**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

** **

**FORM 10-Q**

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

 

**COMMISSION FILE NUMBER 001-11911**

** **

**STEINWAYMUSICAL INSTRUMENTS, INC.**

**(Exact name of registrant as specified in itscharter)**

 

| **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 x    No o

 

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

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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

Yes o    No x

 

Number of shares of Common Stock issued andoutstanding as of August 5, 2008**:**

 
|   | Class A | 477,952   |   |
|--------|--------------|-----------|--------|
|   | Ordinary     | 8,061,007 |   |
|   | Total        | 8,538,959 |   |

 

 

 

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**FORM 10-Q**

**INDEX**

 
| **PART I.**  | **UNAUDITED  FINANCIAL INFORMATION**                                                                    |       |
|-------------------|---------------------------------------------------------------------------------------------------------|------------|
|              |                                                                                                    |       |
| **Item 1.**       | **Condensed  Consolidated Financial Statements:**                                                       | ** ** |
|              |                                                                                                    |       |
|              | Condensed Consolidated Statements of Operations  Three and six months ended June 30, 2008 and 2007 | 3          |
|              |                                                                                                    |       |
|              | Condensed Consolidated Balance Sheets  June 30, 2008 and December 31, 2007                    | 4          |
|              |                                                                                                    |       |
|              | Condensed Consolidated Statements of Cash Flows  Six months ended June 30, 2008 and 2007           | 5          |
|              |                                                                                                    |       |
|              | Condensed Consolidated Statement of Stockholders’  Equity  Six months ended June 30, 2008     | 6          |
|              |                                                                                                    |       |
|              | Notes  to Condensed Consolidated Financial Statements                                                   | 7          |
|              |                                                                                                    |       |
| **Item 2.**       | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**         | 23         |
|              |                                                                                                    |       |
| **Item 3.**       | **Quantitative  and Qualitative Disclosures about Market Risk**                                         | 33         |
|              |                                                                                                    |       |
| **Item 4.**       | **Controls  and Procedures**                                                                            | 34         |
|              |                                                                                                    |       |
| **PART II.** | **OTHER  INFORMATION**                                                                                  |       |
| ** **        | ** **                                                                                              | ** ** |
| **Item 2.**       | **Unregistered Sales of Equity Securities and Use of Proceeds**                                         | 34         |
|              |                                                                                                    |       |
| **Item 4.**       | **Submission  of Matters to a Vote of Security Holders**                                                | 34         |
|              |                                                                                                    |       |
| **Item 6.**       | **Exhibits**                                                                                            | 35         |
|              |                                                                                                    |       |
| ** **        | **Signatures**                                                                                          | 36         |

 

2

----

 

**ITEM 1****                          ****CONDENSED****CONSOLIDATED FINANCIALSTATEMENTS**

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**Unaudited**

**(InThousands Except Share and Per Share Amounts)**

 
| ** **                        | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                        | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                         |       | $                                                   | 98,521     |                                              | $          | 92,257 |   | $ | 192,707 |   | $ | 185,689 |   |
| Cost of sales                     |       | 69,476                                              |       | 63,692                                            |       | 136,270 |   | 129,884 |   |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Gross profit                      |       | 29,045                                              |       | 28,565                                            |       | 56,437 |   | 55,805 |   |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Operating expenses:               |       |                                                |       |                                              |       |   |   |   |   |
| Sales and marketing               |       | 11,937                                              |       | 12,021                                            |       | 25,341 |   | 24,811 |   |
| General and administrative        |       | 8,892                                               |       | 8,141                                             |       | 17,475 |   | 17,151 |   |
| Amortization of intangible assets |       | 261                                                 |       | 196                                               |       | 459 |   | 392 |   |
| Other operating expenses          |       | 66                                                  |       | 158                                               |       | 469 |   | 1,035 |   |
| Facility rationalization charges  |       | 1,062                                               |       | —                                            |       | 1,062 |   | — |   |
| Total operating expenses          |       | 22,218                                              |       | 20,516                                            |       | 44,806 |   | 43,389 |   |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Income from operations            |       | 6,827                                               |       | 8,049                                             |       | 11,631 |   | 12,416 |   |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Other expense (income), net       |       | 54                                                  |       | (21                                               | )          | 17 |   | (191 | ) |
| Gain on extinguishment of debt    |       | —                                              |       | —                                            |       | (636 | ) | — |   |
| Interest income                   |       | (789                                                | )          | (906                                              | )          | (1,741 | ) | (2,002 | ) |
| Interest expense                  |       | 3,065                                               |       | 3,429                                             |       | 6,174 |   | 6,677 |   |
| Total non-operating expenses      |       | 2,330                                               |       | 2,502                                             |       | 3,814 |   | 4,484 |   |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Income before income taxes        |       | 4,497                                               |       | 5,547                                             |       | 7,817 |   | 7,932 |   |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Income tax provision              |       | 1,452                                               |       | 2,394                                             |       | 2,797 |   | 3,349 |   |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Net income                        |       | $                                                   | 3,045      |                                              | $          | 3,153 |   | $ | 5,020 |   | $ | 4,583 |   |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Earnings per share:               |       |                                                |       |                                              |       |   |   |   |   |
| Basic                             |       | $                                                   | 0.35       |                                              | $          | 0.37 |   | $ | 0.59 |   | $ | 0.54 |   |
| Diluted                           |       | $                                                   | 0.35       |                                              | $          | 0.36 |   | $ | 0.58 |   | $ | 0.53 |   |
|                              |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average shares:          |       |                                                |       |                                              |       |   |   |   |   |
| Basic                             |       | 8,580,318                                           |       | 8,520,949                                         |       | 8,579,761 |   | 8,470,049 |   |
| Diluted                           |       | 8,670,687                                           |       | 8,662,405                                         |       | 8,663,569 |   | 8,621,823 |   |

 

See notes to condensed****consolidatedfinancial statements.

 

3

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATEDBALANCE SHEETS**

**Unaudited**

**(In Thousands)**

 
| ** **                                                                                                              | ** ** | **June 30,** | ** ** | **December 31** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                                                                                              | ** ** | **2008**          | ** ** | **2007**             | ** ** |
| Assets                                                                                                                  |       |              |       |                 |       |
| Current assets:                                                                                                         |       |              |       |                 |       |
| Cash                                                                                                                    |       | $                 | 29,416     |                 | $          | 37,304 |   |
| Accounts, notes and other receivables, net  of allowances of   $17,250 and $17,519 in 2008 and 2007, respectively       |       | 72,953            |       | 73,131               |       |
| Inventories, net                                                                                                        |       | 168,208           |       | 152,451              |       |
| Prepaid expenses and other current assets                                                                               |       | 10,905            |       | 11,272               |       |
| Deferred tax assets                                                                                                     |       | 12,908            |       | 11,571               |       |
| Total current assets                                                                                                    |       | 294,390           |       | 285,729              |       |
|                                                                                                                    |       |              |       |                 |       |
| Property, plant and equipment, net of  accumulated depreciation of   $97,309 and $94,221 in 2008 and 2007, respectively |       | 92,277            |       | 94,150               |       |
| Trademarks                                                                                                              |       | 16,718            |       | 14,119               |       |
| Goodwill                                                                                                                |       | 34,078            |       | 32,907               |       |
| Other intangibles, net                                                                                                  |       | 6,044             |       | 3,937                |       |
| Other assets                                                                                                            |       | 17,614            |       | 18,014               |       |
| Long-term deferred tax assets                                                                                           |       | 8,471             |       | 8,822                |       |
|                                                                                                                    |       |              |       |                 |       |
| Total assets                                                                                                            |       | $                 | 469,592    |                 | $          | 457,678 |   |
|                                                                                                                    |       |              |       |                 |       |
| Liabilities and stockholders’ equity                                                                               |       |              |       |                 |       |
| Current liabilities:                                                                                                    |       |              |       |                 |       |
| Debt                                                                                                                    |       | $                 | 2,354      |                 | $          | 2,285 |   |
| Accounts payable                                                                                                        |       | 17,705            |       | 12,381               |       |
| Other current liabilities                                                                                               |       | 51,423            |       | 52,320               |       |
| Total current liabilities                                                                                               |       | 71,482            |       | 66,986               |       |
|                                                                                                                    |       |              |       |                 |       |
| Long-term debt                                                                                                          |       | 168,345           |       | 173,981              |       |
| Deferred tax liabilities                                                                                                |       | 14,984            |       | 15,003               |       |
| Pension and other postretirement benefit  liabilities                                                                   |       | 32,398            |       | 30,093               |       |
| Other non-current liabilities                                                                                           |       | 9,007             |       | 7,836                |       |
| Total liabilities                                                                                                       |       | 296,216           |       | 293,899              |       |
|                                                                                                                    |       |              |       |                 |       |
| Commitments and contingent liabilities                                                                                  |       |              |       |                 |       |
|                                                                                                                    |       |              |       |                 |       |
| Stockholders’ equity:                                                                                              |       |              |       |                 |       |
| Common stock                                                                                                            |       | 11                |       | 11                   |       |
| Additional paid-in capital                                                                                              |       | 94,886            |       | 94,370               |       |
| Retained earnings                                                                                                       |       | 117,917           |       | 112,917              |       |
| Accumulated other comprehensive income                                                                                  |       | 6,416             |       | 1,773                |       |
| Treasury stock, at cost                                                                                                 |       | (45,854           | )          | (45,292              | )          |
| Total stockholders’ equity                                                                                         |       | 173,376           |       | 163,779              |       |
|                                                                                                                    |       |              |       |                 |       |
| Total liabilities and stockholders’ equity                                                                         |       | $                 | 469,592    |                 | $          | 457,678 |   |

 

See notes to condensed****consolidated financial statements.

 

4

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**Unaudited**

**(InThousands)**

 
| ** **                                                                    | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                    | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| Cash flows from operating activities:                                         |       |                                              |       |   |   |
| Net income                                                                    |       | $                                                 | 5,020      |   | $ | 4,583 |   |
| Adjustments to reconcile net income to cash  flows from operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                 |       | 5,465                                             |       | 5,213 |   |
| Amortization of bond discount                                                 |       | 82                                                |       | 83 |   |
| Gain on extinguishment of debt                                                |       | (636                                              | )          | — |   |
| Facility rationalization charges                                              |       | 1,062                                             |       | — |   |
| Stock-based compensation expense                                              |       | 511                                               |       | 643 |   |
| Excess tax benefits from stock-based awards                                   |       | (4                                                | )          | (402 | ) |
| Tax benefit from stock option exercises                                       |       | 5                                                 |       | 726 |   |
| Deferred tax benefit                                                          |       | (1,349                                            | )          | (1,907 | ) |
| Other                                                                         |       | 724                                               |       | 378 |   |
| Changes in operating assets and  liabilities:                                 |       |                                              |       |   |   |
| Accounts, notes and other receivables                                         |       | 1,389                                             |       | (2,261 | ) |
| Inventories                                                                   |       | (13,111                                           | )          | (22,778 | ) |
| Prepaid expenses and other assets                                             |       | 483                                               |       | 63 |   |
| Accounts payable                                                              |       | 4,639                                             |       | (953 | ) |
| Other liabilities                                                             |       | (2,849                                            | )          | 73 |   |
| Cash flows from operating activities                                          |       | 1,431                                             |       | (16,539 | ) |
|                                                                          |       |                                              |       |   |   |
| Cash flows from investing activities:                                         |       |                                              |       |   |   |
| Capital expenditures                                                          |       | (2,426                                            | )          | (2,394 | ) |
| Proceeds from disposals of property, plant  and equipment                     |       | 315                                               |       | 90 |   |
| Acquisition of business, net of cash  acquired                                |       | (2,986                                            | )          | — |   |
| Cash flows from investing activities                                          |       | (5,097                                            | )          | (2,304 | ) |
|                                                                          |       |                                              |       |   |   |
| Cash flows from financing activities:                                         |       |                                              |       |   |   |
| Borrowings under lines of credit                                              |       | 2,066                                             |       | 81,656 |   |
| Repayments under lines of credit                                              |       | (2,162                                            | )          | (62,532 | ) |
| Repayments of long-term debt, net of  discount                                |       | (4,981                                            | )          | — |   |
| Proceeds from issuance of common stock                                        |       | 108                                               |       | 3,495 |   |
| Purchase of treasury stock                                                    |       | (690                                              | )          | — |   |
| Dividends paid                                                                |       | —                                            |       | (25,187 | ) |
| Excess tax benefits from stock-based awards                                   |       | 4                                                 |       | 402 |   |
| Cash flows from financing activities                                          |       | (5,655                                            | )          | (2,166 | ) |
|                                                                          |       |                                              |       |   |   |
| Effect of foreign exchange rate changes on  cash                              |       | 1,433                                             |       | 301 |   |
|                                                                          |       |                                              |       |   |   |
| Decrease in cash                                                              |       | (7,888                                            | )          | (20,708 | ) |
| Cash, beginning of period                                                     |       | 37,304                                            |       | 30,409 |   |
| Cash, end of period                                                           |       | $                                                 | 29,416     |   | $ | 9,701 |   |
|                                                                          |       |                                              |       |   |   |
| Supplemental Cash Flow Information                                            |       |                                              |       |   |   |
| Interest paid                                                                 |       | $                                                 | 6,245      |   | $ | 6,680 |   |
| Taxes paid                                                                    |       | $                                                 | 7,110      |   | $ | 6,086 |   |

 

See notes to condensed****consolidated financial statements.

 

5

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’ EQUITY**

**Unaudited**

**(In Thousands Except Share Data)**

** **
| ** **                                            | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|-----------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
|                                                  |       |              |       |                             |       |                   |       |                                          |       |                |       |                                  |       |
| Balance, January 1, 2008                         |       | $                 | 11         |                             | $          | 94,370                 |       | $                                             | 112,917    |                | $          | 1,773                                 |       | $ | (45,292 | ) | $ | 163,779 |   |
| Comprehensive income:                                 |       |              |       |                             |       |                   |       |                                          |       |                |       |                                  |       |
| Net income                                            |       |              |       |                             |       | 5,020                  |       |                                          |       |                |       | 5,020                                 |       |
| Foreign currency translation adjustments              |       |              |       |                             |       |                   |       | 4,643                                         |       |                |       | 4,643                                 |       |
| Total comprehensive income                            |       |              |       |                             |       |                   |       |                                          |       |                |       | 9,663                                 |       |
| Exercise of 5,500 options for shares of  common stock |       |              |       |                             |       | (20                    | )          |                                          |       | 128                 |       | 108                                   |       |
| Stock-based compensation                              |       |              |       | 511                              |       |                   |       |                                          |       |                |       | 511                                   |       |
| Tax benefit of options exercised                      |       |              |       | 5                                |       |                   |       |                                          |       |                |       | 5                                     |       |
| Purchase of 25,800 shares of treasury stock           |       |              |       |                             |       |                   |       |                                          |       | (690                | )          | (690                                  | )          |
| Balance, June 30, 2008                           |       | $                 | 11         |                             | $          | 94,886                 |       | $                                             | 117,917    |                | $          | 6,416                                 |       | $ | (45,854 | ) | $ | 173,376 |   |

 

See notes to condensed****consolidated financial statements.

 

6

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**NOTES TO****CONDENSED CONSOLIDATED**

**FINANCIAL STATEMENTS**

**JUNE 30, 2008**

**Unaudited**

 

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

 

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

 

Theaccompanying condensed consolidated financial statements of Steinway MusicalInstruments, Inc. and subsidiaries (the “Company”) for the three and sixmonths ended June 30, 2008 and 2007 are unaudited. In the opinion ofmanagement, these statements have been prepared on the same basis as theaudited consolidated financial statements as of and for the year ended December 31,2007, and include all adjustments which are of a normal and recurring nature,necessary for the fair presentation of financial position, results ofoperations and cash flows for the interim periods. We encourage you to read thecondensed consolidated financial statements in conjunction with the riskfactors, consolidated financial statements and notes thereto contained in theCompany’s Annual Report on Form 10-K for the year ended December 31,2007 filed with the Securities and Exchange Commission (“SEC”). The results ofoperations for the three and six months ended June 30, 2008 are notnecessarily indicative of the results that may be expected for the entire year.

 

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

 

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

 

**Principles of Consolidation**- Our consolidated financial statements include the accounts of all direct andindirect subsidiaries, all of which are wholly owned, including the piano (“Steinway”),band (“Conn-Selmer”), and online music (“Arkiv”) divisions. Intercompanybalances have been eliminated in consolidation.

 

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

 

**Income Taxes** - Weprovide for income taxes using an asset and liability approach. We computedeferred income tax assets and liabilities for differences between thefinancial statement and tax bases of assets and liabilities that will result intaxable or deductible amounts in the future based on enacted tax laws and ratesapplicable to the periods in which the differences are expected to affecttaxable income. We establish valuation allowances when necessary to reducedeferred tax assets to the amount that more likely than not will be realized.

 

We provide reserves for potential payments of tax to various taxauthorities related to uncertain tax positions and other issues. Prior to 2007,these reserves were recorded when management determined that it was probablethat a loss would be incurred related to these matters and the amount of theloss was reasonably determinable. In 2007, we adopted Financial AccountingStandards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretationof FASB Statement No. 109” (“FIN 48”). As a result, reserves recordedsubsequent to adoption are based on a determination of whether and how much ofa tax benefit taken in our tax filings or positions is more likely than not tobe realized, assuming that the matter in question will be raised by the taxauthorities. Potential interest and penalties associated with such uncertaintax positions are recorded as a component of income tax expense. Atadoption date, we made a comprehensive review of our uncertain tax positions.We believe appropriate provisions for outstanding issues have been made.

 

7

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

 

Theliability for uncertain tax positions decreased $0.7 million in 2008 as aresult of settlements with state taxing authorities. Although we believe ourtax estimates are appropriate, the final determination of tax audits and anyrelated litigation could result in changes in our estimates.

 

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

 

**Earnings per Common Share** - We compute earnings per share usingthe weighted-average number of common shares outstanding during each period.Diluted earnings per common share reflects the effect of our outstandingoptions using the treasury stock method, except when such options would beantidilutive.

 

A reconciliation of the weighted-average shares used for the basic anddiluted computations is as follows:

 
| ** **                       | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Weighted-average shares:         |       |                                                |       |                                              |       |   |   |   |   |
| For basic earnings per share     |       | 8,580,318                                           |       | 8,520,949                                         |       | 8,579,761 |   | 8,470,049 |   |
| Dilutive effect of stock options |       | 90,369                                              |       | 141,456                                           |       | 83,808 |   | 151,774 |   |
| For diluted earnings per share   |       | 8,670,687                                           |       | 8,662,405                                         |       | 8,663,569 |   | 8,621,823 |   |

 

We did not include158,440 and 461,240 outstanding options to purchase shares of common stock inthe computation of diluted earnings per common share for the three months andsix months ended June 30, 2008, respectively, because their exerciseprices were more than the average market price of our common shares, andtherefore antidilutive. All outstanding options were included in thecomputation of diluted earnings per share for the three months ended June 30,2007 because the exercise prices of the outstanding options were less than theaverage market price of our common shares. We did not include 20,000 options topurchase shares of common stock in the computation of diluted earnings pershare for the six months ended June 30, 2007 because their impact wouldhave been antidilutive.

 

We purchased 25,800 of ourcommon stock for $0.7 million during the second quarter pursuant to our sharerepurchase program. This program, which was announced in the second quarter,permits us to make discretionary purchases of up to $25.0 million.

 

8

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**Accumulated Other Comprehensive Income** - Accumulated other comprehensive incomeis comprised of foreign currency translation adjustments and pension and otherpost-retirement benefits. The components of accumulated other comprehensiveincome are as follows:

 
| ** **                   | ** ** | **Foreign Currency  Translation  Adjustments** | ** ** | **Pension & Other  Post-Retirement  Benefits** | ** ** | **Tax Impact of   Pension & Other  Post-Retirement  Benefits** | ** ** | **Accumulated Other  Comprehensive  Income** | ** ** |
|------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
|                         |       |                                                |       |                                                         |       |                                                                                        |       |                                              |       |
| Balance January 1, 2008 |       | $                                                   | 9,041      |                                                         | $          | (11,616                                                                                     | )          | $                                                 | 4,348      |   | $ | 1,773 |   |
| Activity                     |       | 4,643                                               |       | —                                                       |       | —                                                                                      |       | 4,643                                             |       |
| Balance June 30, 2008   |       | $                                                   | 13,684     |                                                         | $          | (11,616                                                                                     | )          | $                                                 | 4,348      |   | $ | 6,416 |   |

 

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

 

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

 

InDecember 2007, the FASB issued SFAS No. 141R, “Business Combinations,”a revision to SFAS No. 141, “Business Combinations” (“ SFAS 141R”),which provides revised guidance for recognition and measurement of identifiableassets and goodwill acquired, liabilities assumed, and any noncontrollinginterest in the acquiree at fair value. SFAS 141R also establishesdisclosure requirements to enable the evaluation of the nature and financialeffects of a business combination. SFAS 141R is required to be appliedprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008. We will comply with SFAS 141R January 1, 2009. We are currentlyevaluating the potential impact, if any, of the adoption of SFAS 141R on ourconsolidated financial statements.

 

InDecember 2007, the FASB issued SFAS No. 160, “Noncontrolling Interestsin Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS160”). SFAS 160 establishes accounting and reporting standards forownership interests in subsidiaries held by parties other than theparent. Specifically, SFAS 160 requires the presentation of noncontrollinginterests as equity in the Consolidated Statement of Financial Position, andseparate identification and presentation in the Consolidated Statement ofOperations of net income attributable to the entity and the noncontrollinginterest. It also establishes accounting and reporting 

 

9

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standards regarding deconsolidation andchanges in a parent’s ownership interest. We will be required to complywith SFAS 160 January 1, 2009. The provisions of SFAS 160 are generallyrequired to be applied prospectively, except for the presentation anddisclosure requirements, which must be applied retrospectively. We arecurrently evaluating the potential impact, if any, of the adoption of SFAS 160on our consolidated financial statements.

 

InMarch 2008, the FASB issued SFAS No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133”(“SFAS 161”). SFAS 161 amends and expands the disclosure requirements forderivative instruments and hedging activities, with the intent to provide usersof financial statements with an enhanced understanding of how and why an entityuses derivative instruments, how derivative instruments and related hedged itemsare accounted for, and how derivative instruments and related hedged itemsaffect an entity’s financial statements. We will comply with SFAS 161 January 1,2009.

 

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

 

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

 

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

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

 

Subsequent footnotes providing details of oursignificant balance sheet accounts include the impact of the Arkiv acquisitionas of June 30, 2008.

 

10

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

 
| ** **      | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------|------------|-------------------------|------------|-----------------------------|------------|
|            |       |                    |       |                        |       |
| Raw materials   |       | $                       | 19,590     |                        | $          | 18,615 |   |
| Work-in-process |       | 50,026                  |       | 51,402                      |       |
| Finished goods  |       | 98,592                  |       | 82,434                      |       |
|            |       | $                       | 168,208    |                        | $          | 152,451 |   |

 

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

 

Intangibleassets other than goodwill and indefinite-lived trademarks are amortized on astraight-line basis over their estimated useful lives. Deferred financing costsare amortized over the repayment periods of the underlying debt. We test ourgoodwill and indefinite-lived trademark assets for impairment annually, or onan interim basis if events or circumstances indicate that the fair value of anasset has decreased below its carrying value. No other events or circumstanceshave occurred subsequent to our annual impairment date which have indicatedthat these assets may potentially be impaired. The changes in carrying amountsof goodwill and trademarks are as follows:

 
| ** **                                                                   | ** ** | **Piano** | ** ** | **Band** | ** ** | **Online  Music** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------|------------|-----------|------------|----------|------------|-------------------|------------|-----------|------------|
| Goodwill:                                                                    |       |      |       |     |       |              |       |      |       |
| Balance, January 1, 2008                                                |       | $         | 24,352     |     | $          | 8,555             |       | $         | —     |   | $ | 32,907 |   |
| Foreign currency translation impact                                          |       | 1,171     |       | —   |       | —            |       | 1,171     |       |
| Balance, June 30, 2008                                                  |       | $         | 25,523     |     | $          | 8,555             |       | $         | —     |   | $ | 34,078 |   |
|                                                                         |       |      |       |     |       |              |       |      |       |
| Trademarks:                                                                  |       |      |       |     |       |              |       |      |       |
| Balance, January 1, 2008                                                |       | $         | 8,295      |     | $          | 5,824             |       | $         | —     |   | $ | 14,119 |   |
| Additions based on preliminary purchase price  allocation to acquired assets |       | —    |       | —   |       | 2,231             |       | 2,231     |       |
| Foreign currency translation impact                                          |       | 368       |       | —   |       | —            |       | 368       |       |
| Balance, June 30, 2008                                                  |       | $         | 8,663      |     | $          | 5,824             |       | $         | 2,231      |   | $ | 16,718 |   |

 

11

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

 
| ** **                                  | ** ** | **June 30,   2008** | ** ** | **December 31,   2007** | ** ** |
|---------------------------------------------|------------|-------------------------------|------------|-----------------------------------|------------|
|                                        |       |                          |       |                              |       |
| Gross deferred financing costs:             |       | $                             | 5,624      |                              | $          | 5,755 |   |
| Accumulated amortization                    |       | (2,288                        | )          | (1,980                            | )          |
| Deferred financing costs, net               |       | $                             | 3,336      |                              | $          | 3,775 |   |
|                                        |       |                          |       |                              |       |
| Gross non-compete agreements:               |       | $                             | 750        |                              | $          | 500 |   |
| Accumulated amortization                    |       | (394                          | )          | (338                              | )          |
| Non-compete agreements, net                 |       | $                             | 356        |                              | $          | 162 |   |
|                                        |       |                          |       |                              |       |
| Gross customer relationships:               |       | $                             | 425        |                              | $          | — |   |
| Accumulated amortization                    |       | (10                           | )          | —                            |       |
| Customer relationships, net:                |       | $                             | 415        |                              | $          | — |   |
|                                        |       |                          |       |                              |       |
| Gross website and developed technology:     |       | $                             | 1,987      |                              | $          | — |   |
| Accumulated amortization                    |       | (50                           | )          | —                            |       |
| Website and software development costs, net |       | $                             | 1,937      |                              | $          | — |   |

 

Deferred financing costswere impacted by our purchase of $5.8 million of our Senior Notes in March 2008.This repurchase is described more fully in Note 7. Trademarks, non-competeagreements, customer relationships, and website and developed technology wereimpacted by the acquisition of Arkiv, which is described more fully in Note 3.The weighted-average amortization period for deferred financing costs is sevenyears, and the weighted-average amortization period of all other amortizableintangibles is five years. Total amortization expense, which includesamortization of deferred financing costs, is as follows:

 
| ** **           | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **           | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|                 |       |                                                |       |                                              |       |   |   |   |   |
| Amortization expense |       | $                                                   | 261        |                                              | $          | 196 |   | $ | 459 |   | $ | 392 |   |
|                      |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

 

12

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

 
| Remainder of 2008   |   | $     | 652    |   |
|---------------------|--------|-------|--------|--------|
| 2009                |   | 1,263 |   |
| 2010                |   | 1,181 |   |
| 2011                |   | 1,140 |   |
| 2012                |   | 1,029 |   |
| 2013 and thereafter |   | 779   |   |
| Total               |   | $     | 6,044  |   |

 

**(6)           Other CurrentLiabilities**

 
| ** **                                                               | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Accrued payroll and related benefits                                     |       | $                       | 18,267     |                        | $          | 16,721 |   |
| Current portion of pension and other  postretirement benefit liabilities |       | 1,412                   |       | 1,440                       |       |
| Accrued warranty expense                                                 |       | 1,568                   |       | 1,541                       |       |
| Accrued interest                                                         |       | 3,931                   |       | 4,049                       |       |
| Deferred income                                                          |       | 10,065                  |       | 10,224                      |       |
| Environmental liabilities                                                |       | 2,560                   |       | 2,648                       |       |
| Income and other taxes payable                                           |       | 3,559                   |       | 6,139                       |       |
| Other accrued expenses                                                   |       | 10,061                  |       | 9,558                       |       |
| Total                                                                    |       | $                       | 51,423     |                        | $          | 52,320 |   |

 

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

 

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

 
| ** **                          | ** ** | **June 30,  2008** | ** ** | **June 30,  2007** | ** ** | **December 31,  2007** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Beginning balance                   |       | $                       | 1,541      |                    | $          | 1,888                       |       | $ | 1,888 |   |
| Additions                           |       | 596                     |       | 272                     |       | 798                         |       |
| Claims and reversals                |       | (604                    | )          | (580                    | )          | (1,200                      | )          |
| Foreign currency translation impact |       | 35                      |       | 21                      |       | 55                          |       |
| Ending balance                      |       | $                       | 1,568      |                    | $          | 1,601                       |       | $ | 1,541 |   |

 

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**(7)           Long-Term Debt**

 

Our long-term debt consists of the following:

 
| ** **                            | ** ** | **June 30,  2008** | ** ** | **December 31,   2007** | ** ** |
|---------------------------------------|------------|-------------------------|------------|-----------------------------------|------------|
| 7.00% Senior Notes                    |       | $                       | 169,250    |                              | $          | 175,000 |   |
| Unamortized bond discount             |       | (905                    | )          | (1,019                            | )          |
| Domestic line of credit               |       | —                  |       | —                            |       |
| Open account loans, payable on demand |       | 2,354                   |       | 2,285                             |       |
| Total                                 |       | 170,699                 |       | 176,266                           |       |
| Less: current portion                 |       | (2,354                  | )          | (2,285                            | )          |
| Long-term debt                        |       | $                       | 168,345    |                              | $          | 173,981 |   |

 

Scheduled payments of debt are as follows:

 
| ** **        | ** ** | **June 30,   2008** | ** ** |
|-------------------|------------|-------------------------------|------------|
| Remainder of 2008 |       | $                             | 2,354      |   |
| 2009              |       | —                        |       |
| 2010              |       | —                        |       |
| 2011              |       | —                        |       |
| 2012              |       | —                        |       |
| Thereafter        |       | 169,250                       |       |
| Total             |       | $                             | 171,604    |   |

 

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

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

 

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

 

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

 

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

 

**StockPlans** - The 2006 Stock Plan provides for the granting of1,000,000 stock options(including incentive stock options and non-qualified stock options), stockappreciation rights and other stock awards to certain key employees,consultants and advisors. Our stock options generally have five-year vestingterms and ten-year option terms.

 

Our 1996 Stock Plan hasexpired but still has vested and unvested options outstanding. We reached ourregistered share limitation in early 2007, and had previously reserved 721,450treasury stock shares to issue under this plan. We have since issued 97,974shares of treasury stock to cover options exercised, with 391,776 remainingoptions outstanding. Since in most instances the average cost of the treasurystock exceeded the price of the options exercised, the difference between theproceeds received and the average cost of the treasury stock issued resulted ina reduction of retained earnings. This reduction was less than $0.1 million forthe three and six months ended June 30, 2008.

 

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

 
| ** **                                                        | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                        | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Compensation cost included in basic and  diluted income per share |       | $                                                   | 0.02       |                                              | $          | 0.04 |   | $ | 0.05 |   | $ | 0.06 |   |
| Stock-based compensation expense                                  |       | 266                                                 |       | 379                                               |       | 511 |   | 643 |   |
| Income tax benefit                                                |       | 58                                                  |       | 58                                                |       | 85 |   | 100 |   |
|                                                                   |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

 

We measured the fair value of options on theirgrant date, including the valuation of the option feature implicit in ourPurchase Plan, using the Black-Scholes option-pricing model. The risk-freeinterest rate is based on the weighted-average of U.S. Treasury rates over theexpected life of the stock option or the contractual life of the option featurein the Purchase Plan. The expected life of a stock option is based onhistorical data of similar option holders. We have segregated our employeesinto two groups based on historical exercise and termination behavior. Theexpected life of the option feature in the Purchase Plan is the same as itscontractual life. Expected volatility is based on historical volatility of ourstock over the expected life of the option, as our options are not readily tradable.

 

15

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Key assumptions used to apply this pricingmodel to the 2006 Stock Plan are as follows:

 
| ** **                                | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Risk free interest rate                   |       | 3.5%                                                |       | 4.6%                                              |       | 3.4% |   | 4.6% |   |
| Weighted average expected life (in years) |       | 7.2                                                 |       | 7.2                                               |       | 7.2 |   | 8.1 |   |
| Expected volatility of underlying stock   |       | 25.9%                                               |       | 24.7%                                             |       | 25.9% |   | 25.2% |   |
| Expected dividends                        |       | n/a                                                 |       | n/a                                               |       | n/a |   | n/a |   |
| Weighted average fair value               |       | $9.93                                               |       | $13.10                                            |       | $9.94 |   | $13.65 |   |

 

The following table sets forth informationregarding the Stock Plans:

 
| ** **                          | ** ** | **Number of  Options** | ** ** | **Weighted-  Average   Exercise   Price** | ** ** | **Remaining   Contractual   Life   (in years)** | ** ** | **Aggregate   Intrinsic   Value   (not in 000s)** | ** ** |
|-------------------------------------|------------|-----------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| Outstanding at January 1, 2008 |       | 544,576                     |       | $                                                   | 23.78      |                                                                |       |                                                                       |       |   |
| Granted                             |       | 302,300                     |       | 27.20                                               |       |                                                                |       |                                                                       |       |
| Exercised                           |       | (5,500                      | )          | 19.44                                               |       |                                                                |       |                                                                       |       |
| Forfeited                           |       | (26,360                     | )          | 28.65                                               |       |                                                                |       |                                                                       |       |
| Outstanding at June 30, 2008   |       | 815,016                     |       | $                                                   | 24.92      |                                                                | 7.1        |                                                                       | $          | 2,518,886 |   |
|                                |       |                        |       |                                                |       |                                                                |       |                                                                       |       |
| Exercisable at June 30, 2008   |       | 358,756                     |       | $                                                   | 21.02      |                                                                | 4.5        |                                                                       | $          | 2,328,774 |   |

 

The total intrinsic value ofthe options exercised during the six months ended June 30, 2008 and 2007was less than $0.1 million and $2.3 million, respectively.

 

As of June 30, 2008, therewas $4.3 million of unrecognized compensation cost related to nonvestedshare-based compensation arrangements granted under the Stock Plan. Thiscompensation cost is expected to be recognized over a period of 4.4 years.

 

The following tables set forth informationregarding the Purchase Plan:

 
| ** **                                                   | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                       | ** ** | **2007**                                     | ** ** | **2008** | ** ** | **2007** | ** ** |
| Risk-free interest rate                                      |       | 4.8%                                           |       | 5.1%                                         |       | 4.8% |   | 5.1% |   |
| Weighted-average expected life of option  feature (in years) |       | 1.0                                            |       | 1.0                                          |       | 1.0 |   | 1.0 |   |
| Expected volatility of underlying stock                      |       | 25.9%                                          |       | 24.7%                                        |       | 25.9% |   | 24.7% |   |
| Expected dividends                                           |       | n/a                                            |       | n/a                                          |       | n/a |   | n/a |   |
| Weighted-average fair value of option  feature               |       | $8.69                                          |       | $6.22                                        |       | $8.69 |   | $6.22 |   |

 

16

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| ** **                          | ** ** | **Number  of Options** | ** ** | **Weighted-  Average   Exercise   Price** | ** ** | **Remaining   Contractual   Life   (in years)** | ** ** | **Aggregate   Intrinsic   Value   (not in 000s)** | ** ** |
|-------------------------------------|------------|-----------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| Outstanding at January 1, 2008 |       | 10,441                      |       | $                                                   | 28.73      |                                                                |       |                                                                       |       |   |
| Shares subscribed                   |       | 12,779                      |       | 28.73                                               |       |                                                                |       |                                                                       |       |
| Exercised                           |       | —                      |       | —                                              |       |                                                                |       |                                                                       |       |
| Canceled                            |       | (1,230                      | )          | 28.73                                               |       |                                                                |       |                                                                       |       |
| Outstanding at June 30, 2008   |       | 21,990                      |       | $                                                   | 28.73      |                                                                | 0.1        |                                                                       | $          | 89,499 |   |
|                                     |            |                             |            |                                                     |            |                                                                     |            |                                                                            |            |  |  |

 

As reported in the consolidatedstatements of cash flows, cash received from option exercises under the StockPlan for the periods ended June 30, 2008 and 2007 was $0.1 million and$3.5 million, respectively. Cash flows from tax benefits resulting from taxdeductions in excess of the compensation cost recognized for stock-based awardsunder a fair value basis (excess tax benefits) are required to be classified asa cash flow from financing activities. Accordingly, for the periods ended June 30,2008 and 2007, less than $0.1 million and $0.4 million, respectively, of excesstax benefits has been classified as an outflow from operating activities and aninflow from financing activities in the statement of cash flows. For theperiods ended June 30, 2008 and 2007, less than $0.1 million and $0.7million, respectively, of tax benefit from stock option exercises is presentedas a cash inflow from operating activities.

 

**(9)           FacilityRationalization – Band**

 

As part of our effort to reduce excess manufacturingcapacity in our band segment, in December 2007 we announced the pendingclosure of our Kenosha, Wisconsin woodwind manufacturing facility, whicheffectively ceased operations in May 2008. We recorded $0.1 million infacility impairment charges as a component of operating expenses and less than$0.1 million in severance costs as a component of cost of goods sold for theyear ended December 31, 2007 related to this facility. Production wasrelocated to our Elkhart, Indiana woodwind manufacturing facility. In February 2008,management decided to terminate production of musical instrument cases, whichwere manufactured in a leased facility in North Carolina. The remaininginstrument production and assembly work occurring in that facility was notimpacted by this termination, which occurred in April 2008. In June 2008,we announced the pending closure of our Elkhorn, Wisconsin brass instrumentmanufacturing facility. We expect this facility to cease operations in August 2008and will relocate its production to our Eastlake, Ohio brass instrumentmanufacturing facility. As a result of this pending closure, we recorded $0.2million in facility impairment charges as a component of operating expenses.Associated severance costs are shown below.

 

In June 2008, we agreed to sell our Leblancclarinet manufacturing facility and operations in France. This facility’sproduction is being transitioned to our Elkhart, Indiana woodwind manufacturingfacility. As a result of this sale, which closed in July 2008, we recorded$0.9 million in facility impairment charges as a component of operatingexpenses. Since the workers at this facility will be retained by the purchaser,no severance costs have been recorded or are expected.

 

17

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

 
| ** **                                     | ** ** | **Kenosha** | ** ** | **Case** | ** ** | **Elkhorn** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|-------------|------------|----------|------------|-------------|------------|-----------|------------|
|                                           |       |        |       |     |       |        |       |      |       |
| Facility rationalization severance  liability: |       |        |       |     |       |        |       |      |       |
| Balance, January 1, 2008                  |       | $           | 39         |     | $          | —      |       | $         | —     |   | $ | 39 |   |
| Additions charged to cost of sales             |       | 431         |       | 76       |       | 431         |       | 938       |       |
| Payments                                       |       | (175        | )          | (56      | )          | —      |       | (231      | )          |
| Balance, June 30, 2008                    |       | $           | 295        |     | $          | 20          |       | $         | 431        |   | $ | 746 |   |

 

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

 

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

 

**(10)         OtherExpense (Income), Net**

** **
| ** **                   | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                   | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|                         |       |                                                |       |                                              |       |   |   |   |   |
| West 57th building income    |       | $                                                   | (1,164     | )                                                 | $          | (1,164 | ) | $ | (2,327 | ) | $ | (2,327 | ) |
| West 57th building expenses  |       | 820                                                 |       | 827                                               |       | 1,641 |   | 1,638 |   |
| Foreign exchange losses, net |       | 405                                                 |       | 218                                               |       | 358 |   | 453 |   |
| Miscellaneous                |       | (7                                                  | )          | 98                                                |       | 345 |   | 45 |   |
| Other expense (income), net  |       | $                                                   | 54         |                                              | $          | (21 | ) | $ | 17 |   | $ | (191 | ) |

 

**(11)         Commitments andContingent Liabilities**

 

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

 

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

 

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

 

In addition, we are continuing an existingenvironmental remediation plan at a facility we acquired in 2000 andsubsequently sold. We estimate our costs, which approximate $0.7 million, overa 13-year period. We have accrued approximately $0.6 million for the estimatedremaining cost of this remediation program, which represents the present valuetotal cost using a discount rate of 4.54%. A summary of expected paymentsassociated with this project is as follows:

 
| ** **        | ** ** | **Environmental  Payments** | ** ** |
|-------------------|------------|-----------------------------|------------|
| Remainder of 2008 |       | $                           | 21         |   |
| 2009              |       |                        | 61         |   |
| 2010              |       |                        | 61         |   |
| 2011              |       |                        | 61         |   |
| 2012              |       |                        | 61         |   |
| Thereafter        |       |                        | 484        |   |
| Total             |       |                        | $          | 749 |   |

 

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

 

In 2004, we acquired two manufacturing facilities from G. LeblancCorporation, now Grenadilla, Inc. (“Grenadilla”), for which environmentalremediation plans had already been established. In connection with theacquisition, we assumed the existing accrued liability of approximately $0.8million for the cost of these remediation activities. Based on a review of pastand ongoing investigatory and remedial work by our environmental consultants,and discussions with state regulatory officials, as well as periodic sampling,we estimate the remaining costs of such remedial plans to be $2.0 million.Pursuant to the purchase and sale 

 

19

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agreement, we soughtindemnification from Grenadilla for anticipated costs above the originalestimate in the amount of $2.5 million. We filed a claim against the escrow andrecorded a corresponding receivable for this amount in prepaid expenses andother current assets in our consolidated balance sheet. In 2007, we reducedthis receivable to $2.1 million based on the current estimated costs ofremediation. We have reached an agreement with Grenadilla whereby environmentalcosts are paid directly out of the escrow. Should the escrow be reduced tozero, we would seek further indemnification from Grenadilla for theseadditional costs. However, we cannot be assured that we will be able to recoversuch costs.

 

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

 

We entered into an agreement to purchase the stock of 4 RealInvestments, Inc., which does business as Clickpoint Software, Inc. (“Clickpoint”)for $0.2 million. Our Chairman, Kyle Kirkland, and Chief Executive Officer,Dana Messina, are shareholders of Clickpoint. In July 2008, we purchasedClickpoint for $0.2 million, of which $0.1 million was paid to our Chairperson,$0.1million to our Chief Executive Officer, and a residual amount of less than$0.1 million to the remaining owners.

 

**(12)         Retirement Plans**

 

We have defined benefit pension planscovering the majority of our employees, including certain employees in Germanyand the U.K. The components of net periodic pension cost (benefit) for theseplans are as follows:

** **
| ** **                          | ** ** | **Domestic Plans**                             | ** ** | **Foreign Plans**                              | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                          | ** ** | **Three Months Ended June 30,** | ** ** | **Three Months Ended June 30,** | ** ** |
| ** **                          | ** ** | **2008**                                            | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service cost                        |       | $                                                   | 60         |                                                | $          | 246 |   | $ | 209 |   | $ | 201 |   |
| Interest cost                       |       | 851                                                 |       | 801                                                 |       | 497 |   | 404 |   |
| Expected return on plan assets      |       | (1,272                                              | )          | (1,234                                              | )          | (101 | ) | (92 | ) |
| Amortization of prior service cost  |       | 62                                                  |       | 108                                                 |       | — |   | — |   |
| Recognized loss                     |       | 12                                                  |       | 148                                                 |       | 24 |   | 82 |   |
| Net periodic pension cost (benefit) |       | $                                                   | (287       | )                                                   | $          | 69 |   | $ | 629 |   | $ | 595 |   |

 

20

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| ** **                          | ** ** | **Domestic Plans**                           | ** ** | **Foreign Plans**                            | ** ** |
|-------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **Six Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
| ** **                          | ** ** | **2008**                                          | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service cost                        |       | $                                                 | 207        |                                              | $          | 471 |   | $ | 412 |   | $ | 399 |   |
| Interest cost                       |       | 1,705                                             |       | 1,615                                             |       | 979 |   | 798 |   |
| Expected return on plan assets      |       | (2,567                                            | )          | (2,484                                            | )          | (202 | ) | (182 | ) |
| Amortization of prior service cost  |       | 102                                               |       | 216                                               |       | — |   | — |   |
| Recognized loss                     |       | 24                                                |       | 276                                               |       | 48 |   | 152 |   |
| Net periodic pension cost (benefit) |       | $                                                 | (529       | )                                                 | $          | 94 |   | $ | 1,237 |   | $ | 1,167 |   |

 

We providepostretirement health care and life insurance benefits to certain eligiblehourly retirees and their dependents. The components of net periodicpostretirement benefit cost for these benefits are as follows:

 
| ** **                            | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                            | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service cost                          |       | $                                                   | 2          |                                              | $          | 11 |   | $ | 4 |   | $ | 21 |   |
| Interest cost                         |       | 26                                                  |       | 35                                                |       | 52 |   | 69 |   |
| Amortization of transition obligation |       | —                                              |       | 9                                                 |       | — |   | 18 |   |
| Amortization of prior service costs   |       | (13                                                 | )          | —                                            |       | (26 | ) | — |   |
| Recognized loss (gain)                |       | 8                                                   |       | (42                                               | )          | 16 |   | (83 | ) |
| Net postretirement benefit cost       |       | $                                                   | 23         |                                              | $          | 13 |   | $ | 46 |   | $ | 25 |   |

 

We do not intend to make any contributions toour domestic pension plan this year. Our anticipated contributions to thepension plan of our U.K. subsidiary approximate $0.8 million for the currentyear. As of June 30, 2008, we have made contributions of $0.2 million tothis plan. The pension plans of our German entities do not hold any assets anduse operating cash to pay participant benefits as they become due. Expected2008 benefit payments under these plans are $1.4 million, of which $0.7 millionwas paid in the second quarter.

 

**(13)         SegmentInformation**

 

Wehave identified two reportable segments: the piano segment and the band &orchestral instrument segment. We consider these two segments reportable asthey are managed separately and the operating results of each segment areseparately reviewed and evaluated by our senior management on a regular basis.Management and the chief operating decision maker use income from operations asa meaningful measurement of profit or loss for the segments. Income fromoperations for the reportable segments includes certain corporate costsallocated to the segments based primarily on revenue, as well as intercompanyprofit. Amounts reported as “Other & Elim” include those from ouronline music division, corporate costs that were not allocated to thereportable segments, and the remaining intercompany profit elimination.

 

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

 
| ** **                                 | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| **Three months ended 2008** | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to external customers            |       | $                      | 24,346     |                  | $          | 20,125    |       | $          | 12,145     |   | $ | 56,616 |   | $ | 39,263 |   | $ | 1,755 |   | $ | 41,018 |   | $ | 887 |   | $ | 98,521 |   |
| Income (loss) from operations              |       | 636                    |       | 5,269                 |       | 1,355     |       | 7,260      |       | 1,685 |   | (1,277 | ) | 408 |   | (841 | ) | 6,827 |   |
|                                            |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                 | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| **Three months ended 2007** | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to external                      |       |                   |       |                  |       |      |       |       |       |   |   |   |   |   |   |   |   |   |   |
| customers                                  |       | $                      | 24,804     |                  | $          | 15,761    |       | $          | 13,817     |   | $ | 54,382 |   | $ | 36,173 |   | $ | 1,702 |   | $ | 37,875 |   | $ | — |   | $ | 92,257 |   |
| Income (loss) from operations              |       | 926                    |       | 4,962                 |       | 1,639     |       | 7,527      |       | 1,068 |   | 171 |   | 1,239 |   | (717 | ) | 8,049 |   |
|                                            |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                               | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| **Six months ended 2008** | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to external                    |       |                   |       |                  |       |      |       |       |       |   |   |   |   |   |   |   |   |   |   |
| customers                                |       | $                      | 51,640     |                  | $          | 35,056    |       | $          | 24,606     |   | $ | 111,302 |   | $ | 76,643 |   | $ | 3,875 |   | $ | 80,518 |   | $ | 887 |   | $ | 192,707 |   |
| Income (loss) from operations            |       | 1,924                  |       | 8,917                 |       | 2,211     |       | 13,052     |       | 1,674 |   | (1,515 | ) | 159 |   | (1,580 | ) | 11,631 |   |
|                                          |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                               | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other** | ** ** | **Consol** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------|------------|------------|------------|
| **Six months ended 2007** | ** ** | **U.S.**               | ** ** | **Germany**           | ** ** | **Other** | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Total** | ** ** | **& Elim** | ** ** | **Total** | ** ** |
| Net sales to external                    |       |                   |       |                  |       |      |       |       |       |   |   |   |   |   |   |   |   |   |   |
| customers                                |       | $                      | 54,432     |                  | $          | 29,271    |       | $          | 23,604     |   | $ | 107,307 |   | $ | 74,952 |   | $ | 3,430 |   | $ | 78,382 |   | $ | — |   | $ | 185,689 |   |
| Income (loss) from operations            |       | 2,868                  |       | 8,563                 |       | 2,432     |       | 13,863     |       | 169 |   | 224 |   | 393 |   | (1,840 | ) | 12,416 |   |
|                                          |            |                        |            |                       |            |           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

**Introduction**

 

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

 

**CriticalAccounting Policies**

 

The Securities and Exchange Commission (“SEC”)has issued disclosure guidance for “critical accounting policies.” The SECdefines “critical accounting policies” as those that require application ofmanagement’s most difficult, subjective or complex judgments, often as a resultof the need to make estimates about the effect of matters that are inherentlyuncertain and may change in subsequent periods.

 

Management is required to make certainestimates and assumptions during the preparation of the consolidated financialstatements. These estimates and assumptions impact the reported amount ofassets and liabilities and disclosures of contingent assets and liabilities asof the date of the consolidated financial statements. Estimates and assumptionsare reviewed periodically and the effects of revisions are reflected in theconsolidated financial statements in the period they are determined to benecessary. Actual results could differ from those estimates.

 

The significant accounting policies aredescribed in Note 2 of the Notes to Consolidated Financial Statements includedin the Company’s 2007 Annual Report on Form 10-K. Not all of thesesignificant accounting policies require management to make difficult,subjective or complex judgments or estimates. However, management considers thefollowing to be critical accounting policies based on the definition above.

 

**Accounts Receivable**

 

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

 

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**Inventory**

 

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

 

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

 

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

 

**Warranty**

 

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

 

**Long-livedAssets**

 

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

 

We establish long-livedintangible assets based on estimated fair values, and amortize finite-livedintangibles over their estimated useful lives. We test our goodwill andindefinite-lived trademark assets for impairment annually or on an interimbasis if events or circumstances indicate that the fair value of an asset mayhave decreased below its carrying value. Our assessment is based on severalanalyses, including a comparison of estimated fair values to our marketcapitalization and multi-year cash flows.

 

**Pensionsand Other Postretirement Benefit Costs**

 

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

 

**IncomeTaxes**

 

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

 

24

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

 

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

 

**Stock-Based Compensation**

 

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

 

**Environmental Liabilities**

 

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

 

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

 

**Forward-Looking Statements**

 

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

 

25

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

 

**Results of Operations**

 

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

* *
| ** **                       | ** ** | **Three Months Ended June 30,** | ** ** | ** ** | ** ** | **Change** | ** ** |
|----------------------------------|------------|-----------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                       | ** ** | **2008**                                            | ** ** | ** ** | ** ** | **2007**   | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
|                             |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Net sales                        |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Band                             |       | $                                                   | 41,018     |       |       |       | $          | 37,875 |   |   |   | 3,143 |   | 8.3 |   |
| Piano                            |       | 56,616                                              |       |       |       | 54,382     |       |   |   | 2,234 |   | 4.1 |   |
| Online music                     |       | 887                                                 |       |       |       | —     |       |   |   | 887 |   | 100.0 |   |
| Total sales                      |       | 98,521                                              |       |       |       | 92,257     |       |   |   | 6,264 |   | 6.8 |   |
|                             |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Cost of sales                    |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Band                             |       | 32,065                                              |       |       |       | 29,274     |       |   |   | 2,791 |   | 9.5 |   |
| Piano                            |       | 36,763                                              |       |       |       | 34,418     |       |   |   | 2,345 |   | 6.8 |   |
| Online music                     |       | 648                                                 |       |       |       | —     |       |   |   | 648 |   | 100.0 |   |
| Total cost of sales              |       | 69,476                                              |       |       |       | 63,692     |       |   |   | 5,784 |   | 9.1 |   |
|                             |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Gross profit                     |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Band                             |       | 8,953                                               |       | 21.8       | %          | 8,601      |       | 22.7 | % | 352 |   | 4.1 |   |
| Piano                            |       | 19,853                                              |       | 35.1       | %          | 19,964     |       | 36.7 | % | (111 | ) | (0.6 | ) |
| Online music                     |       | 239                                                 |       | 26.9       | %          | —     |       |   |   | 239 |   | 100.0 |   |
| Total gross profit               |       | 29,045                                              |       |       |       | 28,565     |       |   |   | 480 |   | 1.7 |   |
|                             |       | 29.5%                                               |       |       |       | 31.0%      |       |   |   |   |   |   |   |
|                             |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Operating expenses               |       | 21,156                                              |       |       |       | 20,516     |       |   |   | 640 |   | 3.1 |   |
| Facility rationalization charges |       | 1,062                                               |       |       |       | —     |       |   |   | 1,062 |   | 100.0 |   |
| Income from operations           |       | 6,827                                               |       |       |       | 8,049      |       |   |   | (1,222 | ) | (15.2 | ) |
|                             |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Other expense (income), net      |       | 54                                                  |       |       |       | (21        | )          |   |   | 75 |   | (357.1 | ) |
| Net interest expense             |       | 2,276                                               |       |       |       | 2,523      |       |   |   | (247 | ) | (9.8 | ) |
| Non-operating expenses           |       | 2,330                                               |       |       |       | 2,502      |       |   |   | (172 | ) | (6.9 | ) |
|                             |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Income before income taxes       |       | 4,497                                               |       |       |       | 5,547      |       |   |   | (1,050 | ) | (18.9 | ) |
|                             |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Income tax provision             |       | 1,452                                               |       | 32.3       | %          | 2,394      |       | 43.2 | % | (942 | ) | (39.3 | ) |
|                             |       |                                                |       |       |       |       |       |   |   |   |   |   |   |
| Net income                       |       | $                                                   | 3,045      |       |       |       | $          | 3,153 |   |   |   | (108 | ) | (3.4 | ) |

 

**Overview***–*Althoughpiano division revenue improved, margins suffered because of shutdowns at thedomestic manufacturing facility, which were taken in an effort to controlinventory. Improved saxophone, percussion and accessories sales more thanoffset the impact of continued backorders and delivery issues for certainstudent level sourced instruments. However, band division margins deterioratedlargely due to severance

 

26

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costs associated with ourfacility rationalization project. As part of this project, we announced thepending closure of our Elkhorn, Wisconsin brass instrument manufacturingfacility in June 2008. This production is being relocated to our Eastlake,Ohio manufacturing facility.

 

**Net Sales** – Net sales increased due to improvements in piano and band divisionsales, coupled with the $0.9 million contribution from our online music sales.Domestically, piano division revenues deteriorated slightly ($0.5 million)despite a 10% increase in Steinway grand piano shipments due to the absence ofhigher priced special edition units, which we sold in the year-ago period. Inaddition, mid-priced piano line shipments decreased 10%. Overseas Steinwaygrand unit shipments decreased 9%, as the prior period included a largeinstitutional sale made by our European division. Despite this, overseas pianodivision sales increased $2.7 million due to $3.6 million attributable toforeign currency translation. Band division revenues improved $3.1 million asthe 7% decrease in woodwind and brass instruments was offset by increases inpercussion and stringed instrument shipments. Saxophone and accessories salesalso contributed to the improvement.

 

**Gross Profit***–*Gross profit deteriorated due to lower band and piano margins. Domestically,piano margins were adversely impacted by one week of unplanned factory shutdownwhich caused an estimated $0.4 million in unabsorbed overhead. Unfavorableexchange rates on Boston piano purchases were also a factor. The banddivision’s gross profit was adversely impacted by $0.6 million in severancecosts associated with plant closures.

 

**Operating Expenses** – Operating expenses increased $0.6 million for the period. Theadverse impact of $0.7 million in foreign currency translation was offset by a reductionin bad debt reserves of $0.5 million. Legal and consulting expenses associatedwith our facility rationalization project also contributed to theincrease.

 

**Facility rationalization charges –**Facility rationalization charges of $1.1million are comprised of $0.2 million in building write-down on our Elkhorn,Wisconsin facility, and $0.9 million in building write-down on our clarinetmanufacturing facility in France, which we sold in July 2008.

 

**Non-operating Expenses** – Non-operating expenses decreased $0.2million due to lower net interest expense, as we did not have anything outstandingon our domestic line of credit in the current period. The $0.2 million increasein foreign exchange losses was offset by the decrease in legal costs of asimilar amount.

 

**Income Taxes** –**Our effective tax rateis comprised of 37% associated with current year income and a benefit of 4.7%relating to uncertain tax positions, which resulted from settlements with statetaxing authorities. In the year-ago period, the impact of these positions wasnot material to the effective rate.

 

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**Results of Operations**

 

Six Months Ended June 30, 2008 Compared to Six Months Ended June 30,2007

 
| ** **                       | ** ** | **Period Ended June 30,** | ** ** | ** ** | ** ** | **Change** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|------------|------------|------------|------------|
| ** **                       | ** ** | **2008**                                 | ** ** | ** ** | ** ** | **2007**   | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
|                             |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Net sales                        |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Band                             |       | $                                        | 80,518     |       |       |       | $          | 78,382 |   |   |   | 2,136 |   | 2.7 |   |
| Piano                            |       | 111,302                                  |       |       |       | 107,307    |       |   |   | 3,995 |   | 3.7 |   |
| Online music                     |       | 887                                      |       |       |       | —     |       |   |   | 887 |   | 100.0 |   |
| Total sales                      |       | 192,707                                  |       |       |       | 185,689    |       |   |   | 7,018 |   | 3.8 |   |
|                             |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Cost of sales                    |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Band                             |       | 63,040                                   |       |       |       | 61,579     |       |   |   | 1,461 |   | 2.4 |   |
| Piano                            |       | 72,582                                   |       |       |       | 68,305     |       |   |   | 4,277 |   | 6.3 |   |
| Online music                     |       | 648                                      |       |       |       | —     |       |   |   | 648 |   | 100.0 |   |
| Total cost of sales              |       | 136,270                                  |       |       |       | 129,884    |       |   |   | 6,386 |   | 4.9 |   |
|                             |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Gross profit                     |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Band                             |       | 17,478                                   |       | 21.7       | %          | 16,803     |       | 21.4 | % | 675 |   | 4.0 |   |
| Piano                            |       | 38,720                                   |       | 34.8       | %          | 39,002     |       | 36.3 | % | (282 | ) | (0.7 | ) |
| Online music                     |       | 239                                      |       | 26.9       | %          | —     |       |   |   | 239 |   | 100.0 |   |
| Total gross profit               |       | 56,437                                   |       |       |       | 55,805     |       |   |   | 632 |   | 1.1 |   |
|                             |       | 29.3%                                    |       |       |       | 30.1%      |       |   |   |   |   |   |   |
|                             |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Operating expenses               |       | 43,744                                   |       |       |       | 43,389     |       |   |   | 355 |   | 0.8 |   |
| Facility rationalization charges |       | 1,062                                    |       |       |       | —     |       |   |   | 1,062 |   | 100.0 |   |
| Income from operations           |       | 11,631                                   |       |       |       | 12,416     |       |   |   | (785 | ) | (6.3 | ) |
|                             |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Other expense (income), net      |       | 17                                       |       |       |       | (191       | )          |   |   | 208 |   | (108.9 | ) |
| Gain on extinguishment of debt   |       | (636                                     | )          |       |       | —     |       |   |   | (636 | ) | 100.0 |   |
| Net interest expense             |       | 4,433                                    |       |       |       | 4,675      |       |   |   | (242 | ) | (5.2 | ) |
| Non-operating expenses           |       | 3,814                                    |       |       |       | 4,484      |       |   |   | (670 | ) | (14.9 | ) |
|                             |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Income before income taxes       |       | 7,817                                    |       |       |       | 7,932      |       |   |   | (115 | ) | (1.4 | ) |
|                             |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Income tax provision             |       | 2,797                                    |       | 35.8       | %          | 3,349      |       | 42.2 | % | (552 | ) | (16.5 | ) |
|                             |       |                                     |       |       |       |       |       |   |   |   |   |   |   |
| Net income                       |       | $                                        | 5,020      |       |       |       | $          | 4,583 |   |   |   | 437 |   | 9.5 |   |

 

**Overview***–*Although piano division revenue improved, piano margindeteriorated due to fewer Steinway grand unit sales, and the adverse impact ofdomestic manufacturing facility shutdowns. Band division

 

28

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sales improveddue to higher intermediate and professional level saxophone and trumpet sales,despite backorders and delivery issues for certain student level sourcedinstruments. Band division margins improved due to a shift in mix towardshigher margin intermediate and professional level instruments.

 

**Net Sales** – Netsales increased due to improved piano and band division sales, as well as the$0.9 million attributed to our recently acquired online music business.Although overseas Steinway grand unit shipments decreased 4%, overseas revenueimproved $6.8 million, of which $6.4 is attributable to foreign currencytranslation. The remaining increase was generated by improved mid-priced pianoline sales. Domestic piano division sales decreased $2.8 million due to fewersales at the wholesale level, which resulted in a 9% decrease in domesticSteinway grand piano sales.  Despite thedecrease of 9% in band units due to the backorder status of certain studentinstruments which we source from third parties, the shift in mix from theselower-priced student band instruments to intermediate and professional levelinstruments caused an increase in revenue.

 

**Gross Profit***–* Despite the band sales and margin improvements, grossprofit deteriorated due to lower piano division margins. Although domesticretail sales remained strong domestic piano margins dropped (30.0% vs. 31.5%)as a result of the $0.4 million in unabsorbed overhead resulting from ashutdown taken to control inventory levels. Overseas margins deteriorated dueto fewer retail sales and the adverse impact of a strong euro in certain partsof Europe and Asia. The band division’s gross profit benefited from the shiftin mix towards higher margin intermediate and professional level bandinstruments, which more than offset the impact of $1.0 million in severancecosts associated with plant closures, as well as the production inefficienciesexperienced as we transfer manufacturing to our remaining facilities.

 

**Operating Expenses** –Operating expenses increased $0.4 million due to the adverse impact of $1.2million in foreign exchange translation. Offsetting this, bad debt expense was$0.2 million lower. Also, we did not have the impact of a $0.5 million reserveagainst the $2.0 million escrowed deposit relating to an asset purchaseagreement, which occurred in the year-ago period.

 

**Facility rationalization charges –**Facilityrationalization charges of $1.1 million are comprised of $0.2 million inbuilding write-down on our Elkhorn, Wisconsin facility, and $0.9 million inbuilding write-down on our clarinet manufacturing facility in France, which wassold in July 2008.

 

**Non-operating Expenses**- Non-operating expenses decreased $0.7 million due to the $0.6 million gain onextinguishment of $5.8 million of our Senior Notes. Net interest expense was$0.2 million lower, since we did not borrow on our domestic line of credit, as wedid in the year-ago period, and foreign exchange losses were $0.1 millionlower. However, these were offset by a shift of $0.4 million from unrealizedgains to unrealized losses on Supplemental Executive Retirement Plan assets.

 

**Income Taxes** -**Our effective tax rate is comprised of 37% associated withcurrent year income and a benefit of 1.2% relating to uncertain tax positions.These benefits resulted from settlements with certain state taxing authorities.In the year-ago period, the impact of these positions was not material to theeffective rate.

 

**Liquidity and Capital Resources**

 

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

 

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

 
| ** **                                                                   | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
| Net income:                                                                  |       | $        | 5,020      |     | $          | 4,583      |       | $ | 437 |   |
| Changes in operating assets and liabilities                                  |       | (9,449   | )          | (25,856  | )          | 16,407     |       |
| Other adjustments to reconcile net income to  cash from operating activities |       | 5,860    |       | 4,734    |       | 1,126      |       |
| Cash flows from operating activities                                         |       | 1,431    |       | (16,539  | )          | 17,970     |       |
|                                                                         |       |     |       |     |       |       |       |
| Cash flows from investing activities                                         |       | (5,097   | )          | (2,304   | )          | (2,793     | )          |
|                                                                         |       |     |       |     |       |       |       |
| Cash flows from financing activities                                         |       | (5,655   | )          | (2,166   | )          | (3,489     | )          |
|                                                                              |            |          |            |          |            |            |            |  |  |  |

 

Cash flows generated fromoperating activities improved $18.0 million due to improvements in workingcapital accounts, as cash provided by accounts receivable and inventoryincreased $3.7 million and $9.7 million, respectively. In addition, cashgenerated by accounts payable increased $5.6 million, largely due to timing ofpayments to band division vendors.

 

Cash flows used forinvesting activities increased $2.8 million primarily due to our acquisition ofArkiv. Cash used for capital expenditures was comparable to the year-agoperiod. We expect capital expenditures to be in the range of $5.0 to $7.0million in 2008.

 

Cash flows used forfinancing activities increased $3.5 million due to several factors. In 2008, weused operating cash to extinguish $5.8 million of our Senior Notes andpurchased $0.7 million of our own stock, while proceeds generated from stockoption exercises dropped to $0.1 million. In 2007, cash provided by stockoption exercises was $3.5 million. These proceeds helped to offset theborrowing on our domestic credit facility, which we used to partially fund the$25.2 million dividend issued in March 2007.

 

**BorrowingActivities and Availability** - We have a domestic credit facility with a syndicate of domestic lenders(the “Credit Facility”) with a potential borrowing capacity of $110.0 millionin revolving credit loans, which expires on September 29, 2011. Itprovides for periodic borrowings at either London Interbank Offering Rate (“LIBOR”)plus a range from 1.25% to 1.75%, or as-needed borrowings at an alternate baserate, plus a range from 0.00% to 0.25%; both ranges depend upon borrowingavailability at the time of borrowing. The Credit Facility is collateralized byour domestic accounts receivable, inventory, and fixed assets. As of June 30,2008, there was nothing outstanding on our Credit Facility, and borrowingavailability, net of letters of credit, was approximately $107.5 million.

 

We also have certain non-domestic credit facilities originating fromtwo German banks that provide for borrowings by foreign subsidiaries of up to€17.4 million ($27.3 million at the June 30, 2008 exchange rate), net of borrowingrestrictions of €0.5 million ($0.7 million at the June 30, 2008 exchange rate) and are payable on demand.These borrowings are collateralized by most of the assets of the borrowingsubsidiaries. A portion of the loans can be converted into a maximum of £0.5million ($1.0 million at the June 30,2008 exchange rate) for use by our U.K. branch and ¥300 million ($2.8million at the June 30, 2008 exchangerate) for use by our Japanese subsidiary. Our Chinese subsidiary also has theability to convert the equivalent of up to €2.5 million into U.S. dollars orChinese yuan ($3.9 million at the June 30,2008 exchange rate). Euro loans bear interest at rates of Euro InterbankOffered Rate (“EURIBOR”) plus a margin determined at the time of borrowing.Margins fluctuate based on the loan amount and the borrower’s bank rating. Theremaining demand borrowings bear interest rates of LIBOR plus 0.8% for Britishpound loans, LIBOR plus 1.0% for U.S. dollar loans of our

 

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Chinese subsidiary, and TokyoInterbank Offered Rate (“TIBOR”) plus 0.9% for Japanese yen loans. We had nooutstanding borrowings as of June 30, 2008 on these credit facilities.

 

Our Japanese subsidiary also maintains a separate revolving loanagreement that provides additional borrowing capacity of up to ¥460 million($4.3 million at theJune 30, 2008 exchange rate) based on eligible inventory balances.The revolving loan agreement bears interest at an average 30-day TIBOR rateplus 1.0% (outstanding borrowings at 1.6% at June 30, 2008) and expires on January 31, 2010. As of June 30, 2008, we had $2.4million outstanding on this revolving loan agreement.

 

At June 30,2008, our totaloutstanding indebtedness amounted to $171.6 million, consisting of $169.3million of 7.00% Senior Notes and $2.4 million of notes payable to foreignbanks.

 

All of our debt agreements contain covenants that place certainrestrictions on us, including our ability to incur additional indebtedness, tomake investments in other entities, and limitations on cash dividend payments.We were in compliance with all such covenants as of June 30, 2008 and donot anticipate any compliance issues in the future. Our bond indenture containslimitations, based on net income (among other things), on the amount of discretionaryrepurchases we may make of our Ordinary common stock. Our intent and ability torepurchase additional Ordinary common stock either directly from shareholdersor on the open market is directly affected by this limitation. In May 2008we announced a share repurchase program, which permits us to make discretionarypurchases of up to $25.0 million of our Ordinary common stock. We repurchased25,800 shares for $0.7 million in June 2008.

 

We experience long production and inventoryturnover cycles, which we constantly monitor since fluctuations in demand canhave a significant impact on these cycles. We expect to effectively utilizecash flow from operations to fund our debt and capital requirements and pay offour seasonal borrowings on our domestic line of credit. Currently we anticipateall of our divisions will be stable or improve throughout the period. Ourintention is to manage accounts receivable and customer credit, reduceinventory levels, and repay credit facility borrowings.

 

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

 

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

 
| ** **                      | ** ** | **Payments due by period** | ** ** |
|---------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**     | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **More than  5 years** | ** ** |
|                            |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-term debt (1)              |       | $                                         | 238,777    |   | $ | 14,239 |   | $ | 23,695 |   | $ | 23,695 |   | $ | 177,148 |   |
| Capital leases                  |       | 31                                        |       | 16 |   | 15 |   | — |   | — |   |
| Operating leases (2)            |       | 265,059                                   |       | 5,199 |   | 10,100 |   | 8,209 |   | 241,551 |   |
| Purchase obligations (3)        |       | 25,491                                    |       | 25,479 |   | 12 |   | — |   | — |   |
| Other long-term liabilities (4) |       | 42,256                                    |       | 8,043 |   | 6,967 |   | 4,717 |   | 22,529 |   |
| Total                           |       | $                                         | 571,614    |   | $ | 52,976 |   | $ | 40,789 |   | $ | 36,621 |   | $ | 441,228 |   |

 

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**Notes to Contractual Obligations:**

 

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

(2) Approximately $250.0 million of our operatinglease obligations are attributable to the land lease associated with thepurchase of Steinway Hall, which has 89 years remaining. The rest isattributable to the leasing of other facilities and equipment.

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

(4) Our otherlong-term liabilities consist primarily of the long-term portion of our pensionobligations, which are described in Note 12 in the Notes to Condensed ConsolidatedFinancial Statements included within this filing, liabilities relating touncertain tax positions which are expected to be settled within one year, andobligations under employee and consultant agreements. We have not included $2.7million of liabilities relating to uncertain tax positions within this scheduledue to the uncertainty of the payment date, if any.

 

**Recent Accounting Pronouncements**

 

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

 

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

 

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InDecember 2007, the FASB issued SFAS No. 141R, “Business Combinations,”a revision to SFAS No. 141, “Business Combinations” (“ SFAS 141R”),which provides revised guidance for recognition and measurement of identifiableassets and goodwill acquired, liabilities assumed, and any noncontrollinginterest in the acquiree at fair value. SFAS 141R also establishesdisclosure requirements to enable the evaluation of the nature and financialeffects of a business combination. SFAS 141R is required to be appliedprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008. We will comply with SFAS 141R January 1, 2009. We are currentlyevaluating the potential impact, if any, of the adoption of SFAS 141R on ourconsolidated financial statements.

 

InDecember 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements — an amendment of ARB No. 51”(“SFAS 160”). SFAS 160 establishes accounting and reporting standards forownership interests in subsidiaries held by parties other than theparent. Specifically, SFAS 160 requires the presentation of noncontrollinginterests as equity in the Consolidated Statement of Financial Position, andseparate identification and presentation in the Consolidated Statement ofOperations of net income attributable to the entity and the noncontrollinginterest. It also establishes accounting and reporting standards regardingdeconsolidation and changes in a parent’s ownership interest. We will berequired to comply with SFAS 160 January 1, 2009. The provisions of SFAS160 are generally required to be applied prospectively, except for thepresentation and disclosure requirements, which must be appliedretrospectively. We are currently evaluating the potential impact, if any,of the adoption of SFAS 160 on our consolidated financial statements.

 

InMarch 2008, the FASB issued SFAS No. 161, “Disclosures about DerivativeInstruments and Hedging Activities — an amendment of FASB Statement No. 133”(“SFAS 161”). SFAS 161 amends and expands the disclosure requirements forderivative instruments and hedging activities, with the intent to provide usersof financial statements with an enhanced understanding of how and why an entityuses derivative instruments, how derivative instruments and related hedgeditems are accounted for, and how derivative instruments and related hedgeditems affect an entity’s financial statements. We will comply with SFAS161 January 1, 2009.

** **

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

 

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

 

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

 

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

 

33

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**ITEM 4****         CONTROLSAND PROCEDURES**

 

Our principalexecutive officer and our principal financial officer, after evaluatingtogether with management the design and operation of our disclosure controlsand procedures, have concluded that our disclosure controls and procedures (asdefined in Exchange Act Rules 13a-15(e) and 15d-15(e)) were effectiveas of June 30, 2008, the end of the period covered by this report. Indesigning disclosure controls and procedures, management recognizes that anycontrols, no matter how well designed and operated, can only providereasonable, not absolute, assurance of achieving the desired controlobjectives.

 

During the quartercovered by this report, there were no significant changes in our internalcontrols that materially affected, or are reasonably likely to materiallyaffect, internal control over financial reporting.

 

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

 

**ITEM 2****                ****UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 
| ** **                        | ** ** | ** **                | ** ** | ** **           | ** ** | ** **                | ** ** | **(d) Maximum**         | ** ** |
|-----------------------------------|------------|---------------------------|------------|----------------------|------------|---------------------------|------------|------------------------------|------------|
| ** **                        | ** ** | ** **                | ** ** | ** **           | ** ** | **(c) Total Number** | ** ** | **Number (or**               | ** ** |
| ** **                        | ** ** | ** **                | ** ** | ** **           | ** ** | **of Shares (or**         | ** ** | **Approximate Dollar**       | ** ** |
| ** **                        | ** ** | ** **                | ** ** | ** **           | ** ** | **Units) Purchased**      | ** ** | **Value) of Shares (or**     | ** ** |
| ** **                        | ** ** | ** **                | ** ** | ** **           | ** ** | **as Part of**       | ** ** | **Units) that May Yet** | ** ** |
| ** **                        | ** ** | **(a) Total Number** | ** ** | **(b) Average** | ** ** | **Publicly**              | ** ** | **Be Purchased Under**       | ** ** |
| ** **                        | ** ** | **of Shares (or**         | ** ** | **Price Paid per**   | ** ** | **Announced Plans**       | ** ** | **the Plans or**             | ** ** |
| **Period**                        | ** ** | **Units) Purchased**      | ** ** | **Share (or Unit)**  | ** ** | **or Programs**           | ** ** | **Programs**                 | ** ** |
|                              |       |                      |       |                 |       |                      |       |                         |       |
| June 18 - June 30, 2008 |       | 25,800                    |       | $                    | 26.73      |                      | 25,800     |                         | $          | 25,000,000 |   |
| Total                             |       | 25,800                    |       | $                    | 26.73      |                      | 25,800     |                         | $          | 25,000,000 |   |

 

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

 

At the Company’s Annual Meetingof Shareholders held on May 19, 2008, the Board of Directors wasre-elected in its entirety. The votes cast for each nominee were as follows:

 
| ** **               | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|--------------------------|------------|------------|------------|--------------|------------|
| Kyle Kirkland            |       | 50,911,385 |       | 3,202,853    |       |
| Dana D. Messina          |       | 51,693,308 |       | 2,420,930    |       |
| Thomas Kurrer            |       | 51,405,162 |       | 2,709,076    |       |
| John M. Stoner, Jr. |       | 51,406,921 |       | 2,707,317    |       |
| A. Clinton Allen         |       | 54,049,814 |       | 64,424       |       |
| Rudolph K. Kluiber       |       | 54,052,057 |       | 62,181       |       |
| Peter McMillan           |       | 53,920,925 |       | 193,313      |       |
| David Lockwood           |       | 51,495,000 |       | 2,619,238    |       |

 

34

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The proposal to ratify UHYLLP to serve as the Company’s independent registered public accounting firm forthe fiscal year ending December 31, 2008 was approved with 54,106,124votes cast for, 6,196 against, and 1,918 abstentions.

 

**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 |

 

35

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**SIGNATURES**

 

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

 

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

 

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