**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**ý****                                ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLYPERIOD ENDED SEPTEMBER 30, 2004**

** **

**o****                                ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**COMMISSIONFILE NUMBER 001-11911**

 

**STEINWAYMUSICAL INSTRUMENTS, INC.**

(Exact name ofregistrant as specified in its charter)

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

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements during thepast 90 days.

Yes ý    No o

 

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

Yes ý    No o

 
| Number of shares  of Common Stock issued and outstanding as of November 4, 2004: |   | Class A  |   | 477,952   |   |
|----------------------------------------------------------------------------------|--------|----------|--------|-----------|--------|
|                                                                             |   | Ordinary |   | 7,535,195 |   |
|                                                                             |   | Total    |   | 8,013,147 |   |

 

 

----

 

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

**FORM 10-Q**

**INDEX**

 
| **PART I.**  | ** ** | **UNAUDITED FINANCIAL INFORMATION**                                                                              |       |
|--------------|------------|------------------------------------------------------------------------------------------------------------------|------------|
|         |       |                                                                                                             |       |
| **Item  1.** | ** ** | **Consolidated  and Condensed Consolidated Financial Statements:**                                               |       |
|         |       |                                                                                                             |       |
|         |       | Consolidated  Statements of Income  Three months and nine months ended September 30, 2004 and September 27, 2003 |       |
|         |       |                                                                                                             |       |
|         |       | Condensed  Consolidated Balance Sheets  September 30, 2004 and December 31, 2003                                 |       |
|         |       |                                                                                                             |       |
|         |       | Consolidated  Statements of Cash Flows  Nine months ended September 30, 2004 and September 27, 2003              |       |
|         |       |                                                                                                             |       |
|         |       | Consolidated  Statement of Stockholders’ Equity  Nine months ended September 30, 2004                       |       |
|         |       |                                                                                                             |       |
|         |       | Notes  to Consolidated and Condensed Consolidated Financial Statements.                                          |       |
|         |       |                                                                                                             |       |
| **Item  2.** | ** ** | **Management’s  Discussion and Analysis of Financial Condition  and Results of Operations**                 |       |
|         |       |                                                                                                             |       |
| **Item  3.** | ** ** | **Quantitative  and Qualitative Disclosures about Market Risk**                                                  | ** ** |
| ** **   | ** ** | ** **                                                                                                       | ** ** |
| **Item 4.**  | ** ** | **Controls and Procedures**                                                                                      | ** ** |
| ** **   | ** ** | ** **                                                                                                       | ** ** |
| **PART II.** | ** ** | **OTHER INFORMATION**                                                                                            |       |
|         |       |                                                                                                             |       |
| **Item 6.**  | ** ** | **Exhibits and  Reports on Form 8-K**                                                                            |       |
|         |       |                                                                                                             |       |
| ** **   | ** ** | **Signatures**                                                                                                   |       |

 

2

----

 

# **ITEM 1**                                                        CONSOLIDATEDAND CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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

**CONSOLIDATEDSTATEMENTS OF INCOME**

**Unaudited**

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

 
| ** **                        | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|-----------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** |
| Net sales                         |       | $                       | 94,653     |                    | $          | 82,546 |   | $ | 268,402 |   | $ | 243,090 |   |
| Cost of sales                     |       | 68,757                  |       | 59,655                  |       | 192,378 |   | 176,654 |   |
|                              |       |                    |       |                    |       |   |   |   |   |
| Gross Profit                      |       | 25,896                  |       | 22,891                  |       | 76,024 |   | 66,436 |   |
|                              |       |                    |       |                    |       |   |   |   |   |
| Operating  expenses:              |       |                    |       |                    |       |   |   |   |   |
| Sales and  marketing              |       | 10,465                  |       | 9,383                   |       | 32,298 |   | 31,340 |   |
| General and  administrative       |       | 7,358                   |       | 5,480                   |       | 19,771 |   | 16,969 |   |
| Amortization of  intangibles      |       | 269                     |       | 288                     |       | 815 |   | 865 |   |
| Other operating  expenses         |       | 207                     |       | 110                     |       | 232 |   | 418 |   |
| Facility  rationalization charges |       | —                  |       | 2,075                   |       | — |   | 2,075 |   |
| Total operating  expenses         |       | 18,299                  |       | 17,336                  |       | 53,116 |   | 51,667 |   |
|                              |       |                    |       |                    |       |   |   |   |   |
| Income from  operations           |       | 7,597                   |       | 5,555                   |       | 22,908 |   | 14,769 |   |
|                              |       |                    |       |                    |       |   |   |   |   |
| Other income,  net                |       | (806                    | )          | (699                    | )          | (2,152 | ) | (2,032 | ) |
| Interest income                   |       | (512                    | )          | (352                    | )          | (1,740 | ) | (1,473 | ) |
| Interest expense                  |       | 4,202                   |       | 3,541                   |       | 11,994 |   | 10,641 |   |
|                              |       |                    |       |                    |       |   |   |   |   |
| Income before  income taxes       |       | 4,713                   |       | 3,065                   |       | 14,806 |   | 7,633 |   |
|                              |       |                    |       |                    |       |   |   |   |   |
| Income taxes                      |       | 1,885                   |       | 1,227                   |       | 5,920 |   | 2,952 |   |
|                              |       |                    |       |                    |       |   |   |   |   |
| Net income                        |       | $                       | 2,828      |                    | $          | 1,838 |   | $ | 8,886 |   | $ | 4,681 |   |
|                              |       |                    |       |                    |       |   |   |   |   |
| Earnings per  share:              |       |                    |       |                    |       |   |   |   |   |
| Basic                             |       | $                       | 0.35       |                    | $          | 0.21 |   | $ | 1.10 |   | $ | 0.53 |   |
| Diluted                           |       | $                       | 0.34       |                    | $          | 0.21 |   | $ | 1.06 |   | $ | 0.53 |   |
|                              |       |                    |       |                    |       |   |   |   |   |
| Weighted average  shares:         |       |                    |       |                    |       |   |   |   |   |
| Basic                             |       | 7,998,481               |       | 8,930,613               |       | 8,055,457 |   | 8,914,363 |   |
| Diluted                           |       | 8,282,498               |       | 8,931,709               |       | 8,385,558 |   | 8,914,712 |   |

 

See notes to consolidatedand condensed consolidated financial statements.

 

3

----

 

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

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**Unaudited**

**(InThousands)**

** **
| ** **                                                                                                                            | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
|                                                                                                                                  |       |                    |       |                   |       |
| ASSETS:                                                                                                                               |       |                    |       |                   |       |
| Current assets:                                                                                                                       |       |                    |       |                   |       |
| Cash                                                                                                                                  |       | $                       | 14,118     |                   | $          | 42,283 |   |
| Accounts, notes  and leases receivable, net of allowances for doubtful accounts of $10,152 and  $9,944 in 2004 and 2003, respectively |       | 107,076                 |       | 76,403                 |       |
| Inventories                                                                                                                           |       | 176,392                 |       | 152,029                |       |
| Prepaid expenses  and other current assets                                                                                            |       | 4,043                   |       | 4,533                  |       |
| Deferred tax  assets                                                                                                                  |       | 13,244                  |       | 13,022                 |       |
| Total current  assets                                                                                                                 |       | 314,873                 |       | 288,270                |       |
|                                                                                                                                  |       |                    |       |                   |       |
| Property, plant  and equipment, net of accumulated depreciation of $67,344 and $63,952 in 2004  and 2003, respectively                |       | 100,665                 |       | 98,937                 |       |
| Trademarks                                                                                                                            |       | 10,456                  |       | 10,319                 |       |
| Goodwill                                                                                                                              |       | 31,520                  |       | 31,665                 |       |
| Other  intangibles, net                                                                                                               |       | 5,569                   |       | 5,782                  |       |
| Other assets                                                                                                                          |       | 18,478                  |       | 10,692                 |       |
|                                                                                                                                  |       |                    |       |                   |       |
| TOTAL ASSETS                                                                                                                          |       | $                       | 481,561    |                   | $          | 445,665 |   |
|                                                                                                                                  |       |                    |       |                   |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                            |       |                    |       |                   |       |
| Current  liabilities:                                                                                                                 |       |                    |       |                   |       |
| Current portion  of long-term debt                                                                                                    |       | $                       | 10,427     |                   | $          | 10,638 |   |
| Accounts payable                                                                                                                      |       | 13,011                  |       | 11,554                 |       |
| Other current  liabilities                                                                                                            |       | 46,712                  |       | 39,112                 |       |
| Total current  liabilities                                                                                                            |       | 70,150                  |       | 61,304                 |       |
|                                                                                                                                  |       |                    |       |                   |       |
| Long-term debt                                                                                                                        |       | 229,742                 |       | 185,964                |       |
| Deferred tax  liabilities                                                                                                             |       | 25,390                  |       | 25,565                 |       |
| Other  non-current liabilities                                                                                                        |       | 20,652                  |       | 20,197                 |       |
| Total  liabilities                                                                                                                    |       | 345,934                 |       | 293,030                |       |
|                                                                                                                                  |       |                    |       |                   |       |
| Commitments and  contingent liabilities                                                                                               |       |                    |       |                   |       |
|                                                                                                                                  |       |                    |       |                   |       |
| Stockholders’  equity:                                                                                                           |       |                    |       |                   |       |
| Common stock                                                                                                                          |       | 10                      |       | 10                     |       |
| Additional  paid-in capital                                                                                                           |       | 80,881                  |       | 74,626                 |       |
| Retained  earnings                                                                                                                    |       | 105,606                 |       | 96,720                 |       |
| Accumulated  other comprehensive loss                                                                                                 |       | (3,434                  | )          | (2,868                 | )          |
| Treasury stock,  at cost                                                                                                              |       | (47,436                 | )          | (15,853                | )          |
| Total  stockholders’ equity                                                                                                      |       | 135,627                 |       | 152,635                |       |
|                                                                                                                                  |       |                    |       |                   |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                      |       | $                       | 481,561    |                   | $          | 445,665 |   |

 

See notes to consolidatedand condensed consolidated financial statements.

 

4

----

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**Unaudited**

**(InThousands)**

 
| ** **                                                                    | ** ** | **Nine Months Ended**   | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                    | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** |
| Cash flows from  operating activities:                                        |       |                    |       |   |   |
| Net income                                                                    |       | $                       | 8,886      |   | $ | 4,681 |   |
| Adjustments to  reconcile net income to cash flows from operating activities: |       |                    |       |   |   |
| Depreciation and  amortization                                                |       | 8,153                   |       | 8,214 |   |
| Amortization of  bond premium                                                 |       | (167                    | )          | — |   |
| Deferred tax expense  (benefit)                                               |       | (323                    | )          | 231 |   |
| Debt issuance  costs                                                          |       | (105                    | )          | — |   |
| Other                                                                         |       | 105                     |       | 235 |   |
| Facility  rationalization charges                                             |       | —                  |       | 2,075 |   |
| Changes in  operating assets and liabilities:                                 |       |                    |       |   |   |
| Accounts, notes  and leases receivable                                        |       | (17,308                 | )          | (16,512 | ) |
| Inventories                                                                   |       | (4,221                  | )          | 3,846 |   |
| Prepaid expenses  and other assets                                            |       | (5,678                  | )          | 788 |   |
| Accounts payable                                                              |       | 14                      |       | (1,708 | ) |
| Other  liabilities                                                            |       | 2,855                   |       | 3,877 |   |
| Cash flows from  operating activities                                         |       | (7,789                  | )          | 5,727 |   |
|                                                                          |       |                    |       |   |   |
| Cash flows from  investing activities:                                        |       |                    |       |   |   |
| Capital  expenditures                                                         |       | (3,192                  | )          | (2,752 | ) |
| Proceeds from  disposals of fixed assets                                      |       | 76                      |       | 4 |   |
| Acquisition of  subsidiary, net of cash acquired                              |       | (35,309                 | )          | — |   |
| Cash flows from  investing activities                                         |       | (38,425                 | )          | (2,748 | ) |
|                                                                          |       |                    |       |   |   |
| Cash flows from  financing activities:                                        |       |                    |       |   |   |
| Borrowings under  lines of credit                                             |       | 66,875                  |       | 8,465 |   |
| Repayments under  lines of credit                                             |       | (48,928                 | )          | (7,523 | ) |
| Repayments of  long-term debt                                                 |       | (4,984                  | )          | (4,874 | ) |
| Proceeds from  issuance of common stock                                       |       | 5,441                   |       | 501 |   |
| Cash flows from  financing activities                                         |       | 18,404                  |       | (3,431 | ) |
|                                                                          |       |                    |       |   |   |
| Effect of foreign  exchange rate changes on cash                              |       | (355                    | )          | 66 |   |
|                                                                          |       |                    |       |   |   |
| Decrease in cash                                                              |       | (28,165                 | )          | (386 | ) |
| Cash, beginning  of period                                                    |       | 42,283                  |       | 19,099 |   |
|                                                                          |       |                    |       |   |   |
| Cash, end of  period                                                          |       | $                       | 14,118     |   | $ | 18,713 |   |
|                                                                          |       |                    |       |   |   |
| Supplemental  Cash Flow Information                                           |       |                    |       |   |   |
| Interest paid                                                                 |       | $                       | 8,928      |   | $ | 7,719 |   |
| Taxes paid                                                                    |       | $                       | 7,453      |   | $ | 6,443 |   |
|                                                                          |       |                    |       |   |   |
| Non-cash  transaction:                                                        |       |                    |       |   |   |
| Purchase of  common stock by issuance of bonds                                |       | $                       | 31,583     |   | $ | — |   |

 

See notes to consolidatedand condensed consolidated financial statements.

 

5

----

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’ EQUITY**

**Unaudited**

**(InThousands Except Share Data)**

** **
| ** **                                                     | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other Comprehensive  Loss** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|----------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|--------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
|                                                           |       |              |       |                             |       |                   |       |                                       |       |                |       |                                  |       |
| Balance,  December 31, 2003                                    |       | $                 | 10         |                             | $          | 74,626                 |       | $                                          | 96,720     |                | $          | (2,868                                | )          | $ | (15,853 | ) | $ | 152,635 |   |
| Comprehensive  income:                                         |       |              |       |                             |       |                   |       |                                       |       |                |       |                                  |       |
| Net income                                                     |       |              |       |                             |       | 8,886                  |       |                                       |       |                |       | 8,886                                 |       |
| Foreign currency  translation adjustment                       |       |              |       |                             |       |                   |       | (416                                       | )          |                |       | (416                                  | )          |
| Additional  minimum pension liability, net                     |       |              |       |                             |       |                   |       | (145                                       | )          |                |       | (145                                  | )          |
| Unrealized  holding loss on certain marketable securities, net |       |              |       |                             |       |                   |       | (5                                         | )          |                |       | (5                                    | )          |
| Total  comprehensive income                                    |       |              |       |                             |       |                   |       |                                       |       |                |       | 8,320                                 |       |
| Exercise of  252,035 options for shares of common stock        |       |              |       | 4,971                            |       |                   |       |                                       |       |                |       | 4,971                                 |       |
| Issuance of  33,018 shares of common stock                     |       |              |       | 470                              |       |                   |       |                                       |       |                |       | 470                                   |       |
| Tax benefit of  options exercised                              |       |              |       | 814                              |       |                   |       |                                       |       |                |       | 814                                   |       |
| Purchase of  1,271,450 shares of common stock                  |       |              |       |                             |       |                   |       |                                       |       | (31,583             | )          | (31,583                               | )          |
| Balance,  September 30, 2004                                   |       | $                 | 10         |                             | $          | 80,881                 |       | $                                          | 105,606    |                | $          | (3,434                                | )          | $ | (47,436 | ) | $ | 135,627 |   |

 

See notes toconsolidated and condensed consolidated financial statements.

 

6

----

** **

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED AND CONDENSED CONSOLIDATED**

**FINANCIALSTATEMENTS**

**SEPTEMBER30, 2004**

 

**Unaudited**

**(TabularAmounts In Thousands Except Share and Per Share Data)**

 

**(1)   Basis of Presentation**

 

The accompanyingconsolidated and condensed consolidated financial statements of SteinwayMusical Instruments, Inc. and subsidiaries (the “Company”) for the three monthsand nine months ended September 30, 2004 and****September27, 2003 are unaudited.  In the opinionof management, these statements have been prepared on the same basis as theaudited consolidated financial statements as of and for the year ended December31, 2003, and include all adjustments which are of a normal and recurringnature, necessary for the fair presentation of financial position, results ofoperations and cash flows for the interim period.  You should read the consolidated andcondensed consolidated financial statements in conjunction with theconsolidated financial statements and notes thereto contained in the Company’sAnnual Report on Form 10-K for the fiscal year ended December 31, 2003 filedwith the Securities and Exchange Commission. The results of operations for the three months and nine months endedSeptember 30, 2004 are not necessarily indicative of the results that may beexpected for the entire year.

 

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

 

**(2)   Summary of Significant Accounting Policies**

 

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

 

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

 

7

----

 

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

 
| ** **                                                                                                                                    | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                    | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** |
|                                                                                                                                          |       |                    |       |                    |       |   |   |   |   |
| Net income, as  reported                                                                                                                      |       | $                       | 2,828      |                    | $          | 1,838 |   | $ | 8,886 |   | $ | 4,681 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair-value based  method for all awards, net of related tax effects |       | (257                    | )          | (189                    | )          | (765 | ) | (625 | ) |
|                                                                                                                                          |       |                    |       |                    |       |   |   |   |   |
| Pro forma net  income                                                                                                                         |       | $                       | 2,571      |                    | $          | 1,649 |   | $ | 8,121 |   | $ | 4,056 |   |
| Earnings per  share:                                                                                                                          |       |                    |       |                    |       |   |   |   |   |
| Basic - as  reported                                                                                                                          |       | $                       | 0.35       |                    | $          | 0.21 |   | $ | 1.10 |   | $ | 0.53 |   |
| Basic - pro  forma                                                                                                                            |       | $                       | 0.32       |                    | $          | 0.18 |   | $ | 1.01 |   | $ | 0.45 |   |
|                                                                                                                                          |       |                    |       |                    |       |   |   |   |   |
| Diluted - as  reported                                                                                                                        |       | $                       | 0.34       |                    | $          | 0.21 |   | $ | 1.06 |   | $ | 0.53 |   |
| Diluted - pro  forma                                                                                                                          |       | $                       | 0.31       |                    | $          | 0.18 |   | $ | 0.97 |   | $ | 0.45 |   |

 

We measured the fair value of options on their grantdate, including the valuation of the option feature implicit in our PurchasePlan, using the Black-Scholes option-pricing model.  Key assumptions used to apply this pricingmodel are as follows:

 
| ** **                                                                         | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                         | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** |
|                                                                               |       |                    |       |                    |       |   |   |   |   |
| Weighted-average  interest rates                                                   |       | 1.72%                   |       | 1.60%                   |       | 1.38% |   | 2.12% |   |
| Weighted-average  expected life of option feature  in the Purchase Plan (in years) |       | 0.92                    |       | 0.92                    |       | 0.92 |   | 0.92 |   |
| Weighted-average  expected life of option grants (in years)                        |       | —                  |       | —                  |       | — |   | 6 |   |
| Expected  volatility of underlying stock                                           |       | 26%                     |       | 27%                     |       | 26% |   | 27% |   |

 

The weighted-average fairvalue of options on their grant date is as follows:

 
| ** **                       | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|----------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** |
|                             |       |                    |       |                    |       |   |   |   |   |
| Stock Plan                       |       | $                       | —     |                    |       | $ | — |   |   | $ | — |   |   | $ | 4.77 |   |   |
| Option feature  in Purchase Plan |       | $                       | 6.03       |                    |       | $ | 4.48 |   |   | $ | 4.62 |   |   | $ | 4.64 |   |   |

 

8

----

 

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

 

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

 

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

 
| ** **                        | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|-----------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** |
| Weighted-average  shares:         |       |                    |       |                    |       |   |   |   |   |
| For basic  earnings per share     |       | 7,998,481               |       | 8,930,613               |       | 8,055,457 |   | 8,914,363 |   |
| Dilutive effect  of stock options |       | 284,017                 |       | 1,096                   |       | 330,101 |   | 349 |   |
| For diluted  earnings per share   |       | 8,282,498               |       | 8,931,709               |       | 8,385,558 |   | 8,914,712 |   |

 

All outstanding options were included in thecomputation of diluted net earnings per common share for the three months andnine months ended September 30, 2004. Under the Stock Plan, options to purchase 991,800 shares of common stockat prices ranging from $18.55 to $21.94 were outstanding during the threemonths and nine months ended September 27, 2003 but were not included in thecomputation of diluted earnings per share because the exercise prices of theoptions were greater than the average market price of the common shares.

 

*Accumulated Other ComprehensiveIncome/Loss —*Accumulated other comprehensive income/loss iscomprised of net income, foreign currency translation adjustments, additionalminimum pension liabilities, and unrealized holding gains and losses on certainmarketable securities.  The components ofaccumulated other comprehensive loss are as follows:

 
| ** **          | ** ** | **Foreign  Currency  Translation  Adjustment** | ** ** | **Unrealized  Holding  Gain/(Loss) on  Marketable  Securities** | ** ** | **Tax Impact of  Unrealized  Holding  Gain/(Loss) on  Marketable  Securities** | ** ** | **Additional  Minimum  Pension  Liability** | ** ** | **Tax Impact of  Additional  Minimum   Pension  Liability** | ** ** | **Accumulated   Other  Comprehensive  Loss** | ** ** |
|---------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------|------------|
|                |       |                                           |       |                                                            |       |                                                                           |       |                                        |       |                                                        |       |                                         |       |
| December 31,  2003  |       | $                                              | 1,226      |                                                            | $          | 73                                                                             |       | $                                           | (29        | )                                                           | $          | (6,853                                       | )          | $ | 2,715 |   | $ | (2,868 | ) |
| Activity            |       | (416                                           | )          | (7                                                              | )          | 2                                                                              |       | (208                                        | )          | 63                                                          |       | (566                                         | )          |
| September 30,  2004 |       | $                                              | 810        |                                                            | $          | 66                                                                             |       | $                                           | (27        | )                                                           | $          | (7,061                                       | )          | $ | 2,778 |   | $ | (3,434 | ) |

 

*New Accounting Pronouncements –*InDecember 2003, the Financial Accounting Standards Board (“FASB”) revisedStatement of Financial Accounting Standard (“SFAS”) No. 132, “Employers’Disclosures

 

9

----

 

about Pensions and Other Postretirement Benefits.”  SFAS No. 132 requires additional disclosureabout the assets, obligations, cash flows, and net periodic benefit cost ofdefined benefit pension plans and other defined benefit postretirement plans.  This statement also requires disclosure aboutthe types of plan assets, investment strategy, measurement dates, planobligations, and cash flows.  SFAS No.132 is effective for fiscal years ending after December 15, 2003. Disclosure ofinformation about foreign plans required by this statement is effective forfiscal years ending after June 15, 2004. Interim period disclosures for both domestic and foreign plans requiredby this statement are effective for periods beginning after December 15, 2003,and are included in Note 12.

 

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

 

**(3)   Acquisitions**

 

On August 12, 2004, weacquired substantially all of the assets of G. Leblanc Corporation (“Leblanc”)of Wisconsin, a high-quality band instrument manufacturer.  We have included the results of Leblanc sincethe date of acquisition in our financial statements.

 

We acquired Leblanc becauseits complete line of wind instruments and accessories is complementary to ourexisting product lines, enabling us to gain or strengthen market share incertain instrument categories. Under terms of the asset purchase agreement, theCompany provisionally disbursed $37.6 million for the purchase price.  The final purchase price is dependent upon acalculation derived from the closing balance sheet, which when finalized, mayresult in a recovery of a portion of the initial payment, or may require anadditional payment to be made.  AtSeptember 30, 2004, the Company recognized an expected recovery of $2.2 millionbased on preliminary information.  Thepurchase price allocation has been based on the preliminary determination of$35.4 million as the acquisition cost and has been allocated to acquired assetsand assumed liabilities as follows:

 
| Inventories                                     |   | $      | 21,874 |   |
|-------------------------------------------------|--------|--------|--------|--------|
| Receivables and  other current assets           |   | 13,797 |   |
| Property, plant,  and equipment                 |   | 5,588  |   |
| Other assets                                    |   | 1,257  |   |
| Accounts payable  and other current liabilities |   | (7,115 | )      |
|                                            |   | $      | 35,401 |   |

 

10

----

 

**(4)   Inventories**

 
| ** **      | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------|------------|-------------------------|------------|------------------------|------------|
|            |       |                    |       |                   |       |
| Raw materials   |       | $                       | 25,163     |                   | $          | 21,268 |   |
| Work in process |       | 58,015                  |       | 50,620                 |       |
| Finished goods  |       | 93,214                  |       | 80,141                 |       |
| Total           |       | $                       | 176,392    |                   | $          | 152,029 |   |

 

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

 

We test our goodwill and indefinite lived trademarkassets for impairment annually, or on an interim basis if events orcircumstances indicate that the fair value of an asset has decreased below itscarrying value.  At July 31, 2004 weevaluated such assets and determined that the fair value had not decreasedbelow the carrying value and, accordingly, no impairments have been recognizedsince we ceased amortization.

 

The changes in net carrying amounts of goodwill andtrademarks, which include the impact of the preliminary purchase priceallocation associated with the acquisition of certain assets of Leblanc, are asfollows:

 
| ** **                                                                    | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| Goodwill:                                                                     |       |              |       |             |       |
| Balance at  December 31, 2003                                                 |       | $                 | 23,110     |             | $          | 8,555 |   |
| Foreign currency  translation impact                                          |       | (145              | )          | —           |       |
| Balance at  September 30, 2004                                                |       | $                 | 22,965     |             | $          | 8,555 |   |
|                                                                          |       |              |       |             |       |
| Trademarks:                                                                   |       |              |       |             |       |
| Balance at  December 31, 2003                                                 |       | $                 | 7,648      |             | $          | 2,671 |   |
| Additions based  on preliminary purchase price  allocation to acquired assets |       | —            |       | 183              |       |
| Foreign currency  translation impact                                          |       | (46               | )          | —           |       |
| Balance at  September 30, 2004                                                |       | $                 | 7,602      |             | $          | 2,854 |   |

 

11

----

 

We also carry certainintangible assets that are amortized. Once fully amortized, these assets are removed from both the gross andaccumulated amortization balance.  Theseassets consist of the following:

 
| ** **                      | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------|------------|-------------------------|------------|------------------------|------------|
|                            |       |                    |       |                   |       |
| Gross deferred  financing costs |       | $                       | 8,653      |                   | $          | 9,293 |   |
| Accumulated  amortization       |       | (3,619                  | )          | (3,596                 | )          |
| Deferred  financing costs, net  |       | $                       | 5,034      |                   | $          | 5,697 |   |
|                            |       |                    |       |                   |       |
| Gross covenants  not to compete |       | $                       | 750        |                   | $          | 250 |   |
| Accumulated  amortization       |       | (215                    | )          | (165                   | )          |
| Covenants not to  compete, net  |       | $                       | 535        |                   | $          | 85 |   |

 

The weighted-averageamortization period for deferred financing costs is 9.1 years, and the weighted-averageamortization period of covenants not to compete is 5.0 years.  Total amortization expense is as follows:

 
| ** **            | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|-----------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **            | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** |
|                  |       |                    |       |                    |       |   |   |   |   |
| Amortization  expense |       | $                       | 269        |                    | $          | 288 |   | $ | 815 |   | $ | 865 |   |
|                       |            |                         |            |                         |            |  |  |  |  |  |  |  |  |

 

The followingtable shows the total estimated amortization expense for 2004 and the next fivesucceeding fiscal years:

 

Estimated amortizationexpense:

 
| 2004 |   | $     | 1,096  |   |
|------|--------|-------|--------|--------|
| 2005 |   | 1,101 |   |
| 2006 |   | 1,066 |   |
| 2007 |   | 1,066 |   |
| 2008 |   | 921   |   |
| 2009 |   | 528   |   |

 

12

----

 

**(6)   Other Current Liabilities**

** **
| ** **                            | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------|------------|-------------------------|------------|------------------------|------------|
|                                  |       |                    |       |                   |       |
| Accrued payroll  and related benefits |       | $                       | 17,212     |                   | $          | 16,986 |   |
| Current portion  of pension liability |       | 983                     |       | 2,663                  |       |
| Accrued warranty  expense             |       | 2,373                   |       | 2,602                  |       |
| Accrued interest                      |       | 7,051                   |       | 2,706                  |       |
| Deferred income                       |       | 5,290                   |       | 4,161                  |       |
| Other accrued  expenses               |       | 13,803                  |       | 9,994                  |       |
| Total                                 |       | $                       | 46,712     |                   | $          | 39,112 |   |

 

Accrued warranty expense for instruments that have awarranty period ranging from five to ten years is generally recorded at thetime of sale.  The warranty cost estimateis based on a percentage of sales and is adjusted periodically following ananalysis of actual warranty claim activity. Accrued warranty expense for instruments that have a warranty period ofone year is recorded based on warranty return trends.

 

The accruedwarranty expense activity for the nine months ended September 30, 2004 and theyear ended December 31, 2003 is as follows:

 
| ** **               | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------|------------|-------------------------|------------|------------------------|------------|
|                     |       |                    |       |                   |       |
| Beginning  balance       |       | $                       | 2,602      |                   | $          | 2,357 |   |
| Additions                |       | 840                     |       | 1,361                  |       |
| Claims and  reversals    |       | (1,064                  | )          | (1,314                 | )          |
| Foreign exchange  impact |       | (5                      | )          | 198                    |       |
| Ending balance           |       | $                       | 2,373      |                   | $          | 2,602 |   |

 

**(7)  Long-Term Debt**

 

Long-term debt consistsof the following:
| ** **                                               | ** ** | **September 30,  2004** | ** **    |
|----------------------------------------------------------|------------|-------------------------|---------------|
|                                                     |       |                    |          |
| Term loans                                               |       | $                       |  42,194  |   |
| 8.75% Senior  Notes                                      |       | 174,345                 |          |
| Unamortized bond  premium                                |       | 1,647                   |          |
| Domestic line of  credit                                 |       | 18,167                  |          |
| Open account  loans, payable on demand to a foreign bank |       | 3,816                   |          |
| Total                                                    |       | 240,169                 |          |
| Less current  portion                                    |       | 10,427                  |          |
| Long-term debt                                           |       | $                       |  229,742 |   |

 

13

----

 

Scheduled payments oflong-term debt are as follows:

 
| ** **         | ** ** | **September 30,  2004** | ** ** |
|--------------------|------------|-------------------------|------------|
| Remainder of  2004 |       | $                       | 5,429      |   |
| 2005               |       | 7,041                   |       |
| 2006               |       | 8,204                   |       |
| 2007               |       | 8,259                   |       |
| 2008               |       | 35,244                  |       |
| Thereafter         |       | 174,345                 |       |
| Total              |       | $                       | 238,522    |   |

 

**(8)   Stockholders’ Equity**

 

Our common stock is comprised of two classes: Class Aand Ordinary.  With the exception ofdisparate voting power, both classes are substantially identical.  Each share of Class A common stock entitlesthe holder to 98 votes.  Holders ofOrdinary common stock are entitled to one vote per share.  Class A common stock shall automaticallyconvert to Ordinary common stock if, at any time, the Class A common stock isnot owned by an original Class A holder. At September 30, 2004 the Chairman and Chief Executive Officer own 100%of the Class A common shares, representing approximately 86% of the combinedvoting power of the Class A common stock and Ordinary common stock.

 

On February 4, 2004 we purchased 1,271,450 shares ofour Ordinary common stock from AIG Retirement Services, Inc. (formerly AIGSunAmerica), our then largest institutional shareholder.  In exchange, we issued $29.0 million inprincipal amount of our 8.75% Senior Notes due 2011 under our existingindenture.  We issued these bonds at apremium of 106.3%.  This transactionresulted in an increase to our treasury stock of $31.6 million.

 

14

----

 

**(9)           Facility Rationalization Charges –Band Segment**

 

In 2003, we began a facility rationalization projectto reduce excess manufacturing capacity in our band segment.  As part of this project, we closed ourwoodwind manufacturing facility in Nogales, Arizona in November 2003.  This facility is currently valued at $1.0million and is held as an asset available for sale.  In April 2004, we closed one of our woodwind manufacturingfacilities in Elkhart, Indiana and transferred that plant’s production to othercompany-owned facilities. As a result of this closure, we recorded charges of$1.4 million in severance and related expenses through September 30, 2004.  We expect to pay out the remainder of thesecosts by the end of 2004.

 

The severance liabilityand related activity associated with the band segment’s facilityrationalization project is as follows:

 
| Facility  rationalization severance liability: |   |   |   |
|------------------------------------------------|--------|--------|--------|
| Balance at  January 1, 2003                    |   | $      | — |   |
| Additions  charged to cost of sales            |   | 1,683  |   |
| Payments                                       |   | (525   | )      |
| Balance January  1, 2004                       |   | 1,158  |   |
| Additions  charged to cost of sales            |   | 1,444  |   |
| Payments                                       |   | (2,514 | )      |
| Balance at  September 30, 2004                 |   | $      | 88     |   |

 

**(10)         Other Income, Net**

** **
| ** **                            | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|---------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** |
|                                  |       |                    |       |                    |       |   |   |   |   |
| West 57th  building income            |       | $                       | (1,164     | )                       | $          | (1,164 | ) | $ | (3,490 | ) | $ | (3,490 | ) |
| West 57th  building expenses          |       | 813                     |       | 813                     |       | 2,441 |   | 2,441 |   |
| Foreign exchange  (gains) losses, net |       | (27                     | )          | (63                     | )          | (110 | ) | (453 | ) |
| Miscellaneous                         |       | (428                    | )          | (285                    | )          | (993 | ) | (530 | ) |
| Other income,  net                    |       | $                       | (806       | )                       | $          | (699 | ) | $ | (2,152 | ) | $ | (2,032 | ) |

 

**(11)         Commitments and Contingent Liabilities**

 

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

 

15

----

 

We operated manufacturingfacilities at certain locations where hazardous substances (includingchlorinated solvents) were used.  Webelieve that an entity that formerly operated one such facility may havereleased hazardous substances at such location, which we leased through July2001.  We did not contribute to therelease.  Further, we have a contractualindemnity from certain stockholders of this entity.  This facility is not the subject of a legalproceeding that involves us, nor, to our knowledge, is the facility subject toinvestigation.  However, no assurance canbe given that legal proceedings will not arise in the future and that suchindemnitors would make the payments described in the indemnity.

 

We operate othermanufacturing facilities which were previously owned by Philips ElectronicsNorth America Corporation (“Philips”). Philips agreed to indemnify us for any and all losses, damages,liabilities and claims relating to environmental matters resulting from certainactivities of Philips occurring prior to December 29, 1988 (the “EnvironmentalIndemnity Agreement”).  Philips has fullyperformed its obligations under the Environmental Indemnity Agreement, whichterminates on December 29, 2008.  Fourmatters covered by the Environmental Indemnity Agreement are currently pending.  Philips has entered into Consent Orders withthe Environmental Protection Agency (“EPA”) for one site and the North CarolinaDepartment of Environment, Health and Natural Resources for a second site,whereby Philips has agreed to pay required response costs.  On October 22, 1998, we were joined asdefendant in an action involving a site formerly occupied by a business weacquired in Illinois.  Philips hasaccepted the defense of this action pursuant to the terms of the EnvironmentalIndemnity Agreement.  For the fourthsite, the EPA has notified us it intends to carry out the final remediationitself.  The EPA estimates that thisremedy has a present net cost of approximately $14.5 million. The EPA has namedover 40 persons or entities as potentially responsible parties at this Elkhart,Indiana site, including four Conn-Selmer predecessor entities.  For two of these entities, which werepreviously owned by Philips, this matter has been tendered to Philips pursuantto the Environmental Indemnity Agreement. Our potential liability at any of these sites is affected by severalfactors including, but not limited to, the method of remediation, our portionof the materials in the site relative to that of the other named parties, thenumber of parties participating, and the financial capabilities of the otherpotentially responsible parties once the relative share has beendetermined.  No assurance can be given,however, that additional environmental issues will not require additional,currently unanticipated investigation, assessment or remediation expendituresor that Philips will make payments that it is obligated to make under theEnvironmental Indemnity Agreement.

 

We are continuing anexisting environmental remediation program at a facility we acquired in2000.  We currently estimate that thisproject will take eighteen years to complete, at a total cost of approximately$0.9 million.  We have accruedapproximately $0.7 million for the estimated remaining cost of this remediationprogram, which represents the present value total cost using a discount rate of4.5%.  A summary of expected paymentsassociated with this project is as follows:

 
| ** ** | ** ** | **Environmental  Payments** | ** ** |
|------------|------------|-----------------------------|------------|
| 2004       |       | $                           | 124        |   |
| 2005       |       | 136                         |       |
| 2006       |       | 46                          |       |
| 2007       |       | 46                          |       |
| 2008       |       | 46                          |       |
| Thereafter |       | 516                         |       |
| Total      |       | $                           | 914        |   |

 

16

----

 

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

 

**(12)         Retirement Plans**

 

We have defined benefit pension plans covering themajority of our employees, including certain employees in foreigncountries.  The components of netperiodic pension cost for these plans are as follows:

 
| ** **                          | ** ** | **Domestic Plans**      | ** ** | **Foreign Plan**        | ** ** |
|-------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                          | ** ** | **Three Months Ended**  | ** ** | **Three Months Ended**  | ** ** |
| ** **                          | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** |
| Service cost                        |       | $                       | 179        |                    | $          | 217 |   | $ | 164 |   | $ | 181 |   |
| Interest cost                       |       | 648                     |       | 694                     |       | 316 |   | 298 |   |
| Expected return  on plan assets     |       | (873                    | )          | (687                    | )          | (67 | ) | (67 | ) |
| Amortization of  prior service cost |       | 134                     |       | 158                     |       | — |   | — |   |
| Amortization of  net loss           |       | 62                      |       | 147                     |       | 19 |   | 22 |   |
| Net periodic  benefit cost          |       | $                       | 150        |                    | $          | 529 |   | $ | 432 |   | $ | 434 |   |

** **
| ** **                          | ** ** | **Domestic Plans**      | ** ** | **Foreign Plans**       | ** ** |
|-------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                          | ** ** | **Nine Months Ended**   | ** ** | **Nine Months Ended**   | ** ** |
| ** **                          | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** |
| Service cost                        |       | $                       | 618        |                    | $          | 569 |   | $ | 493 |   | $ | 535 |   |
| Interest cost                       |       | 2,233                   |       | 1,813                   |       | 950 |   | 883 |   |
| Expected return  on plan assets     |       | (3,016                  | )          | (1,796                  | )          | (201 | ) | (192 | ) |
| Amortization of  prior service cost |       | 459                     |       | 413                     |       | — |   | — |   |
| Amortization of  net loss           |       | 201                     |       | 382                     |       | 57 |   | 54 |   |
| Net periodic  benefit cost          |       | $                       | 495        |                    | $          | 1,381 |   | $ | 1,299 |   | $ | 1,280 |   |

 

17

----

 

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

 
| ** **                             | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|----------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                             | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** | **September 30,  2004** | ** ** | **September 27,  2003** | ** ** |
| Service cost                           |       | $                       | 11         |                    | $          | 18 |   | $ | 50 |   | $ | 53 |   |
| Interest cost                          |       | 26                      |       | 35                      |       | 103 |   | 104 |   |
| Amortization of  transition obligation |       | 9                       |       | 11                      |       | 34 |   | 34 |   |
| Amortization of  net loss              |       | 2                       |       | 5                       |       | 11 |   | 13 |   |
| Net postretirement  benefit cost       |       | $                       | 48         |                    | $          | 69 |   | $ | 198 |   | $ | 204 |   |

 

We anticipate domestic pension plan contributions ofapproximately $3.0 million for the current year.  As of September 30, 2004 we have contributed$2.2 million to these plans.

 

**(13)         Segment Information**

 

We have identified tworeportable segments: the piano segment and the band and orchestral instrumentsegment.  We consider these two segmentsreportable as they are managed separately and the operating results of eachsegment are separately reviewed and evaluated by our senior management on aregular basis.  Management and the chiefoperating decision maker use income from operations as a meaningful measurementof profit or loss for the segments. Income from operations for the reportable segments includes certaincorporate costs allocated to the segments based primarily on revenue, as wellas intercompany profit.  Amounts reportedas “Other & Elim” include those corporate costs that were not allocated tothe reportable segments and the remaining intercompany profit elimination.

 

18

----

 

The following tablespresent information about our operating segments for the three-month andnine-month periods ended September 30, 2004 and September 27, 2003:

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other  & Elim** | ** ** | **Consol  Total** | ** ** |
|----------------------------------|------------|-------------------|------------|------------------|------------|-----------------------|------------|-------------------|------------|
| **Three months ended 2004**      | ** ** | **U.S.**          | ** ** | **Germany**      | ** ** | **Other**             | ** ** | **Total**         | ** ** | **U.S.** | ** ** | **Other** | ** ** | **Total** | ** ** | ** ** | ** ** |
| Net sales to  external customers |       | $                 | 31,518     |             | $          | 8,638                 |       | $                 | 7,445      |   | $ | 47,601 |   | $ | 45,286 |   | $ | 1,766 |   | $ | 47,052 |   | $ | — |   | $ | 94,653 |   |
| Income (loss)  from operations   |       | 4,505             |       | 1,610            |       | 408                   |       | 6,523             |       | 2,159 |   | 175 |   | 2,334 |   | (1,260 | ) | 7,597 |   |
|                                  |            |                   |            |                  |            |                       |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other  & Elim** | ** ** | **Consol  Total** | ** ** |
|----------------------------------|------------|-------------------|------------|------------------|------------|-----------------------|------------|-------------------|------------|
| **Three months ended 2004**      | ** ** | **U.S.**          | ** ** | **Germany**      | ** ** | **Other**             | ** ** | **Total**         | ** ** | **U.S.** | ** ** | **Other** | ** ** | **Total** | ** ** | ** ** | ** ** |
| Net sales to  external customers |       | $                 | 27,213     |             | $          | 9,502                 |       | $                 | 5,605      |   | $ | 42,320 |   | $ | 38,938 |   | $ | 1,288 |   | $ | 40,226 |   | $ | — |   | $ | 82,546 |   |
| Income (loss)  from operations   |       | 3,176             |       | 839              |       | 614                   |       | 4,629             |       | 1,474 |   | 55 |   | 1,529 |   | (603 | ) | 5,555 |   |
|                                  |            |                   |            |                  |            |                       |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other  & Elim** | ** ** | **Consol  Total** | ** ** |
|----------------------------------|------------|-------------------|------------|------------------|------------|-----------------------|------------|-------------------|------------|
| **Three months ended 2004**      | ** ** | **U.S.**          | ** ** | **Germany**      | ** ** | **Other**             | ** ** | **Total**         | ** ** | **U.S.** | ** ** | **Other** | ** ** | **Total** | ** ** | ** ** | ** ** |
| Net sales to  external customers |       | $                 | 84,478     |             | $          | 30,421                |       | $                 | 23,352     |   | $ | 138,251 |   | $ | 126,167 |   | $ | 3,984 |   | $ | 130,151 |   | $ | — |   | $ | 268,402 |   |
| Income (loss)  from operations   |       | 9,081             |       | 5,031            |       | 2,079                 |       | 16,191            |       | 8,979 |   | 233 |   | 9,212 |   | (2,495 | ) | 22,908 |   |
|                                  |            |                   |            |                  |            |                       |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Other  & Elim** | ** ** | **Consol  Total** | ** ** |
|----------------------------------|------------|-------------------|------------|------------------|------------|-----------------------|------------|-------------------|------------|
| **Three months ended 2004**      | ** ** | **U.S.**          | ** ** | **Germany**      | ** ** | **Other**             | ** ** | **Total**         | ** ** | **U.S.** | ** ** | **Other** | ** ** | **Total** | ** ** | ** ** | ** ** |
| Net sales to  external customers |       | $                 | 73,598     |             | $          | 29,530                |       | $                 | 16,437     |   | $ | 119,565 |   | $ | 120,178 |   | $ | 3,347 |   | $ | 123,525 |   | $ | — |   | $ | 243,090 |   |
| Income (loss)  from operations   |       | 5,594             |       | 2,801            |       | 1,864                 |       | 10,259            |       | 6,056 |   | 102 |   | 6,158 |   | (1,648 | ) | 14,769 |   |
|                                  |            |                   |            |                  |            |                       |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**(14)         Summary of Guarantees**

 

During 2001, we completed a $150.0 million 8.75%Senior Note offering.  At the end of2002, we repurchased $4.7 million of these Senior Notes at 99.25%.  On February 4, 2004, we issued an additional$29.0 million of these Senior Notes at 106.3%.

 

Our payment obligations under the 8.75% Senior Notesare fully and unconditionally guaranteed on a joint and several basis byConn-Selmer, Steinway, and certain other of our direct and indirectwholly-owned subsidiaries, each a Guarantor (the “Guarantor Subsidiaries”).  These subsidiaries represent all of our (the “Issuer”)operations conducted in the United States. The remaining subsidiaries, which do not guarantee the 8.75% SeniorNotes, represent non-U.S. operations (the “Non Guarantor Subsidiaries”).

 

The following condensed consolidating supplementarydata illustrates the financial position, results of operations, and cash flowsof the Guarantor Subsidiaries and the Non Guarantor Subsidiaries.  Separate complete financial statements of therespective Guarantors would not provide additional material information thatwould be useful in assessing the financial composition of the GuarantorSubsidiaries.  No single GuarantorSubsidiary has any significant legal restrictions on the ability of investorsor creditors to obtain access to its assets in event of default on theguarantee other than its subordination to senior indebtedness.

 

19

----

 

We record investments insubsidiaries on the cost method for purposes of the supplemental consolidatingpresentation.  Earnings of subsidiariesare therefore not reflected in the parent company’s investment accounts andearnings.  The principal eliminationentries eliminate investments in subsidiaries and intercompany balances andtransactions.

 

20

----

 

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

**CONSOLIDATINGSTATEMENTS OF INCOME**

** THREE MONTHS ENDED SEPTEMBER 30, 2004**

**Unaudited**

** (In Thousands)**

 
| ** **                         | ** ** | **Issuer   of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|-----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                  |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                     | —     |                        | $          | 80,822                           |       | $                          | 18,198     |             | $          | (4,367 | ) | $ | 94,653 |   |
| Cost of sales                      |       | —                |       | 61,962                      |       | 11,058                           |       | (4,263                     | )          | 68,757           |       |
|                               |       |                  |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —                |       | 18,860                      |       | 7,140                            |       | (104                       | )          | 25,896           |       |
|                               |       |                  |       |                        |       |                             |       |                       |       |             |       |
| Operating  expenses:               |       |                  |       |                        |       |                             |       |                       |       |             |       |
| Sales and  marketing               |       | —                |       | 7,321                       |       | 3,144                            |       | —                     |       | 10,465           |       |
| General and  administrative        |       | 2,465                 |       | 3,470                       |       | 1,423                            |       | —                     |       | 7,358            |       |
| Amortization of  intangible assets |       | 116                   |       | 152                         |       | 1                                |       | —                     |       | 269              |       |
| Other operating  (income) expense  |       | (1,356                | )          | 1,121                       |       | 442                              |       | —                     |       | 207              |       |
| Total operating  expenses          |       | 1,225                 |       | 12,064                      |       | 5,010                            |       | —                     |       | 18,299           |       |
|                               |       |                  |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  from operations     |       | (1,225                | )          | 6,796                       |       | 2,130                            |       | (104                       | )          | 7,597            |       |
|                               |       |                  |       |                        |       |                             |       |                       |       |             |       |
| Other (income)  expense, net       |       | 4                     |       | (449                        | )          | (361                             | )          | —                     |       | (806             | )          |
| Interest income                    |       | (3,661                | )          | (5,534                      | )          | (48                              | )          | 8,731                      |       | (512             | )          |
| Interest expense                   |       | 3,853                 |       | 9,019                       |       | 61                               |       | (8,731                     | )          | 4,202            |       |
|                               |       |                  |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  before income taxes |       | (1,421                | )          | 3,760                       |       | 2,478                            |       | (104                       | )          | 4,713            |       |
|                               |       |                  |       |                        |       |                             |       |                       |       |             |       |
| Income taxes                       |       | (554                  | )          | 1,511                       |       | 942                              |       | (14                        | )          | 1,885            |       |
|                               |       |                  |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                 |       | $                     | (867       | )                           | $          | 2,249                            |       | $                          | 1,536      |             | $          | (90 | ) | $ | 2,828 |   |

 

21

----

 

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

**CONSOLIDATINGSTATEMENTS OF INCOME**

**THREEMONTHS ENDED SEPTEMBER 27, 2003**

**Unaudited**

**(InThousands)**

 
| ** **                         | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                    | —     |                        | $          | 67,660                           |       | $                          | 17,240     |             | $          | (2,354 | ) | $ | 82,546 |   |
| Cost of sales                      |       | —               |       | 50,267                      |       | 11,613                           |       | (2,225                     | )          | 59,655           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —               |       | 17,393                      |       | 5,627                            |       | (129                       | )          | 22,891           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Operating  expenses:               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Sales and  marketing               |       | —               |       | 6,797                       |       | 2,602                            |       | (16                        | )          | 9,383            |       |
| General and  administrative        |       | 1,095                |       | 3,103                       |       | 1,282                            |       | —                     |       | 5,480            |       |
| Amortization of  intangible assets |       | 113                  |       | 174                         |       | 1                                |       | —                     |       | 288              |       |
| Other operating  (income) expense  |       | (768                 | )          | 628                         |       | 234                              |       | 16                         |       | 110              |       |
| Facility  rationalization charges  |       | —               |       | 2,075                       |       | —                           |       | —                     |       | 2,075            |       |
| Total operating  expenses          |       | 440                  |       | 12,777                      |       | 4,119                            |       | —                     |       | 17,336           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  from operations     |       | (440                 | )          | 4,616                       |       | 1,508                            |       | (129                       | )          | 5,555            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Other (income)  expense, net       |       | 8                    |       | (553                        | )          | (154                             | )          | —                     |       | (699             | )          |
| Interest income                    |       | (3,657               | )          | (5,060                      | )          | (15                              | )          | 8,380                      |       | (352             | )          |
| Interest expense                   |       | 3,281                |       | 8,538                       |       | 102                              |       | (8,380                     | )          | 3,541            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  before income taxes |       | (72                  | )          | 1,691                       |       | 1,575                            |       | (129                       | )          | 3,065            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income taxes                       |       | (25                  | )          | 107                         |       | 1,202                            |       | (57                        | )          | 1,227            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                 |       | $                    | (47        | )                           | $          | 1,584                            |       | $                          | 373        |             | $          | (72 | ) | $ | 1,838 |   |

 

22

----

 

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

**CONSOLIDATINGSTATEMENTS OF INCOME**

**NINEMONTHS ENDED SEPTEMBER 30, 2004**

**Unaudited**

**(InThousands)**

 
| ** **                         | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                    | —     |                        | $          | 220,016                          |       | $                          | 59,344     |             | $          | (10,958 | ) | $ | 268,402 |   |
| Cost of sales                      |       | —               |       | 166,069                     |       | 37,248                           |       | (10,939                    | )          | 192,378          |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —               |       | 53,947                      |       | 22,096                           |       | (19                        | )          | 76,024           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Operating  expenses:               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Sales and  marketing               |       | —               |       | 23,005                      |       | 9,275                            |       | 18                         |       | 32,298           |       |
| General and  administrative        |       | 5,290                |       | 10,012                      |       | 4,469                            |       | —                     |       | 19,771           |       |
| Amortization of  intangible assets |       | 348                  |       | 464                         |       | 3                                |       | —                     |       | 815              |       |
| Other operating  (income) expense  |       | (3,137               | )          | 2,318                       |       | 1,069                            |       | (18                        | )          | 232              |       |
| Total operating  expenses          |       | 2,501                |       | 35,799                      |       | 14,816                           |       | —                     |       | 53,116           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  from operations     |       | (2,501               | )          | 18,148                      |       | 7,280                            |       | (19                        | )          | 22,908           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Other (income)  expense, net       |       | 4                    |       | (1,102                      | )          | (1,054                           | )          | —                     |       | (2,152           | )          |
| Interest income                    |       | (10,975              | )          | (16,655                     | )          | (146                             | )          | 26,036                     |       | (1,740           | )          |
| Interest expense                   |       | 11,339               |       | 26,482                      |       | 209                              |       | (26,036                    | )          | 11,994           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  before income taxes |       | (2,869               | )          | 9,423                       |       | 8,271                            |       | (19                        | )          | 14,806           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income taxes                       |       | (1,118               | )          | 3,799                       |       | 3,237                            |       | 2                          |       | 5,920            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                 |       | $                    | (1,751     | )                           | $          | 5,624                            |       | $                          | 5,034      |             | $          | (21 | ) | $ | 8,886 |   |

 

23

----

 

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

**CONSOLIDATINGSTATEMENTS OF INCOME**

**NINEMONTHS ENDED SEPTEMBER 27, 2003**

**Unaudited**

**(InThousands)**

 
| ** **                         | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net sales                          |       | $                    | —     |                        | $          | 199,927                          |       | $                          | 51,463     |             | $          | (8,300 | ) | $ | 243,090 |   |
| Cost of sales                      |       | —               |       | 151,028                     |       | 33,684                           |       | (8,058                     | )          | 176,654          |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                       |       | —               |       | 48,899                      |       | 17,779                           |       | (242                       | )          | 66,436           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Operating  expenses:               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Sales and  marketing               |       | —               |       | 22,855                      |       | 8,549                            |       | (64                        | )          | 31,340           |       |
| General and  administrative        |       | 3,382                |       | 9,786                       |       | 3,801                            |       | —                     |       | 16,969           |       |
| Amortization of  intangible assets |       | 339                  |       | 523                         |       | 3                                |       | —                     |       | 865              |       |
| Other operating  (income) expense  |       | (2,368               | )          | 2,063                       |       | 659                              |       | 64                         |       | 418              |       |
| Facility  rationalization charges  |       | —               |       | 2,075                       |       | —                           |       | —                     |       | 2,075            |       |
| Total operating  expenses          |       | 1,353                |       | 37,302                      |       | 13,012                           |       | —                     |       | 51,667           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  from operations     |       | (1,353               | )          | 11,597                      |       | 4,767                            |       | (242                       | )          | 14,769           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Other (income)  expense, net       |       | 8                    |       | (1,750                      | )          | (290                             | )          | —                     |       | (2,032           | )          |
| Interest income                    |       | (10,971              | )          | (15,458                     | )          | (56                              | )          | 25,012                     |       | (1,473           | )          |
| Interest expense                   |       | 9,842                |       | 25,549                      |       | 262                              |       | (25,012                    | )          | 10,641           |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss)  before income taxes |       | (232                 | )          | 3,256                       |       | 4,851                            |       | (242                       | )          | 7,633            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income taxes                       |       | (81                  | )          | 1,478                       |       | 1,658                            |       | (103                       | )          | 2,952            |       |
|                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                 |       | $                    | (151       | )                           | $          | 1,778                            |       | $                          | 3,193      |             | $          | (139 | ) | $ | 4,681 |   |

 

24

----

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATING BALANCE SHEETS**

**SEPTEMBER30, 2004**

**Unaudited**

**(InThousands)**

** **
| ** **                                       | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| ASSETS                                           |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current assets:                                  |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash                                             |       | $                    | —     |                        | $          | 5,654                            |       | $                          | 8,464      |             | $          | — |   | $ | 14,118 |   |
| Accounts, notes  and leases receivable, net      |       | —               |       | 97,398                      |       | 9,678                            |       | —                     |       | 107,076          |       |
| Inventories                                      |       | —               |       | 137,243                     |       | 40,299                           |       | (1,150                     | )          | 176,392          |       |
| Prepaid expenses  and other current assets       |       | 401                  |       | 2,521                       |       | 1,121                            |       | —                     |       | 4,043            |       |
| Deferred tax  assets                             |       | —               |       | 8,152                       |       | 5,092                            |       | —                     |       | 13,244           |       |
| Total current  assets                            |       | 401                  |       | 250,968                     |       | 64,654                           |       | (1,150                     | )          | 314,873          |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Property, plant  and equipment, net              |       | 171                  |       | 83,980                      |       | 16,514                           |       | —                     |       | 100,665          |       |
| Investment in  subsidiaries                      |       | 69,643               |       | 276,889                     |       | —                           |       | (346,532                   | )          | —           |       |
| Trademarks                                       |       | —               |       | 6,463                       |       | 3,993                            |       | —                     |       | 10,456           |       |
| Goodwill                                         |       | —               |       | 18,795                      |       | 12,725                           |       | —                     |       | 31,520           |       |
| Other  intangibles, net                          |       | 3,054                |       | 2,514                       |       | 1                                |       | —                     |       | 5,569            |       |
| Other assets                                     |       | 3,033                |       | 12,451                      |       | 2,994                            |       | —                     |       | 18,478           |       |
| TOTAL ASSETS                                     |       | $                    | 76,302     |                        | $          | 652,060                          |       | $                          | 100,881    |             | $          | (347,682 | ) | $ | 481,561 |   |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY       |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current  liabilities:                            |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current portion  of long-term debt               |       | $                    | —     |                        | $          | 6,611                            |       | $                          | 3,816      |             | $          | — |   | $ | 10,427 |   |
| Accounts payable                                 |       | 604                  |       | 9,162                       |       | 3,245                            |       | —                     |       | 13,011           |       |
| Other current  liabilities                       |       | (12,236              | )          | 45,233                      |       | 14,015                           |       | (300                       | )          | 46,712           |       |
| Total current  liabilities                       |       | (11,632              | )          | 61,006                      |       | 21,076                           |       | (300                       | )          | 70,150           |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Long-term debt                                   |       | 176,677              |       | 53,065                      |       | —                           |       | —                     |       | 229,742          |       |
| Intercompany                                     |       | (118,509             | )          | 119,533                     |       | (1,024                           | )          | —                     |       | —           |       |
| Deferred tax  liabilities                        |       | —               |       | 16,204                      |       | 9,159                            |       | 27                         |       | 25,390           |       |
| Other  non-current liabilities                   |       | 803                  |       | 1,707                       |       | 18,142                           |       | —                     |       | 20,652           |       |
| Total  liabilities                               |       | 47,339               |       | 251,515                     |       | 47,353                           |       | (273                       | )          | 345,934          |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Stockholders’  equity                       |       | 28,963               |       | 400,545                     |       | 53,528                           |       | (347,409                   | )          | 135,627          |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY |       | $                    | 76,302     |                        | $          | 652,060                          |       | $                          | 100,881    |             | $          | (347,682 | ) | $ | 481,561 |   |

 

25

----

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATING BALANCE SHEETS**

**DECEMBER31, 2003**

**Unaudited**

**(InThousands)**

** **
| ** **                                       | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| ASSETS                                           |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current assets:                                  |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash                                             |       | $                    | —     |                        | $          | 12,255                           |       | $                          | 8,792      |             | $          | 21,236 |   | $ | 42,283 |   |
| Accounts, notes  and leases receivable, net      |       | —               |       | 63,180                      |       | 13,209                           |       | 14                         |       | 76,403           |       |
| Inventories                                      |       | —               |       | 117,922                     |       | 35,238                           |       | (1,131                     | )          | 152,029          |       |
| Prepaid expenses  and other current assets       |       | 660                  |       | 2,833                       |       | 1,040                            |       | —                     |       | 4,533            |       |
| Deferred tax  assets                             |       | —               |       | 8,157                       |       | 4,894                            |       | (29                        | )          | 13,022           |       |
| Total current  assets                            |       | 660                  |       | 204,347                     |       | 63,173                           |       | 20,090                     |       | 288,270          |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Property, plant  and equipment, net              |       | 172                  |       | 82,131                      |       | 16,634                           |       | —                     |       | 98,937           |       |
| Investment in  subsidiaries                      |       | 69,643               |       | 237,821                     |       | —                           |       | (307,464                   | )          | —           |       |
| Trademarks                                       |       | —               |       | 6,280                       |       | 4,039                            |       | —                     |       | 10,319           |       |
| Goodwill                                         |       | —               |       | 18,795                      |       | 12,870                           |       | —                     |       | 31,665           |       |
| Other  intangibles, net                          |       | 3,297                |       | 2,478                       |       | 7                                |       | —                     |       | 5,782            |       |
| Other assets                                     |       | 1,478                |       | 8,591                       |       | 623                              |       | —                     |       | 10,692           |       |
| TOTAL ASSETS                                     |       | $                    | 75,250     |                        | $          | 560,443                          |       | $                          | 97,346     |             | $          | (287,374 | ) | $ | 445,665 |   |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY       |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current  liabilities:                            |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current portion  of long-term debt               |       | $                    | —     |                        | $          | 6,559                            |       | $                          | 4,079      |             | $          | — |   | $ | 10,638 |   |
| Accounts payable                                 |       | 123                  |       | 7,881                       |       | 3,550                            |       | —                     |       | 11,554           |       |
| Other current  liabilities                       |       | (14,261              | )          | 39,572                      |       | 14,103                           |       | (302                       | )          | 39,112           |       |
| Total current  liabilities                       |       | (14,138              | )          | 54,012                      |       | 21,732                           |       | (302                       | )          | 61,304           |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Long-term debt                                   |       | 145,369              |       | 19,359                      |       | —                           |       | 21,236                     |       | 185,964          |       |
| Intercompany                                     |       | (112,543             | )          | 116,840                     |       | (4,311                           | )          | 14                         |       | —           |       |
| Deferred tax  liabilities                        |       | —               |       | 16,384                      |       | 9,181                            |       | —                     |       | 25,565           |       |
| Other  non-current liabilities                   |       | 515                  |       | 1,720                       |       | 17,962                           |       | —                     |       | 20,197           |       |
| Total  liabilities                               |       | 19,203               |       | 208,315                     |       | 44,564                           |       | 20,948                     |       | 293,030          |       |
|                                             |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Stockholders’  equity                       |       | 56,047               |       | 352,128                     |       | 52,782                           |       | (308,322                   | )          | 152,635          |       |
| .                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY |       | $                    | 75,250     |                        | $          | 560,443                          |       | $                          | 97,346     |             | $          | (287,374 | ) | $ | 445,665 |   |

 

26

----

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONSOLIDATING STATEMENTS OF CASH FLOWS**

**NINEMONTHS ENDED SEPTEMBER 30, 2004**

**Unaudited**

**(InThousands)**

** **
| ** **                                                                           | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| Cash flows from  operating activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                                                                   |       | $                    | (1,751     | )                           | $          | 5,624                            |       | $                          | 5,034      |             | $          | (21 | ) | $ | 8,886 |   |
| Adjustments to  reconcile net income (loss) to cash flows from operating activities: |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Depreciation and  amortization                                                       |       | 394                  |       | 6,486                       |       | 1,273                            |       | —                     |       | 8,153            |       |
| Amortization of  bond premium                                                        |       | (167                 | )          | —                      |       | —                           |       | —                     |       | (167             | )          |
| Deferred tax  benefit                                                                |       | —               |       | (175                        | )          | (148                             | )          | —                     |       | (323             | )          |
| Debt issuance  costs                                                                 |       | (105                 | )          | —                      |       | —                           |       | —                     |       | (105             | )          |
| Other                                                                                |       | —               |       | (13                         | )          | 118                              |       | —                     |       | 105              |       |
| Changes in  operating assets and liabilities:                                        |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Accounts, notes  and leases receivable                                               |       | —               |       | (20,647                     | )          | 3,339                            |       | —                     |       | (17,308          | )          |
| Inventories                                                                          |       | —               |       | 1,799                       |       | (6,039                           | )          | 19                         |       | (4,221           | )          |
| Prepaid expenses  and other assets                                                   |       | (1,301               | )          | (1,936                      | )          | (2,441                           | )          | —                     |       | (5,678           | )          |
| Accounts payable                                                                     |       | 481                  |       | (169                        | )          | (298                             | )          | —                     |       | 14               |       |
| Other  liabilities                                                                   |       | 2,358                |       | (17                         | )          | 512                              |       | 2                          |       | 2,855            |       |
| Cash flows from  operating activities                                                |       | (91                  | )          | (9,048                      | )          | 1,350                            |       | —                     |       | (7,789           | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  investing activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Capital  expenditures                                                                |       | (45                  | )          | (2,482                      | )          | (665                             | )          | —                     |       | (3,192           | )          |
| Proceeds from  disposal of fixed assets                                              |       | —               |       | 76                          |       | —                           |       | —                     |       | 76               |       |
| Acquisition of  subsidiary, net of cash acquired                                     |       | —               |       | (35,309                     | )          | —                           |       | —                     |       | (35,309          | )          |
| Cash flows from  investing activities                                                |       | (45                  | )          | (37,715                     | )          | (665                             | )          | —                     |       | (38,425          | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  financing activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Borrowings under  lines of credit                                                    |       | 661                  |       | 80,031                      |       | 7,419                            |       | (21,236                    | )          | 66,875           |       |
| Repayments under  lines of credit                                                    |       | —               |       | (41,289                     | )          | (7,639                           | )          | —                     |       | (48,928          | )          |
| Repayments of  long-term debt                                                        |       | —               |       | (4,984                      | )          | —                           |       | —                     |       | (4,984           | )          |
| Proceeds from  issuance of stock                                                     |       | 5,441                |       | —                      |       | —                           |       | —                     |       | 5,441            |       |
| Intercompany  transactions                                                           |       | (5,966               | )          | 6,346                       |       | (380                             | )          | —                     |       | —           |       |
| Cash flows from  financing activities                                                |       | 136                  |       | 40,104                      |       | (600                             | )          | (21,236                    | )          | 18,404           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Effect of  exchange rate changes on cash                                             |       | —               |       | 58                          |       | (413                             | )          | —                     |       | (355             | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Decrease in cash                                                                     |       | —               |       | (6,601                      | )          | (328                             | )          | (21,236                    | )          | (28,165          | )          |
| Cash, beginning  of period                                                           |       | —               |       | 12,255                      |       | 8,792                            |       | 21,236                     |       | 42,283           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash, end of  period                                                                 |       | $                    | —     |                        | $          | 5,654                            |       | $                          | 8,464      |             | $          | — |   | $ | 14,118 |   |

 

27

----

 

**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONSOLIDATING STATEMENTS OF CASH FLOWS**

**NINEMONTHS ENDED SEPTEMBER 27, 2003**

**Unaudited**

**(InThousands)**

** **
| ** **                                                                           | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| Cash flows from  operating activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                                                                   |       | $                    | (151       | )                           | $          | 1,778                            |       | $                          | 3,193      |             | $          | (139 | ) | $ | 4,681 |   |
| Adjustments to  reconcile net income (loss) to cash flows from operating activities: |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Depreciation and  amortization                                                       |       | 382                  |       | 6,656                       |       | 1,176                            |       | —                     |       | 8,214            |       |
| Deferred tax expense  (benefit)                                                      |       | —               |       | (176                        | )          | 407                              |       | —                     |       | 231              |       |
| Other                                                                                |       | 8                    |       | 105                         |       | 122                              |       | —                     |       | 235              |       |
| Facility  rationalization charges                                                    |       | —               |       | 2,075                       |       | —                           |       | —                     |       | 2,075            |       |
| Changes in  operating assets and liabilities:                                        |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Accounts, notes  and leases receivable                                               |       | —               |       | (15,849                     | )          | (573                             | )          | (90                        | )          | (16,512          | )          |
| Inventories                                                                          |       | —               |       | 6,836                       |       | (3,232                           | )          | 242                        |       | 3,846            |       |
| Prepaid expenses  and other assets                                                   |       | 203                  |       | 1,147                       |       | (562                             | )          | —                     |       | 788              |       |
| Accounts payable                                                                     |       | 326                  |       | (2,294                      | )          | 182                              |       | 78                         |       | (1,708           | )          |
| Other  liabilities                                                                   |       | 3,127                |       | 490                         |       | 363                              |       | (103                       | )          | 3,877            |       |
| Cash flows from  operating activities                                                |       | 3,895                |       | 768                         |       | 1,076                            |       | (12                        | )          | 5,727            |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  investing activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Capital  expenditures                                                                |       | (54                  | )          | (2,035                      | )          | (663                             | )          | —                     |       | (2,752           | )          |
| Capital  contribution to subsidiary                                                  |       | —               |       | (513                        | )          | 513                              |       | —                     |       | —           |       |
| Proceeds from  disposal of fixed assets                                              |       | —               |       | 4                           |       | —                           |       | —                     |       | 4                |       |
| Cash flows from  investing activities                                                |       | (54                  | )          | (2,544                      | )          | (150                             | )          | —                     |       | (2,748           | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from  financing activities:                                               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Borrowings under  lines of credit                                                    |       | —               |       | 5,119                       |       | 3,346                            |       | —                     |       | 8,465            |       |
| Repayments under  lines of credit                                                    |       | (29                  | )          | (8,636                      | )          | (2,404                           | )          | 3,546                      |       | (7,523           | )          |
| Repayment of  long-term debt                                                         |       | —               |       | (4,874                      | )          | —                           |       | —                     |       | (4,874           | )          |
| Proceeds from  issuance of stock                                                     |       | 501                  |       | —                      |       | —                           |       | —                     |       | 501              |       |
| Intercompany  transactions                                                           |       | (4,313               | )          | 9,665                       |       | (5,364                           | )          | 12                         |       | —           |       |
| Cash flows from  financing activities                                                |       | (3,841               | )          | 1,274                       |       | (4,422                           | )          | 3,558                      |       | (3,431           | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Effect of  exchange rate changes on cash                                             |       | —               |       | —                      |       | 66                               |       | —                     |       | 66               |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Increase  (decrease) in cash                                                         |       | —               |       | (502                        | )          | (3,430                           | )          | 3,546                      |       | (386             | )          |
| Cash, beginning  of period                                                           |       | —               |       | 1,871                       |       | 6,031                            |       | 11,197                     |       | 19,099           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash, end of  period                                                                 |       | $                    | —     |                        | $          | 1,369                            |       | $                          | 2,601      |             | $          | 14,743 |   | $ | 18,713 |   |

 

28

----

 

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

**(TabularAmounts in Thousands Except Share and Per Share Data)**

** **

**Introduction**

 

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

 

**Critical Accounting Policies**

 

The nature of ourbusiness - the production and sale of musical instruments - is such that itrarely involves application of highly complex or subjective accountingprinciples.  The accounting policies thatare subject to significant management estimates are those normally found intraditional businesses and include inventory reserves, accounts receivablereserves, reserves on notes receivable, recourse reserves on notes receivable,and warranty reserves.  We havesignificant experience and data on which to base these estimates.  Historical information is adjusted forspecific uncertainties, such as new product introductions, and contemporaneousinformation, such as price fluctuations.  The allocation of purchase price forbusinesses acquired also requires substantial judgment. Management regularlyperforms assessments of the underlying assumptions and believes that theyprovide a reasonable basis for the estimates contained in our financialstatements.

 

**Forward-Looking Statements**

 

Certain statementscontained in this document are “forward-looking statements” within the meaningof Section 21E of the Securities and Exchange Act of 1934, as amended.  These forward-looking statements representour present expectations or beliefs concerning future events.  We caution that such statements arenecessarily based on certain assumptions which are subject to risks anduncertainties which could cause actual results to differ materially from thoseindicated in this report.  These riskfactors include, but are not limited to, the following:  changes in general economic conditions;geopolitical events; increased competition; work stoppages and slowdowns; exchangerate fluctuations; variations in the mix of products sold; market acceptance ofnew band instrument product and distribution strategies; ability of suppliersto meet demand; fluctuations in effective tax rates resulting from shifts insources of income; and the ability to successfully integrate and operateacquired businesses.  Further informationon these risk factors is included in our Annual Report on Form 10-K for theyear ended December 31, 2003, our Final Prospectus filed in August 1996, and RegistrationStatement No. 333-62790 filed in June 2001, particularly in the sectionsentitled “Risk Factors.”  We encourageyou to read those descriptions carefully. We caution investors not to place undue reliance on the forward-lookingstatements contained in this report. These statements, like all statements contained in this report, speakonly as of the date of this report (unless another date is indicated) and weundertake no obligation to update or revise the statements except as requiredby law.

 

29

----

 

**Resultsof Operations**

 

*Three Months Ended September 30,2004 Compared to Three Months Ended September 27, 2003*

* *
| ** **                  | ** ** | **Quarter Ended**       | ** ** | ** ** | ** ** | **Change**              | ** ** |
|-----------------------------|------------|-------------------------|------------|------------|------------|-------------------------|------------|
| ** **                  | ** ** | **September 30,  2004** | ** ** | ** ** | ** ** | **September 27,  2003** | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Net sales                   |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Band                        |       | $                       | 47,052     |       |       |                    | $          | 40,226 |   |   |   | 6,826 |   | 17.0 |   |
| Piano                       |       | 47,601                  |       |       |       | 42,320                  |       |   |   | 5,281 |   | 12.5 |   |
| Total sales                 |       | 94,653                  |       |       |       | 82,546                  |       |   |   | 12,107 |   | 14.7 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Cost of sales               |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Band                        |       | 38,456                  |       |       |       | 30,754                  |       |   |   | 7,702 |   | 25.0 |   |
| Piano                       |       | 30,301                  |       |       |       | 28,901                  |       |   |   | 1,400 |   | 4.8 |   |
| Total cost of  sales        |       | 68,757                  |       |       |       | 59,655                  |       |   |   | 9,102 |   | 15.3 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Gross profit                |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Band                        |       | 8,596                   |       | 18.3%      |       | 9,472                   |       | 23.5% |   | (876 | ) | (9.2 | ) |
| Piano                       |       | 17,300                  |       | 36.3%      |       | 13,419                  |       | 31.7% |   | 3,881 |   | 28.9 |   |
| Total gross  profit         |       | 25,896                  |       |       |       | 22,891                  |       |   |   | 3,005 |   | 13.1 |   |
|                        |       | 27.4%                   |       |       |       | 27.7%                   |       |   |   |   |   |   |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Operating  expenses         |       | 18,299                  |       |       |       | 17,336                  |       |   |   | 963 |   | 5.6 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Income from  operations     |       | 7,597                   |       |       |       | 5,555                   |       |   |   | 2,042 |   | 36.8 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Other income,  net          |       | (806                    | )          |       |       | (699                    | )          |   |   | (107 | ) | 15.3 |   |
| Net interest  expense       |       | 3,690                   |       |       |       | 3,189                   |       |   |   | 501 |   | 15.7 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Income before  income taxes |       | 4,713                   |       |       |       | 3,065                   |       |   |   | 1,648 |   | 53.8 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Income taxes                |       | 1,885                   |       | 40.0%      |       | 1,227                   |       | 40.0% |   | 658 |   | 53.6 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Net income                  |       | $                       | 2,828      |       |       |                    | $          | 1,838 |   |   |   | 990 |   | 53.9 |   |

 

*Overview –* Weacquired substantially all of the assets of G. Leblanc Corporation, ahigh-quality band instrument manufacturer, on August 12, 2004.  Leblanc’s complete line of wind instrumentsand accessories is complementary to our existing product lines.  We expect to gain or strengthen market sharein certain instrument areas as a result of this acquisition.  Our core band results were somewhat disappointingfor the quarter. Although we experienced an increase in sales volume, the highproduction costs associated with these sales, as well as reduced productionlevels at some of our plants, continued to adversely impact band gross margins.

 

30

----

 

The performance of ourpiano division improved over the year ago quarter.  Our domestic operations experienced increasesin both wholesale and retail sales volume, and our European and Asianoperations also had improvements in sales and gross margin.

 

*Net Sales –*The increase in net sales of $12.1 millionresulted in part from an 8% increase in Steinway grand unit shipments, as wellas $0.7 million in benefit attributable to foreign exchange.  A 10% increase in Boston product shipmentsalso contributed to the sales improvement of the piano division.  Our band division sales increased $6.8million, $4.5 of which was generated from sales of Leblanc product since theacquisition date.  The remaining increaseis attributable to sales of student band instruments to dealers who neededproduct to fulfill back-to-school demand, as well as a 16% increase inpercussion unit shipments.

 

*G**ross Profit –* Gross profit increased $3.0 million due to thehigher overall sales and improved margin performance for the pianodivision.  Piano margins increased from31.7% to 36.3% due to strong domestic retail sales and a favorable shift in mixtowards higher margin grand units sold by our international divisions.  The increase in production days at ourdomestic piano factory also had a favorable impact on piano gross profit.  Band gross margins declined from 23.5% to18.3% because we sold instruments that had higher costs resulting from ourreduced production levels in 2003.  Inaddition, the $0.9 million charge to cost of sales that arose from the write-upof Leblanc inventory to fair value also negatively impacted gross margin.

 

*Operating Expenses* – Despite theabsence of impairment charges of $2.1 million that resulted from our 2003 facilityrationalization project, operating expenses increased $1.0 million. In thecurrent period we incurred $1.2 million in professional service fees associatedwith regulatory compliance projects, $0.6 million in expenses attributable toLeblanc, and $0.4 million resulting from foreign currency translation.  Consistent with the sales improvement, weincurred $0.8 million more in sales and marketing costs primarily associatedwith increased promotions and commissions.

 

*Interest Expense and Other Income, Net –*These other expenses increased $0.4 million to$2.9 million due to the additional interest expense resulting from our issuanceof an additional $29.0 million in 8.75% Senior Notes in February, 2004.

 

*Income Taxes* –**Our effective tax rate of 40% is consistentwith the prior period.

 

31

----

 

*NineMonths**Ended September 30, 2004Compared to Nine Months Ended September 27, 2003*

* *
| ** **                  | ** ** | **Nine Months Ended**   | ** ** | ** ** | ** ** | **Change**              | ** ** |
|-----------------------------|------------|-------------------------|------------|------------|------------|-------------------------|------------|
| ** **                  | ** ** | **September 30,  2004** | ** ** | ** ** | ** ** | **September 27,  2003** | ** ** | ** ** | ** ** | **$** | ** ** | **%** | ** ** |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Net sales                   |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Band                        |       | $                       | 130,151    |       |       |                    | $          | 123,525 |   |   |   | 6,626 |   | 5.4 |   |
| Piano                       |       | 138,251                 |       |       |       | 119,565                 |       |   |   | 18,686 |   | 15.6 |   |
| Total sales                 |       | 268,402                 |       |       |       | 243,090                 |       |   |   | 25,312 |   | 10.4 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Cost of sales               |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Band                        |       | 102,616                 |       |       |       | 96,033                  |       |   |   | 6,583 |   | 6.9 |   |
| Piano                       |       | 89,762                  |       |       |       | 80,621                  |       |   |   | 9,141 |   | 11.3 |   |
| Total cost of  sales        |       | 192,378                 |       |       |       | 176,654                 |       |   |   | 15,724 |   | 8.9 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Gross profit                |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Band                        |       | 27,535                  |       | 21.2%      |       | 27,492                  |       | 22.3% |   | 43 |   | 0.2 |   |
| Piano                       |       | 48,489                  |       | 35.1%      |       | 38,944                  |       | 32.6% |   | 9,545 |   | 24.5 |   |
| Total gross  profit         |       | 76,024                  |       |       |       | 66,436                  |       |   |   | 9,588 |   | 14.4 |   |
|                        |       | 28.3%                   |       |       |       | 27.3%                   |       |   |   |   |   |   |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Operating  expenses         |       | 53,116                  |       |       |       | 51,667                  |       |   |   | 1,449 |   | 2.8 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Income from  operations     |       | 22,908                  |       |       |       | 14,769                  |       |   |   | 8,139 |   | 55.1 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Other income,  net          |       | (2,152                  | )          |       |       | (2,032                  | )          |   |   | (120 | ) | 5.9 |   |
| Net interest  expense       |       | 10,254                  |       |       |       | 9,168                   |       |   |   | 1,086 |   | 11.8 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Income before  income taxes |       | 14,806                  |       |       |       | 7,633                   |       |   |   | 7,173 |   | 94.0 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Income taxes                |       | 5,920                   |       | 40.0%      |       | 2,952                   |       | 38.7% |   | 2,968 |   | 100.5 |   |
|                        |       |                    |       |       |       |                    |       |   |   |   |   |   |   |
| Net income                  |       | $                       | 8,886      |       |       |                    | $          | 4,681 |   |   |   | 4,205 |   | 89.8 |   |

 

*Overview –*We are continuing to implement our strategicplans in our band business.  Our newproduct introduction and channel distribution strategies have been accepted bythe marketplace and we recently acquired substantially all of the assets of G.Leblanc Corporation, which will enable us to offer additional wind instrumentsthat are complementary to our existing product lines.  Despite the increase in revenues, productsproduced domestically in the prior year continued to have lingering adverseeffects on our gross margins.

 

32

----

 

Our piano division was ableto significantly improve performance over the year ago period. Domestically,demand has fueled sales increases, especially at the retail level, andinternationally we were able to capitalize on recent improvements in the Asianeconomy.

 

*Net Sales–*The increase in net sales of $25.3 millionresulted from an 11% increase in Steinway grand unit shipments, which wereprimarily attributable to domestic operations, and a similar increase inoverall Boston product shipments.  A $5.1million benefit attributable to foreign exchange also contributed to theimprovement.  The sales results for theband division increased $6.6 million, the majority of which was attributable toLeblanc product sales of $4.5 million in the third quarter.  The remaining $2.1 million resulted fromrecent improvements caused by the increased demand for band instrument productsas school music dealers ordered product for the back-to-school season.  Demand for our percussion products remainedstrong throughout the period, also contributing to the sales improvement.

 

*G**ross Profit–* Gross profit increased $9.6 million as pianomargins increased from 32.6% to 35.1%. The improvement in domestic retail sales, increased productivity in ourdomestic factory, and a favorable product mix sold by our European divisionsall contributed to the increase in piano gross profit.  In 2003, band gross profit was adverselyimpacted by $1.9 million in payments to employees in accordance with expiredlabor contracts,  $1.3 million from workstoppages at two of our plants, and $0.3 million in severance costs associatedwith our facility rationalization project. In 2004, gross profit was negatively impacted by $1.4 million inseverance costs related to the same project, and a $0.9 million charge to costof sales that arose from the write-up of Leblanc inventory to fair value.  Despite the decrease in these atypicalcharges, the band division’s gross margin deteriorated from 22.3% to 21.2% forthe period as we sold instruments that had higher costs resulting from ourreduced production levels in 2003.

 

*Operating Expenses**–* Although the current period did not include $2.1 millionin impairment charges associated with our facility rationalization project asin the prior year, operating expenses still increased $1.4 million.  The major contributors to the increaseinclude the following:  $1.2 million in professionalservice costs associated with regulatory compliance projects, $1.2 million as aresult of foreign currency translation, and $0.6 million attributable toLeblanc operations since the date of acquisition.   Sales and promotional expenses, increasedcommissions, and bonuses also contributed to the increase.

 

*Interest Expense and Other Income, Net –*These other expenses increased $1.0million to $8.1 million primarily due to the additional interest expenseresulting from our issuance of an additional $29.0 million in 8.75% SeniorNotes in February, 2004.

 

*Income Taxes**–*Asa result of the strengthening of our domestic piano and band divisions andchanges in tax legislation in certain states in which we do business, oureffective tax rate has increased from 38.7% to 40.0% in the current period.

 

33

----

 

**Liquidity and Capital Resources**

 

We have relied primarilyupon cash provided by operations, supplemented as necessary by seasonalborrowings under our working capital line, to finance our operations, repaylong-term indebtedness and fund capital expenditures.

 

Our statements of cashflows for the nine months ended September 30, 2004 and September 27, 2003 aresummarized as follows:

 
| ** **                                                                   | ** ** | **2004** | ** ** | **2003** | ** ** | **Change** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
| Net income:                                                                  |       | $        | 8,886      |     | $          | 4,681      |       | $ | 4,205 |   |
| Changes in  operating assets and liabilities                                 |       | (24,338  | )          | (9,709   | )          | (14,629    | )          |
| Other  adjustments to reconcile net income to cash from operating activities |       | 7,663    |       | 10,755   |       | (3,092     | )          |
| Cash flows from  operating activities                                        |       | (7,789   | )          | 5,727    |       | (13,516    | )          |
|                                                                         |       |     |       |     |       |       |       |
| Cash flows from  investing activities                                        |       | (38,425  | )          | (2,748   | )          | (35,677    | )          |
|                                                                         |       |     |       |     |       |       |       |
| Cash flows from  financing activities                                        |       | 18,404   |       | (3,431   | )          | 21,835     |       |
|                                                                              |            |          |            |          |            |            |            |  |  |  |

 

Cash flows from operatingactivities decreased $13.5 million.  Thisresulted from our use of an additional $8.1 million associated with increasesin inventory purchases and production levels, which were comparatively low inthe prior year, in part due to strikes at our Eastlake, Ohio and La Grange,Illinois manufacturing facilities.  Theremaining use was associated with the funding of workers compensationdepositary trust accounts, the anticipated refund of $2.2 million resultingfrom adjustments to the estimated purchase price for Leblanc, and the timing ofpayments against accrued liabilities.

 

The usage of in cash for investingactivities of $35.7 million is primarily due to our acquisition of certainassets and liabilities of G.Leblanc Corporation in August 2004.  The increase in cash flows from financingactivities of $21.8 million resulted primarily from borrowings on our domesticline of credit, which was used to finance the Leblanc acquisition.  In addition, stock option exercises and stockpurchase plan activities contributed $5.4 million to cash flows.

 

## **Borrowing Availability and Activities**

 

Our real estate termloan, acquisition term loan and domestic seasonal borrowing requirements areaccommodated through a committed credit facility with a syndicate of domesticlenders (the “Credit Facility”).  TheCredit Facility provides us with a potential borrowing capacity of up to $85.0million in revolving credit loans, based on eligible accounts receivable andinventory balances.  The acquisition termloan and revolving credit loan portions of the Credit Facility bear interest ataverage 30-day LIBOR plus 1.75%, and the real estate term loan bears interestat average 30-day LIBOR plus 1.5%.  TheCredit facility expires on September 14, 2008. As of September 30, 2004, there was $18.2 million in revolving creditloans outstanding and availability based on eligible accounts receivable andinventory balances, net of letter of credit deductions of $2.3 million, wasapproximately $64.5 million.  Openaccount loans with foreign banks also provide for borrowings by Steinway’sforeign subsidiaries of up to €12.6 million ($15.7 million at the September 30,2004 exchange rate), net of borrowing restrictions of €0.4 million ($0.5million at the September 30, 2004 exchange rate), and ¥600 million ($5.5million at the September 30, 2004 exchange rate).  A portion of the euro account loans can beconverted into a maximum of £0.5 million ($0.9 million at the September 30,2004 exchange rate) for use by our UK branch. We had $3.8 million in foreign loans outstanding as of September 30,2004.

 

34

----

 

On February 4, 2004 wepurchased 1,271,450 shares of our Ordinary common stock directly from our then largestinstitutional shareholder.  In exchange,we issued $29.0 million in principal amount of our 8.75% Senior Notes due 2011under the existing indenture.  We issuedthese bonds at a premium of 106.3%.  Thistransaction increased our treasury stock by $31.6 million.

 

Our bond indenturecontains limitations based on net income (among other things) on the amount ofdiscretionary repurchases we may make of our Ordinary common stock.  As a result of the February 4th stockrepurchase, we have approached the current limitation.  Although this limitation will increase overtime, we currently have no short-term plans to repurchase additional Ordinarycommon stock either directly from shareholders or on the open market.

 

Our long-term financingconsists primarily of $174.3 million of 8.75% Senior Notes, $18.2 million inrevolving credit notes outstanding under the Credit Facility, and $42.2 millionof term loans outstanding under the Credit Facility. Our debt agreementscontain covenants that place certain restrictions on us, including our abilityto incur additional indebtedness, to make investments in other entities and topay cash dividends.  We were incompliance with all such covenants as of September 30, 2004.

 

Our facilityrationalization project, which was started in 2003, is substantially complete,as we closed one of our Elkhart, Indiana woodwind manufacturing facilities onApril 1, 2004.  We have an additionalannual interest requirement of $2.5 million as a result of the $29.0 millionbond issuance described above. We do not expect any residual effects from ourfacility rationalization project or our additional interest obligations to havea material impact on our liquidity.

 

On August 12, 2004 wepurchased substantially all of the assets of G. Leblanc Corporation, amanufacturer of high-quality band instruments, for $35.4 million.  The purchase is subject to customary closingconditions and purchase price adjustments. We funded this acquisition with approximately $22.0 million in cash,supplemented by borrowings on our credit facility.  We expect to pay off the borrowingsassociated with the acquisition by the end of 2004.  Although we anticipate approximately $12.0million in revenue to be generated by Leblanc in 2004, we do not expect amaterial impact on earnings until we sell through acquired inventory.  We expect this to occur by mid-2005.  We are not aware of any other trends,demands, commitments, or costs of resources that are expected to materiallyimpact liquidity or capital resources. Therefore, we believe that cash on hand, together with cash flowsanticipated from operations and available borrowings under the Credit Facility,will be adequate to meet existing debt service requirements, fund continuingcapital requirements and satisfy working capital and general corporate needsfor the next twelve months.

 

We have reserved 721,750shares of our existing treasury stock to be utilized for the exercise ofoutstanding stock options under our Amended and Restated 1996 Stock Plan.  These options will have no impact on our cashflow or the number of shares outstanding unless and until the options areexercised.

 

35

----

 

**ContractualObligations**

 

The followingtable provides a summary of our contractual obligations at September 30, 2004:

 
| ** **                       | ** ** | **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)              |       | $                          | 238,522    |   | $ | 10,427 |   | $ | 16,436 |   | $ | 37,314 |   | $ | 174,345 |   |
| Operating leases  (2)            |       | 274,185                    |       | 5,266 |   | 8,827 |   | 6,960 |   | 253,132 |   |
| Purchase  obligations (3)        |       | 10,549                     |       | 10,147 |   | 288 |   | 114 |   | — |   |
| Other long-term  liabilities (4) |       | 18,946                     |       | 1,512 |   | 3,023 |   | 3,023 |   | 11,388 |   |
| Total                            |       | $                          | 542,202    |   | $ | 27,352 |   | $ | 28,574 |   | $ | 47,411 |   | $ | 438,865 |   |

 

**Notesto Contractual Obligations:**

 

----

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

(2) Approximately $258.1 million of our operatinglease obligations are attributable to the ninety-nine year land leaseassociated with the purchase of Steinway Hall; the remainder is attributable tothe leasing of other facilities and equipment.

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

(4) Other long-term liabilities consist primarily ofpension obligations.

 

**NewAccounting Pronouncements**

 

In December 2003, theFASB revised SFAS No. 132, “Employers’ Disclosures about Pensions and OtherPostretirement Benefits.”  SFAS No. 132requires additional disclosure about the assets, obligations, cash flows, andnet periodic benefit cost of defined benefit pension plans and other definedbenefit postretirement plans.  Thisstatement also requires disclosure about the types of plan assets, investmentstrategy, measurement dates, plan obligations, and cash flows.  SFAS No. 132 is effective for fiscal yearsending after December 15, 2003. Disclosure of information about foreign plans required by this statementis effective for fiscal years ending after June 15, 2004.  Interim period disclosures for both domesticand foreign plans required by this statement are effective for periodsbeginning after December 15, 2003, and are included in Note 12.

 

36

----

 

**ITEM 3**                  QUANTITATIVE AND QUALITATIVE DISCLOSURES

**ABOUT MARKET RISK**

** **

**We are exposed to market risk associated with changes inforeign currency exchange rates and interest rates.  We mitigate a portion of our foreign currencyexchange rate risk by maintaining foreign currency cash balances and holdingforward foreign currency contracts. These contracts are used as a hedge against foreign currencytransactions and are not used for trading or speculative purposes.  The fair value of the forward foreigncurrency exchange contracts is sensitive to changes in foreign currencyexchange rates.  The impact of an adversechange in foreign currency exchange rates would not be materially differentthan that disclosed in the our Annual Report on Form 10-K for the year endedDecember 31, 2003.**

** **

**Our revolving loans and term loans bear interest at ratesthat fluctuate with changes in LIBOR.  Assuch, our interest expense on our revolving loans and term loans and the fairvalue of our fixed long-term debt are sensitive to changes in market interestrates.  The effect of an adverse changein market interest rates on our interest expense would not be materiallydifferent than that disclosed in our Annual Report on Form 10-K for the yearended December 31, 2003.**

** **

**The majority of our long-term debt is at a fixed interest rate.  Therefore, the associated interest expense isnot sensitive to fluctuations in market interest rates.  However, the fair value of our fixed interestdebt would be sensitive to market rate changes. Such fair value changes may affect our decision whether to retain,replace, or retire this debt.**

 

**ITEM 4****                   CONTROLS AND PROCEDURES**

 

As of the end of the period covered by this report, weevaluated the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)). Our disclosure controls and procedures are the controls and otherprocedures that we designed to ensure that we record, process, summarize andreport in a timely manner the information we must disclose in reports that wefile with or submit to the SEC. Our Chief Executive Officer and Chief FinancialOfficer reviewed and participated in this evaluation. Based on this evaluationthe Chief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls were effective.  Indesigning the Company’s disclosure controls and procedures, the Company’smanagement recognizes that any controls, no matter how well designed andoperated, can only provide reasonable, not absolute, assurance of achieving thedesired control objectives.  During thefiscal quarter covered by this report, there have not been any significantchanges in our internal accounting controls or in other factors that couldsignificantly affect those controls.

 

37

----

 

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

 

(a)   Exhibits

 

31.1   Certificationof the Principal Executive Officer pursuant to Section 302 of theSarbanes-Oxley Act of 2002

 

31.2   Certificationof the Principal Financial Officer pursuant to Section 302 of theSarbanes-Oxley Act of 2002

 

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

 

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

 

(b)   Reportson Form 8-K

 

During the quarter endedSeptember 30, 2004 we filed or furnished the following reports on

Form 8-K:

 

(i)    OnJuly 27, 2004 the Company filed a Current Report on Form 8-K announcing itsentrance into an asset purchase agreement with G. Leblanc Corporation on July22, 2004. Attached thereto as exhibits were the asset purchase agreement and apress release dated July 22, 2004 announcing the Company’s agreement topurchase substantially all of Leblanc’s properties, business, rights, andassets.

 

(ii)   OnAugust 5, 2004, the Company filed a current Report on Form 8-K that included apress release issued on the same day announcing its results for the secondquarter and six months ended June 30, 2004.

 

38

----

 

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

 
|                  | STEINWAY MUSICAL  INSTRUMENTS, INC.              |
|-----------------------|--------------------------------------------------|
|                  |                                             |
|                  |  /s/ Dana D. Messina                        |   |
|                  | Dana D. Messina                                  |
|                  | Director, President and  Chief Executive Officer |
|                  |                                             |
|                  |  /s/ Dennis M. Hanson                       |   |
|                  | Dennis M. Hanson                                 |
|                  | Senior Executive Vice  President and             |
|                  | Chief Financial Officer                          |
|                  |                                             |
|                  |                                             |
| Date November 4, 2004 |                                             |

 

39

----