentedas a cash inflow from operating activities.

 

**(9)****                                 FacilityRationalization – Band**

 

As part of our effort to reduce excess manufacturingcapacity in our band segment, in December 2007 we announced the pendingclosure of our Kenosha, Wisconsin woodwind manufacturing facility, whicheffectively ceased operations in May 2008. We recorded $0.1 million in facilityimpairment charges as a component of operating expenses and less than $0.1million in severance costs as a component of cost of goods sold for the yearended December 31, 2007 related to this facility. Production was relocatedto our Elkhart, Indiana 

 

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woodwind manufacturing facility. In September 2008,this facility, which has a remaining book value of $1.2 million, wasreclassified from property, plant and equipment to other assets, as it is nowbeing held for sale.

 

In February 2008, management decided to terminateproduction of musical instrument cases, which were manufactured in a leasedfacility in North Carolina. The remaining instrument production and assemblywork occurring in that facility was not impacted by this termination, whichoccurred in April 2008.

 

We closed our Elkhorn, Wisconsin brass instrumentmanufacturing facility in August 2008 and relocated its production to ourEastlake, Ohio brass instrument manufacturing facility. In the second quarter,we recorded $0.2 million in associated facility impairment charges as acomponent of operating expenses. Associated severance costs are shown below. InSeptember 2008, this facility, which has a remaining book value of $0.3million, was reclassified from property, plant and equipment to other assets,as it is now being held for sale.

 

In July 2008, we sold our Leblanc clarinetmanufacturing facility and operations in France. This facility’s production isbeing transitioned to our Elkhart, Indiana woodwind manufacturing facility. Inthe second quarter, we recorded $0.9 million in related facility impairmentcharges as a component of operating expenses. Since the workers at thisfacility have been retained by the purchaser, no severance costs have beenrecorded.

 

The severance liability and related activityassociated with the band segment’s facility rationalization project are asfollows:

 
| ** **                                     | ** ** | **Kenosha** | ** ** | **Case** | ** ** | **Elkhorn** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|-------------|------------|----------|------------|-------------|------------|-----------|------------|
|                                           |       |        |       |     |       |        |       |      |       |
| Facility  rationalization severance liability: |       |        |       |     |       |        |       |      |       |
| Balance,  January 1, 2008                 |       | $           | 39         |     | $          | —      |       | $         | —     |   | $ | 39 |   |
| Additions  charged to cost of sales            |       | 438         |       | 88       |       | 431         |       | 957       |       |
| Payments                                       |       | (410        | )          | (77      | )          | (240        | )          | (727      | )          |
| Reversals                                      |       | —      |       | (11      | )          | (70         | )          | (81       | )          |
| Balance,  September 30, 2008              |       | $           | 67         |     | $          | —      |       | $         | 121        |   | $ | 188 |   |

 

In the first quarter of2008, we recorded $0.1 million of inventory write-down charges as a componentof cost of goods sold related to musical instrument cases.

 

Currently we do notexpect to incur any additional material charges associated with the facilityrationalization project.

 

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

** **
| ** **                         | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
|                               |       |                                                     |       |                                                    |       |   |   |   |   |
| West 57th  building income         |       | $                                                        | (1,163     | )                                                       | $          | (1,163 | ) | $ | (3,490 | ) | $ | (3,490 | ) |
| West 57th  building expenses       |       | 823                                                      |       | 823                                                     |       | 2,464 |   | 2,461 |   |
| Foreign exchange  (gain) loss, net |       | (178                                                     | )          | 111                                                     |       | 180 |   | 564 |   |
| Miscellaneous                      |       | 113                                                      |       | 266                                                     |       | 458 |   | 311 |   |
| Other (income)  expense, net       |       | $                                                        | (405       | )                                                       | $          | 37 |   | $ | (388 | ) | $ | (154 | ) |

 

**(11)****                          Commitmentsand Contingent Liabilities**

 

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

 

Certain environmental laws, such as the Comprehensive EnvironmentalResponse, Compensation, and Liability Act, as amended (“CERCLA”), imposestrict, retroactive, joint and several liability upon persons responsible forreleases of hazardous substances, which liability is broadly construed. UnderCERCLA and other laws, we may have liability for investigation and cleanupcosts and other damages relating to our current or former properties, orthird-party sites to which we sent wastes for disposal. Our potential liabilityat any of these sites is affected by many factors including, but not limitedto, the method of remediation, our portion of the hazardous substances at thesite relative to that of other parties, the number of responsible parties, thefinancial capabilities of other parties, and contractual rights andobligations.

 

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

 

In addition, we are continuing an existingenvironmental remediation plan at a facility we acquired in 2000 andsubsequently sold. We estimate our costs, which approximate $0.7 million, overa 13-year period. We have

 

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accruedapproximately $0.6 million for the estimated remaining cost of this remediationprogram, which represents the present value total cost using a discount rate of4.54%. A summary of expected payments

 

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associatedwith this project is as follows:

 
| ** **        | ** ** | **Environmental  Payments** | ** ** |
|-------------------|------------|-----------------------------|------------|
| Remainder of 2008 |       | $                           | 8          |   |
| 2009              |       | 61                          |       |
| 2010              |       | 61                          |       |
| 2011              |       | 61                          |       |
| 2012              |       | 61                          |       |
| Thereafter        |       | 484                         |       |
| Total             |       | $                           | 736        |   |

 

We received notification from the Arizona Department of EnvironmentalQuality (“ADEQ”) that, among other things, the required periodic reportsrelated to this environmental remediation effort were not filed timely for1999-2005 and, therefore, ADEQ proposed a fine of $0.8 million, which wassubsequently reduced to $0.2 million. Since the violations are limited toadministrative items, and research indicates that fines paid to ADEQ forsimilar violations (those with no environmental harm) were less than $0.1million, we believe this matter will be settled for less than $0.2 million andhave included this amount in accounts payable.

 

In 2004, we acquired two manufacturing facilities from G. LeblancCorporation, now Grenadilla, Inc. (“Grenadilla”), for which environmentalremediation plans had already been established. In connection with theacquisition, we assumed the existing accrued liability of approximately $0.8million for the cost of these remediation activities. Based on a review of pastand ongoing investigatory and remedial work by our environmental consultants,and discussions with state regulatory officials, as well as periodic sampling,we estimate the remaining costs of such remedial plans to be $2.0 million.Pursuant to the purchase and sale agreement, we sought indemnification fromGrenadilla for anticipated costs above the original estimate in the amount of$2.5 million. We filed a claim against the escrow and recorded a correspondingreceivable for this amount in prepaid expenses and other current assets in ourconsolidated balance sheet. In 2007, we reduced this receivable, which is $2.0million as of September 30, 2008, based on the current estimated costs ofremediation. We have reached an agreement with Grenadilla whereby environmentalcosts are paid directly out of the escrow. Should the escrow be reduced tozero, we would seek further indemnification from Grenadilla for theseadditional costs. However, we cannot be assured that we will be able to recoversuch costs.

 

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

 

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**(12)****                         ****Retirement Plans**

 

We have definedbenefit pension plans covering the majority of our employees, including certainemployees in Germany and the U.K. The components of net periodic pension cost(benefit) for these plans are as follows:

** **
| ** **                           | ** ** | **Domestic Plans**                              | ** ** | **Foreign Plans**                               | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Three Months Ended  September 30,** | ** ** |
| ** **                           | ** ** | **2008**                                             | ** ** | **2007**                                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service cost                         |       | $                                                    | 104        |                                                 | $          | 236 |   | $ | 204 |   | $ | 219 |   |
| Interest cost                        |       | 853                                                  |       | 807                                                  |       | 486 |   | 433 |   |
| Expected return  on plan assets      |       | (1,284                                               | )          | (1,242                                               | )          | (96 | ) | (94 | ) |
| Amortization of  prior service cost  |       | 51                                                   |       | 108                                                  |       | — |   | — |   |
| Amortization of  net loss            |       | 12                                                   |       | 137                                                  |       | 23 |   | 86 |   |
| Net periodic  pension cost (benefit) |       | $                                                    | (264       | )                                                    | $          | 46 |   | $ | 617 |   | $ | 644 |   |

 
| ** **                           | ** ** | **Domestic Plans**                             | ** ** | **Foreign Plans**                              | ** ** |
|--------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                           | ** ** | **Nine Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
| ** **                           | ** ** | **2008**                                            | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service cost                         |       | $                                                   | 311        |                                                | $          | 707 |   | $ | 616 |   | $ | 618 |   |
| Interest cost                        |       | 2,558                                               |       | 2,422                                               |       | 1,465 |   | 1,231 |   |
| Expected return  on plan assets      |       | (3,851                                              | )          | (3,726                                              | )          | (298 | ) | (276 | ) |
| Amortization of  prior service cost  |       | 153                                                 |       | 324                                                 |       | — |   | — |   |
| Amortization of  net loss            |       | 36                                                  |       | 413                                                 |       | 71 |   | 238 |   |
| Net periodic  pension cost (benefit) |       | $                                                   | (793       | )                                                   | $          | 140 |   | $ | 1,854 |   | $ | 1,811 |   |

 

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

 

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| ** **                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service cost                                |       | $                                                    | —     |                                                | $          | 11 |   | $ | 4 |   | $ | 32 |   |
| Interest cost                               |       | (1                                                   | )          | 33                                                  |       | 51 |   | 102 |   |
| Amortization of  transition obligation      |       | —                                               |       | 8                                                   |       | — |   | 26 |   |
| Amortization of  prior service costs        |       | (13                                                  | )          | —                                              |       | (39 | ) | — |   |
| Recognized gain                             |       | (16                                                  | )          | (41                                                 | )          | — |   | (124 | ) |
| Net periodic  postretirement cost (benefit) |       | $                                                    | (30        | )                                                   | $          | 11 |   | $ | 16 |   | $ | 36 |   |

 

We intend to makecontributions of $3.0 to $5.0 million to our domestic pension plan this year.Our anticipated contributions to the pension plan of our U.K. subsidiaryapproximate $0.8 million for the current year. As of September 30, 2008,we have made contributions of $0.5 million to this plan. The pension plans ofour German entities do not hold any assets and use operating cash to payparticipant benefits as they become due. Expected 2008 benefit payments underthese plans are $1.3 million, of which $1.0 million was paid through September 2008.

 

**(13)****                         ****Segment Information**

 

Wehave identified two reportable segments: the piano segment and the band &orchestral instrument segment. We consider these two segments reportable asthey are managed separately and the operating results of each segment areseparately reviewed and evaluated by our senior management on a regular basis.We have reclassified the results of our online music division from “Other &Elim” into “U.S. Piano Segment” as we believe its results are not material andits products and customer base are most correlated with piano operations.Management and the chief operating decision maker use income from operations asa meaningful measurement of profit or loss for the segments. Income fromoperations for the reportable segments includes certain corporate costsallocated to the segments based primarily on revenue, as well as intercompanyprofit. Amounts reported as “Other & Elim” corporate costs that werenot allocated to the reportable segments, and the remaining intercompany profitelimination.

 

The following tablespresent information about our operating segments for the three and nine monthsended September 30, 2008 and 2007:

 

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**Three months ended 2008**

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| ** **                       | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to  external customers |       | $                      | 28,988     |                  | $          | 17,236    |       | $          | 9,482      |   | $ | 55,706 |   | $ | 42,841 |   | $ | 1,941 |   | $ | 44,782 |   | $ | — |   | $ | 100,488 |   |
| Income (loss)  from operations   |       | 1,242                  |       | 4,954                 |       | 482       |       | 6,678      |       | (5,225 | ) | 203 |   | (5,022 | ) | (1,069 | ) | 587 |   |
|                                  |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Three months ended 2007**

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| ** **                       | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to  external customers |       | $                      | 28,087     |                  | $          | 13,673    |       | $          | 10,225     |   | $ | 51,985 |   | $ | 45,150 |   | $ | 2,158 |   | $ | 47,308 |   | $ | — |   | $ | 99,293 |   |
| Income (loss)  from operations   |       | 2,669                  |       | 2,408                 |       | 718       |       | 5,795      |       | 1,824 |   | 244 |   | 2,068 |   | (628 | ) | 7,235 |   |
|                                  |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Nine months ended 2008**

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| ** **                       | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to  external customers |       | $                      | 81,515     |                  | $          | 52,292    |       | $          | 34,088     |   | $ | 167,895 |   | $ | 119,484 |   | $ | 5,816 |   | $ | 125,300 |   | $ | — |   | $ | 293,195 |   |
| Income (loss)  from operations   |       | 3,093                  |       | 13,871                |       | 2,693     |       | 19,657     |       | (3,551 | ) | (1,312 | ) | (4,863 | ) | (2,576 | ) | 12,218 |   |
|                                  |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Nine monthsended 2007**

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| ** **                       | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to  external customers |       | $                      | 82,519     |                  | $          | 42,944    |       | $          | 33,829     |   | $ | 159,292 |   | $ | 120,102 |   | $ | 5,588 |   | $ | 125,690 |   | $ | — |   | $ | 284,982 |   |
| Income (loss)  from operations   |       | 5,537                  |       | 10,971                |       | 3,150     |       | 19,658     |       | 1,993 |   | 468 |   | 2,461 |   | (2,468 | ) | 19,651 |   |
|                                  |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

**(Tabular Amounts in Thousands Except  Percentages, Share and Per Share Data)** |
|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

**Introduction**

 

We are a worldleader in the design, manufacture, marketing, and distribution of high qualitymusical instruments. Our piano division concentrates on the high-end grandpiano segment of the industry, handcrafting Steinway pianos in New York andGermany. We also offer upright pianos and two mid-priced lines of pianos underthe Boston and Essex brand names. We are also the largest domestic producer ofband and orchestral instruments and offer a complete line of brass, woodwind,percussion and string instruments and related accessories with well-known brandnames such as Bach, Selmer, C.G. Conn, Leblanc, King, and Ludwig. We sell ourproducts through dealers and distributors worldwide. Our piano customer baseconsists of professional artists, amateur pianists, and institutions such asconcert halls, universities, and music schools. Our band and orchestralinstrument customer base consists primarily of middle school and high schoolstudents, but also includes adult amateur and professional musicians. In May 2008,we acquired ArkivMusic, LLC (“Arkiv”), an online retailer of classical music.

 

**CriticalAccounting Policies**

 

The Securities andExchange Commission (“SEC”) has issued disclosure guidance for “criticalaccounting policies.” The SEC defines “critical accounting policies” as thosethat require application of management’s most difficult, subjective or complexjudgments, often as a result of the need to make estimates about the effect ofmatters that are inherently uncertain and may change in subsequent periods.

 

Management isrequired to make certain estimates and assumptions during the preparation ofthe consolidated financial statements. These estimates and assumptions impactthe reported amount of assets and liabilities and disclosures of contingentassets and liabilities as of the date of the consolidated financial statements.Estimates and assumptions are reviewed periodically and the effects ofrevisions are reflected in the consolidated financial statements in the periodthey are determined to be necessary. Actual results could differ from thoseestimates.

 

The significantaccounting policies are described in Note 2 of the Notes to ConsolidatedFinancial Statements included in the Company’s 2007 Annual Report on Form 10-K.Not all of these significant accounting policies require management to makedifficult, subjective or complex judgments or estimates. However, managementconsiders the following to be critical accounting policies based on thedefinition above.

 

**Accounts Receivable**

 

Weestablish reserves for accounts receivable and notes receivable. We reviewoverall collectibility trends and customer characteristics such as debtleverage, solvency, and outstanding balances in order to develop our reserveestimates. Historically, a large portion of our sales at both our piano andband divisions has been generated by our top 15 customers. As a result, weexperience some inherent concentration of credit risk in our accountsreceivable due to its composition and the relative proportion of large customerreceivables to the total. This is especially true at our band division, whichcharacteristically has a majority of our consolidated accounts receivablebalance. We consider the credit health and solvency of our customers whendeveloping our receivable reserve estimates.

 

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**Inventory**

 

Weestablish inventory reserves for items such as lower-of-cost-or-market andobsolescence. We review inventory levels on a detailed basis, concentrating onthe age and amounts of raw materials, work-in-process, and finished goods, aswell as recent usage and sales dates and quantities to help develop ourestimates. Ongoing changes in our business strategy, including a shift frombatch processing to single piece production flow, coupled with increasedoffshore sourcing, could affect our ability to realize the current cost of ourinventory, and are considered by management when developing our estimates. Wealso establish reserves for anticipated book-to-physical adjustments based uponour historical level of adjustments from our annual physical inventories. Weaccount for our inventory using standard costs. Accordingly, variances betweenactual and standard costs that are not abnormal in nature are capitalized intoinventory and released based on calculated inventory turns. Abnormal costs arerecorded in the period in which they occur.

 

**Workers’Compensation and Self-Insured Health Claims**

 

Weestablish self-insured workers’ compensation and health claims reserves basedon our trend analysis of data provided by third-party administrators regardinghistorical claims and anticipated future claims.

 

**Warranty**

 

Weestablish reserves for warranty claims based on our analysis of historicalclaims data, recent claims trends, and the various lengths of time for which wewarranty our products.

 

**Long-livedAssets**

 

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

 

We establish long-livedintangible assets based on estimated fair values, and amortize finite-livedintangibles over their estimated useful lives. We test our goodwill and indefinite-livedtrademark assets for impairment annually or on an interim basis if events orcircumstances indicate that the fair value of an asset may have decreased belowits carrying value. Our assessment is based on several analyses, including acomparison of estimated fair values to our market capitalization and multi-yearcash flows.

 

**Pensions and Other PostretirementBenefit Costs**

 

We make certain assumptions when calculating our benefit obligationsand expenses. We base our selection of assumptions, such as discount rates andlong-term rates of return, on information provided by our actuaries, investmentadvisors, investment committee, current rate trends, and historical trends forour pension asset portfolio. Our benefit obligations and expenses can fluctuatesignificantly based on the assumptions management selects.

 

**Income Taxes**

 

Werecord valuation allowances for certain deferred tax assets related to foreigntax credit carryforwards and state net operating loss carryforwards. Whenassessing the realizability of deferred tax assets, we consider whether it ismore likely than not that the deferred tax assets will be fully realized. Theultimate realization of these assets is dependent upon many factors, includingthe ratio of foreign source income to overall income and generation ofsufficient future taxable income in the states for which we have loss 

 

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carryforwards. When establishing or adjustingvaluation allowances, we consider these factors, as well as anticipated trendsin foreign source income and tax planning strategies which may impact futurerealizability of these assets.

 

Aliability has been recorded for uncertain tax positions. When analyzing thesepositions, we consider the probability of various outcomes which could resultfrom examination, negotiation, or settlement with various taxing authorities.The final outcome on these positions could differ significantly from ouroriginal estimates due to the following: expiring statues of limitations;availability of detailed historical data; the results of audits or examinationsconducted by taxing authorities or agents that vary from management’s anticipatedresults; identification of new tax contingencies; the release of applicableadministrative tax guidance; management’s decision to settle or appealassessments; or the rendering of court decisions affecting our estimates of taxliabilities; as well as other factors.

 

**Stock-Based Compensation**

 

Wegrant stock-based compensation awards which generally vest over a specifiedperiod. When determining the fair value of stock options and subscriptions topurchase shares under the Purchase Plan, we use the Black-Scholes optionvaluation model, which requires input of certain management assumptions,including dividend yield, expected volatility, risk-free interest rate,expected life of stock options granted during the period, and the lifeapplicable to the Purchase Plan subscriptions. The estimated fair value of theoptions and subscriptions to purchase shares, and the resultant stock-basedcompensation expense, can fluctuate based on the assumptions used bymanagement.

 

**Environmental Liabilities**

 

Wemake certain assumptions when calculating our environmental liabilities. Webase our selection of assumptions, such as cost and length of time forremediation, on data provided by our environmental consultants, as well asinformation provided by regulatory authorities. We also make certainassumptions regarding the indemnifications we have received from others,including whether remediation costs are within the scope of theindemnification, the indemnifier’s ability to perform under the agreement, andwhether past claims have been successful. Our environmental obligations andexpenses can fluctuate significantly based on management’s assumptions.

 

We believe the assumptionsmade by management provide a reasonable basis for the estimates reflected inour financial statements.

 

**Forward-Looking Statements**

 

Certain statements contained in this document are “forward-lookingstatements” within the meaning of Section 21E of the Securities andExchange Act of 1934, as amended. These forward-looking statements representour present expectations or beliefs concerning future events. We caution thatsuch statements are necessarily based on certain assumptions which are subjectto risks and uncertainties which could cause actual results to differmaterially from those indicated in this report. These risk factors include, butare not limited to, the following: changes in general economicconditions; recent geopolitical events; increased competition; work stoppages andslowdowns; ability to successfully consolidate band manufacturing; impact ofdealer consolidations on orders; exchange rate fluctuations; variations in themix of products sold; market acceptance of new product and distributionstrategies; ability of suppliers to meet demand; concentration of credit risk;fluctuations in effective tax rates resulting from shifts in sources of income;and the ability to successfully operate acquired businesses. Further information on these riskfactors is included in Item 1A of our Annual Report on Form 10-K for theyear ended December 31, 2007. We encourage you to read those descriptionscarefully. We caution investors not to place undue reliance on theforward-looking statements contained in this 

 

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report. These statements, like all statementscontained in this report, speak only as of the date of this report (unlessanother date is indicated) and we undertake no obligation to update or revisethe statements except as required by law.

 

**Results of Operations**

 

Three Months Ended September 30,2008 Compared to Three Months Ended September 30, 2007

* *
| ** **                                       | ** ** | **Three Months Ended September 30,** | ** ** | ** ** | ** ** | **Change** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                       | ** ** | **2008**                                                 | ** ** | ** ** | ** ** | **2007**   | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
|                                             |       |                                                     |       |       |       |       |       |   |   |   |   |   |   |
| Net sales                                        |       |                                                     |       |       |       |       |       |   |   |   |   |   |   |
| Band                                             |       | $                                                        | 44,782     |       |       |       | $          | 47,308 |   |   |   | (2,526 | ) | (5.3 | ) |
| Piano                                            |       | 55,706                                                   |       |       |       | 51,985     |       |   |   | 3,721 |   | 7.2 |   |
| Total sales                                      |       | 100,488                                                  |       |       |       | 99,293     |       |   |   | 1,195 |   | 1.2 |   |
|                                             |       |                                                     |       |       |       |       |       |   |   |   |   |   |   |
| Cost of sales                                    |       |                                                     |       |       |       |       |       |   |   |   |   |   |   |
| Band                                             |       | 34,405                                                   |       |       |       | 38,099     |       |   |   | (3,694 | ) | (9.7 | ) |
| Piano                                            |       | 36,154                                                   |       |       |       | 33,103     |       |   |   | 3,051 |   | 9.2 |   |
| Total cost of  sales                             |       | 70,559                                                   |       |       |       | 71,202     |       |   |   | (643 | ) | (0.9 | ) |
|                                             |       |                                                     |       |       |       |       |       |   |   |   |   |   |   |
| Gross profit                                     |       |                                                     |       |       |       |       |       |   |   |   |   |   |   |
| Band                                             |       | 10,377                                                   |       | 23.2%      |       | 9,209      |       | 19.5% |   | 1,168 |   | 12.7 |   |
| Piano                                            |       | 19,552                                                   |       | 35.1%      |       | 18,882     |       | 36.3% |   | 670 |   | 3.5 |   |
| Total gross  profit                              |       | 29,929                                                   |       |       |       | 28,091     |       |   |   | 1,838 |   | 6.5 |   |
|                                             |       | 29.8%                                                    |       |       |       | 28.3%      |       |   |   |   |   |   |   |
|                                             |       |                                                     |       |       |       |       |       |   |   |   |   |   |   |
| Operating  expenses                              |       | 20,787                                                   |       |       |       | 20,856     |       |   |   | (69 | ) | (0.3 | ) |
| Facility  rationalization and impairment charges |       | 8,555                                                    |       |       |       | —     |       |   |   | 8,555 |   | 100.0 |   |
| Income from  operations                          |       | 587                                                      |       |       |       | 7,235      |       |   |   | (6,648 | ) | (91.9 | ) |
|                                             |       |                                                     |       |       |       |       |       |   |   |   |   |   |   |
| Other (income) expense,  net                     |       | (405                                                     | )          |       |       | 37         |       |   |   | (442 | ) | (1,194.6 | ) |
| Net interest  expense                            |       | 2,378                                                    |       |       |       | 2,905      |       |   |   | (527 | ) | (18.1 | ) |
| Non-operating  expenses                          |       | 1,973                                                    |       |       |       | 2,942      |       |   |   | (969 | ) | (32.9 | ) |
|                                             |       |                                                     |       |       |       |       |       |   |   |   |   |   |   |
| Income (loss)  before income taxes               |       | (1,386                                                   | )          |       |       | 4,293      |       |   |   | (5,679 | ) | (132.3 | ) |
|                                             |       |                                                     |       |       |       |       |       |   |   |   |   |   |   |
| Income tax  provision (benefit)                  |       | (1,126                                                   | )          | 81.2%      |       | 1,285      |       | 29.9% |   | (2,411 | ) | (187.6 | ) |
|                                             |       |                                                     |       |       |       |       |       |   |   |   |   |   |   |
| Net income  (loss)                               |       | $                                                        | (260       | )          |       |       | $          | 3,008 |   |   |   | (3,268 | ) | (108.6 | ) |

 

**Overview***–*Piano division revenue improved, while margins were lowerdue to a shift in mix towards upright pianos and the absence of limited editionpiano sales, which occurred in 2007 and generated higher margins. Band divisionsales decreased due to fewer unit sales across all product lines. However,gross margins improved due to lower unabsorbed overhead and productionvariances than in the year ago period. Scheduled plant closures under ourfacility rationalization project have been completed, and virtually allproduction has been incorporated into existing facilities.

 

Our fall budgetingand planning process provides multi-year cash flow projections which we use toconduct our annual impairment testing of intangible assets. Recent decreases inorder volume, the adverse impact of

 

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unavailable sourcedproducts, delays in producing new product lines, and recent economic events,coupled with other factors, caused us to lower sales expectations. As a result,our future anticipated cash flows at the band division were reduced and our goodwillwas determined to be impaired. Accordingly, we recorded an $8.6 million chargeduring the period to fully write off this asset. Analyses of band divisiontrademarks and other assets indicated no other impairment, so no charges havebeen taken nor are they anticipated. No impairment indicators were noted duringour analysis of the piano division.

 

Piano divisionresults include the operations of our online music division.

 

**Net Sales**– Net sales improved due to higher piano division sales. Domestically, pianodivision revenues increased $0.9 million due to the incremental $1.8 million ofonline music sales. This more than offset the impact of the 6% decrease inSteinway grand piano shipments, which occurred primarily at the retail level.Overseas Steinway grand unit shipments decreased 3%. Despite this, overseaspiano division sales increased $2.8 million, $1.6 million of which isattributable to foreign currency translation. Improved sales of larger, higherpriced models by our German division also contributed to the increase. Althoughunit shipments decreased 15%, band division revenues were only 5% lower, assales of intermediate and professional level woodwinds as well as certainhigher priced products mitigated the deterioration in shipments.

 

**GrossProfit***-* Gross profitimproved due to higher piano sales and better band margins. Domestically, pianomargins were adversely impacted by lower retail sales and a shift in mixtowards lower margin upright pianos. This was partially offset by the shift inmix overseas towards larger, higher margin models and favorable manufacturingvariances at our factory in Germany. The band division’s gross profit improved,as production inefficiencies and unabsorbed overhead at our manufacturingfacilities was reduced by approximately $1.2 million, and we eliminated anaccessory sales program which cost $0.9 million in the prior year.

 

**OperatingExpenses** – Operating expenses were consistent with the yearago period. The $0.8 million reduction in bad debt expense was offset by anincrease in other operating expenses of a comparable amount.

 

**Facilityrationalization and impairment charges –**Facilityrationalization and impairment charges of $8.6 million are comprised entirelyof $8.6 million associated with the write off of goodwill discussed above.

 

**Non-operatingExpenses** - Non-operating expenses decreased $1.0 million dueto $0.5 million lower net interest expense, as we did not have anythingoutstanding on our domestic line of credit in the current period. A $0.3million shift from foreign exchange losses to foreign exchange gains and adecrease in legal costs also contributed to the expense reduction.

 

**IncomeTaxes** -**Our effectivetax rate is comprised of 39% associated with current year income and a $0.7million benefit relating primarily to uncertain tax positions which were settledwith state taxing authorities. As a result of the pretax loss incurred duringthe quarter, the combination of these items resulted in an effective rate of81% for the quarter. The year-to-date rate discussed below is more reflectiveof our effective rate for the year.

 

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**Results of Operations**

 

Nine Months Ended September 30,2008 Compared to Nine Months Ended September 30, 2007

 
| ** **                                       | ** ** | **Nine months ended September 30,** | ** ** | ** ** | ** ** | **Change** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                       | ** ** | **2008**                                                | ** ** | ** ** | ** ** | **2007**   | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
|                                             |       |                                                    |       |       |       |       |       |   |   |   |   |   |   |
| Net sales                                        |       |                                                    |       |       |       |       |       |   |   |   |   |   |   |
| Band                                             |       | $                                                       | 125,300    |       |       |       | $          | 125,690 |   |   |   | (390 | ) | (0.3 | ) |
| Piano                                            |       | 167,895                                                 |       |       |       | 159,292    |       |   |   | 8,603 |   | 5.4 |   |
| Total sales                                      |       | 293,195                                                 |       |       |       | 284,982    |       |   |   | 8,213 |   | 2.9 |   |
|                                             |       |                                                    |       |       |       |       |       |   |   |   |   |   |   |
| Cost of sales                                    |       |                                                    |       |       |       |       |       |   |   |   |   |   |   |
| Band                                             |       | 97,445                                                  |       |       |       | 99,678     |       |   |   | (2,233 | ) | (2.2 | ) |
| Piano                                            |       | 109,384                                                 |       |       |       | 101,408    |       |   |   | 7,976 |   | 7.9 |   |
| Total cost of  sales                             |       | 206,829                                                 |       |       |       | 201,086    |       |   |   | 5,743 |   | 2.9 |   |
|                                             |       |                                                    |       |       |       |       |       |   |   |   |   |   |   |
| Gross profit                                     |       |                                                    |       |       |       |       |       |   |   |   |   |   |   |
| Band                                             |       | 27,855                                                  |       | 22.2%      |       | 26,012     |       | 20.7% |   | 1,843 |   | 7.1 |   |
| Piano                                            |       | 58,511                                                  |       | 34.8%      |       | 57,884     |       | 36.3% |   | 627 |   | 1.1 |   |
| Total gross  profit                              |       | 86,366                                                  |       |       |       | 83,896     |       |   |   | 2,470 |   | 2.9 |   |
|                                             |       | 29.5%                                                   |       |       |       | 29.4%      |       |   |   |   |   |   |   |
|                                             |       |                                                    |       |       |       |       |       |   |   |   |   |   |   |
| Operating  expenses                              |       | 64,531                                                  |       |       |       | 64,245     |       |   |   | 286 |   | 0.4 |   |
| Facility  rationalization and impairment charges |       | 9,617                                                   |       |       |       | —     |       |   |   | 9,617 |   | 100.0 |   |
| Income from  operations                          |       | 12,218                                                  |       |       |       | 19,651     |       |   |   | (7,433 | ) | (37.8 | ) |
|                                             |       |                                                    |       |       |       |       |       |   |   |   |   |   |   |
| Other income,  net                               |       | (388                                                    | )          |       |       | (154       | )          |   |   | (234 | ) | 151.9 |   |
| Loss on  extinguishment of debt                  |       | (636                                                    | )          |       |       | —     |       |   |   | (636 | ) | 100.0 |   |
| Net interest  expense                            |       | 6,811                                                   |       |       |       | 7,580      |       |   |   | (769 | ) | (10.1 | ) |
| Non-operating  expenses                          |       | 5,787                                                   |       |       |       | 7,426      |       |   |   | (1,639 | ) | (22.1 | ) |
|                                             |       |                                                    |       |       |       |       |       |   |   |   |   |   |   |
| Income (loss)  before income taxes               |       | 6,431                                                   |       |       |       | 12,225     |       |   |   | (5,794 | ) | (47.4 | ) |
|                                             |       |                                                    |       |       |       |       |       |   |   |   |   |   |   |
| Income tax  provision (benefit)                  |       | 1,671                                                   |       | 26.0%      |       | 4,634      |       | 37.9% |   | (2,963 | ) | (63.9 | ) |
|                                             |       |                                                    |       |       |       |       |       |   |   |   |   |   |   |
| Net income  (loss)                               |       | $                                                       | 4,760      |       |       |       | $          | 7,591 |   |   |   | (2,831 | ) | (37.3 | ) |

 

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**Overview***–* Piano division revenue improved, though piano margindeteriorated due to fewer Steinway grand unit sales and the adverse impact ofdomestic manufacturing facility shutdowns, which were taken in an effort to controlinventory. Band division sales deteriorated slightly, despite improvedintermediate and professional level saxophone and clarinet sales, due todelivery issues for certain student level sourced instruments and decreaseddemand. Band division margins improved due to lower production variances andunabsorbed overhead than in the year-ago period.

 

Our facilityrationalization project is nearing completion, as we sold our clarinetmanufacturing facility in France, and closed our Elkhorn brass instrument manufacturingfacility in August. We are currently in the process of incorporating theproduction processes from these closed facilities into our remaining factories.

 

We recorded animpairment charge of $8.6 million relating to the write-off of band divisiongoodwill. Circumstances which led us to conclude that goodwill was impaired aredescribed above.

 

**Net Sales** – Net sales increased due to improvedpiano division revenues. Although overseas Steinway grand unit shipmentsdecreased 4%, overseas revenue improved $9.6 million, of which $8.1million isattributable to foreign currency translation. The remaining increase wasgenerated by improved mid-priced piano line sales. Domestic piano divisionsales decreased $1.0 million despite the $2.7 million incremental online musicsales, largely due to fewer sales at the wholesale level, which resulted in an8% decrease in domestic Steinway grand piano sales. Band division unitshipments decreased 12% during the period. This was due to sourced instrumentsupply issues and decrease demand resulting from dealers managing workingcapital and using existing inventory. However, the shift in mix from lower pricedstudent band instruments to intermediate and professional level instrumentsmitigated the decrease in unit shipments.

 

**GrossProfit***–* Gross profit improved due to higherpiano division sales and improved band division margins. Although domesticpiano margins dropped (29.1% vs. 32.8%) due to fewer production days and theresulting unabsorbed overhead, overseas piano margins remained relativelystable. This coupled with higher overseas piano sales, resulted in a highergross profit for the period. The band division’s gross profit benefited fromless unabsorbed overhead and production inefficiencies than in the year-ago period.This, coupled with the shift in mix towards higher margin intermediate andprofessional level band instruments in the first half of the year, more thanoffset the impact of $0.9 million in severance costs associated with plantclosures.

 

**OperatingExpenses** –Operating expenses increased $0.3 million as a $1.5 million decrease in baddebt expense and other reserves was offset by the adverse impact of foreignexchange translation.

 

**Facilityrationalization and impairment charges –**Charges of $9.6 million are comprised of $8.6 millionin write off of our band division goodwill, and $1.1 million in fixed assetimpairment charges. We wrote down our Elkhorn, Wisconsin manufacturing facilityby $0.2 million in conjunction with the closure of that plant. We also wrotedown our clarinet manufacturing facility in France by $0.9 million inconjunction with the sale of that plant in July 2008.

 

**Non-operatingExpenses** -Non-operating expenses decreased $1.6 million due to the $0.8 million reductionin net interest expense, as our domestic line of credit has gone virtuallyunused in the current period. The $0.6 million gain on extinguishment of $5.8million of our Senior Notes also contributed to the improvement.

 

**IncomeTaxes** -**Our effective tax rate is comprised of 39% associated withcurrent year income and a benefit of 13% primarily relating to the favorablesettlement of several uncertain tax positions with state taxing authorities. Inthe year-ago period, the impact of these positions was not material to the effectiverate.

 

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**Liquidityand Capital Resources**

 

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

 

Our statements ofcash flows for the nine months ended September 30, 2008 and 2007 are summarizedas follows:

 
| ** **                                                                             | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
| Net income:                                                                            |       | $        | 4,760      |     | $          | 7,591      |       | $ | (2,831 | ) |
| Changes in  operating assets and liabilities                                           |       | (22,116  | )          | (27,104  | )          | 4,988      |       |
| Other  adjustments to reconcile net income to cash from operating activities |       | 14,954   |       | 8,139    |       | 6,815      |       |
| Cash flows from  operating activities                                                  |       | (2,402   | )          | (11,374  | )          | 8,972      |       |
|                                                                                   |       |     |       |     |       |       |       |
| Cash flows from  investing activities                                                  |       | (6,198   | )          | (3,445   | )          | (2,753     | )          |
|                                                                                   |       |     |       |     |       |       |       |
| Cash flows from  financing activities                                                  |       | (5,613   | )          | (1,344   | )          | (4,269     | )          |
|                                                                                        |            |          |            |          |            |            |            |  |  |  |

 

Cash flows used byoperating activities was $9.0 million less than a year ago. Cash used foraccounts receivable decreased $7.2 million due to more stringent creditcriteria at our band division. Major non-cash adjustments include facilityrationalization and goodwill impairment charges, which are added back inadjustments to reconcile net income to cash flows from operating activities.

 

Cash flows usedfor investing activities increased $2.8 million primarily due to ouracquisitions of Arkiv and Clickpoint. Cash used for capital expenditures wascomparable to the year-ago period. We expect capital expenditures to be in therange of $5.0 to $6.0 million in 2008.

 

Cash flows usedfor financing activities increased $4.3 million due to several factors. In2008, we used operating cash to extinguish $5.8 million of our Senior Notes andpurchased $2.0 million of our own stock, while proceeds generated from stockoption exercises dropped $3.3 million from a year ago. In the prior period,borrowings on our domestic credit facility of $20.7 million were largely offsetby the use of cash to fund the $25.2 million dividend issued in March 2007.

 

**BorrowingActivities and Availability –**We have a domestic credit facility with asyndicate of domestic lenders (the “Credit Facility”) with a potential borrowingcapacity of $110.0 million in revolving credit loans, which expires on September 29,2011. It provides for periodic borrowings at either London Interbank OfferingRate (“LIBOR”) plus a range from 1.25% to 1.75%, or as-needed borrowings at analternate base rate, plus a range from 0.00% to 0.25%; both ranges depend uponborrowing availability at the time of borrowing. The Credit Facility iscollateralized by our domestic accounts receivable, inventory, and fixedassets. As of September 30, 2008, there was nothing outstanding on ourCredit Facility, and borrowing availability, net of letters of credit, wasapproximately $108.8 million.

 

We also have certainnon-domestic credit facilities originating from two German banks that providefor borrowings by foreign subsidiaries of up to €17.7 million ($24.9 million atthe September 30, 2008 exchange rate), net of borrowing restrictions of €1.2million ($1.7 million at the September 30, 2008 exchange rate) and are payable on demand.These borrowings are collateralized by most of the assets of the borrowingsubsidiaries. A portion of the loans can be converted into a maximum of £0.5million ($0.9 million at the September 30, 2008

 

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exchange rate) for use by our U.K. branch and ¥300 million ($2.8million at the September 30, 2008 exchange rate) for use by our Japanese subsidiary. OurChinese subsidiary also has the ability to convert the equivalent of up to €2.5million into U.S. dollars or Chinese yuan ($3.5 million at the September 30,2008 exchange rate).Euro loans bear interest at rates of Euro Interbank Offered Rate (“EURIBOR”)plus a margin determined at the time of borrowing. Margins fluctuate based onthe loan amount and the borrower’s bank rating. The remaining demand borrowingsbear interest rates of LIBOR plus 0.8% for British pound loans, LIBOR plus 1.0%for U.S. dollar loans of our Chinese subsidiary, and Tokyo Interbank OfferedRate (“TIBOR”) plus 0.8% for Japanese yen loans. We had outstanding borrowingsof $0.2 million at 1.6% as of September 30, 2008 on these credit facilities.

 

Our Japanese subsidiaryalso maintains a separate revolving loan agreement that provides additionalborrowing capacity of up to ¥460 million ($4.3 million at the September 30,2008 exchange rate)based on eligible inventory balances. The revolving loan agreement bearsinterest at an average 30-day TIBOR rate plus 0.9% (outstanding borrowings at1.6% at September 30, 2008) and expires on January 31, 2010. As of September 30,2008, we had $2.8million outstanding on this revolving loan agreement.

 

At September 30,2008, our totaloutstanding indebtedness amounted to $172.2 million, consisting of $169.3million of 7.00% Senior Notes and $3.0 million of notes payable to foreignbanks.

 

All of our debt agreementscontain covenants that place certain restrictions on us, including our abilityto incur additional indebtedness, to make investments in other entities, andlimitations on cash dividend payments. We were in compliance with all suchcovenants as of September 30, 2008 and do not anticipate any complianceissues in the future. Our bond indenture contains limitations, based on netincome (among other things), on the amount of discretionary repurchases we maymake of our Ordinary common stock. Our intent and ability to repurchaseadditional Ordinary common stock either directly from shareholders or on theopen market is directly affected by this limitation. In May 2008 weannounced a share repurchase program, which permits us to make discretionarypurchases of up to $25.0 million of our Ordinary common stock. We repurchased74,700 shares for $2.0 million through September 2008.

 

We experience long productionand inventory turnover cycles, which we constantly monitor since fluctuationsin demand can have a significant impact on these cycles. We expect toeffectively utilize cash flow from operations to fund our debt and capitalrequirements and pay off our seasonal borrowings on our domestic line ofcredit. Currently we anticipate all of our divisions will be stable or improvethroughout the period. Our intention is to manage accounts receivable andcustomer credit, reduce inventory levels, and repay credit facility borrowings.

 

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

 

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**ContractualObligations** - Thefollowing table provides a summary of our contractual obligations at September 30,2008.

 
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **More than  5 years** | ** ** |
|                             |       |                                      |       |   |   |   |   |   |   |   |   |
| **Contractual  Obligations**     |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-term debt (1)               |       | $                                         | 236,456    |   | $ | 14,880 |   | $ | 23,695 |   | $ | 23,695 |   | $ | 174,186 |   |
| Capital leases                   |       | 27                                        |       | 17 |   | 10 |   | — |   | — |   |
| Operating leases  (2)            |       | 263,562                                   |       | 5,228 |   | 9,729 |   | 7,999 |   | 240,606 |   |
| Purchase  obligations (3)        |       | 21,514                                    |       | 21,503 |   | 11 |   | — |   | — |   |
| Other long-term  liabilities (4) |       | 36,878                                    |       | 6,271 |   | 6,808 |   | 4,715 |   | 19,084 |   |
| Total                            |       | $                                         | 558,437    |   | $ | 47,899 |   | $ | 40,253 |   | $ | 36,409 |   | $ | 433,876 |   |

 

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**Notes to Contractual Obligations:**

 

(1) Long-term debtrepresents long-term debt obligations, the fixed interest on our Notes, and thevariable interest on our other loans. We estimated the future variable interestobligation using the applicable September 30, 2008 rates. The nature of our long-term debtobligations, including changes to our long-term debt structure, is describedmore fully in the “Borrowing Availability and Activities” section of “Liquidityand Capital Resources.”

(2) Approximately $249.4 million of our operatinglease obligations are attributable to the land lease associated with thepurchase of Steinway Hall, which has 89 years remaining. The rest isattributable to the leasing of other facilities and equipment.

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

(4) Our other long-term liabilities consistprimarily of the long-term portion of our pension obligations, which aredescribed in Note 12 in the Notes to Condensed Consolidated FinancialStatements included within this filing, liabilities relating to uncertain taxpositions which are expected to be settled within one year, and obligationsunder employee and consultant agreements. We have not included $0.4 million ofliabilities relating to uncertain tax positions within this schedule due to theuncertainty of the payment date, if any.

 

**Recent Accounting Pronouncements**

 

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

 

In September 2006, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 definesfair value, establishes a framework for measuring fair value and expandsdisclosures about fair value measurements. On January 1, 2008, we adoptedSFAS 157, which did not have an impact on our consolidated financialstatements. In February 2008, the FASB delayed the effective date of SFAS157 for all nonrecurring fair value measurements of nonfinancial assets andnonfinancial liabilities. We will comply with this component of SFAS 157 January 1,2009.

 

In December 2007, theFASB issued SFAS No. 141R, “Business Combinations,” a revision to SFAS No. 141,“Business Combinations” (“ SFAS 141R”), which provides revised guidancefor recognition and 

 

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measurement of identifiable assets and goodwill acquired, liabilitiesassumed, and any noncontrolling interest in the acquiree at fairvalue. SFAS 141R also establishes disclosure requirements to enable the evaluationof the nature and financial effects of a business combination. SFAS 141Ris required to be applied prospectively to business combinations for which theacquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008. We will comply with SFAS141R January 1, 2009.

 

In December 2007, theFASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements – an amendment of ARB No. 51” (“SFAS 160”). SFAS160 establishes accounting and reporting standards for ownership interests insubsidiaries held by parties other than the parent. Specifically, SFAS 160requires the presentation of noncontrolling interests as equity in theConsolidated Statement of Financial Position, and separate identification andpresentation in the Consolidated Statement of Operations of net incomeattributable to the entity and the noncontrolling interest. It alsoestablishes accounting and reporting standards regarding deconsolidation andchanges in a parent’s ownership interest. We will be required to complywith SFAS 160 January 1, 2009. The provisions of SFAS 160 are generallyrequired to be applied prospectively, except for the presentation anddisclosure requirements, which must be applied retrospectively. We arecurrently evaluating the potential impact, if any, of the adoption of SFAS 160on our consolidated financial statements.

 

In March 2008, the FASBissued SFAS No. 161, “Disclosures about Derivative Instruments and HedgingActivities – an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS161 amends and expands the disclosure requirements for derivative instrumentsand hedging activities, with the intent to provide users of financialstatements with an enhanced understanding of how and why an entity usesderivative instruments, how derivative instruments and related hedged items areaccounted for, and how derivative instruments and related hedged items affectan entity’s financial statements. We will comply with SFAS 161 January 1,2009.

 

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

 

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

 

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

 

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

 

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**ITEM 4           CONTROLS AND PROCEDURES**

 

Our principal executive officer and our principalfinancial officer, after evaluating together with management the design andoperation of our disclosure controls and procedures, have concluded that ourdisclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)) were effective as of September 30, 2008, the end of the periodcovered by this report. In designing disclosure controls and procedures,management recognizes that any controls, no matter how well designed andoperated, can only provide reasonable, not absolute, assurance of achieving thedesired control objectives.

 

During the quarter covered by this report, there wereno significant changes in our internal controls that materially affected, orare reasonably likely to materially affect, internal control over financialreporting.

 

**PART II****        OTHERINFORMATION**

 

**ITEM 2           UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

** **
| ** **                              | ** ** | ** **                     | ** ** | ** **                    | ** ** | ** **                     | ** ** | **(d) Maximum**                    | ** ** |
|-----------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-----------------------------------------|------------|
| ** **                              | ** ** | ** **                     | ** ** | ** **                    | ** ** | **(c) Total Number** | ** ** | **Number (or**                     | ** ** |
| ** **                              | ** ** | ** **                     | ** ** | ** **                    | ** ** | **of Shares (or**    | ** ** | **Approximate Dollar**             | ** ** |
| ** **                              | ** ** | ** **                     | ** ** | ** **                    | ** ** | **Units) Purchased**      | ** ** | **Value) of Shares (or** | ** ** |
| ** **                              | ** ** | ** **                     | ** ** | ** **                    | ** ** | **as Part of**       | ** ** | **Units) that May Yet**  | ** ** |
| ** **                              | ** ** | **(a) Total Number** | ** ** | **(b) Average**          | ** ** | **Publicly**                   | ** ** | **Be Purchased Under**        | ** ** |
| ** **                              | ** ** | **of Shares (or**    | ** ** | **Price Paid per**  | ** ** | **Announced Plans**       | ** ** | **the Plans or**              | ** ** |
| **Period**                              | ** ** | **Units) Purchased**      | ** ** | **Share (or Unit)** | ** ** | **or Programs**           | ** ** | **Programs**                            | ** ** |
|                                    |       |                           |       |                          |       |                           |       |                                    |       |
| June 18 -  September 30, 2008 |       | 74,700                         |       | $                             | 26.52      |                           | 74,700     |                                    | $          | 25,000,000 |   |
| Total                                   |       | 74,700                         |       | $                             | 26.52      |                           | 74,700     |                                    | $          | 25,000,000 |   |

 

**ITEM 6   EXHIBITS**

 

(i)             Exhibits

 

31.1 Certification of the Principal Executive Officerpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

31.2 Certification of the Principal Financial Officerpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

32.1 Certification of the Principal Executive Officerpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002

 

32.2 Certification of the Principal Financial Officerpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002

 

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**SIGNATURES**

 

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

 

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

 

 

Date: November 10,2008

 

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