**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|------------|------------|---------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                    |
| ** ** | ** ** | **FOR THE  QUARTERLY PERIOD ENDED JUNE 30, 2005**                                                  |
|       |       |                                                                                                    |
| **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 telephone number including area code:    **(781) 894-9770**

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements during the past 90 days.

Yes ý    No o

 

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

Yes ý    No o

 
| Number of shares  of Common Stock issued and outstanding as of August 2, 2005**:** | Class A |   | 477,952   |   |
|-----------------------------------------------------------------------------------------|--------------|--------|-----------|--------|
|                                                                                    | Ordinary     |   | 7,606,998 |   |
|                                                                                    | Total        |   | 8,084,950 |   |

 

 

----

 

###### **STEINWAY MUSICALINSTRUMENTS, INC. AND SUBSIDIARIES**

**FORM 10-Q**

**INDEX**

 
| **PART I.**  | **UNAUDITED  FINANCIAL INFORMATION**                                                            |       |
|-------------------|-------------------------------------------------------------------------------------------------|------------|
|              |                                                                                            |       |
| **Item 1.**       | **Consolidated and Condensed  Consolidated Financial Statements:**                              |       |
|              |                                                                                            |       |
|              | Consolidated Statements of  Income                                                              |       |
|              | Three  months and six months ended June 30, 2005 and June 30, 2004                    |       |
|              |                                                                                            |       |
|              | Condensed Consolidated  Balance Sheets                                                          |       |
|              | June 30,  2005 and December 31, 2004                                                  |       |
|              |                                                                                            |       |
|              | Consolidated Statements of  Cash Flows                                                          |       |
|              | Six  months ended June 30, 2005 and June 30, 2004                                     |       |
|              |                                                                                            |       |
|              | Consolidated Statement of  Stockholders’ Equity                                            |       |
|              | Six  months ended June 30, 2005                                                            |       |
|              |                                                                                            |       |
|              | Notes to Consolidated and  Condensed Consolidated Financial Statements                          |       |
|              |                                                                                            |       |
| **Item 2.**       | **Management’s Discussion and Analysis of  Financial Condition and Results of Operations** |       |
|              |                                                                                            |       |
| **Item 3.**       | **Quantitative and Qualitative  Disclosures about Market Risk**                                 | ** ** |
| ** **        | ** **                                                                                      | ** ** |
| **Item 4.**       | **Controls and Procedures**                                                                     | ** ** |
| ** **        | ** **                                                                                      | ** ** |
| **PART II.** | **OTHER INFORMATION**                                                                           |       |
|              |                                                                                            |       |
| **Item 4**        | **Submission  of Matters to a Vote of Security Holders**                                        |       |
|              |                                                                                            |       |
| **Item 6.**       | **Exhibits**                                                                                    |       |
|              |                                                                                            |       |
|              | **Signatures**                                                                                  |       |

 

2

----

 

# **ITEM1      CONSOLIDATED AND CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

# ** **

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**Unaudited**

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

 
| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                         | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net sales                          |       | $                                    | 89,761     |                               | $          | 83,688 |   | $ | 181,103 |   | $ | 173,749 |   |
| Cost of sales                      |       | 63,635                               |       | 59,285                             |       | 129,280 |   | 123,621 |   |
|                               |       |                                 |       |                               |       |   |   |   |   |
| Gross profit                       |       | 26,126                               |       | 24,403                             |       | 51,823 |   | 50,128 |   |
|                               |       |                                 |       |                               |       |   |   |   |   |
| Operating  expenses:               |       |                                 |       |                               |       |   |   |   |   |
| Sales and  marketing               |       | 11,132                               |       | 10,539                             |       | 22,404 |   | 21,833 |   |
| General and  administrative        |       | 6,960                                |       | 6,399                              |       | 13,935 |   | 12,413 |   |
| Amortization of  intangible assets |       | 284                                  |       | 255                                |       | 566 |   | 546 |   |
| Other operating  expenses          |       | 23                                   |       | (3                                 | )          | 133 |   | 25 |   |
| Total operating  expenses          |       | 18,399                               |       | 17,190                             |       | 37,038 |   | 34,817 |   |
|                               |       |                                 |       |                               |       |   |   |   |   |
| Income from  operations            |       | 7,727                                |       | 7,213                              |       | 14,785 |   | 15,311 |   |
|                               |       |                                 |       |                               |       |   |   |   |   |
| Other (income)  expense, net       |       | 33                                   |       | (734                               | )          | (406 | ) | (1,346 | ) |
| Interest income                    |       | (723                                 | )          | (591                               | )          | (1,693 | ) | (1,228 | ) |
| Interest expense                   |       | 4,389                                |       | 4,014                              |       | 8,528 |   | 7,792 |   |
|                               |       |                                 |       |                               |       |   |   |   |   |
| Income before  income taxes        |       | 4,028                                |       | 4,524                              |       | 8,356 |   | 10,093 |   |
|                               |       |                                 |       |                               |       |   |   |   |   |
| Income tax  provision              |       | 1,610                                |       | 1,810                              |       | 3,340 |   | 4,035 |   |
|                               |       |                                 |       |                               |       |   |   |   |   |
| Net income                         |       | $                                    | 2,418      |                               | $          | 2,714 |   | $ | 5,016 |   | $ | 6,058 |   |
|                               |       |                                 |       |                               |       |   |   |   |   |
| Earnings per  share:               |       |                                 |       |                               |       |   |   |   |   |
| Basic                              |       | $                                    | 0.30       |                               | $          | 0.34 |   | $ | 0.62 |   | $ | 0.75 |   |
| Diluted                            |       | $                                    | 0.29       |                               | $          | 0.33 |   | $ | 0.61 |   | $ | 0.72 |   |
|                               |       |                                 |       |                               |       |   |   |   |   |
| Weighted average  shares:          |       |                                 |       |                               |       |   |   |   |   |
| Basic                              |       | 8,052,418                            |       | 7,957,483                          |       | 8,041,649 |   | 8,083,945 |   |
| Diluted                            |       | 8,276,096                            |       | 8,340,726                          |       | 8,259,070 |   | 8,436,605 |   |

 

See notes to consolidated and condensed consolidated financial statements.

 

3

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCESHEETS**

**Unaudited**

**(In Thousands)**

 
| ** **                                                                                                             | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                                 |       |                    |       |                        |       |
| Current assets:                                                                                                        |       |                    |       |                        |       |
| Cash                                                                                                                   |       | $                       | 17,742     |                        | $          | 27,372 |   |
| Accounts, notes  and other receivables, net of allowances of  $11,980 and $13,271 in 2005 and 2004, respectively       |       | 90,354                  |       | 88,059                      |       |
| Inventories                                                                                                            |       | 179,872                 |       | 172,346                     |       |
| Prepaid expenses  and other current assets                                                                             |       | 3,675                   |       | 5,937                       |       |
| Deferred tax  assets                                                                                                   |       | 14,636                  |       | 15,047                      |       |
| Total current  assets                                                                                                  |       | 306,279                 |       | 308,761                     |       |
|                                                                                                                   |       |                    |       |                        |       |
| Property, plant  and equipment, net of accumulated depreciation of  $71,675 and $70,473 in 2005 and 2004, respectively |       | 98,739                  |       | 102,944                     |       |
| Trademarks                                                                                                             |       | 13,318                  |       | 12,325                      |       |
| Goodwill                                                                                                               |       | 30,355                  |       | 31,854                      |       |
| Other  intangibles, net                                                                                                |       | 4,816                   |       | 5,290                       |       |
| Other assets                                                                                                           |       | 14,530                  |       | 16,371                      |       |
|                                                                                                                   |       |                    |       |                        |       |
| TOTAL ASSETS                                                                                                           |       | $                       | 468,037    |                        | $          | 477,545 |   |
|                                                                                                                   |       |                    |       |                        |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                             |       |                    |       |                        |       |
| Current  liabilities:                                                                                                  |       |                    |       |                        |       |
| Current portion  of long-term debt                                                                                     |       | $                       | 13,794     |                        | $          | 14,212 |   |
| Accounts payable                                                                                                       |       | 13,299                  |       | 14,789                      |       |
| Other current  liabilities                                                                                             |       | 37,403                  |       | 43,892                      |       |
| Total current  liabilities                                                                                             |       | 64,496                  |       | 72,893                      |       |
|                                                                                                                   |       |                    |       |                        |       |
| Long-term debt                                                                                                         |       | 210,887                 |       | 208,580                     |       |
| Deferred tax  liabilities                                                                                              |       | 25,260                  |       | 26,240                      |       |
| Other  non-current liabilities                                                                                         |       | 22,588                  |       | 24,279                      |       |
| Total  liabilities                                                                                                     |       | 323,231                 |       | 331,992                     |       |
|                                                                                                                   |       |                    |       |                        |       |
| Commitments and  contingent liabilities                                                                                |       |                    |       |                        |       |
|                                                                                                                   |       |                    |       |                        |       |
| Stockholders’  equity:                                                                                            |       |                    |       |                        |       |
| Common stock                                                                                                           |       | 10                      |       | 10                          |       |
| Additional  paid-in capital                                                                                            |       | 81,884                  |       | 81,129                      |       |
| Retained  earnings                                                                                                     |       | 117,603                 |       | 112,587                     |       |
| Accumulated  other comprehensive loss                                                                                  |       | (7,255                  | )          | (737                        | )          |
| Treasury stock,  at cost                                                                                               |       | (47,436                 | )          | (47,436                     | )          |
| Total  stockholders’ equity                                                                                       |       | 144,806                 |       | 145,553                     |       |
|                                                                                                                   |       |                    |       |                        |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                       |       | $                       | 468,037    |                        | $          | 477,545 |   |

 

See notes to consolidatedand condensed consolidated financial statements.

 

4

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**Unaudited**

**(In Thousands)**

 
| ** **                                                                    | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                    | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                        |       |                               |       |   |   |
| Net income                                                                    |       | $                                  | 5,016      |   | $ | 6,058 |   |
| Adjustments to  reconcile net income to cash flows from operating activities: |       |                               |       |   |   |
| Depreciation and  amortization                                                |       | 5,739                              |       | 5,338 |   |
| Amortization of  bond premium                                                 |       | (126                               | )          | (105 | ) |
| Deferred tax  benefit                                                         |       | (279                               | )          | (218 | ) |
| Tax benefit from  stock option exercises                                      |       | 99                                 |       | 732 |   |
| Other                                                                         |       | 104                                |       | (28 | ) |
| Changes in  operating assets and liabilities:                                 |       |                               |       |   |   |
| Accounts, notes  and other receivables                                        |       | (3,443                             | )          | (8,463 | ) |
| Inventories                                                                   |       | (13,145                            | )          | (9,231 | ) |
| Prepaid expenses  and other assets                                            |       | 2,821                              |       | (3,935 | ) |
| Accounts payable                                                              |       | (1,097                             | )          | 753 |   |
| Other  liabilities                                                            |       | (5,786                             | )          | (1,513 | ) |
| Cash flows from  operating activities                                         |       | (10,097                            | )          | (10,612 | ) |
|                                                                          |       |                               |       |   |   |
| Cash flows from  investing activities:                                        |       |                               |       |   |   |
| Capital  expenditures                                                         |       | (2,349                             | )          | (2,052 | ) |
| Proceeds from  disposals of fixed assets                                      |       | 1,353                              |       | 76 |   |
| Cash flows from  investing activities                                         |       | (996                               | )          | (1,976 | ) |
|                                                                          |       |                               |       |   |   |
| Cash flows from  financing activities:                                        |       |                               |       |   |   |
| Borrowings under  lines of credit                                             |       | 70,708                             |       | 10,349 |   |
| Repayments under  lines of credit                                             |       | (64,200                            | )          | (10,491 | ) |
| Debt issuance  costs                                                          |       | —                             |       | (105 | ) |
| Repayments of  term loan debt                                                 |       | (4,090                             | )          | (3,352 | ) |
| Proceeds from  issuance of common stock                                       |       | 656                                |       | 4,594 |   |
| Cash flows from  financing activities                                         |       | 3,074                              |       | 995 |   |
|                                                                          |       |                               |       |   |   |
| Effect of  foreign exchange rate changes on cash                              |       | (1,611                             | )          | (367 | ) |
|                                                                          |       |                               |       |   |   |
| Decrease in cash                                                              |       | (9,630                             | )          | (11,960 | ) |
| Cash, beginning  of year                                                      |       | 27,372                             |       | 42,283 |   |
|                                                                          |       |                               |       |   |   |
| Cash, end of  period                                                          |       | $                                  | 17,742     |   | $ | 30,323 |   |
|                                                                          |       |                               |       |   |   |
| Supplemental  Cash Flow Information                                           |       |                               |       |   |   |
| Interest paid                                                                 |       | $                                  | 9,517      |   | $ | 8,488 |   |
| Taxes paid                                                                    |       | $                                  | 6,694      |   | $ | 5,695 |   |
|                                                                          |       |                               |       |   |   |
| Non-cash  transaction:                                                        |       |                               |       |   |   |
| Purchase of  common stock by issuance of bonds                                |       | $                                  | —     |   | $ | 31,583 |   |

 

See notes to consolidated and condensed consolidated financialstatements.

 

5

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENT OFSTOCKHOLDERS’ EQUITY**

**Unaudited**

**(In Thousands Except Share Data)**

 
| ** **                                             | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|--------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|---------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
|                                                   |       |              |       |                             |       |                   |       |                                        |       |                |       |                                  |       |
| Balance,  January 1, 2005                         |       | $                 | 10         |                             | $          | 81,129                 |       | $                                           | 112,587    |                | $          | (737                                  | )          | $ | (47,436 | ) | $ | 145,553 |   |
| Comprehensive  income:                                 |       |              |       |                             |       |                   |       |                                        |       |                |       |                                  |       |
| Net income                                             |       |              |       |                             |       | 5,016                  |       |                                        |       |                |       | 5,016                                 |       |
| Foreign currency  translation adjustment               |       |              |       |                             |       |                   |       | (6,499                                      | )          |                |       | (6,499                                | )          |
| Unrealized  holding loss on marketable securities, net |       |              |       |                             |       |                   |       | (19                                         | )          |                |       | (19                                   | )          |
| Total  comprehensive income                            |       |              |       |                             |       |                   |       |                                        |       |                |       | (1,502                                | )          |
| Exercise of  33,640 options for shares of common stock |       |              |       | 656                              |       |                   |       |                                        |       |                |       | 656                                   |       |
| Tax benefit of  options exercised                      |       |              |       | 99                               |       |                   |       |                                        |       |                |       | 99                                    |       |
| Balance,  June 30, 2005                           |       | $                 | 10         |                             | $          | 81,884                 |       | $                                           | 117,603    |                | $          | (7,255                                | )          | $ | (47,436 | ) | $ | 144,806 |   |

 

See notes to consolidated and condensed consolidated financialstatements.

 

6

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

###### **NOTES TO CONSOLIDATED AND CONDENSED CONSOLIDATED**

**FINANCIAL STATEMENTS**

**JUNE 30, 2005**

**Unaudited**

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

 

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

 

The accompanyingconsolidated and condensed consolidated financial statements of SteinwayMusical Instruments, Inc. and subsidiaries (the “Company”) for the threeand six months ended June 30, 2005 and 2004 are unaudited.  In the opinion of management, thesestatements have been prepared on the same basis as the audited consolidatedfinancial statements as of and for the year ended December 31, 2004, andinclude all adjustments which are of a normal and recurring nature, necessaryfor the fair presentation of financial position, results of operations and cashflows for the interim periods.  Youshould read the consolidated and condensed consolidated financial statements inconjunction with the consolidated financial statements and notes theretocontained in the Company’s Annual Report on Form 10-K for the year ended December 31,2004 filed with the Securities and Exchange Commission (“SEC”).  The results of operations for the three andsix months ended June 30, 2005 are not necessarily indicative of theresults that may be expected for the entire year.

 

Throughout this report “we,”“us,” and “our” refer to Steinway Musical Instruments, Inc. andsubsidiaries taken as a whole.

 

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

 

*Principles of Consolidation -*Ourconsolidated financial statements include the accounts of all direct andindirect subsidiaries, all of which are wholly-owned, including The SteinwayPiano Company, Inc. (“Steinway”) and Conn-Selmer, Inc. (“Conn-Selmer”).  Significant intercompany balances have beeneliminated in consolidation.

 

*Use of Estimates*- The preparation of financial statements inconformity with accounting principles generally accepted in the UnitedStates of America necessarily requires us to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, the disclosure ofcontingent assets and liabilities at the date of the financial statements, andthe reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

*Income Taxes* - We provide for income taxes using anasset and liability approach.  We computedeferred income tax assets and liabilities annually for differences betweenthe financial statement and tax bases of assets and liabilities that willresult in taxable or deductible amounts in the future based on enacted tax lawsand rates applicable to the periods in which the differences are expected toaffect taxable income.  We establishvaluation allowances when necessary to reduce deferred tax assets to the amountthat more likely than not will be realized.

 

*Stock-based Compensation*- We have an employee stock purchase plan (“Purchase Plan”) and a stock optionplan (“Stock Plan”).  As permitted underaccounting principles generally accepted in the

 

7

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United States of America, we have elected to continueto follow the intrinsic value method in accounting for our stock-based employeecompensation arrangements.

 

The followingtable illustrates the effect on net income and earnings per share as if we hadapplied the fair value method to measure stock-based employee compensation:

 
| ** **                                                                                                                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Net income, as  reported                                                                                                        |       | $                                    | 2,418      |                               | $          | 2,714 |   | $ | 5,016 |   | $ | 6,058 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair-value based  method,  net of related tax effects |       | (220                                 | )          | (253                               | )          | (472 | ) | (507 | ) |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Pro forma net  income                                                                                                           |       | $                                    | 2,198      |                               | $          | 2,461 |   | $ | 4,544 |   | $ | 5,551 |   |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Earnings per  share:                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Basic - as  reported                                                                                                            |       | $                                    | 0.30       |                               | $          | 0.34 |   | $ | 0.62 |   | $ | 0.75 |   |
| Basic - pro  forma                                                                                                              |       | $                                    | 0.27       |                               | $          | 0.31 |   | $ | 0.57 |   | $ | 0.69 |   |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Diluted - as  reported                                                                                                          |       | $                                    | 0.29       |                               | $          | 0.33 |   | $ | 0.61 |   | $ | 0.72 |   |
| Diluted - pro  forma                                                                                                            |       | $                                    | 0.27       |                               | $          | 0.30 |   | $ | 0.56 |   | $ | 0.67 |   |

 

We measured the fair value of options on their grant date, includingthe valuation of the option feature implicit in our Purchase Plan, using theBlack-Scholes option-pricing model. There were no stock option awards during the three and six months ended June 30,2005 and 2004.

 

8

----

 

*Earnings per Common Share –*We compute basic earnings per share usingthe weighted-average number of common shares outstanding during eachperiod.  Diluted earnings per commonshare reflects the effect of our outstanding options using the treasury stockmethod, except when such options would be antidilutive.

 

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

 
| ** **                        | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                        | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted-average  shares:         |       |                                 |       |                               |       |   |   |   |   |
| For basic earnings  per share     |       | 8,052,418                            |       | 7,957,483                          |       | 8,041,649 |   | 8,083,945 |   |
| Dilutive effect  of stock options |       | 223,678                              |       | 383,243                            |       | 217,421 |   | 352,660 |   |
| For diluted  earnings per share   |       | 8,276,096                            |       | 8,340,726                          |       | 8,259,070 |   | 8,436,605 |   |

 

All outstanding options were included in the computation of diluted netearnings per common share for the three and six months ended June 30, 2005and 2004 because the exercise prices of the options were less than the averagemarket price of our common shares.

 

*AccumulatedOther Comprehensive Income (Loss) –*Accumulated other comprehensiveincome (loss) is comprised of net income, foreign currency translationadjustments, additional minimum pension liabilities, and unrealized gains andlosses on available-for-sale (“AFS”) marketable securities.  The components of accumulated othercomprehensive loss are as follows:

 
| ** **                     | ** ** | **Foreign  Currency  Translation  Adjustment** | ** ** | **Unrealized  Holding  Gain/(Loss) on  AFS Securities** | ** ** | **Tax Impact of  Unrealized  Holding  Gain/(Loss) on  AFS Securities** | ** ** | **Additional  Minimum  Pension  Liability** | ** ** | **Tax Impact of  Additional  Minimum  Pension  Liability** | ** ** | **Accumulated Other  Comprehensive  Loss** | ** ** |
|--------------------------------|------------|------------------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------|------------|
|                           |       |                                           |       |                                                    |       |                                                                   |       |                                        |       |                                                       |       |                                       |       |
| Balance,  January 1, 2005 |       | $                                              | 5,746      |                                                    | $          | 157                                                                    |       | $                                           | (63        | )                                                          | $          | (10,802                                    | )          | $ | 4,225 |   | $ | (737 | ) |
| Activity                       |       | (6,499                                         | )          | (32                                                     | )          | 13                                                                     |       | —                                      |       | —                                                     |       | (6,518                                     | )          |
| Balance,  June 30, 2005   |       | $                                              | (753       | )                                                       | $          | 125                                                                    |       | $                                           | (50        | )                                                          | $          | (10,802                                    | )          | $ | 4,225 |   | $ | (7,255 | ) |

 

*Recent Accounting Pronouncements* – In December 2004, the FinancialAccounting Standards Board (“FASB”) revised Statement of Financial AccountingStandards (“SFAS”) No. 123 and issued SFAS No. 123R, “Share-BasedPayments” (SFAS No. 123R). This accounting standard, which was originallyeffective for interim and annual periods beginning after June 15, 2005,requires the recognition of compensation expense related to stock options usingthe fair value method.  In April 2005,the SEC revised the first required compliance date to fiscal years beginningafter June 15, 2005.  We plan toadopt SFAS No. 123R in the first quarter of 2006 using the modifiedprospective application method. Based on current outstanding awards, expectedparticipation in the Purchase Plan consistent with past patterns, and nosignificant changes in the number of shares of outstanding stock, we anticipatean impact on earnings of approximately $0.11 per basic share in additionalstock compensation expense in 2006.  Theactual amount will be impacted by changes in the aforementioned factors.

 

In November 2004, the FASB issued SFAS No. 151, “InventoryCosts, an amendment of ARB No. 43, Chapter 4” (SFAS No. 151). Thisaccounting standard, which is effective for annual periods beginning after June 15,2005, requires that abnormal amounts of idle facility expense, freight,handling

 

9

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costs, and wasted materials (spoilage) should berecognized as current-period charges. The adoption of SFAS No. 151 is notexpected to have a material effect on our financial position or results ofoperations.

 

*Reclassifications* – Certain prioryear amounts have been reclassified to conform to the current yearpresentation.

 

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

 

On August 12, 2004, we acquired substantially all of the assetsand assumed the operating liabilities of G. Leblanc Corporation (“Leblanc”) ofWisconsin, a high-quality band instrument manufacturer.  We have included the operating results andnet assets of Leblanc in our financial statements since the date ofacquisition.

 

We acquired Leblanc because its line of instruments and accessories iscomplementary to our existing product lines, enabling us to gain or strengthenmarket share in certain instrument categories. The Company disbursed $37.6million for the purchase price at closing, of which $3.9 million is being heldin escrow pending expiration of an indemnification period.  The final purchase price was dependent upon acalculation derived from the closing balance sheet, which resulted in anadditional payment of $1.4 million in June 2005.  The total purchase price of $38.9 million has been allocated to acquired assets andassumed liabilities as of August 12, 2004 as follows:

 
| Inventories                           |   | $      | 20,723 |   |
|---------------------------------------|--------|--------|--------|--------|
| Receivables and  other current assets |   | 12,680 |   |
| Property, plant,  and equipment       |   | 7,469  |   |
| Trademarks                            |   | 3,153  |   |
| Non-compete  agreements               |   | 500    |   |
| Other assets                          |   | 674    |   |
| Accounts payable                      |   | (1,451 | )      |
| Recourse  reserves                    |   | (1,138 | )      |
| Environmental  reserves               |   | (815   | )      |
| Other  liabilities                    |   | (2,856 | )      |
|                                  |   | $      | 38,939 |   |

 

We acquired a manufacturing facility via thistransaction that had been scheduled for closure by the predecessor owner.  We vacated this facility in early 2005 anddid not incur significant costs as a result of this closure.  This acquired facility and a previously closedwoodwind manufacturing facility in Elkhart, Indiana were sold in the currentperiod for combined net proceeds of $1.0 million.  The gain on the sales was less than $0.2million and related primarily to the closed woodwind manufacturing facility.

 

10

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

 
| ** **      | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------|------------|-------------------------|------------|-----------------------------|------------|
|            |       |                    |       |                        |       |
| Raw materials   |       | $                       | 22,595     |                        | $          | 23,439 |   |
| Work in process |       | 53,795                  |       | 54,612                      |       |
| Finished goods  |       | 103,482                 |       | 94,295                      |       |
| Total           |       | $                       | 179,872    |                        | $          | 172,346 |   |

 

**(5)****         Goodwill,Trademarks, and Other Intangible Assets**

 

Intangible assets other than goodwill and indefinite-lived trademarksare amortized on a straight-line basis over their estimated useful lives.  Deferred financing costs are amortized overthe repayment periods of the underlying debt. We test our goodwill and indefinite-lived trademark assets forimpairment annually, or on an interim basis if events or circumstances indicatethat the fair value of an asset has decreased below its carrying value.  Our annual impairment assessment is inJuly.  The changes in carrying amounts ofgoodwill and trademarks are as follows:

 
| ** **                                                       | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|-----------|------------|
| Goodwill:                                                        |       |              |       |             |       |      |       |
| Balance,  January 1, 2005                                   |       | $                 | 23,299     |             | $          | 8,555     |       | $ | 31,854 |   |
| Foreign currency  translation impact                             |       | (1,499            | )          | —           |       | (1,499    | )          |
| Balance,  June 30, 2005                                     |       | $                 | 21,800     |             | $          | 8,555     |       | $ | 30,355 |   |
|                                                             |       |              |       |             |       |      |       |
| Trademarks:                                                      |       |              |       |             |       |      |       |
| Balance,  January 1, 2005                                   |       | $                 | 7,964      |             | $          | 4,361     |       | $ | 12,325 |   |
| Additions based  on purchase price allocation to acquired assets |       | —            |       | 1,463            |       | 1,463     |       |
| Foreign currency  translation impact                             |       | (470              | )          | —           |       | (470      | )          |
| Balance,  June 30, 2005                                     |       | $                 | 7,494      |             | $          | 5,824     |       | $ | 13,318 |   |

 

11

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

 
| ** **                      | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------|------------|-------------------------|------------|------------------------|------------|
|                            |       |                    |       |                   |       |
| Gross deferred  financing costs |       | $                       | 8,717      |                   | $          | 8,627 |   |
| Accumulated  amortization       |       | (4,323                  | )          | (3,834                 | )          |
| Deferred  financing costs, net  |       | $                       | 4,394      |                   | $          | 4,793 |   |
|                            |       |                    |       |                   |       |
| Gross covenants  not to compete |       | $                       | 750        |                   | $          | 750 |   |
| Accumulated amortization        |       | (328                    | )          | (253                   | )          |
| Covenants not to  compete, net  |       | $                       | 422        |                   | $          | 497 |   |

 

Theweighted-average amortization period for deferred financing costs is 9 years,and the weighted-average amortization period of covenants not to compete is 5years.  Total amortization expense, whichincludes amortization of deferred financing costs, is as follows:

 
| ** **            | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **            | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                  |       |                                 |       |                               |       |   |   |   |   |
| Amortization  expense |       | $                                    | 284        |                               | $          | 255 |   | $ | 566 |   | $ | 546 |   |
|                       |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

The following table shows the total estimated amortization expense for2005 and the next five succeeding fiscal years:

 

Estimated amortization expense:

 
| 2005 |   | $     | 1,117  |   |
|------|--------|-------|--------|--------|
| 2006 |   | 1,084 |   |
| 2007 |   | 1,084 |   |
| 2008 |   | 939   |   |
| 2009 |   | 548   |   |
| 2010 |   | 468   |   |

 

12

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**(6)****         OtherCurrent Liabilities**

 
| ** **                            | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                  |       |                    |       |                        |       |
| Accrued payroll  and related benefits |       | $                       | 19,152     |                        | $          | 18,072 |   |
| Current portion  of pension liability |       | 2,876                   |       | 2,811                       |       |
| Accrued warranty  expense             |       | 2,120                   |       | 2,139                       |       |
| Accrued interest                      |       | 3,284                   |       | 3,257                       |       |
| Deferred income                       |       | 4,465                   |       | 4,468                       |       |
| Other accrued  expenses               |       | 5,506                   |       | 13,145                      |       |
| Total                                 |       | $                       | 37,403     |                        | $          | 43,892 |   |

 

Accrued warranty expense is recorded at the time of sale forinstruments that have a warranty period ranging from one to ten years. The accrued expense recorded is generally calculated on a percentage of salesbased on our warranty history and is adjusted periodically following ananalysis of actual warranty activity.

 

The accrued warranty expense activity for the six months ended June 30,2005 and 2004, and the year ended December 31, 2004 is as follows:

 
| ** **                           | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------|------------|-------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Beginning  balance                   |       | $                       | 2,139      |                    | $          | 2,602                       |       | 2,602 |   |
| Additions                            |       | 542                     |       | 520                     |       | 932                         |       |
| Claims and  reversals                |       | (480                    | )          | (774                    | )          | (1,455                      | )          |
| Foreign currency  translation impact |       | (81                     | )          | (23                     | )          | 60                          |       |
| Ending balance                       |       | $                       | 2,120      |                    | $          | 2,325                       |       | 2,139 |   |

 

**(7)****        ****Long-Term Debt**

 

Long-term debt consistsof the following:

 
| ** **                             | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                   |       |                    |       |                        |       |
| Term loans                             |       | $                       | 35,533     |                        | $          | 39,623 |   |
| 8.75% Senior  Notes                    |       | 174,345                 |       | 174,345                     |       |
| Unamortized bond  premium              |       | 1,458                   |       | 1,584                       |       |
| Domestic line of  credit               |       | 7,238                   |       | —                      |       |
| Open account  loans, payable on demand |       | 6,107                   |       | 7,240                       |       |
| Total                                  |       | 224,681                 |       | 222,792                     |       |
| Less: current  portion                 |       | 13,794                  |       | 14,212                      |       |
| Long-term debt                         |       | $                       | 210,887    |                        | $          | 208,580 |   |

 

13

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Scheduled payments oflong-term debt are as follows:

 

| ** **         | ** ** | **June 30,  2005** | ** ** |
|--------------------|------------|-------------------------|------------|
| Remainder of  2005 |       | $                       | 9,802      |   |
| 2006               |       | 7,997                   |       |
| 2007               |       | 8,071                   |       |
| 2008               |       | 23,008                  |       |
| 2009               |       | —                  |       |
| Thereafter         |       | 174,345                 |       |
| Total              |       | $                       | 223,223    |   |

 

**(8)****        ****Stockholders’ Equity**

 

Our common stock is comprised of two classes: Class Aand Ordinary.  With the exception ofdisparate voting power, both classes are substantially identical.  Each share of Class A common stockentitles the holder to 98 votes.  Holdersof Ordinary common stock are entitled to one vote per share.  Class A common stock shall automaticallyconvert to Ordinary common stock if, at any time, the Class A common stockis not owned by an original Class A holder.  At June 30, 2005 the Chairman and ChiefExecutive Officer own 100% of the Class A common shares, representingapproximately 86% of the combined voting power of the Class A common stockand Ordinary common stock.

 

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

 
| ** **                            | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                            | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                  |       |                                 |       |                               |       |   |   |   |   |
| West 57th  building income            |       | $                                    | (1,163     | )                                  | $          | (1,163 | ) | $ | (2,327 | ) | $ | (2,326 | ) |
| West 57th  building expense           |       | 816                                  |       | 814                                |       | 1,631 |   | 1,628 |   |
| Foreign exchange  (gains) losses, net |       | 457                                  |       | 175                                |       | 442 |   | (83 | ) |
| Miscellaneous                         |       | (77                                  | )          | (560                               | )          | (152 | ) | (565 | ) |
| Other (income)  expense, net          |       | $                                    | 33         |                               | $          | (734 | ) | $ | (406 | ) | $ | (1,346 | ) |

 

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**(10) Commitments and Contingent Liabilities**

 

We are involved in certain legal proceedings regardingenvironmental matters, which are described below.  Further, in the ordinary course of business,we are party to various legal actions that we believe are routine in nature andincidental to the operation of our business. While the outcome of such actions cannot be predicted with certainty, webelieve that, based on our experience in dealing with these matters, theirultimate resolution will not have a material adverse impact on our business,financial condition, or results of operations.

 

We operated manufacturing facilities at certainlocations where hazardous substances (including chlorinated solvents) wereused.  We believe that an entity thatformerly operated one such facility may have released hazardous substances atsuch location, which we leased through July 2001.  We did not contribute to the release.  Further, we have a contractual indemnity fromcertain stockholders of this entity. This facility is not the subject of a legal proceeding that involves us,nor, to our knowledge, is the facility subject to investigation.  However, no assurance can be given that legalproceedings will not arise in the future and that such indemnitors would makethe payments described in the indemnity.

 

We operate other manufacturing facilities which werepreviously owned by Philips Electronics North America Corporation (“Philips”).  Philips agreed to indemnify us for any andall losses, damages, liabilities and claims relating to environmental mattersresulting from certain activities of Philips occurring prior to December 29,1988 (the “Environmental Indemnity Agreement”). Philips has fully performed its obligations under the EnvironmentalIndemnity Agreement, which terminates on December 29, 2008.  Four matters covered by the EnvironmentalIndemnity Agreement are currently pending. Philips has entered into Consent Orders with the EnvironmentalProtection Agency (“EPA”) for one site and the North Carolina Department ofEnvironment, Health and Natural Resources for a second site, whereby Philipshas agreed to pay required response costs. On October 22, 1998, we were joined as defendant in an actioninvolving a site formerly occupied by a business we acquired in Illinois.  Philips has accepted the defense of thisaction pursuant to the terms of the Environmental Indemnity Agreement.  For the fourth site, the EPA has notified usit intends to carry out the final remediation itself.  The EPA estimates that this remedy has apresent net cost of approximately $14.5 million. The EPA has named over 40persons or entities as potentially responsible parties at this Elkhart, Indianasite, including four Conn-Selmer predecessor entities.  For two of these entities, which werepreviously owned by Philips, this matter has been tendered to Philips pursuantto the Environmental Indemnity Agreement. Our potential liability at any of these sites is affected by severalfactors including, but not limited to, the method of remediation, our portionof the materials in the site relative to that of the other named parties, thenumber of parties participating, and the financial capabilities of the otherpotentially responsible parties once the relative share has beendetermined.  No assurance can be given,however, that additional environmental issues will not require additional,currently unanticipated investigation, assessment or remediation expendituresor that Philips will make payments that it is obligated to make under theEnvironmental Indemnity Agreement.

 

We are continuing an existing environmentalremediation program at a facility we acquired in 2000.  We currently estimate that this project willtake eighteen years to complete, at a total cost of approximately $0.9million.  We have accrued approximately$0.7 million for the estimated remaining cost of this remediation program,which represents the present value total cost using a discount rate of

 

15

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4.1%.  A summary of expected payments associatedwith this project is as follows:

 
| ** ** | ** ** | **Environmental  Payments** | ** ** |
|------------|------------|-----------------------------|------------|
| 2005       |       | 156                         |       |
| 2006       |       | 80                          |       |
| 2007       |       | 54                          |       |
| 2008       |       | 47                          |       |
| 2009       |       | 47                          |       |
| Thereafter |       | 514                         |       |
| Total      |       | $                           | 898        |   |
|            |            |                             |            |  |

 

In 2004, we acquired manufacturing facilities forwhich environmental remediation programs had already been established.  Based on our current assessment, we haveaccrued approximately $0.7 million for the cost of these remediationprograms.  Should the liability increase,we are able to seek a claim against the escrow, which has a remaining balanceof approximately $3.9 million and is available until February 2006.

 

The matters described above and our other liabilitiesand compliance costs arising under environmental laws are not expected to havea material impact on our capital expenditures, earnings, or competitiveposition in any individual year.  However, some risk of environmental liabilityis inherent in the nature of our current and former business and we might, inthe future, incur material costs to meet current or more stringent compliance,cleanup, or other obligations pursuant to environmental laws.

 

**(11) Retirement Plans**

 

Wehave defined benefit pension plans covering the majority of our employees,including certain employees in Germany and the U.K.   The components of net periodic pension costfor these plans are as follows:

 
| ** **                          | ** ** | **Domestic Plans**                   | ** ** | **Foreign Plans**                    | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| ** **                          | ** ** | **Three Months Ended June 30,** | ** ** | **Three Months Ended June 30,** | ** ** |
| ** **                          | ** ** | **2005**                             | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost                        |       | $                                    | 126        |                                 | $          | 153 |   | $ | 171 |   | $ | 162 |   |
| Interest cost                       |       | 566                                  |       | 552                                  |       | 330 |   | 312 |   |
| Expected return  on plan assets     |       | (782                                 | )          | (743                                 | )          | (73 | ) | (66 | ) |
| Amortization of  prior service cost |       | 76                                   |       | 114                                  |       | — |   | — |   |
| Amortization of  net loss           |       | 114                                  |       | 52                                   |       | 1 |   | 19 |   |
| Net periodic  benefit cost          |       | $                                    | 100        |                                 | $          | 128 |   | $ | 429 |   | $ | 427 |   |

 

16

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| ** **                          | ** ** | **Domestic Plans**                 | ** ** | **Foreign Plans**                  | ** ** |
|-------------------------------------|------------|------------------------------------|------------|------------------------------------|------------|
| ** **                          | ** ** | **Six Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
| ** **                          | ** ** | **2005**                           | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost                        |       | $                                  | 252        |                               | $          | 439 |   | $ | 339 |   | $ | 329 |   |
| Interest cost                       |       | 1,132                              |       | 1,585                              |       | 655 |   | 634 |   |
| Expected return  on plan assets     |       | (1,564                             | )          | (2,144                             | )          | (148 | ) | (134 | ) |
| Amortization of  prior service cost |       | 152                                |       | 326                                |       | — |   | — |   |
| Amortization of  net loss           |       | 228                                |       | 140                                |       | 1 |   | 38 |   |
| Net periodic  benefit cost          |       | $                                  | 200        |                               | $          | 346 |   | $ | 847 |   | $ | 867 |   |

 

Weprovide postretirement health care and life insurance benefits to eligiblehourly retirees and their dependents. The components of net periodic pension cost for these benefits are asfollows:

 
| ** **                             | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                             | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost                           |       | $                                    | 9          |                               | $          | 39 |   | $ | 20 |   | $ | 58 |   |
| Interest cost                          |       | 29                                   |       | 77                                 |       | 65 |   | 115 |   |
| Amortization of  transition obligation |       | 10                                   |       | 25                                 |       | 23 |   | 38 |   |
| Amortization of  net loss              |       | —                               |       | 9                                  |       | — |   | 14 |   |
| Net  postretirement benefit cost       |       | $                                    | 48         |                               | $          | 150 |   | $ | 108 |   | $ | 225 |   |

 

Weanticipate domestic pension plan contributions of approximately $1.5 millionfor the current year.  As of June 30,2005 we have not yet made a contribution to this plan.  Our anticipated contributions to the pensionplan of our U.K. subsidiary approximate $0.2 million for the current year.  As of June 30, 2005, we have madecontributions of less than $0.2 million to this plan.  The pension plans of our German subsidiariesdo not hold any assets and pay participant benefits as incurred.  Expected 2005 benefit payments under theseplans are $0.8 million.  For the threeand six months ended June 30, 2005, we have made benefit payments of $0.5million under these plans.

 

**(12) SegmentInformation**

 

We have identified two reportable segments: the pianosegment and the band and orchestral instrument segment.  We consider these two segments reportable as theyare managed separately and the operating results of each segment are separatelyreviewed and evaluated by our senior management on a regular basis.  Management and the chief operating decisionmaker use income from operations as a meaningful measurement of profit or lossfor the segments.  Income from operationsfor the reportable segments includes certain corporate costs allocated to thesegments based primarily on revenue, as well as intercompany profit.  Amounts reported as “Other & Elim”include those corporate costs that were not allocated to the reportablesegments and the remaining intercompany profit elimination.

 

17

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Thefollowing tables present information about our operating segments for the threeand six month periods ended June 30, 2005 and 2004:

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

 
| ** **                       | ** ** | **Piano  Segment** | ** ** | **Band  Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|----------------------------------|------------|--------------------|------------|-------------------|------------|-----------|------------|------------|------------|
| **Three months ended 2004**      | ** ** | **U.S.**           | ** ** | **Germany**       | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **&  Elim** | ** ** | **Total** | ** ** |
| Net sales to  external customers |       | $                  | 26,219     |              | $          | 11,395    |       | $          | 7,319      |   | $ | 44,933 |   | $ | 37,700 |   | $ | 1,055 |   | $ | 38,755 |   | $ | — |   | $ | 83,688 |   |
| Income (loss)  from operations   |       | 2,324              |       | 1,865             |       | 519       |       | 4,708      |       | 3,031 |   | 23 |   | 3,054 |   | (549 | ) | 7,213 |   |
|                                  |            |                    |            |                   |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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

 
| ** **                       | ** ** | **Piano  Segment** | ** ** | **Band  Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|----------------------------------|------------|--------------------|------------|-------------------|------------|-----------|------------|------------|------------|
| **Six months ended 2004**        | ** ** | **U.S.**           | ** ** | **Germany**       | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **&  Elim** | ** ** | **Total** | ** ** |
| Net sales to  external customers |       | $                  | 52,960     |              | $          | 21,783    |       | $          | 15,907     |   | $ | 90,650 |   | $ | 80,881 |   | $ | 2,218 |   | $ | 83,099 |   | $ | — |   | $ | 173,749 |   |
| Income (loss)  from operations   |       | 4,576              |       | 3,421             |       | 1,671     |       | 9,668      |       | 6,820 |   | 58 |   | 6,878 |   | (1,235 | ) | 15,311 |   |
|                                  |            |                    |            |                   |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**(13) Summaryof Guarantees**

 

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

 

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

 

Werecord investments in subsidiaries on the cost method for purposes of the supplementalconsolidating presentation.  Earnings ofsubsidiaries are therefore not reflected in the parent company’s investmentaccounts and earnings.  The principalelimination entries eliminate investments in subsidiaries and intercompanybalances and transactions.

 

18

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENTS OF INCOME**

**THREE MONTHS ENDED JUNE 30, 2005**

**Unaudited**

**(In Thousands)**

 
| ** **                         | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                    | —     |                        | $          | 70,113                           |       | $                          | 23,403     |             | $          | (3,755 | ) | $ | 89,761 |   |
| Cost of sales                      |       | —               |       | 52,435                      |       | 14,944                           |       | (3,744                     | )          | 63,635           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —               |       | 17,678                      |       | 8,459                            |       | (11                        | )          | 26,126           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Operating  expenses:               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Sales and  marketing               |       | —               |       | 7,719                       |       | 3,413                            |       | —                     |       | 11,132           |       |
| General and  administrative        |       | 1,891                |       | 3,557                       |       | 1,512                            |       | —                     |       | 6,960            |       |
| Amortization of  intangible assets |       | 116                  |       | 162                         |       | 6                                |       | —                     |       | 284              |       |
| Other operating  (income) expense  |       | (1,217               | )          | 849                         |       | 391                              |       | —                     |       | 23               |       |
| Total operating  expenses          |       | 790                  |       | 12,287                      |       | 5,322                            |       | —                     |       | 18,399           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  from operations     |       | (790                 | )          | 5,391                       |       | 3,137                            |       | (11                        | )          | 7,727            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Other (income)  expense, net       |       | —               |       | (58                         | )          | 91                               |       | —                     |       | 33               |       |
| Interest income                    |       | (3,667               | )          | (6,312                      | )          | (71                              | )          | 9,327                      |       | (723             | )          |
| Interest expense                   |       | 3,856                |       | 9,779                       |       | 81                               |       | (9,327                     | )          | 4,389            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  before income taxes |       | (979                 | )          | 1,982                       |       | 3,036                            |       | (11                        | )          | 4,028            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income tax  provision (benefit)    |       | 354                  |       | (36                         | )          | 1,299                            |       | (7                         | )          | 1,610            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                 |       | $                    | (1,333     | )                           | $          | 2,018                            |       | $                          | 1,737      |             | $          | (4 | ) | $ | 2,418 |   |

 

19

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENTS OF INCOME**

**THREE MONTHS ENDED JUNE 30, 2004**

**Unaudited**

**(In Thousands)**

 
| ** **                         | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                    | —     |                        | $          | 66,499                           |       | $                          | 20,090     |             | $          | (2,901 | ) | $ | 83,688 |   |
| Cost of sales                      |       | —               |       | 49,574                      |       | 12,798                           |       | (3,087                     | )          | 59,285           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —               |       | 16,925                      |       | 7,292                            |       | 186                        |       | 24,403           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Operating  expenses:               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Sales and  marketing               |       | —               |       | 7,472                       |       | 3,067                            |       | —                     |       | 10,539           |       |
| General and  administrative        |       | 1,465                |       | 3,423                       |       | 1,511                            |       | —                     |       | 6,399            |       |
| Amortization of  intangible assets |       | 116                  |       | 138                         |       | 1                                |       | —                     |       | 255              |       |
| Other operating  (income) expense  |       | (886                 | )          | 577                         |       | 306                              |       | —                     |       | (3               | )          |
| Total operating  expenses          |       | 695                  |       | 11,610                      |       | 4,885                            |       | —                     |       | 17,190           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  from operations     |       | (695                 | )          | 5,315                       |       | 2,407                            |       | 186                        |       | 7,213            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Other income,  net                 |       | —               |       | (296                        | )          | (438                             | )          | —                     |       | (734             | )          |
| Interest income                    |       | (3,657               | )          | (5,568                      | )          | (69                              | )          | 8,703                      |       | (591             | )          |
| Interest expense                   |       | 3,852                |       | 8,803                       |       | 62                               |       | (8,703                     | )          | 4,014            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  before income taxes |       | (890                 | )          | 2,376                       |       | 2,852                            |       | 186                        |       | 4,524            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income tax provision  (benefit)    |       | (347                 | )          | 958                         |       | 1,142                            |       | 57                         |       | 1,810            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                 |       | $                    | (543       | )                           | $          | 1,418                            |       | $                          | 1,710      |             | $          | 129 |   | $ | 2,714 |   |

 

20

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENTS OF INCOME**

**SIX MONTHS ENDED JUNE 30, 2005**

**Unaudited**

**(In Thousands)**

 
| ** **                         | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                    | —     |                        | $          | 144,716                          |       | $                          | 44,366     |             | $          | (7,979 | ) | $ | 181,103 |   |
| Cost of sales                      |       | —               |       | 109,002                     |       | 28,315                           |       | (8,037                     | )          | 129,280          |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —               |       | 35,714                      |       | 16,051                           |       | 58                         |       | 51,823           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Operating  expenses:               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Sales  and marketing               |       | —               |       | 16,037                      |       | 6,367                            |       | —                     |       | 22,404           |       |
| General  and administrative        |       | 3,662                |       | 7,169                       |       | 3,104                            |       | —                     |       | 13,935           |       |
| Amortization  of intangible assets |       | 233                  |       | 324                         |       | 9                                |       | —                     |       | 566              |       |
| Other  operating (income) expense  |       | (2,268               | )          | 1,674                       |       | 727                              |       | —                     |       | 133              |       |
| Total operating  expenses          |       | 1,627                |       | 25,204                      |       | 10,207                           |       | —                     |       | 37,038           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  from operations     |       | (1,627               | )          | 10,510                      |       | 5,844                            |       | 58                         |       | 14,785           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Other (income)  expense, net       |       | (8                   | )          | (474                        | )          | 76                               |       | —                     |       | (406             | )          |
| Interest income                    |       | (7,332               | )          | (12,262                     | )          | (161                             | )          | 18,062                     |       | (1,693           | )          |
| Interest expense                   |       | 7,714                |       | 18,721                      |       | 155                              |       | (18,062                    | )          | 8,528            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  before income taxes |       | (2,001               | )          | 4,525                       |       | 5,774                            |       | 58                         |       | 8,356            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income tax provision  (benefit)    |       | 891                  |       | (66                         | )          | 2,464                            |       | 51                         |       | 3,340            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                 |       | $                    | (2,892     | )                           | $          | 4,591                            |       | $                          | 3,310      |             | $          | 7 |   | $ | 5,016 |   |

 

21

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENTS OF INCOME**

**SIX MONTHS ENDED JUNE 30, 2004**

**Unaudited**

**(In Thousands)**

 
| ** **                         | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                    | —     |                        | $          | 139,194                          |       | $                          | 41,146     |             | $          | (6,591 | ) | $ | 173,749 |   |
| Cost of sales                      |       | —               |       | 104,107                     |       | 26,190                           |       | (6,676                     | )          | 123,621          |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —               |       | 35,087                      |       | 14,956                           |       | 85                         |       | 50,128           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Operating  expenses:               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Sales and  marketing               |       | —               |       | 15,684                      |       | 6,131                            |       | 18                         |       | 21,833           |       |
| General and  administrative        |       | 2,825                |       | 6,542                       |       | 3,046                            |       | —                     |       | 12,413           |       |
| Amortization of  intangible assets |       | 232                  |       | 312                         |       | 2                                |       | —                     |       | 546              |       |
| Other operating  (income) expense  |       | (1,781               | )          | 1,197                       |       | 627                              |       | (18                        | )          | 25               |       |
| Total operating  expenses          |       | 1,276                |       | 23,735                      |       | 9,806                            |       | —                     |       | 34,817           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  from operations     |       | (1,276               | )          | 11,352                      |       | 5,150                            |       | 85                         |       | 15,311           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Other income,  net                 |       | —               |       | (653                        | )          | (693                             | )          | —                     |       | (1,346           | )          |
| Interest income                    |       | (7,314               | )          | (11,121                     | )          | (98                              | )          | 17,305                     |       | (1,228           | )          |
| Interest expense                   |       | 7,486                |       | 17,463                      |       | 148                              |       | (17,305                    | )          | 7,792            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  before income taxes |       | (1,448               | )          | 5,663                       |       | 5,793                            |       | 85                         |       | 10,093           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income tax  provision (benefit)    |       | (564                 | )          | 2,288                       |       | 2,295                            |       | 16                         |       | 4,035            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                 |       | $                    | (884       | )                           | $          | 3,375                            |       | $                          | 3,498      |             | $          | 69 |   | $ | 6,058 |   |

 

22

----

 

 **STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATING BALANCE SHEETS**

**JUNE 30, 2005**

**Unaudited**

**(In Thousands)**

 
| ** **                                       | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| ASSETS                                           |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current assets:                                  |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash                                             |       | $                    | —     |                        | $          | 37,288                           |       | $                          | 13,419     |             | $          | (32,965 | ) | $ | 17,742 |   |
| Accounts, notes  and leases receivable, net      |       | —               |       | 80,696                      |       | 9,658                            |       | —                     |       | 90,354           |       |
| Inventories                                      |       | —               |       | 136,594                     |       | 44,485                           |       | (1,207                     | )          | 179,872          |       |
| Prepaid expenses  and other current assets       |       | 458                  |       | 1,908                       |       | 1,309                            |       | —                     |       | 3,675            |       |
| Deferred tax  assets                             |       | —               |       | 9,705                       |       | 4,931                            |       | —                     |       | 14,636           |       |
| Total current  assets                            |       | 458                  |       | 266,191                     |       | 73,802                           |       | (34,172                    | )          | 306,279          |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Property, plant  and equipment, net              |       | 214                  |       | 80,929                      |       | 17,596                           |       | —                     |       | 98,739           |       |
| Investment in  subsidiaries                      |       | 69,643               |       | 248,346                     |       | —                           |       | (317,989                   | )          | —           |       |
| Trademarks                                       |       | —               |       | 9,319                       |       | 3,885                            |       | 114                        |       | 13,318           |       |
| Goodwill                                         |       | —               |       | 17,973                      |       | 12,382                           |       | —                     |       | 30,355           |       |
| Other  intangibles, net                          |       | 2,705                |       | 2,028                       |       | 83                               |       | —                     |       | 4,816            |       |
| Other assets                                     |       | 3,296                |       | 8,185                       |       | 3,049                            |       | —                     |       | 14,530           |       |
| TOTAL ASSETS                                     |       | $                    | 76,316     |                        | $          | 632,971                          |       | $                          | 110,797    |             | $          | (352,047 | ) | $ | 468,037 |   |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY       |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current  liabilities:                            |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current portion  of long-term debt               |       | $                    | —     |                        | $          | 7,687                            |       | $                          | 6,107      |             | $          | — |   | $ | 13,794 |   |
| Accounts payable                                 |       | 233                  |       | 9,806                       |       | 3,260                            |       | —                     |       | 13,299           |       |
| Other current  liabilities                       |       | 2,777                |       | 20,633                      |       | 14,253                           |       | (260                       | )          | 37,403           |       |
| Total current  liabilities                       |       | 3,010                |       | 38,126                      |       | 23,620                           |       | (260                       | )          | 64,496           |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Long-term debt                                   |       | 175,803              |       | 68,049                      |       | —                           |       | (32,965                    | )          | 210,887          |       |
| Intercompany                                     |       | (132,701             | )          | 130,965                     |       | 1,736                            |       | —                     |       | —           |       |
| Deferred tax  liabilities                        |       | 50                   |       | 18,731                      |       | 6,479                            |       | —                     |       | 25,260           |       |
| Other  non-current liabilities                   |       | 1,045                |       | 1,939                       |       | 19,604                           |       | —                     |       | 22,588           |       |
| Total  liabilities                               |       | 47,207               |       | 257,810                     |       | 51,439                           |       | (33,225                    | )          | 323,231          |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Stockholders’  equity                       |       | 29,109               |       | 375,161                     |       | 59,358                           |       | (318,822                   | )          | 144,806          |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY |       | $                    | 76,316     |                        | $          | 632,971                          |       | $                          | 110,797    |             | $          | (352,047 | ) | $ | 468,037 |   |

 

23

----

 

**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATING BALANCE SHEETS**

**DECEMBER 31, 2004**

**Unaudited**

**(In Thousands)**

 
| ** **                                       | ** ** | **Issuer  Of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| ASSETS                                           |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current assets:                                  |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash                                             |       | $                    | —     |                        | $          | 44,990                           |       | $                          | 14,238     |             | $          | (31,856 | ) | $ | 27,372 |   |
| Accounts, notes  and other receivables, net      |       | —               |       | 74,805                      |       | 13,254                           |       | —                     |       | 88,059           |       |
| Inventories                                      |       | —               |       | 127,577                     |       | 46,034                           |       | (1,265                     | )          | 172,346          |       |
| Prepaid expenses  and other current assets       |       | 1,007                |       | 3,956                       |       | 974                              |       | —                     |       | 5,937            |       |
| Deferred tax  assets                             |       | —               |       | 9,695                       |       | 5,352                            |       | —                     |       | 15,047           |       |
| Total current  assets                            |       | 1,007                |       | 261,023                     |       | 79,852                           |       | (33,121                    | )          | 308,761          |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Property, plant  and equipment, net              |       | 181                  |       | 83,713                      |       | 19,072                           |       | (22                        | )          | 102,944          |       |
| Investment in  subsidiaries                      |       | 69,643               |       | 278,513                     |       | —                           |       | (348,156                   | )          | —           |       |
| Trademarks                                       |       | —               |       | 7,625                       |       | 4,700                            |       | —                     |       | 12,325           |       |
| Goodwill                                         |       | —               |       | 17,973                      |       | 13,881                           |       | —                     |       | 31,854           |       |
| Other  intangibles, net                          |       | 2,938                |       | 2,352                       |       | —                           |       | —                     |       | 5,290            |       |
| Other assets                                     |       | 3,126                |       | 10,241                      |       | 3,004                            |       | —                     |       | 16,371           |       |
| TOTAL ASSETS                                     |       | $                    | 76,895     |                        | $          | 661,440                          |       | $                          | 120,509    |             | $          | (381,299 | ) | $ | 477,545 |   |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY       |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current  liabilities:                            |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current portion  of long-term debt               |       | $                    | —     |                        | $          | 6,972                            |       | $                          | 7,240      |             | $          | — |   | $ | 14,212 |   |
| Accounts payable                                 |       | 677                  |       | 10,716                      |       | 3,396                            |       | —                     |       | 14,789           |       |
| Other current  liabilities                       |       | 5,618                |       | 21,950                      |       | 16,635                           |       | (311                       | )          | 43,892           |       |
| Total current  liabilities                       |       | 6,295                |       | 39,638                      |       | 27,271                           |       | (311                       | )          | 72,893           |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Long-term debt                                   |       | 175,929              |       | 64,507                      |       | —                           |       | (31,856                    | )          | 208,580          |       |
| Intercompany                                     |       | (137,549             | )          | 139,993                     |       | (2,444                           | )          | —                     |       | —           |       |
| Deferred tax  liabilities                        |       | 63                   |       | 18,843                      |       | 7,334                            |       | —                     |       | 26,240           |       |
| Other  non-current liabilities                   |       | 892                  |       | 1,784                       |       | 21,603                           |       | —                     |       | 24,279           |       |
| Total  liabilities                               |       | 45,630               |       | 264,765                     |       | 53,764                           |       | (32,167                    | )          | 331,992          |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Stockholders’  equity                       |       | 31,265               |       | 396,675                     |       | 66,745                           |       | (349,132                   | )          | 145,553          |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY |       | $                    | 76,895     |                        | $          | 661,440                          |       | $                          | 120,509    |             | $          | (381,299 | ) | $ | 477,545 |   |

 

24

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENTS OF CASH FLOWS**

**SIX MONTHS ENDED JUNE 30, 2005**

**Unaudited**

**(In Thousands)**

 
| ** **                                                                           | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| Cash flows from  operating activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                                                                   |       | $                    | (2,892     | )                           | $          | 4,591                            |       | $                          | 3,310      |             | $          | 7 |   | $ | 5,016 |   |
| Adjustments to  reconcile net income (loss) to cash flows from operating activities: |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Depreciation and  amortization                                                       |       | 275                  |       | 4,488                       |       | 976                              |       | —                     |       | 5,739            |       |
| Amortization of  bond premium                                                        |       | (126                 | )          | —                      |       | —                           |       | —                     |       | (126             | )          |
| Deferred tax  benefit                                                                |       | (13                  | )          | (122                        | )          | (144                             | )          | —                     |       | (279             | )          |
| Tax benefit from  stock option exercises                                             |       | 99                   |       | —                      |       | —                           |       | —                     |       | 99               |       |
| Other                                                                                |       | —               |       | 98                          |       | 6                                |       | —                     |       | 104              |       |
| Changes in  operating assets and liabilities:                                        |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Accounts, notes  and leases receivable                                               |       | —               |       | (6,149                      | )          | 2,706                            |       | —                     |       | (3,443           | )          |
| Inventories                                                                          |       | —               |       | (9,471                      | )          | (3,616                           | )          | (58                        | )          | (13,145          | )          |
| Prepaid expenses  and other assets                                                   |       | 360                  |       | 3,365                       |       | (904                             | )          | —                     |       | 2,821            |       |
| Accounts payable                                                                     |       | (444                 | )          | (910                        | )          | 257                              |       | —                     |       | (1,097           | )          |
| Other  liabilities                                                                   |       | (2,688               | )          | (2,578                      | )          | (571                             | )          | 51                         |       | (5,786           | )          |
| Cash flows from  operating activities                                                |       | (5,429               | )          | (6,688                      | )          | 2,020                            |       | —                     |       | (10,097          | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  investing activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Capital  expenditures                                                                |       | (75                  | )          | (1,720                      | )          | (554                             | )          | —                     |       | (2,349           | )          |
| Proceeds from  disposal of fixed assets                                              |       | —               |       | 954                         |       | 399                              |       | —                     |       | 1,353            |       |
| Cash flows from  investing activities                                                |       | (75                  | )          | (766                        | )          | (155                             | )          | —                     |       | (996             | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  financing activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Borrowings under  lines of credit                                                    |       | —               |       | 69,664                      |       | 2,153                            |       | (1,109                     | )          | 70,708           |       |
| Repayments under  lines of credit                                                    |       | —               |       | (61,317                     | )          | (2,883                           | )          | —                     |       | (64,200          | )          |
| Repayments of  term-loan debt                                                        |       | —               |       | (4,090                      | )          | —                           |       | —                     |       | (4,090           | )          |
| Proceeds from  issuance of stock                                                     |       | 656                  |       | —                      |       | —                           |       | —                     |       | 656              |       |
| Intercompany  transactions                                                           |       | 4,848                |       | (4,505                      | )          | (343                             | )          | —                     |       | —           |       |
| Cash flows from  financing activities                                                |       | 5,504                |       | (248                        | )          | (1,073                           | )          | (1,109                     | )          | 3,074            |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Effect of  exchange rate changes on cash                                             |       | —               |       | —                      |       | (1,611                           | )          | —                     |       | (1,611           | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Decrease in cash                                                                     |       | —               |       | (7,702                      | )          | (819                             | )          | (1,109                     | )          | (9,630           | )          |
| Cash, beginning  of year                                                             |       | —               |       | 44,990                      |       | 14,238                           |       | (31,856                    | )          | 27,372           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash, end of  period                                                                 |       | $                    | —     |                        | $          | 37,288                           |       | $                          | 13,419     |             | $          | (32,965 | ) | $ | 17,742 |   |

 

25

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENTS OF CASH FLOWS**

**SIX MONTHS ENDED JUNE 30, 2004**

**Unaudited**

**(In Thousands)**

 
| ** **                                                                           | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| Cash flows from  operating activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                                                                   |       | $                    | (884       | )                           | $          | 3,375                            |       | $                          | 3,498      |             | $          | 69 |   | $ | 6,058 |   |
| Adjustments to  reconcile net income (loss) to cash flows from operating activities: |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Depreciation and  amortization                                                       |       | 262                  |       | 4,233                       |       | 843                              |       | —                     |       | 5,338            |       |
| Amortization of  bond premium                                                        |       | (105                 | )          | —                      |       | —                           |       | —                     |       | (105             | )          |
| Deferred tax  benefit                                                                |       | —               |       | (131                        | )          | (87                              | )          | —                     |       | (218             | )          |
| Tax benefit from  stock option exercises                                             |       | 732                  |       | —                      |       | —                           |       | —                     |       | 732              |       |
| Other                                                                                |       | —               |       | (136                        | )          | 108                              |       | —                     |       | (28              | )          |
| Changes in  operating assets and liabilities:                                        |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Accounts, notes  and leases receivable                                               |       | —               |       | (11,642                     | )          | 3,179                            |       | —                     |       | (8,463           | )          |
| Inventories                                                                          |       | —               |       | (6,140                      | )          | (3,006                           | )          | (85                        | )          | (9,231           | )          |
| Prepaid expenses  and other assets                                                   |       | (1,298               | )          | 719                         |       | (3,356                           | )          | —                     |       | (3,935           | )          |
| Accounts payable                                                                     |       | 333                  |       | 752                         |       | (332                             | )          | —                     |       | 753              |       |
| Other liabilities                                                                    |       | (1,243               | )          | (973                        | )          | 687                              |       | 16                         |       | (1,513           | )          |
| Cash flows from  operating activities                                                |       | (2,203               | )          | (9,943                      | )          | 1,534                            |       | —                     |       | (10,612          | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  investing activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Capital  expenditures                                                                |       | (19                  | )          | (1,568                      | )          | (465                             | )          | —                     |       | (2,052           | )          |
| Proceeds from  disposal of fixed assets                                              |       | —               |       | 76                          |       | —                           |       | —                     |       | 76               |       |
| Cash flows from  investing activities                                                |       | (19                  | )          | (1,492                      | )          | (465                             | )          | —                     |       | (1,976           | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  financing activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Borrowings under  lines of credit                                                    |       | —               |       | 3,583                       |       | 3,766                            |       | 3,000                      |       | 10,349           |       |
| Repayments under  lines of credit                                                    |       | (7                   | )          | (6,576                      | )          | (3,908                           | )          | —                     |       | (10,491          | )          |
| Debt issuance  costs                                                                 |       | (105                 | )          | —                      |       | —                           |       | —                     |       | (105             | )          |
| Repayments of  term loan debt                                                        |       | —               |       | (3,352                      | )          | —                           |       | —                     |       | (3,352           | )          |
| Proceeds from  issuance of stock                                                     |       | 4,594                |       | —                      |       | —                           |       | —                     |       | 4,594            |       |
| Intercompany  transactions                                                           |       | (2,260               | )          | 5,174                       |       | (2,914                           | )          | —                     |       | —           |       |
| Cash flows from  financing activities                                                |       | (2,222               | )     | (1,171                      | )          | (3,056                           | )          | 3,000                      |       | 995              |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Effect of  exchange rate changes on cash                                             |       | —               |       | —                      |       | (367                             | )          | —                     |       | (367             | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Increase  (decrease) in cash                                                         |       | —               |       | (12,606                     | )          | (2,354                           | )          | 3,000                      |       | (11,960          | )          |
| Cash, beginning  of year                                                             |       | —               |       | 12,255                      |       | 8,792                            |       | 21,236                     |       | 42,283           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash, end of  period                                                                 |       | $                    | —     |                        | $          | (351                             | )          | $                          | 6,438      |             | $          | 24,236 |   | $ | 30,323 |   |

 

26

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**ITEM 2****          MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**(Tabular Amounts in Thousands Except Share and PerShare Data)**

 

**Introduction**

 

We are a worldleader in the design, manufacture, marketing, and distribution of high-qualitymusical instruments.  Our piano divisionconcentrates on the high-end grand piano segment of the industry, handcraftingSteinway pianos in New York and Germany. We also offer upright pianos and two mid-priced lines of pianos underthe Boston and Essex brand names. Moreover, we are the largest domestic producer of band and orchestralinstruments and offer a complete line of brass, woodwind, percussion and stringinstruments and related accessories with well-known brand names such as Bach,Selmer, C.G. Conn, Leblanc, King, and Ludwig. We sell our products through dealers and distributors worldwide. Ourpiano customer base consists of professional artists, amateur pianists, andinstitutions such as concert halls, universities, and music schools.  Our band and orchestral instrument customerbase consists primarily of middle school and high school students, but alsoincludes adult amateur and professional musicians.

 

**CriticalAccounting Estimates**

 

The application of many accounting policies involvesestimates and assumptions that have a material impact on our reportedresults.  We establish reserves forinventory, workers’ compensation, warranty claims, accounts receivable, notesreceivable, (including recourse reserves when our customers have financed notesreceivable with a third party), all of which are developed using certainestimates.  We have significantexperience and data on which to base these estimates.  Historical information is adjusted forspecific uncertainties, such as new product introductions, and contemporaneousinformation, such as price fluctuations. We regularly perform assessments of the underlying assumptions we use.The impairment (if any) and recoverability of long-lived assets, the selectionof assumptions used to determine pension expense or income, the allocation ofpurchase price for businesses acquired, and certain components of our taxprovision calculation, such as valuation allowances on deferred tax assets, theability to utilize foreign tax credits, and income tax contingencies are basedon estimates that require a greater degree of management judgment. We believethe assumptions made by management provide a reasonable basis for the estimatesreflected in our financial statements.

 

**Forward-LookingStatements**

 

Certain statements contained in this document are “forward-lookingstatements” within the meaning of Section 21E of the Securities andExchange Act of 1934, as amended.  Theseforward-looking statements represent our present expectations or beliefsconcerning future events.  We cautionthat such statements are necessarily based on certain assumptions which aresubject to risks and uncertainties which could cause actual results to differmaterially from those indicated in this report. These risk factors include, but are not limited to, the following:  changes in general economic conditions;geopolitical events; increased competition; work stoppages and slowdowns;exchange rate fluctuations; variations in the mix of products sold; marketacceptance of new band instrument product and distribution strategies; abilityof suppliers to meet demand; fluctuations in effective tax rates resulting fromshifts in sources of income; and the ability to successfully integrate andoperate acquired businesses.  Furtherinformation on these risk factors is included in our Annual Report on Form 10-Kfor the year ended December 31, 2004, our Final Prospectus filed in August 1996,and Registration Statement No. 333-62790 filed in June 2001,particularly in the sections entitled “Risk Factors.”  We encourage you to read those descriptionscarefully.  We caution investors not toplace undue reliance on

 

27

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the forward-lookingstatements contained in this report. These statements, like all statements contained in this report, speakonly as of the date of this report (unless another date is indicated) and weundertake no obligation to update or revise the statements except as requiredby law.

 

**Results of Operations**

 

*Three MonthsEnded June 30, 2005 Compared to Three Months Ended June 30, 2004*

 
| ** **                   | ** ** | **Quarter Ended June 30,** | ** ** | **Change** | ** ** |
|------------------------------|------------|---------------------------------|------------|------------|------------|
| ** **                   | ** ** | **2005**                        | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
|                         |       |                            |       |       |       |   |   |   |   |
| Net sales                    |       |                            |       |       |       |   |   |   |   |
| Band                         |       | $                               | 43,368     |       | $          | 38,755 |   | 4,613 |   | 11.9 |   |
| Piano                        |       | 46,393                          |       | 44,933     |       | 1,460 |   | 3.2 |   |
| Total sales                  |       | 89,761                          |       | 83,688     |       | 6,073 |   | 7.3 |   |
|                         |       |                            |       |       |       |   |   |   |   |
| Cost of sales                |       |                            |       |       |       |   |   |   |   |
| Band                         |       | 33,709                          |       | 29,844     |       | 3,865 |   | 13.0 |   |
| Piano                        |       | 29,926                          |       | 29,441     |       | 485 |   | 1.6 |   |
| Total cost of  sales         |       | 63,635                          |       | 59,285     |       | 4,350 |   | 7.3 |   |
|                         |       |                            |       |       |       |   |   |   |   |
| Gross profit                 |       |                            |       |       |       |   |   |   |   |
| Band                         |       | 9,659                           | 22.3%      | 8,911      | 23.0%      | 748 |   | 8.4 |   |
| Piano                        |       | 16,467                          | 35.5%      | 15,492     | 34.5%      | 975 |   | 6.3 |   |
| Total gross  profit          |       | 26,126                          |       | 24,403     |       | 1,723 |   | 7.1 |   |
|                         |       | 29.1%                           |       | 29.2%      |       |   |   |   |   |
|                         |       |                            |       |       |       |   |   |   |   |
| Operating  expenses          |       | 18,399                          |       | 17,190     |       | 1,209 |   | 7.0 |   |
|                         |       |                            |       |       |       |   |   |   |   |
| Income from  operations      |       | 7,727                           |       | 7,213      |       | 514 |   | 7.1 |   |
|                         |       |                            |       |       |       |   |   |   |   |
| Other (income)  expense, net |       | 33                              |       | (734       | )          | 767 |   | (104.5 | ) |
| Net interest  expense        |       | 3,666                           |       | 3,423      |       | 243 |   | 7.1 |   |
|                         |       |                            |       |       |       |   |   |   |   |
| Income before  income taxes  |       | 4,028                           |       | 4,524      |       | (496 | ) | (11.0 | ) |
|                         |       |                            |       |       |       |   |   |   |   |
| Income taxes                 |       | 1,610                           | 40.0%      | 1,810      | 40.0%      | (200 | ) | (11.0 | ) |
|                         |       |                            |       |       |       |   |   |   |   |
| Net income                   |       | $                               | 2,418      |       | $          | 2,714 |   | (296 | ) | (10.9 | ) |

 

28

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*Overview–*The increase inband division revenue in the current period resulted primarily from Leblancinstruments. Also, this period we were better able to align our shipments ofnew sourced products and certain domestically produced woodwind instrumentswith orders received for these items. We had increased production staff at ourwoodwind manufacturing facility in early 2005 to help us better meet the demandfor instruments produced at that location. Although productioninefficiencies resulting from training personnel at our woodwind facilitycontinued during the period, these were more than offset by lower employeebenefit costs.  As a result, overall bandoperating profit improved over the prior period.

 

Domesticpiano revenues were consistent with the prior year, and overseas piano revenueincreased primarily due to strong wholesale volume.  Margins improved due to increased salesvolume of higher margin wholesale units, and overall piano operating profitimproved over the prior period.

 

*Net Sales–*The increase in net sales of $6.1 million resulted fromimproved performance in both the piano and band segments.  Although overall Steinway grand unitshipments were off 3% from the prior year, piano division sales increased $1.5million.  This improvement was driven by an11% increase in overseas Steinway grand unit shipments and strong wholesalevolume at our European operations.  Inaddition, the annual sales price increase on Steinway products and priceincrease on Boston products mitigated the decrease in overall unit shipments of2%. We were not able to fill all orders received for certain woodwindinstruments, particularly flutes, due to the production inefficienciesresulting from the training of new production workers at our woodwindmanufacturing facility. Despite this, band segment revenues increased $4.6million on an overall unit increase of 4%. This increase was fueled by Leblanc product sales of $5.4 million, whichresulted in a brass and woodwind unit increase of 13% for the period.

 

*GrossProfit –* Gross profit improved $1.7 million driven by pianomargin improvements and band sales volume improvements.  Despite flat retail sales, piano marginsincreased from 34.5% to 35.5% due to strong wholesale demand in higher marginEuropean territories. Band gross margins declined from 23.0% to 22.3% in theperiod.  This decrease resulted fromcharges of $0.6 million that arose from the turn through of Leblanc inventory,which was written up to fair value. Although the production inefficiencies atour woodwind manufacturing plant adversely impacted band margins, this wasoffset by reduced employee medical costs during the period.

 

*OperatingExpenses* – Operating expenses increased $1.2 million, $0.3million of which is due to incremental costs associated with Leblanc.  Approximately $0.4 million of the increase isdue to a shift in external costs associated with Sarbanes-Oxley complianceefforts into the current period.  Thesecosts were concentrated in the third and fourth quarters in the prioryear.  The remainder is attributable toincreased sales and marketing costs, primarily associated with promotionalefforts.

 

*InterestExpense and Other Income, Net –*These other expensesincreased $1.0 million to $3.7 million due primarily to certainreclassifications, an increase in foreign exchange losses of $0.3 million, and$0.2 million in additional interest expense. Higher domestic interest expense resulted from the rise in interestrates, as well as our use of the domestic line in the current period.

 

*IncomeTaxes**–*Our effectivetax rate of 40% is consistent with the prior comparative period.

 

29

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*Six Months Ended June 30, 2005 Compared to SixMonths Ended June 30, 2004*

 
| ** **                  | ** ** | **Period Ended June 30,** | ** ** | **Change** | ** ** |
|-----------------------------|------------|--------------------------------|------------|------------|------------|
| ** **                  | ** ** | **2005**                       | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
|                        |       |                           |       |       |       |   |   |   |   |
| Net sales                   |       |                           |       |       |       |   |   |   |   |
| Band                        |       | $                              | 90,935     |       | $          | 83,099 |   | 7,836 |   | 9.4 |   |
| Piano                       |       | 90,168                         |       | 90,650     |       | (482 | ) | (0.5 | ) |
| Total sales                 |       | 181,103                        |       | 173,749    |       | 7,354 |   | 4.2 |   |
|                        |       |                           |       |       |       |   |   |   |   |
| Cost of sales               |       |                           |       |       |       |   |   |   |   |
| Band                        |       | 71,523                         |       | 64,160     |       | 7,363 |   | 11.5 |   |
| Piano                       |       | 57,757                         |       | 59,461     |       | (1,704 | ) | (2.9 | ) |
| Total cost of  sales        |       | 129,280                        |       | 123,621    |       | 5,659 |   | 4.6 |   |
|                        |       |                           |       |       |       |   |   |   |   |
| Gross profit                |       |                           |       |       |       |   |   |   |   |
| Band                        |       | 19,412                         | 21.3%      | 18,939     | 22.8%      | 473 |   | 2.5 |   |
| Piano                       |       | 32,411                         | 35.9%      | 31,189     | 34.4%      | 1,222 |   | 3.9 |   |
| Total gross  profit         |       | 51,823                         |       | 50,128     |       | 1,695 |   | 3.4 |   |
|                        |       | 28.6%                          |       | 28.9%      |       |   |   |   |   |
|                        |       |                           |       |       |       |   |   |   |   |
| Operating  expenses         |       | 37,038                         |       | 34,817     |       | 2,221 |   | 6.4 |   |
|                        |       |                           |       |       |       |   |   |   |   |
| Income from  operations     |       | 14,785                         |       | 15,311     |       | (526 | ) | (3.4 | ) |
|                        |       |                           |       |       |       |   |   |   |   |
| Other income,  net          |       | (406                           | )          | (1,346     | )          | 940 |   | (69.8 | ) |
| Net interest  expense       |       | 6,835                          |       | 6,564      |       | 271 |   | 4.1 |   |
|                        |       |                           |       |       |       |   |   |   |   |
| Income before  income taxes |       | 8,356                          |       | 10,093     |       | (1,737 | ) | (17.2 | ) |
|                        |       |                           |       |       |       |   |   |   |   |
| Income taxes                |       | 3,340                          | 40.0%      | 4,035      | 40.0%      | (695 | ) | (17.2 | ) |
|                        |       |                           |       |       |       |   |   |   |   |
| Net income                  |       | $                              | 5,016      |       | $          | 6,058 |   | (1,042 | ) | (17.2 | ) |

 

*Overview–*Sales of Leblancinstruments drove the band division’s revenue improvement for the period.  Sales of other band instruments were lower asdemand for newly introduced sourced-product models and certain woodwindinstruments exceeded amounts available for shipment. We expect the productiondisruptions caused by training new personnel at the woodwind manufacturingfacility to taper off in the third quarter. These production disruptions also adversely impacted band grossmargins.

 

Althoughpiano sales were relatively flat for the period, piano division operatingprofit improved, primarily as a result of gross margin improvements.

 

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*Net Sales–*The increase in net sales of $7.4 million was driven by theincrease in band sales.  Piano divisionsales were relatively consistent with the prior period as the strong Europeanwholesale performance in the latter part of the period essentially offset the$1.4 million decrease in domestic retail sales in the first quarter.  Steinway grand unit shipments, as well asoverall unit shipments, decreased 3% over the prior period.  However, standard price increases on Steinwayand Boston product helped mitigate the impact of lower shipments.  Our band division sales increased $7.8million as a result of incremental Leblanc product sales of $11.4 million.  In the first part of the period, orders forcertain new sourced product models as well as certain domestically manufacturedclarinets and flutes exceeded amounts we had available for shipment. Theavailability of sourced products and clarinets improved in the latter part ofthe period, mitigating the revenue shortfall in these categories.

 

*GrossProfit –* Gross profit improved $1.7 million, fueled by theimprovement in piano division margins.   Piano margins increased from 34.4% to 35.9% despite lower retail salesdue to wholesale shipments to high-margin territories by our Europeanoperations, as well as a shift in domestic sales mix toward larger, highermargin Steinway grand units. Increased production levels at our Germanmanufacturing facility and lower domestic overhead expenses in the first partof the period also contributed to the margin improvement.  Band gross margins declined from 22.8% to21.3% in the period.  Atypical chargesaffecting margin in 2005 totaled $1.3 million, comprised of charges from theturn through of Leblanc inventory, which was written up to fair value.  Atypical charges affecting margin in 2004included $1.4 million in severance costs associated with the closure of one ofour woodwind manufacturing facilities. Despite the decrease in atypical charges, gross margins declinedprimarily as a result of the factory disruptions caused by production ramp-upefforts and new workforce training at our domestic woodwind manufacturingfacility.

 

*OperatingExpenses* – Operating expenses increased $2.2 million, primarilydue to incremental costs of $0.9 million associated with Leblanc, the majorityof which was incurred in the first part of the period.  Approximately $0.6 million of the increase isdue to a shift in external costs associated with ongoing compliance efforts tothe current period.  In 2004, themajority of costs were incurred in the latter half of the year.  The remainder is primarily attributable toincreased sales and marketing costs associated with promotional efforts andcommissions incurred by the piano division.

 

*InterestExpense and Other Income, Net –*These other expensesincreased $1.2 million to $6.4 million due the $0.5 million shift from foreigncurrency gains to foreign currency losses during the period.  Increased domestic interest expense due tothe rise in interest rates, our increased bond debt ($29.0 million issued in February 2004),and borrowings on the domestic line of credit resulted in $0.3 million of theincrease.  The remainder is due to thereclassification of certain items.

 

*IncomeTaxes**–*Our effectivetax rate of 40% is consistent with the prior comparative period.

 

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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.

 

Ourstatements of cash flows for the six months ended June 30, 2005 and 2004are summarized as follows:

 
| ** **                                                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **Change** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
| Net income:                                                                  |       | $        | 5,016      |     | $          | 6,058      |       | $ | (1,042 | ) |
| Changes in  operating assets and liabilities                                 |       | (20,650  | )          | (22,389  | )          | 1,739      |       |
| Other  adjustments to reconcile net income to cash from operating activities |       | 5,537    |       | 5,719    |       | (182       | )          |
| Cash flows from  operating activities                                        |       | (10,097  | )          | (10,612  | )          | 515        |       |
|                                                                         |       |     |       |     |       |       |       |
| Cash flows from  investing activities                                        |       | (996     | )          | (1,976   | )          | 980        |       |
|                                                                         |       |     |       |     |       |       |       |
| Cash flows from  financing activities                                        |       | 3,074    |       | 995      |       | 2,079      |       |
|                                                                              |            |          |            |          |            |            |            |  |  |  |

 

Although net income decreased $1.0 million, cash usedfor operating activities was $0.5 million lower during the period. Havingestablished and funded new workers’ compensation trust accounts in the priorperiod, cash used for such assets decreased significantly.  Cash used for band division accountsreceivable also decreased significantly during the period as collectionsimproved.

 

The use of cash for investing activities decreased$1.0 million as proceeds of $1.4 million from the sale of certain acquiredassets, including one manufacturing facility in Wisconsin, more than offset theincrease in capital expenditures of $0.3 million.  Cash flows from financing activitiesincreased $2.1 million during the period due to increased borrowings on thedomestic line of credit.  Theseborrowings more than offset the $3.9 million decrease in cash generated fromstock option exercises.

 

## **Borrowing Availabilityand Activities**

 

Our real estate term loan, acquisition term loan anddomestic seasonal borrowing requirements are accommodated through a committedcredit facility with a syndicate of domestic lenders (the “Credit Facility”).  The Credit Facility provides us with apotential borrowing capacity of up to $85.0 million in revolving credit loans,based on eligible accounts receivable and inventory balances.  The acquisition term loan and revolvingcredit loan portions of the Credit Facility bear interest at average 30-dayLIBOR plus 1.75%, and the real estate term loan bears interest at average 30-dayLIBOR plus 1.5%.   The Credit facilityexpires on September 14, 2008.  Asof June 30, 2005 there was $7.2 million in revolving credit loansoutstanding, and remaining availability based on eligible accounts receivableand inventory balances was approximately $75.4 million net of letters ofcredit of $2.3 million.  We also havecertain non-domestic credit facilities originating from two German banks thatprovide for borrowings by foreign subsidiaries of up to €16.5 million ($20.0million at the June 30, 2005 exchange rate), net of borrowing restrictionsof €0.9 million ($1.1 million at the June 30, 2005 exchange rate) and arepayable on demand.  These borrowings arecollateralized by most of the assets of the borrowing subsidiaries.  A portion of the open account loans can beconverted into a maximum of £0.5 million ($0.9 million at the June 30,2005 exchange rate) for use by our U.K. branch and ¥300 million ($2.7 millionat the June 30, 2005 exchange rate) for use by our Japanese subsidiary.Our Chinese subsidiary also has the ability to convert the equivalent of up to€1.8 million into U.S.

 

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dollars or Chinese renminbi ($2.2 million at the June 30,2005 exchange rate).  We had $1.6 millionoutstanding as of June 30, 2005 on these credit facilities.  In January 2005, our Japanese subsidiaryentered into a separate revolving loan agreement that provides additionalborrowing capacity of up to ¥500 million ($4.5 million at the June 30,2005 exchange rate) based on eligible inventory balances. The revolving loanagreement bears interest at an average 30-day Tokyo Interbank Offered Rate (“TIBOR”)(0.08%as of June 30, 2005) plus 0.875% and expires on January 31,2010.  As of June 30, 2005, we had$4.5 million outstanding on this revolving loan agreement.

 

On February 4, 2004 we purchased 1,271,450 sharesof our Ordinary common stock directly from our then largest institutionalshareholder.  In exchange, we issued$29.0 million in principal amount of our 8.75% Senior Notes due 2011 under theexisting indenture.  We issued thesebonds at a premium of 106.3%.  Thistransaction increased our treasury stock by $31.6 million.

 

Our bond indenture contains limitations based on netincome (among other things) on the amount of discretionary repurchases we maymake of our Ordinary common stock.  As aresult of the February 2004 stock repurchase, we had approached thelimitation.  Although our availabilityunder these limitations has increased over time as we have earned income, wecurrently have no short-term plans to repurchase additional Ordinary commonstock either directly from shareholders or on the open market.

 

Our long-term financing consists primarily of $174.3million of 8.75% Senior Notes, and $7.2 million in revolving credit loans and$35.5 million of term loans outstanding under the Credit Facility. Our debtagreements contain covenants that place certain restrictions on us, includingour ability to incur additional indebtedness, to make investments in otherentities and to pay cash dividends.  Wewere in compliance with all such covenants as of June 30, 2005.

 

We are not aware of any other trends, demands,commitments, or costs of resources that are expected to materially impactliquidity or capital resources. Therefore, we believe that cash on hand, together with cash flowsanticipated from operations and available borrowings under the Credit Facility,will be adequate to meet existing debt service requirements, fund continuingcapital requirements and satisfy working capital and general corporate needsfor the next twelve months.

 

We have reserved 721,750 shares of our existingtreasury stock to be utilized for the exercise of outstanding stock optionsunder our Amended and Restated 1996 Stock Plan. These options will have no impact on our cash flow or the number ofshares outstanding unless and until the options are exercised.

 

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**ContractualObligations**

 

The following table provides a summary of our contractual obligationsat June 30, 2005:

 
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|----------------------------|------------|
| **Contractual Obligations**      | ** ** | **Total**                  | ** ** | **Less than  1 year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **More than  5 years** | ** ** |
|                             |       |                       |       |   |   |   |   |   |   |   |   |
| Long-term debt  (1)              |       | $                          | 313,935    |   | $ | 29,457 |   | $ | 47,249 |   | $ | 50,485 |   | $ | 186,744 |   |
| Operating leases  (2)            |       | 270,990                    |       | 4,831 |   | 8,430 |   | 7,537 |   | 250,192 |   |
| Purchase  obligations (3)        |       | 12,686                     |       | 12,442 |   | 244 |   | — |   | — |   |
| Other long-term  liabilities (4) |       | 23,371                     |       | 3,571 |   | 3,947 |   | 3,208 |   | 12,645 |   |
| Total                            |       | $                          | 620,982    |   | $ | 50,301 |   | $ | 59,870 |   | $ | 61,230 |   | $ | 449,581 |   |

 

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**Notes to Contractual Obligations:**

 
| (1)    | Long-term debt represents long-term debt obligations  and the fixed interest on our Notes. The nature of our long-term debt  obligations is described more fully in the “Borrowing Availability and  Activities” section of “Liquidity and Capital Resources.” |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                    |
| (2)    | Approximately $256.4 million of our operating lease  obligations are attributable to the ninety-nine year land lease associated  with the purchase of Steinway Hall; the remainder is attributable to the  leasing of other facilities and equipment.                                   |
|   |                                                                                                                                                                                                                                                                                    |
| (3)    | Purchase obligations consist of firm purchase  commitments for raw materials, imported products, and tooling.                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                    |
| (4)    | Other long-term liabilities consist primarily of the  long-term portion of our pension obligations and obligations under employee  and consultant agreements.                                                                                                                           |

 

**Recent Accounting Pronouncements**

 

In December 2004,the Financial Accounting Standards Board (“FASB”) revised Statement ofFinancial Accounting Standards (“SFAS”) No. 123, and issued SFAS No. 123R,“Share-Based Payments” (SFAS No. 123R). This accounting standard, whichwas originally effective for interim and annual periods beginning after June 15,2005, requires the recognition of compensation expense related to stock optionsusing the fair value method.  In April 2005,the SEC revised the first required compliance date to fiscal years beginningafter June 15, 2005.  We plan toadopt SFAS No. 123R in the first quarter of 2006 using the modifiedprospective application method. Based on current outstanding awards, expectedparticipation in the Purchase Plan consistent with past patterns, and nosignificant changes in the number of shares of outstanding stock, we anticipatean impact on earnings of approximately $0.11 per basic share in additionalstock compensation expense in 2006. The actual amount will be impacted by changesin the aforementioned factors.

 

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs, an amendment of ARB No. 43, Chapter 4” (SFAS No. 151).This accounting standard, which is effective for annual periods beginning afterJune 15, 2005, requires that abnormal amounts of idle facility expense,freight, handling costs, and wasted materials (spoilage) should be recognizedas current-period charges. The adoption of SFAS No. 151 is not expected tohave a material effect on our financial position or results of operations.

 

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**ITEM 3**                                QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK

 

**We are exposed to market riskassociated with changes in foreign currency exchange rates and interestrates.  We mitigate a portion of ourforeign currency exchange rate risk by maintaining foreign currency cashbalances and holding option and forward foreign currency contracts.  They are not designated as hedges foraccounting purposes.  These contractsrelate primarily to intercompany transactions and are not used for trading orspeculative purposes.  The fair value ofthe option and forward foreign currency exchange contracts is sensitive tochanges in foreign currency exchange rates. The impact of an adverse change in foreign currency exchange rates wouldnot be materially different than that disclosed in the our Annual Report on Form 10-Kfor the year ended December 31, 2004.**

 

**Our revolving loans and term loansbear interest at rates that fluctuate with changes in LIBOR and TIBOR.  As such, our interest expense on ourrevolving loans and term loans and the fair value of our fixed long-term debtare sensitive to changes in market interest rates.  The effect of an adverse change in marketinterest rates on our interest expense would not be materially different thanthat disclosed in our Annual Report on Form 10-K for the year ended December 31,2004.**

 

**The majority of our long-term debtis at a fixed interest rate.  Therefore,the associated interest expense is not sensitive to fluctuations in marketinterest rates.  However, the fair valueof our fixed interest debt would be sensitive to market rate changes.  Such fair value changes may affect ourdecision whether to retain, replace, or retire this debt.**

 

**ITEM 4**                                CONTROLS AND PROCEDURES

 

As of the end of the period covered by this report, weevaluated the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)). Our disclosure controls and procedures are the controls and otherprocedures that we

 

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designed to ensure that we record, process, summarizeand report in a timely manner the information we must disclose in reports thatwe file with or submit to the SEC. Our Chief Executive Officer and ChiefFinancial Officer reviewed and participated in this evaluation. Based on thisevaluation the Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective.  In designing the Company’s disclosurecontrols and procedures, the Company’s management recognizes that any controls,no matter how well designed and operated, can only provide reasonable, notabsolute, assurance of achieving the desired control objectives.

 

During the quarter covered by this report, there wereno significant changes in our internal controls other than those related to theintegration of the Leblanc business, purchased in 2004, into our pre-existinginternal control structure.  During themost recent quarter, we consolidated the majority of the Leblanc businessprocesses into the Conn-Selmer processes and internal controls.  These changes have not materially affected,and are not reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

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

 

**ITEM 4****                               ****SUBMISSION OF MATTERS TO A VOTEOF SECURITY HOLDERS**

 

At the Company’s Annual Meeting of Shareholders heldon May 19, 2005, the Board of Directors was re-elected in itsentirety.  The votes cast for eachnominee were as follows:

 
| ** **                | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|---------------------------|------------|------------|------------|--------------|------------|
|                      |       |       |       |         |       |
| Kyle Kirkland             |       | 52,065,800 |       | 2,122,101    |       |
| Dana D. Messina           |       | 51,817,295 |       | 2,370,606    |       |
| John M.  Stoner, Jr. |       | 51,796,347 |       | 2,391,554    |       |
| Bruce A. Stevens          |       | 51,797,417 |       | 2,390,484    |       |
| A. Clinton Allen          |       | 53,989,545 |       | 198,356      |       |
| Rudolph K.  Kluiber       |       | 53,993,044 |       | 194,857      |       |
| Peter McMillan            |       | 53,993,045 |       | 194,856      |       |

 

The proposal to ratify Deloitte &Touche to serve as the Company’s independent auditors for the fiscal yearending December 31, 2005 was approved with 54,140,162 votes cast for,45,274 against, and 2,465 abstentions.

 

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**ITEM 6****                               ****EXHIBITS**

 

(i)                       Exhibits

 
| 31.1   | Certification  of the Principal Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                      |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                   |
| 31.2   | Certification  of the Principal Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                      |
|   |                                                                                                                                                                   |
| 32.1   | Certification  of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  |
|   |                                                                                                                                                                   |
| 32.2   | Certification  of the Principal Financial Officer pursuant to 18 U.S. C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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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:  August 9, 2005 |

 

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