**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

** **

**FORM 10-K**

 
| **ý** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
|------------|-----------------------------------------------------------------------------------------------|
|       |                                                                                          |
|       | **FOR  THE FISCAL YEAR ENDED DECEMBER 31, 2002**                                              |
|       |                                                                                          |
| **o**      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |

 

**COMMISSION FILE NUMBER 001-11911**

 

**STEINWAY MUSICAL INSTRUMENTS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **DELAWARE**                                                                            |   | **35-1910745**                        |
|-----------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization)                         |   | (I.R.S. Employer  Identification No.) |
|                                                                                    |   |                                  |
| **800 South Street, Suite 305,  Waltham, Massachusetts**                                |   | **02453**                             |
| (Address of Principal Executive Offices)                                                |   | (Zip Code)                            |
|                                                                                    |   |                                  |
| Registrant’s telephone number including area code:   **(781)  894-9770** |

 

Securities registered pursuant to Section 12(b) of theAct:

 

| **Title of  each class**                |   | **Name of  each exchange on which registered** |
|-----------------------------------------|--------|------------------------------------------------|
| Ordinary Common Shares, $.001 par value |   | New York Stock Exchange                        |

 

Securities registered pursuant to Section 12(g) of theAct:  **None**

 

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 mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of the Form 10-K or any amendment to this Form10-K.  ý

 

The aggregate marketvalue of the Common Stock held by non-affiliates of the registrant was$118,156,493 as of February 27, 2003 and $164,617,681 as of June 28, 2002.

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct).   Yes ý   No o

 
| Number of shares of  Common Stock outstanding as of February 27, 2003: |   | Class A  |   | 477,953   |
|------------------------------------------------------------------------|--------|----------|--------|-----------|
|                                                                   |   | Ordinary |   | 8,428,285 |
|                                                                   |   | Total    |   | 8,906,238 |

 

Documentsincorporated by reference:  Part III -Items 10-13 - Definitive Proxy Statement of the Registrant to be filed pursuantto Regulation 14A, Parts I-IV - Final Prospectus of the Registrant dated August1, 1996 filed pursuant to Rule 424(b).

 

 

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**NOTE REGARDING FORWARD-LOOKINGSTATEMENTS**

 

Certain statementscontained throughout this Annual Report on Form 10-K are “forward-lookingstatements” within the meaning of Section 21E of the Securities Exchange Act of1934, as amended.  These forward-lookingstatements represent our present expectations or beliefs concerning futureevents.  We caution you that suchstatements are necessarily based on certain assumptions which are subject torisks and uncertainties, including, but not limited to, changes in generaleconomic conditions; increased competition; work stoppages and slowdowns;exchange rate fluctuations; variations in the mix of products sold;fluctuations in effective tax rates resulting from shifts in sources of income;and the ability to successfully integrate and operate acquired businesses whichmay cause actual results to differ materially from those indicated in thisreport.  We have included further informationon these factors in our Final Prospectus filed in August 1996 and inRegistration Statement No. 333-62790 filed in June 2001, particularly in thesections entitled “Risk Factors.”  Weencourage you to read those descriptions carefully.  We caution investors not to place undue reliance on theforward-looking statements contained in this report.  These statements, like all statements contained in this report,speak only as of the date of this report (unless another date is indicated) andwe undertake no obligation to update or revise the statements except asrequired by law.

 

### **NOTE REGARDINGINCORPORATION BY REFERENCE**

 

The Securities andExchange Commission (“SEC”) allows us to disclose certain information to you byreferring you to other documents we have filed with the SEC.  The information that we refer you to is“incorporated by reference” into this Annual Report on Form 10-K.  Please read that information.

 

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**PART I**

 

**ITEM 1                   BUSINESS**

 

**Introduction**

 

Steinway MusicalInstruments, Inc. (the “Company”), formerly Selmer Industries, Inc., wasincorporated in 1993 under Delaware law.  During the last ten years, the Company has made various acquisitions ofmusical instrument manufacturers, including Steinway Musical Properties in 1995and United Musical Instruments in 2000.

 

The Company, through itswholly-owned subsidiaries, The Steinway Piano Company, Inc. (“Steinway”) andConn-Selmer, Inc. (“Conn-Selmer”) is engaged in the design, manufacture,marketing, and distribution of high quality musical instruments.  Throughout this form “we”, “us”, and “our”refer to Steinway Musical Instruments, Inc. and subsidiaries taken as a whole.

 

During 2002 we combinedthe operations of The Selmer Company (“Selmer”) and United Musical Instruments,Inc. (“UMI”) into Conn-Selmer.  Thelegal merger became effective on January 1, 2003. References to “Selmer” and“UMI” refer to events or circumstances prior to the merger.

 

Our principal executiveoffices are located at 800 South Street, Suite 305, Waltham, Massachusetts,02453.  Our primary telephone number is781-894-9770, and our Internet website is located atwww.steinwaymusical.com.  All of our filingswith the SEC are available free of charge, immediately upon filing, through theInvestor Relations page on our website.

 

**Financial Information by Segment andGeographic Location**

 

Ourrevenues from external customers, operating profit, total assets, and financialinformation by geographic area for the last three years for our piano and bandsegments can be found in Note 17 to the consolidated financial statementsincluded in this filing.

 

**Business and Products**

 

Weare organized into two reportable segments — pianos and band and orchestralinstruments.  Our piano divisionconcentrates on the high-end grandpiano market, handcrafting Steinway pianos in New York and Germany.  We also offer upright pianos as well as twomid-priced lines of pianos under the Boston and Essex brand names.  Moreover, we are the largest domesticproducer of band and orchestral instruments and offer a complete line ofbrasswind, woodwind, percussion and stringed instruments and relatedaccessories with well known brand names such as Bach, C.G. Conn, King, andLudwig.

 

TheSteinway & Sons grand piano is considered to be the highest quality pianoin the world and has one of the most widely recognized and prestigious brandnames.  We sell our pianos worldwidethrough approximately 170 independent piano dealers and seven company-operatedretail showrooms including those located in New York, London, Munich andBerlin.  In 2002, approximately 62% ofpiano sales were in the United States, 26% in Europe and the remaining 12%primarily in Asia. As of December 31, 2002, we had $1.5 million of backlogorders, which we expect to fill within the upcoming year, as compared to $4.3million of backlog orders as of December 31, 2001. The change in backlogposition is primarily attributable to the mix of products available forshipment as compared to the mix of products ordered by customers. We do notbelieve that our backlog order position is necessarily indicative of futureresults.

 

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Ourband and orchestral division holds the leading domestic market share invirtually all of our product lines*.* Instruments are made by a highly skilled workforce at manufacturingfacilities in Indiana, Ohio, North Carolina, Illinois and Arizona, and soldthrough approximately 1,800 independent dealers and distributors.  Beginner instruments accounted for 73% ofband and orchestral unit sales and 47% of instrument revenues in 2002, withadvanced and professional instruments representing the balance.  In 2002, approximately 83% of band saleswere in the United States, 7% in Europe and the remaining 10% primarily inAsia.  As of December 31, 2002, we had$20.8 million of backlog orders, which we expect to fill within the upcomingyear, as compared to $16.0 million in backlog orders as of December 31, 2001.  Similar to our piano segment, the change inbacklog position is primarily attributable to the mix of products available forshipment as compared to the mix of products ordered by customers.  We do not believe that our backlog orderposition is necessarily indicative of future results.

 

We offer pianos, band andorchestral instruments and services through the following subsidiaries andoperating divisions:

 

*Steinway & Sons* offers two premium-priced productlines: grand pianos and upright pianos. Steinway pianos differ from all others in design specifications,materials used and the assembly process. Grand pianos historically have accounted for the bulk of Steinway’sproduction.  We offer eight models ofthe grand piano ranging from the 5’1” baby grand to the largest 9’ concertgrand.  The smaller grands are sold toboth individual and institutional customers, while the concert grands are soldprimarily to institutions.  Steinwaygrand pianos are premium pianos in terms of quality and price, with retailprices generally ranging from $36,100 to $92,800 in the United States.  In 2002, we sold 2,947 grand pianos, ofwhich 2,026 units were shipped from our New York facility to dealers in Northand Latin America.  The remaining 921units were shipped from our German facility to various countries in Europe and Asia.

 

Our upright pianos offerdealers a complete line of quality pianos to satisfy the needs of institutionsand other customers who are constrained by space limitations.  We also provide services, such asrestoration, repair, replacement part sales, tuning and regulation of pianos atlocations in New York, London, Hamburg and Berlin.  Restoration services range from minor damage repairs to completerestorations of old pianos.

 

*Boston Piano Company*offers two complete lines of grand and upright pianos for the mid-priced pianomarket under the Boston and Essex brand names. These pianos, which were designed by us and are produced by Asianmanufacturers, provide our dealers with anopportunity to realize better margins in this price range while capturing salesthat would have otherwise gone to a competitor.  These pianos provide future Steinway grand piano customers withthe opportunity to join the Steinway family of owners sooner, since ourresearch indicates that the vast majority of Steinway customers have previouslyowned another piano.  The product linesalso increase our business with ourdealers, making us the dealer’s primary supplier in many instances, since thesethree product lines together offer a full spectrum of piano prices andstyles.  The Boston and Essex productlines together offer thirteen grand piano models, with retail prices rangingfrom $5,200 to $37,425.

 

*The BandInstrument Division*manufactures brasswind and woodwind instruments, including piccolos, flutes,clarinets, oboes, bassoons, saxophones, trumpets, French horns, tubas, andtrombones at facilities in Elkhart, Indiana, Eastlake, Ohio and Nogales,Arizona.  We also manufacturemouthpieces and distribute accessories such as oils, lubricants, polishes,stands, batons, straps, mutes and reeds. We sell products under the *Armstrong, Bach, C.G. Conn, Emerson, King, Selmer*and*Signet* brand names to student, amateur and professional musicians.Suggested retail prices generally range from $675 to $1,700 for studentinstruments and from $1,025 to $8,350 for step-up and professionalinstruments.  We often customize theproducts that we sell to professional musicians so that the product meetsrequested design specifications or

 

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has certain sound characteristics. We believe thatspecialization of products helps maintain a competitive edge in quality andproduct design.

 

Weare the exclusive U.S. distributor for *Selmer Paris* products. The *Selmer Paris*saxophone is generally considered to be one of the best in the world.  *Selmer Paris*, in turn, has exclusive distribution rights to certain of ourwoodwind and brasswind products in France.

 

*The PercussionDivision* manufactures anddistributes acoustical and tuned percussion instruments, including outfitdrums, marching drums, concert drums, marimbas, xylophones, vibraphones,orchestra bells, chimes, mallets and accessories.  We manufacture percussion products in Monroe, North Carolina andLaGrange, Illinois under the *Ludwig* and *Musser* brand names.  *Ludwig* is considered a leading brand namein acoustical drums and timpani and *Musser* has a strong market position intuned percussion products.  Suggestedretail prices range from $700 to $4,600 for acoustical drum outfits and from$2,000 to $16,500 for tuned percussion instruments.

 

*The StringedInstrument Division*manufactures and distributes violins, violas, cellos, and basses, andaccessories such as bridges, covers, mutes, pads, chin rests, rosins, strings,bows, cases and instrument care products. Products are sold under the *Glaesel, Hermann Beyer, Otto Bruckner, Scherl &Roth*and *W**illiam Lewis& Son*brand names. Suggested retail prices generally range from $525 to $2,100 for studentinstruments and from $1,000 to $11,000 for intermediate and advancedinstruments. Components are primarily imported from Europe and Asia andassembled at our factory in Cleveland, Ohio.

 

**Customers**

 

Ourcore piano customer base consists of professional artists and amateur pianists,as well as institutions such as concert halls, conservatories, colleges,universities and music schools.  Themajority of Steinway grand piano sales is to individuals.  These individuals are typically over 40 years old, have household income rangingfrom $150,000 to $300,000 per year and have a serious interest in music.  Sales to institutional customers havehistorically represented a larger portion of international revenue thandomestic revenue.  Over the past severalyears, we have introduced several unique marketing programs designed to increaseinstitutional sales in the United States. As a result, domestic unit shipments to institutions increased nearly 5%in 2001 and another 2% in 2002 and they now represent 17% of domestic unitsales. Our largest piano dealer accounted for approximately 5% of piano salesin 2002, while the top 15 accounts represented 30% of piano sales.

 

The majority of our bandinstruments are purchased or rented from dealers by students enrolled in musiceducation programs.  Traditionally,students join school bands or orchestras at age 10 or 11 and learn on beginnerlevel instruments, progressing to an advanced or professional level instrumentin high school or college.  We estimatethat approximately 85% of our domestic band sales are generated througheducational programs.  The remainingdomestic band sales are to professional or amateur musicians or performinggroups, including orchestras and symphonies. Our largest band dealer accounted for approximately 8% of band sales in2002, while the top 15 accounts represented approximately 32% of sales.

 

**Sales and Marketing**

 

*Pianos.*We distribute pianos primarily on awholesale basis through approximately 170 select dealers around the world.  These dealers accounted for approximately85% of pianos sold in 2002. The remaining 15% were sold directly by us at oneof our seven company-operated retail locations.  We also have a Japanese subsidiary and a representative office inChina to provide direct access to the expansive Asian piano market.

 

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We employ district salesmanagers, whose responsibilities include developing close working relationshipswith domestic and international piano dealers. These highly experiencedprofessionals provide sales training and technical support to dealers, as wellas developing appropriate sales and marketing programs for consumers andinstitutions.  These sales managers arealso responsible for promoting the Piano Bank and the Steinway Artists programsdescribed below.

 

*The Concert and Artist Piano Bank.*  To ensure that all pianists, especiallySteinway Artists, have a broad selection of instruments to meet theirindividual touch and tonal preferences, we maintain the Concert and ArtistPiano Bank (the “Piano Bank”).  ThePiano Bank includes approximately 375 instruments worldwide.  Of these instruments, approximately 300 arelocated in the United States.  In NewYork City alone, the Steinway concert department has approximately 100 concertgrands available for various occasions. The balance of the domestic-based pianos are leased to dealers aroundthe country who actively support the Steinway Artists program.  In addition to promoting our instruments inthe music industry, the Piano Bank provides continuous feedback on the qualityand performance of recently produced instruments from our most criticalcustomer, the professional pianist.  ThePiano Bank instruments are generally sold after five years and replaced withnew pianos.

 

*Steinway Artists.*  For years, we have successfully usedrenowned artists in our marketing programs. This technique has helped reinforce recognition of the brand nameSteinway and its association with quality. The “Steinway Artists” program is the endorsement of world-classpianists who voluntarily select the Steinway piano. It is unique in that we donot pay artists to endorse our instruments. To become a Steinway Artist, a pianist must not only meet certainperformance and professional criteria, he or she must also own a Steinwaypiano.  The Steinway Artist rostercurrently includes approximately 1,300 of the world’s finest pianists whoperform on Steinway pianos.  In returnfor their endorsements, Steinway Artists are provided with access to the PianoBank described above.

 

*Distribution**, Sales andMarketing of the Boston and Essex Piano Lines.*  The Boston and Essex piano lines aretargeted at the mid-priced segment of the market.  The lines provide both a broader product offering for dealers andentry-level products for future Steinway grand piano customers. With certainlimited exceptions, we allow only Steinway dealers to carry the Boston andEssex piano lines, thereby ensuring that these pianos will be marketed ascomplementary product lines.  Increasedtraffic generated by these pianos creates current and future customers forSteinway.  We do not believe that theavailability of lower-priced Boston and Essex alternatives has negativelyimpacted the sales of Steinway & Sons pianos.  These lines benefit from the “spillover” effect created by themarketing efforts supporting the main Steinway product line.

 

*Band and Orchestral Instruments.* Band, string and percussion instruments andrelated accessories are distributed worldwide through approximately 1,800independent musical instrument dealers and distributors.  These products are marketed by districtsales managers and telemarketing representatives who are responsible for saleswithin assigned geographic territories in the United States and Canada.

 

Each district salesmanager is also responsible for developing relationships with band andorchestral directors.  These directorsrepresent all levels of music educators, from those who teach elementary schoolchildren through those involved at the college and professional levels. Theseindividuals are the primary influence in the choice of an instrumentbrand.  Band directors will generallyrefer students to designated dealers for the purchase of instruments.  As part of our music director outreach andsupport strategy, we have developed Conn-Selmer University, which providesyoung teachers with the tools and instruction to excel in the music educationenvironment.  We believe that our

 

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well-established, long-standing relationships with these influentialmusic educators are an important component of our distribution strategy.

 

Internationally, we sellour products through dealers and distributors located in each majorcountry.  International representativeshelp market our products to these dealers and distributors. Dealers and distributorsin the United States and abroad are supported through incentive programs,advertising and promotional activities. The primary methods of reaching customers are trade shows, educatorconferences, print media, direct mail, telemarketing, the Internet and personalsales calls. We also actively advertise in consumer, educator and trademagazines and publications and provide educational materials, catalogs andproduct specifications to students, educators, dealers and distributors.  In addition, our representatives attendseveral trade shows and educator conferences each year, which provideopportunities to interact directly with customers.  Moreover, our educational director travels extensively, lecturingand motivating students, educators and parents on the value of music in achild’s development.

 

**Musical Instrument Industry**

 

*Pianos.*Theoverall piano industry is comprised of three main categories: high-end grandpianos, mid/low-end grand pianos, and upright pianos.  From the middle through the end of the 1990s, the industryexperienced growth in all categories of pianos. The introduction of the Bostonline in the early 1990s permitted us to compete in the mid-price categorywithout sacrificing quality.  However, theindustry is currently being impacted by the recent worldwide economic downturn,and all categories of pianos are being adversely affected.  We believe that the recent economic slowdownwill be mitigated by favorable demographics and the public’s continuinginterest in music.

 

Market size and volumetrends are difficult to quantify for international markets, as there is nosingle source for worldwide sales data. Our strongest international markets outside the Americas are Germany,Japan, the United Kingdom, Switzerland and France.

 

Outside of the UnitedStates, China, Korea and Japan are the three largest piano markets in theworld, with Japan representing the second largest grand piano market.  With our three piano lines, our marketshare, based on grand piano units, is currently 4% in Japan, compared to anaverage market share of approximately 12% in other major markets.  While adverse economic conditions in some ofthe Asian markets have slowed our expansion, other markets, such as China, aregrowing at a rapid pace.  We continue totarget this region in our distribution strategies and have recently appointed apresident of Asian operations whose responsibilities include growthinitiatives, strategic activities, and manufacturing relationships.  We believe that our long-term prospects inAsia are favorable.

 

*Band and Orchestral*Instruments*. *We believe that the band and orchestral instrument industry inthe U.S. has historically been impacted more by demographic trends and schoolbudgeting than by macroeconomic cycles. While the domestic market continued to grow through the late 1990s,domestic supply has outpaced the demand. In recent years there has been anincrease in units imported into the domestic market from offshore low costproducers, as well as a decline in exports by domestic manufacturers.  Additionally, key dealers have become moreefficient at using their existing instrument stock and have increased effortsto repair and refurbish existing inventory instead of purchasing new inventoryfrom manufacturers. The combination of these factors has created a highly pricesensitive domestic market, where manufacturers have implemented aggressivepricing programs in an attempt to maintain market share positions.

 

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However, we believe theoutlook for future growth remains positive. Relatively stable demographic trends and recent studies emphasizing theimportance of music education in a child’s development are expected tocontribute to the industry’s growth.  Webelieve that parents are encouraging their children to pursue musicalinstruments as a response to the growing number of reports that showparticipation in music programs increase a student’s ability to excel in otheraspects of their education.  Inaddition, many school band directors are promoting band programs as socialorganizations rather than the first step of intensive music study.

 

**Competition**

 

Few manufacturers competedirectly with Steinway & Sons pianos, both in terms of quality andprice.  We believe that used Steinwaypianos provide the primary competition in our market segment.  Because of the potential savings associatedwith buying a used Steinway piano, as well as the durability of the instrument,a large market exists for used Steinways. It is difficult to estimate the significance of used piano sales, sincemost are conducted in the private aftermarket. However, our increased emphasis on restoration services and theprocurement, refurbishment and sales of used Steinway pianos has helped usmitigate the impact of these aftermarket sales.

 

We are the largestdomestic producer of band and orchestral instruments.  New entrants into the domestic market experience difficultycompeting with us due to the long learning curve inherent in the production ofmusical instruments, the high quality standards set by the market, cost oftooling, significant capital requirements, lack of name-brand recognition andthe utilization of an effective distribution system.  However, offshore musical instrument manufacturers present anincreasing level of competition for us, primarily because their labor costs areso low.  They now offer a broad range ofproducts at highly competitive prices. It is difficult to quantify the impact of imported musical instrumentssince the majority of offshore manufacturers do not report data through typicalindustry channels, if at all.  However,it is clear from our research that there is increased competition from offshoresources.  Accordingly, we continue toinvest in new technology to increase productivity and efficiency in themanufacturing process.  We also utilizeaggressive marketing programs to maintain our market positions, brandrecognition, and reputation for quality as we implement the appropriate balancebetween sourced and manufactured instruments.

 

**Patents and Trademarks**

 

We pioneered thedevelopment of the modern piano with over 125 patents granted since ourfounding. Although we have several patents effective and pending, for varyinglengths of time, in the United States and in several foreign countries, we donot believe our business is materially dependent upon any single patent.

 

We also have some of themost well known brand names in the music industry.  Our piano trademarks include *Steinway, Steinway & Sons,*the Lyresymbol, *Boston,designed by Steinway & Sons,*and*Essex*. Our band and orchestral trademarksinclude *Selmer,Bach, Bundy, Signet, William Lewis & Son, Ludwig, Musser,**Emerson,**C.G.**Conn, King, Armstrong, Artley, Benge,*and*Scherl& Roth.*  We maintaintrademark registrations in appropriate jurisdictions on an ongoing basis andvigorously pursue any infringement by competitors. We consider our trademarksto be important and valuable assets.

 

### **Raw Materials andComponent Parts**

 

Our raw materials consistprimarily of metals and woods, the majority of which are sourced from theAmericas, with the balance coming from Europe, Asia and Africa.  We have made strategic

 

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acquisitions of our sole domestic piano plate manufacturer and primarypiano key maker to ensure availability of these component parts.  Our Boston and Essex piano lines are eachsourced from a single manufacturer, as are our Selmer Paris instruments andcertain other component parts.  Inaddition, component parts are imported from Europe and Asia for stringed andpercussion instruments.  We have hadadequate supplies of raw materials and component parts in the past and do notexpect any disruption to the supply of these items during 2003 and in thefuture.

 

**Manufacturing Process**

 

We manufacture themajority of the musical instruments that we sell. The manufacturing processinvolves essentially two main production phases: the production of componentparts and instrument assembly. Employees perform various forming, drilling, and cutting operationsduring the parts production phase. Skilled crafters assemble component parts, creating theinstruments.  Each instrument is testedor tuned and regulated to our specifications. The manufacturing process for our band instruments typically takesapproximately two months, whereas the manufacturing process for pianos takesnine months to a year.

 

Historically, we havemaintained a fairly constant production schedule for band and orchestralinstruments in order to minimize labor disruptions and to keep work-in-processinventories relatively stable.  However,in the last two years we have implemented periodic shutdowns of selectedmanufacturing facilities in each segment of our business.  We utilize this process in order to controlinventory levels while maintaining a skilled workforce.

 

**Labor**

 

As of December 31, 2002,we employed 2,552 people, consisting of 1,886 hourly production workers and 666salaried employees.  Of the 2,552employees, 2,026 were employed in the United States and the remaining 526 wereemployed primarily in Europe.

 

Manufacturing employeesin Germany are represented by the workers’ council that negotiates annually ontheir behalf, whereas approximately 60% of our workforce in the United Statesis represented by labor unions.  Collectivebargaining agreements covering these employees expire at different datesthrough 2003, and the majority of agreements are currently in various stages ofnegotiation. Restrictive labor agreements at certain of the Conn-Selmerfacilities, which have prevented flexibility and productivity improvement insome of our manufacturing operations, as well as increasing healthcare costs,are issues being addressed in these negotiations to ensure that we remaincompetitive in the market. This has led to more difficult negotiations than inthe past.  In January 2003 and March2003, employees at our LaGrange, Illinois and Eastlake, Ohio plants,respectively, initiated work stoppages in an attempt to obtain improved contractoffers.  We do not believe that the outcomeof these labor negotiations will have a material adverse affect on us, but weremain committed to resolving these issues and maintaining our historicallygood relationship with the unions.

 

**ITEM 2                   PROPERTIES**

 

We own most of ourmanufacturing and warehousing facilities, as well as the building that includesSteinway Hall in New York.  Theremaining Steinway retail stores are leased. Substantially all of the domestic real estate has been pledged to secureour debt.

 

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The following table lists our significant owned and leased facilities:

 
| **Location**       |   | **Owned/Leased** |   | **Approximate  Floor Space  (Square Feet)** |   | **Type of  Facility and Activity Performed**                                |
|--------------------|--------|------------------|--------|---------------------------------------------|--------|-----------------------------------------------------------------------------|
| New York, NY       |   | Owned            |   | 449,900                                     |   | Piano manufacturing;  restoration center;  administrative offices; training |
|               |   | Owned            |   | 217,000                                     |   | Piano retail  store/showroom, office  rental property                       |
| Hamburg, Germany   |   | Owned            |   | 220,660                                     |   | Piano manufacturing;  executive offices; training                           |
| Eastlake, OH       |   | Owned            |   | 160,000                                     |   | Brasswind manufacturing                                                     |
| Elkhart, IN        |   | Owned            |   | 144,000                                     |   | Brasswind manufacturing                                                     |
|               |   | Owned            |   | 88,000                                      |   | Woodwind manufacturing;  warehouse; office                                  |
|               |   | Owned            |   | 77,000                                      |   | Woodwind manufacturing                                                      |
|               |   | Owned            |   | 75,000                                      |   | Warehouse                                                                   |
|               |   | Owned            |   | 25,000                                      |   | Administrative offices                                                      |
| Springfield, OH    |   | Owned            |   | 110,000                                     |   | Piano plate  manufacturing                                                  |
| Nogales, AZ        |   | Owned            |   | 90,000                                      |   | Band instrument  manufacturing                                              |
| LaGrange, IL       |   | Owned            |   | 46,000                                      |   | Percussion instrument  manufacturing                                        |
|               |   | Leased           |   | 18,000                                      |   | Timpani production                                                          |
| Wilkow, Poland     |   | Owned            |   | 9,740                                       |   | Piano key manufacturing                                                     |
| Monroe, NC         |   | Leased           |   | 147,000                                     |   | Drum and case  manufacturing                                                |
| Cleveland, OH      |   | Leased           |   | 52,000                                      |   | Stringed instrument  manufacturing                                          |
| Munich, Germany    |   | Leased           |   | 29,000                                      |   | Piano retail  store/showroom                                                |
| Wuppertal, Germany |   | Leased           |   | 27,450                                      |   | Piano key manufacturing                                                     |
| London, England    |   | Leased           |   | 20,000                                      |   | Band instrument office;  warehouse                                          |

 

Wespent $5.6 million for capital improvements in 2002.  The majority of the expenditures was used for new machinery,equipment and facility upgrades in conjunction with certain EPA complianceprojects, and general facility improvements. We expect capital spending in 2003to be in the range of $5-6 million as we renovate facilities and continue toupgrade machinery in order to increase production efficiency.

 

**ITEM 3                   LEGAL PROCEEDINGS**

 

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 management believes areroutine in nature and incidental to the operation of its 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 orprospects.

 

*Environmental Matters –*We are subject to compliance withvarious federal, state, local and foreign environmental laws, including thoserelating to discharges to air, water and land, the handling and disposal ofsolid and hazardous waste and the cleanup of properties affected by hazardoussubstances.  Certain environmental laws,such as the Comprehensive Environmental Response, Compensation, and LiabilityAct, as amended, impose strict, retroactive, joint and several liability uponpersons responsible for releases of hazardous substances, which responsibilityis broadly construed.

 

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As the result of aninspection in 1999, the Indiana Department of Environmental Management (“IDEM”)informed us that one of our facilities was not in compliance with several airpollution control rules regulating its use of volatile organic compounds(primarily trichloroethylene). Immediately after the inspection, we took the necessary steps to returnthe facility to compliance with these rules. We reached an agreement with IDEM regarding the disposition of thismatter, including the assessment of certain immaterial fines.  In addition, we agreed to permanentlyeliminate the use of trichloroethylene from our manufacturing process.  We completed the capital project andupgrades associated with this matter in 2002.

 

We are also continuingexisting environmental remediation programs at facilities acquired in2000.  We have accrued approximately$0.6 million for the estimated remaining cost of these remediation programs.

 

On August 9, 1993,Philips Electronics North America Corporation (“Philips”) agreed to continue toindemnify us for any and all losses, damages, liabilities and claims relatingto environmental matters resulting from certain activities of Philips occurringprior to December 29, 1988 (the “Environmental Indemnity Agreement”).  Philips has fully performed its obligationsunder the Environmental Indemnity Agreement, which terminates on December 29,2008.  Four matters covered by theEnvironmental 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.  For the third site, the EPA has notified usit intends to carry out the final remediation itself.  The EPA estimates that this remedy has a present net cost ofapproximately $12.0 million.  Over 40persons or entities have been named by the EPA as potentially responsibleparties at this site.  This matter hasbeen tendered to Philips pursuant to the Environmental IndemnityAgreement.  On October 22, 1998, we werejoined as defendant in an action involving a site formerly occupied by abusiness we acquired in Illinois. Philips has accepted the defense of this action pursuant to the terms ofthe 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 the other named parties, the number ofparties participating, and the financial capabilities of the other potentiallyresponsible parties once the relative share has been determined.  No assurance can be given, however, thatadditional environmental issues will not require additional, currentlyunanticipated investigation, assessment or remediation expenditures or thatPhilips will make payments that it is obligated to make under the EnvironmentalIndemnity Agreement.

 

We operate manufacturingfacilities at locations where hazardous substances (including chlorinatedsolvents) were used.  We believe that anentity that formerly operated one such facility may have released hazardoussubstances at such location, which we leased through July 2001.  We did not contribute to such release.  Further, we have a contractual indemnityfrom certain stockholders of such entity. This facility is not the subject of a legal proceeding that involves us,nor, to our knowledge, is the facility subject to investigation.  However, no assurance can be given thatlegal proceedings will not arise in the future and that such indemnitors wouldmake the payments described in the indemnity.

 

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 thenature of 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.

 

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**ITEM 4                   SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

No matter was submittedto a vote of our security holders during the fourth quarter of the fiscal yearended December 31, 2002.

 

**PART II**

 

**ITEM 5                   MARKET FOR REGISTRANT’SCOMMON EQUITY**

** AND RELATED STOCKHOLDER MATTERS**

 

Our ordinary common stockis traded on the New York Stock Exchange (“NYSE”) under the symbol “LVB”.  The following table sets forth, for the periodindicated, the high and low sales prices per share of our ordinary common stockas reported on the NYSE.

 
|                                 |   | **High** |   | **Low** |   |
|--------------------------------------|--------|----------|--------|---------|--------|
| Fiscal  Year Ended December 31, 2001 |   |     |   |    |   |
| First  Quarter                       |   | $        | 17.81  |    | $      | 16.35 |   |
| Second  Quarter                      |   | 20.54    |   | 16.05   |   |
| Third  Quarter                       |   | 18.28    |   | 14.40   |   |
| Fourth  Quarter                      |   | 17.45    |   | 12.40   |   |
|                                 |   |     |   |    |   |
| Fiscal  Year Ended December 31, 2002 |   |     |   |    |   |
| First  Quarter                       |   | $        | 20.85  |    | $      | 15.49 |   |
| Second  Quarter                      |   | 23.83    |   | 18.88   |   |
| Third  Quarter                       |   | 22.44    |   | 15.00   |   |
| Fourth  Quarter                      |   | 19.19    |   | 15.25   |   |

 

We have two classes ofcommon stock: Class A and Ordinary. With the exception of disparate voting power, both classes aresubstantially identical.  Each share ofClass A common stock entitles the holder to 98 votes.  Holders of Ordinary common stock are entitled to one vote pershare.  Class A common stock shallautomatically convert to Ordinary common stock if, at any time, the Class Acommon stock is not owned by an original Class A holder.  As of February 10, 2003, there were 2,064holders of record of our Ordinary common stock and two holders of record of theClass A common stock.

 

We are restricted by theterms of our outstanding debt and financing agreements from paying cashdividends on our common stock, and we may, in the future, enter into loan orother agreements that restrict the payment of cash dividends on the commonstock.

 

We presently intend toretain earnings to reduce outstanding indebtedness and to fund the growth ofour business.  The payment of any futuredividends will be determined by the Board of Directors in light of conditionsthen existing, including our results of operations, financial condition, cashrequirements, restrictions in financing agreements, tax treatment of dividends,business conditions and other factors.

 

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### **EquityCompensation Plans**

 

The following table setsforth the equity compensation plan information for our Amended and Restated1996 Stock Plan:

 
|                                                        |   | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights** |   | **Weighted-average  exercise price of  outstanding options,  warrants and rights** |   | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** |    |
|-------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|---------|
| **Plan  Category**                                          |   | **(a)**                                                                                            |   | **(b)**                                                                            |   | **(c)**                                                                                                                                               |    |
| Equity compensation plans approved by security  holders     |   | 1,098,300                                                                                          |   | $                                                                                  | 19.10  |                                                                                                                                                  | 332,600 |   |
|                                                        |   |                                                                                               |   |                                                                               |   |                                                                                                                                                  |    |
| Equity compensation plans not approved by security  holders |   | —                                                                                             |   | —                                                                             |   | —                                                                                                                                                |    |
|                                                        |   |                                                                                               |   |                                                                               |   |                                                                                                                                                  |    |
| Total                                                       |   | 1,098,300                                                                                          |   | $                                                                                  | 19.10  |                                                                                                                                                  | 332,600 |   |

 

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**ITEM 6                   SELECTED CONSOLIDATEDFINANCIAL DATA**

 

The following table sets forth our selectedconsolidated financial data as of and for the five years ended December 31,2002, derived from our audited financial statements.  The table should be read in conjunction with our auditedconsolidated financial statements, including the footnotes, and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included elsewhere in this report.

 
| **(In thousands except share and   per share information)** |     | **Year Ended  December 31,** |     |
|-------------------------------------------------------------|----------|------------------------------|----------|
|                                                        | **1998** |                         | **1999** |   | **2000(1)** |   | **2001** |   | **2002** |   |
| **Income Statement Data:**                                  |     |                         |     |   |   |   |   |   |   |   |   |
| Net  sales                                                  |     | $                            | 293,251  |   | $ | 304,636 |   | $ | 331,698 |   | $ | 352,612 |   | $ | 332,297 |   |
| Gross  profit                                               |     | 98,479                       |     | 100,748 |   | 104,958 |   | 107,498 |   | 97,151 |   |
| Income  from operations                                     |     | 41,813                       |     | 41,140 |   | 41,689 |   | 38,472 |   | 31,399 |   |
| Net  income                                                 |     | 16,651                       |     | 17,345 |   | 16,904 |   | 11,319 |   | 14,909 |   |
| Income  per share:                                          |     |                         |     |   |   |   |   |   |   |   |   |
| Basic                                                       |     | $                            | 1.78     |   | $ | 1.88 |   | $ | 1.89 |   | $ | 1.27 |   | $ | 1.68 |   |
| Diluted                                                     |     | $                            | 1.75     |   | $ | 1.87 |   | $ | 1.89 |   | $ | 1.27 |   | $ | 1.68 |   |
|                                                        |     |                         |     |   |   |   |   |   |   |   |   |
| **Weighted average shares:**                                |     |                         |     |   |   |   |   |   |   |   |   |
| Basic                                                       |     | 9,339,896                    |     | 9,213,145 |   | 8,921,091 |   | 8,928,000 |   | 8,877,256 |   |
| Diluted                                                     |     | 9,505,640                    |     | 9,277,798 |   | 8,921,108 |   | 8,928,000 |   | 8,882,165 |   |
|                                                        |     |                         |     |   |   |   |   |   |   |   |   |
| **Other Financial Data:**                                   |     |                         |     |   |   |   |   |   |   |   |   |
| Cash  flows from:                                           |     |                         |     |   |   |   |   |   |   |   |   |
| Operating  activities                                       |     | $                            | 14,227   |   | $ | 15,372 |   | $ | 13,265 |   | $ | 28,877 |   | $ | 31,048 |   |
| Investing  activities                                       |     | (5,289                       | )        | (39,312 | ) | (93,798 | ) | (7,988 | ) | (7,749 | ) |
| Financing  activities                                       |     | (1,718                       | )        | 16,304 |   | 80,584 |   | (20,411 | ) | (9,718 | ) |
| EBITDA  (2)                                                 |     | 54,072                       |     | 54,822 |   | 57,352 |   | 54,059 |   | 46,375 |   |
| Interest  expense, net                                      |     | 11,911                       |     | 13,276 |   | 16,110 |   | 16,731 |   | 13,279 |   |
| Capital  expenditures (3)                                   |     | 6,264                        |     | 5,399 |   | 7,890 |   | 7,141 |   | 5,604 |   |
| EBITDA  (2)/interest expense, net                           |     | 4.5x                         |     | 4.1x |   | 3.6x |   | 3.2x |   | 3.5x |   |
|                                                        |     |                         |     |   |   |   |   |   |   |   |   |
| **Margins:**                                                |     |                         |     |   |   |   |   |   |   |   |   |
| Gross  profit                                               |     | 33.6%                        |     | 33.1% |   | 31.6% |   | 30.5% |   | 29.2% |   |
| EBITDA  (2)                                                 |     | 18.4%                        |     | 18.0% |   | 17.3% |   | 15.3% |   | 14.0% |   |
|                                                        |     |                         |     |   |   |   |   |   |   |   |   |
| **Balance Sheet Data (at year end):**                       |     |                         |     |   |   |   |   |   |   |   |   |
| Cash                                                        |     | $                            | 12,460   |   | $ | 4,664 |   | $ | 4,989 |   | $ | 5,545 |   | $ | 19,099 |   |
| Current  assets                                             |     | 170,381                      |     | 171,954 |   | 265,453 |   | 258,977 |   | 271,849 |   |
| Total  assets                                               |     | 283,927                      |     | 309,641 |   | 421,816 |   | 414,040 |   | 428,234 |   |
| Current  liabilities                                        |     | 42,243                       |     | 44,959 |   | 56,575 |   | 49,223 |   | 53,207 |   |
| Total  debt                                                 |     | 117,028                      |     | 140,080 |   | 223,410 |   | 211,203 |   | 200,636 |   |
| Stockholders’  equity                                  |     | 91,757                       |     | 98,202 |   | 113,207 |   | 120,371 |   | 135,806 |   |

 

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**Notes to Selected ConsolidatedFinancial Data:**

 

(1)                      Weacquired UMI in September 2000.

(2)                      EBITDArepresents earnings before net interest expense, income tax expense (benefit),depreciation and amortization, adjusted to exclude non-recurring charges anddebt extinguishment costs.  While EBITDAshould not be construed as a substitute for operating income or a betterindicator of liquidity than cash flows from operating activities, which aredetermined in accordance with accounting principles generally accepted in theUnited States of America, it is included herein to provide additionalinformation with respect to our ability to meet our future debt service,capital expenditure requirements and working capital needs.  Although we believe certain investors findEBITDA useful, it is not necessarily a measure of our ability to fund our cashneeds.

(3)                      Capitalexpenditures for 1999 exclude $30.8 million for the purchase of Steinway Hall.

 

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**ITEM 7                   MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL**

** CONDITION AND RESULTS OF OPERATIONS**

 

**Introduction**

 

The following discussionprovides an assessment of the results of our operations and liquidity andcapital resources together with a brief description of certain of ouraccounting policies.  Accordingly, thefollowing discussion should be read in conjunction with our consolidatedfinancial statements and the notes thereto included elsewhere in this report.

 

**Overview**

 

We, through our operatingsubsidiaries, are one of the world’s leading manufacturers of musicalinstruments.  Our strategy is tocapitalize on our strong brand names, leading market positions, strong distributionnetworks, and quality products.

 

**Piano Segment**

 

Sales of our pianos are influenced by general economicconditions, demographic trends and general interest in music and the arts.  The operating results of our piano segmentare primarily affected by Steinway & Sons grand piano sales.  Given the total number of these pianos thatwe sell in any year (2,947 sold in 2002), a slight change in units sold canhave a material impact on our business and operating results.  Our results are also influenced by sales ofBoston and Essex pianos, which together represented approximately 55% of totalpiano units sold and approximately 20% of total piano revenues in 2002.  Our Boston and Essex piano lines aremanufactured in Asia, each by a single manufacturer.  The ability of these manufacturers to produce and ship productsto us could materially impact our business and operating results.  In 2002, approximately 62% of piano saleswere in the United States, 26% in Europe and the remaining 12% primarily inAsia. For the year ended December 31, 2002,our piano sales were $164.6 million, representing 49% of our total revenues.

 

**Piano Outlook for 2003**

 

We expect a challengingyear for our piano segment due to uncertainties in the economies worldwide,especially in Europe and Asia.  Grossmargins are expected to remain relatively stable.  The celebration of the 150th anniversary of Steinway& Sons in 2003, while increasing marketing expenses, is expected to provideus with increased public recognition and generate additional salesprospects.  We currently havesufficient, but not excessive, manufacturing capacity to meet anticipated orincreased demand.

 

**Band Segment**

 

Our student bandinstrument sales are influenced by trends in school enrollment and generalattitudes toward music and the arts. Management estimates that 85% of ourdomestic band sales are generated through educational programs. Our schoolinstrument business is correlated to the number of school children in theUnited States, which has peaked and is expected to remain relatively stableover the next few years.  However, dueto the current economic climate, many school budgets have recently beenreduced.  This has often adverselyimpacted school music program funding, resulting in delays or eliminations ofbeginning band programs, which has negatively impacted our revenues.  In addition, limited resources have affectedthe sales of instruments typically purchased by schools, such as tubas,sousaphones, and certain percussion instruments.

 

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In addition, our bandinstrument sales have also been adversely affected by high levels of availableinventories from domestic suppliers and an abundance of competitively pricedinstruments being imported from offshore, low cost producers. As a result, weare currently competing in a highly price sensitive domestic market with excesscapacity.  Musical instrument dealers,our primary customers, are also focusing on selling through current inventoriesbefore ordering new instruments.  Withthe increase in product availability, dealers are ordering on an “as needed”basis instead of making substantial investments in their own inventories.  We refined our pricing structure on certaininstruments in order to remain competitive in the increasingly efficient bandinstrument market.

 

Consistent with past patterns, beginner instrumentsaccounted for 73% of band and orchestral unit shipments and 47% of instrumentrevenues in 2002, with advanced and professional instruments representing thebalance. In 2002, approximately 83% of band sales were in the United States, 7%in Europe and the remaining 10% primarily in Asia.  For the year ended December31, 2002, our band sales were $167.7 million, representing 51% of our totalrevenues.

 

**BandOutlook for 2003**

 

Aggressive competition,low domestic industry capacity utilization, and uncertainty regarding theoutcome of our labor contract negotiations will make 2003 another challengingyear for our band segment.  We intend tofocus on strengthening this segment in the upcoming year by increasing ourmanufacturing flexibility, taking greater advantage of our availabledistribution channels, and refining the balance between manufactured andimported products while maintaining the high quality standards for which ourbrands are known.  We believe that theimplementation of these strategies is necessary for the long-term growth ofthis segment of our business.

 

**Inflationand Foreign Currency Impact**

 

Although we cannot accurately predict the preciseeffect of inflation on our operations, we do not believe that inflation has hada material effect on sales or results of operations in recent years.  Sales to customers outside the United Statesrepresent approximately 27% of consolidated sales, with international pianosales accounting for approximately 70% of these international sales.  A significant portion of international pianosales originate from our German manufacturing facility, resulting in sales,cost of sales and related operating expenses denominated in Euros. Whilecurrency translation has affected international sales, cost of sales andrelated operating expenses, it has not had a material impact on operatingincome.  We utilize financialinstruments such as forward exchange contracts and currency options to reducethe impact of exchange rate fluctuations on firm and anticipated cash flowexposures and certain assets and liabilities denominated in currencies otherthan the functional currency of the affected division.  We do not purchase currency related financialinstruments for purposes other than exchange rate risk management.

 

**Taxes**

 

Our effective tax rates vary depending on the relativeproportion of foreign to U.S. income and the absorption of foreign tax creditsin the U.S.  In 2000, a one-time tax benefitassociated with the reduction of deferred tax balances, caused by an enactedrate reduction in Germany, lowered our effective tax rate to 38%.  This rate change was effective on January 1,2001, resulting in a reduction of our effective tax rate in Germany from 56% in2000 to 38% in 2001.  In 2001, the costsassociated with our debt extinguishment, which were absorbed domestically,caused an increase in the proportion of our

 

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foreign source income, allowing us to utilize foreign tax creditscarried forward from prior years.  In2002, we were not able to utilize foreign tax credits carried forward fromprior years. However, with the overall effective German rates now on par withthe U.S. rates, the shift towards income generated from the German divisionsallows us to better utilize our overall foreign tax credits.

 

**Acquisitions**

 

Historically, some of our growth has come fromstrategic acquisitions of complementary businesses.  We acquired Pianohaus Karl Lang (“PKL”), Germany’s largest retailpiano store, in January 2000, and United Musical Instruments Holdings, Inc.(“UMI”), a domestic manufacturer of band and orchestral instruments, inSeptember 2000. The following discussion includes each of these businessessince its date of acquisition.

 

**Results of Operations**

 

*Fiscal Year 2002 Compared to FiscalYear 2001*

 

*NetSales –* Net sales decreased $20.3 million (6%) to $332.3million in 2002, despite a $6.1 million (7%) revenue increase in the fourthquarter, which was attributable to our piano sales.  Year over year, piano sales declined $4.4 million (3%) to $164.6million, reflecting the 11% decrease in shipments of our Steinway grand units.  Our domestic sales were less impacted by theweakened worldwide economy than our sales in Europe and Asia.  Domestic grand unit shipments decreased only9% as compared to the 16% decrease in our grand unit shipments overseas.  However, this was mitigated by the continuedstrong domestic demand for our lower priced Boston piano lines, whichexperienced a domestic unit shipment increase of 16% in the current year.  As a result, domestic piano revenuesremained stable year over year.  Bandand orchestral instrument sales decreased $15.9 million (9%) to $167.7 millionin 2002.  This resulted from a unitdecrease of 13% and more competitive pricing strategies on certain instruments,which was partially offset by a shift in sales mix towards higher pricedstep-up and professional instruments.

 

*GrossProfit –*Grossprofit decreased $10.3 million (10%) to $97.2 million in 2002.  Gross margins declined to 29.2% from 30.5%in 2001 primarily as a result of a decline in our band margins, whichdeteriorated from 26.3% in 2001 to 23.8% in 2002.  This was due to reduced production, which was at or below 2001levels in virtually all of our plants, as well as manufacturing inefficienciesresulting from layoffs and staff retraining requirements at one of ourplants.  Piano margins decreased onlyslightly, to 34.8% from 35.1% in the prior year.  In response to the slowing economy, we applied periodic factoryshutdowns in order to control inventory levels while retaining our skilledworkforce.  A decrease in productiondays at our overseas manufacturing facility had an unfavorable impact of approximately$1.6 million on our margin, but was mitigated by the favorable exchange rateson the Boston product line inventories.

 

*OperatingExpenses –*Operatingexpenses decreased $3.3 million (5%) to $65.8 million in 2002, primarily due tothe $3.1 million decrease in our amortization expense resulting from theimplementation of SFAS No. 142. Increases in general and administrative costs associated with consultingand severance costs were more than offset by the $1.0 million decrease in salesand marketing expenses year over year.

 

*Non-operatingExpenses*– Non-operating expenses decreased $12.2 million to$9.3 million in 2002 primarily as a result of the reclassification of $6.6million of debt extinguishment costs in the prior year.  These costs, which are attributable to ourlong-term debt refinancing in April 2001, have been reclassified from anextraordinary item to a non-operating expense due to our implementation of SFAS

 

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No. 145.  Exclusive of thesecosts, non-operating expenses decreased $5.6 million.  This was due to the $3.5 million decrease in net interest expenseresulting from the significant decrease in borrowings on our domestic revolvingloan as compared to 2001.  Foreignexchange gains of $0.7 million compared to foreign exchange losses of $0.8million in 2001 also contributed to the reduction of non-operating expenses inthe current period.

 

*Fiscal Year 2001 Compared to FiscalYear 2000*

 

*NetSales –* Net sales increased $20.9 million (6%) to $352.6million in 2001. Piano sales declined $13.9 million (8%) to $169.0 million,reflecting a domestic unit shipment decrease of 20% as a result of the U.S.economic slowdown.  However, thedecrease in domestic piano sales of 15% was partially offset by the strongperformance of international piano sales, which increased $2.5 million, or 4%in 2001.  Band and orchestral salesincreased $34.6 million (23%) to $183.6 million on a corresponding increase inband shipments of 23%.  This increasewas primarily due to the $43.1 million of incremental revenue from UMI, whichmore than offset the negative effect of dealer consolidation.

 

*GrossProfit –*Grossprofit increased $2.5 million (2%) to $107.5 million in 2001.  Gross margins declined to 30.5% from 31.6% in2000 as a result of declines in both the piano and band margins. Piano marginsdeclined slightly, from 35.6% to 35.1%, despite a favorable sales mix of highermargin concert grands reported by our international piano operations.  This decline was a result of additionalfactory shutdowns and the lower absorption of overhead costs in domestic pianooperations.  These periodic shutdownswere instituted by management in order to control inventory levels, yet retainthe skilled workforce, in response to the slowing economy.  Band instrument margins declined from 26.8%to 26.3% due to production changes at one manufacturing facility, whichresulted in additional training costs and labor inefficiencies.  The incremental costs in 2001 ofapproximately $0.5 million related to a reengineering project at certain bandinstrument manufacturing plants also adversely impacted gross margin.

 

*OperatingExpenses –*Operatingexpenses increased $5.8 million (9%) to $69.0 million in 2001. Operatingexpenses as a percentage of sales increased slightly from 19% in 2000 to 20% in2001.  Excluding the incrementaloperating expenses of UMI of $7.8 million in 2001 and the one-time charges of$1.5 million associated with the acquisition of UMI in 2000, operating expensesremained relatively flat.

 

*Non-operatingExpenses*– Other expense increased approximately $7.3 million(51%) to $21.6 million in 2001.  Thisincrease is primarily the result of the $6.6 million of debt extinguishmentcosts associated with our long-term debt refinancing in April 2001, which hasbeen reclassified from an extraordinary item to a non-operating expense due toour implementation of SFAS No. 145.  Theremaining increase is a result of higher net interest expense associated withhigher average outstanding debt balances incurred primarily as a result of theacquisition of UMI.

 

**Liquidity and Capital Resources**

 

We have relied primarily upon cash provided byoperations, supplemented as necessary by seasonal borrowings under our workingcapital line, to finance our operations, repay long-term indebtedness and fundour capital expenditures.

 

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**CashFlows**

 

Cash provided by operations was $13.3 million in 2000,$28.9 million in 2001, and $31.0 million in 2002.  The increase in 2002 is the result of our continued control ofinventory as well as effective management of our accounts receivable andpayable.  In 2000, we embarked on amajor initiative to effect fundamental changes in our band instrumentmanufacturing operations.  We incurredproject related expenses of approximately $1.8 million in 2000, $2.1 million in2001, and $0.6 million in 2002.  Thelong-term benefits of the project include improved production flow, efficiencyand quality.

 

Cash used for the acquisitions of PKL and UMI was$86.6 million in 2000.  Cash used inother investing activities consists primarily of capital expenditures of $7.9million in 2000, $7.1 million in 2001, and $5.6 million in 2002.  In 2000, cash provided by financingactivities, which totaled $80.5 million, was primarily derived from borrowingson our line of credit and the $45 million acquisition loan obtained to purchaseUMI.  In 2001, cash used in financingactivities totaled $20.4 million and was due to a combination of factors, includingour issuance of $150.0 million in Senior Notes, our redemption of $110.0million in Senior Subordinated Notes, and repayment of our domestic line ofcredit.  In 2002, cash used forfinancing activities of $9.7 million was due to our long-term debt repayment of$6.4 million and the repurchase of $4.7 million of our Senior Notes.

 

**CapitalExpenditures**

 

Our capital expenditures consist primarily ofmachinery and equipment purchases, facility upgrades in conjunction withcertain EPA compliance projects, and general facility improvements.  We expect our capital spending in 2003 to bein the range of $5-6 million, relating to facility renovations, machinery andprocess improvements, and equipment replacement.

 

**Seasonality**

 

Consistent with industry practice, we sell bandinstruments almost entirely on credit utilizing the two financing programsdescribed below.  Due to these programs,we have large working capital requirements during certain times of the yearwhen band instrument receivable balances reach highs of approximately $85-90million in August and September, and lesser requirements when they are at lowsof approximately $60-65 million in January and February.  The financing options, intended to assistdealers with the seasonality inherent in the industry and to facilitate therent-to-own programs offered to students by many retailers, also allow us tomatch our production and delivery schedules. The following forms of financing are offered to qualified band instrumentdealers:

 

a)                   *Receivabledating:* Payments on purchases made from January through August aredue in October.  Payments on purchasesmade from September to December are due in January.  Dealers are offered discounts for early payment.

 

b)                  *Notereceivable financing:* Qualified dealers may convert open accounts toa note payable to us.  The note programis offered in January and October and coincides with the receivable datingprogram.  In most instances, the note receivableis secured by dealer inventories and receivables.

 

**OffBalance Sheet Arrangements**

 

Prior to August 2002, we sold notes receivable on arecourse basis to a financing company. The financing company had the option to purchase up to $18.0 million ofour notes receivable.  We receivedproceeds from the sale of such notes of approximately $12.7 million in 2001 and$2.6 million in 2002.

 

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Outstanding balances on these notes were $6.7 million as of December31, 2001.  Subsequent to August 2002 wehave retained these notes receivable.

 

Unlike many of our competitors in the piano industry,with limited exceptions, we do not provide extended financing arrangements toour dealers.  To facilitate long-termfinancing required by some dealers, we have arranged financing through athird-party provider.  We generallyprovide no guarantee with respect to these arrangements.

 

**Pensionsand Other Postretirement Benefits**

 

When determining the amounts to be recognized in theconsolidated financial statements related to our domestic pension and otherpost retirement benefits, we used a long-term rate of return on plan assets of9%, which was developed with input from our actuaries and our investmentadvisors, and is consistent with previous rates we have used.  During 2002, we implemented a pension assetinvestment policy, conducted a review and redistribution of our investmentassets in accordance with our policy, and reviewed past portfolio performanceand future performance expectations for our pension assets.  We also amended one of our plans to eliminatefuture years of service credit under the plan. We believe that 9% is representative of the long-term rate of returnthat we may expect from our domestic pension assets.  The discount rate utilized for determining future pensionobligations for our domestic plans is based on long-term bonds receiving an AA-or better rating by a recognized rating agency.  The resulting discount rate decreased from 7.5% to 6.75% atDecember 31, 2002.

 

The discount rates and rates of returns on plan assetsfor our foreign pension and other postretirement benefit plans were similarlydeveloped utilizing long-term rates of return and discount rates reasonablyexpected to occur.

 

**BorrowingActivities and Availability**

 

Our real estate term loan, acquisition term loan, and domestic,seasonal borrowing requirements are accommodated through a committed creditfacility with a syndicate of domestic lenders (the “Credit Facility”).  The Credit Facility, which was amended andrestated to accommodate the $150.0 million bond offering completed on April 19,2001, provides us with a potential borrowing capacity of $85.0 million inrevolving credit loans, and expires on September 14, 2008. Borrowings arecollateralized by our domestic accounts receivable, inventory, and fixedassets.  As of December 31, 2002, therewere no revolving credit loans outstanding and availability based on eligibleaccounts receivable and inventory balances was approximately $80.5 million, netof letters of credit. The real estate term loan is payable in monthlyinstallments of $0.2 million and includes interest at average 30-day LIBOR(1.38% at December 31, 2002) plus 1.5%. This term loan is secured by all of our interests in the Steinway Hallproperty.  The acquisition term loan isrepayable in monthly installments of $0.4 million for the first five years andmonthly installments of $0.6 million in years six through eight.  The acquisition term loan and revolvingcredit loans bear interest at average 30-day LIBOR plus 1.75%.  All of our borrowings under the CreditFacility are secured by a first lien on our domestic inventory, receivables,and fixed assets.  Open account loanswith foreign banks also provide for borrowings of up to €17.6 million ($18.5million at December 31, 2002) by Steinway’s foreign subsidiaries.

 

20

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On April 19, 2001, wecompleted a $150.0 million 8.75% Senior Note offering.  The proceeds of this offering were used toredeem $110.0 million of previously outstanding Senior Subordinated Notes, withthe balance used to pay down the Credit Facility.  The early retirement of the Senior Subordinated Notes, which wereredeemed on June 1, 2001 at 102.75% of the principal amount, generated a debtextinguishment charge of approximately $6.6 million, and a related tax benefitof $2.7 million.  On December 18, 2002we repurchased $4.7 million of our Senior Notes.

 

At December 31, 2002, our total outstandingindebtedness amounted to $200.6 million, consisting of $145.3 million of 8.75%Senior Notes, $19.7 million on the real estate term loan, $34.0 million on theacquisition term loan, and $1.6 million of notes payable to foreign banks.  Cash interest paid was $19.1 million in 2001and $15.3 million in 2002. All of our debt agreements contain covenants thatplace certain restrictions on us, including our ability to incur additionalindebtedness, to make investments in other entities and to pay cash dividends.We were in compliance with all such covenants as of December 31, 2002.

 

Our share repurchase program authorizes us to makediscretionary repurchases of our ordinary common stock up to a limit of $25.0million.  Repurchased shares are beingheld as treasury shares to be used for corporate purposes.  We have reserved 721,750 shares of ourexisting treasury stock to be utilized for the issuance for stock options underour Amended and Restated 1996 Stock Plan. These options will have no impact on our cash flow or number of sharesoutstanding unless and until the options are exercised.  In 2001, we repurchased 114,600 shares at acost of $1.9 million.  We did notrepurchase any shares in 2002, but intend to consider repurchases in 2003,contingent upon our cash flow, share price, and availability of shares forpurchase.

 

We experience long production and inventory turnovercycles, which we constantly monitor, since fluctuations in demand can have asignificant impact on these cycles.  In2002, we successfully continued to focus on managing our inventory levels andaccounts receivable in order to maximize cash flow from operations.  We were once again able to eliminate theoutstanding debt on the revolving portion of the Credit Facility by the end ofthe fiscal year.  Looking forward to2003, we anticipate a challenging year. We will continue to focus on keeping our balance sheet strong bymanaging accounts receivable, maintaining sufficient, but not excessive,inventory levels, and repaying debt. Other than those described, we are not aware of any trends, demands,commitments, or costs of resources that are expected to materially impact ourliquidity or capital resources. Accordingly, we believe that cash on hand, together with cash flowsanticipated from operations and available borrowings under the Credit Facility,will be adequate to meet our debt service requirements, fund continuing capitalrequirements and satisfy our working capital and general corporate needsthrough 2003.

 

21

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**ContractualObligations**

 

The following table provides a summary of our contractualobligations at December 31, 2002.

 
|                             |   | **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)              |   | $                          | 200,636 |   | $ | 8,055 |   | $ | 13,111 |   | $ | 13,295 |   | $ | 166,175 |   |
| Operating  leases (2)            |   | 272,850                    |    | 4,400 |   | 7,943 |   | 6,453 |   | 254,054 |   |
| Other  long-term liabilities (3) |   | 22,407                     |    | 2,440 |   | 4,880 |   | 4,880 |   | 10,207 |   |
| Total                            |   | $                          | 495,893 |   | $ | 14,895 |   | $ | 25,934 |   | $ | 24,628 |   | $ | 430,436 |   |

 

----

**Notes toContractual Obligations:**

 

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

(2)  Approximately $261.9 million of ouroperating lease obligations are attributable to the ninety-nine year land leaseassociated with the purchase of Steinway Hall, which is described in Note 13 inthe Notes to Consolidated Financial Statements included within this filing; theremainder is attributable to the leasing of other facilities and equipment.

(3)  Our other long-term liabilities consistprimarily of pension obligations, which are described in Note 14 in the Notesto Consolidated Financial Statements included within this filing.

 

**CriticalAccounting Policies**

 

The nature of our business - the production and saleof musical instruments - is such that it rarely involves application of highlycomplex or subjective accounting principles. The accounting policies that are subject to significant management estimatesare those normally found in traditional businesses and include inventoryreserves, accounts receivable reserves, reserves on notes receivable (includingrecourse reserves when notes had been sold to third parties), and warrantyreserves.  We have significantexperience and data on which to base these estimates.  Historical information is adjusted for specific uncertainties,such as new product introductions, and contemporaneous information, such asprice fluctuations.  We regularlyperform assessments of the underlying assumptions and believe that they providea reasonable basis for the estimates contained in our financial statements.

 

**New Accounting Pronouncements**

 

On April 30, 2002 the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44,and 64, Amendment of FASB Statement No. 13, and Technical Corrections,” whichaddresses, among other things, the treatment of gains and losses resulting fromthe early extinguishment of debt.  Weadopted SFAS No. 145 in 2002 and reclassified the components of the earlyextinguishment of debt recorded in 2001 to an element of non-operating expensesand the income tax provision; this reclassification does not change the amountof the loss recorded nor, other than the reclassification, does it have a materialimpact on our financial position or results of operations.

 

22

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On July 30, 2002 the FASB issued SFAS No. 146,  “Accounting for Costs Associated with Exitor Disposal Activities.”  SFAS No. 146requires costs associated with exit or disposal activities to be recognizedwhen the costs are incurred, rather than at the date of commitment to an exitor disposal plan.  The provisions ofSFAS No. 146 are effective for disposal activities initiated after December 31,2002.

 

In December 2002, the FASB issued SFAS No. 148,“Accounting for Stock-Based Compensation-Transition and Disclosure-an Amendmentof FASB Statement No. 123.”  SFAS No.148 provides alternative methods of transition for a voluntary change to thefair value based method of accounting for stock-based employeecompensation.  We do not currentlyintend to adopt the fair value based method of measuring compensationassociated with stock awards and grants. As a consequence of continuing to utilize the intrinsic value method ofmeasuring such compensation, we will be required in 2003 to provide additionaldisclosures in our quarterly financial statements, which will reflect theimpact on net income and earnings per share on a pro forma basis as if we hadapplied the fair value method to stock-based employee compensation.

 

**ITEM 7A****                                               QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We are subject to market risk associated with changesin foreign currency exchange rates and interest rates.  We mitigate our foreign currency exchangerate risk by holding forward foreign currency contracts.  These contracts are used as a hedge againstintercompany transactions and are not used for trading or speculative purposes.  The fair value of the forward foreign currencyexchange contracts is sensitive to changes in foreign currency exchangerates.  As of December 31, 2002, a 10%negative change in foreign currency exchange rates from market rates woulddecrease the fair value of the contracts by approximately $0.3 million.  Gains and losses on the foreign currencyexchange contracts are defined as the difference between the contract rate atits inception date and the current exchange rate.  However, we would offset any such gains and losses bycorresponding losses and gains, respectively, on the related hedged asset orliability.

 

Our interest rate exposure is limited primarily tointerest rate changes on our variable rate debt.  The Credit Facility and term loans bear interest at rates thatfluctuate with changes in LIBOR.  Forthe year ended December 31, 2002, a hypothetical 10% increase in interest rateswould have increased our interest expense by approximately $0.2 million.  We use interest rate caps to manage interestrate risk on foreign debt.  The carryingvalue of the caps is not material and a 10% change in interest rates would nothave a material effect on the fair value of the caps.

 

Our long-term debt includes $145.3 million of SeniorNotes with a fixed interest rate. Accordingly, there would be no immediate impact on our interest expenseassociated with these Notes due to fluctuations in market interest rates.  However, based on a hypothetical 10%immediate decrease in market interest rates, the fair value of our SeniorNotes, which would be sensitive to such interest rate changes, would beincreased by approximately $2.2 million as of December 31, 2002.  Such fair value changes may affect ourdetermination whether to retain, replace or retire these Notes.

 

23

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**ITEM 8                   FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

INDEPENDENT AUDITORS’ REPORT

 

CONSOLIDATED FINANCIALSTATEMENTS:

 

Consolidated Statementsof Income for the Years Ended December 31, 2000, 2001, and 2002

Consolidated Balance Sheetsas of December 31, 2001 and 2002

ConsolidatedStatements of Cash Flows for the Years Ended December 31, 2000, 2001 and 2002

ConsolidatedStatements of Stockholders’ Equity for the Years Ended December 31, 2000, 2001and 2002

Notes toConsolidated Financial Statements

ScheduleII - Valuation and Qualifying Accounts

 

24

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**INDEPENDENT AUDITORS’ REPORT**

 

To the Board of Directorsand Stockholders of Steinway Musical Instruments, Inc.:

 

We have audited the accompanying consolidated balance sheets ofSteinway Musical Instruments, Inc. and subsidiaries as of December 31, 2001 and2002, and the related consolidated statements of income, stockholders’ equity,and cash flows for each of the three years in the period ended December 31,2002.  Our audits also included thefinancial statement schedule listed in the Index at Item 15(a)(1).  These financial statements and financialstatement schedule are the responsibility of the Company’s management.  Our responsibility is to express an opinionon the financial statements and financial statement schedule based on ouraudits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly,in all material respects, the financial position of Steinway MusicalInstruments, Inc. and subsidiaries as of December 31, 2001 and 2002, and theresults of their operations and their cash flows for each of the three years inthe period ended December 31, 2002, in conformity with accounting principlesgenerally accepted in the United States of America.  Also, in our opinion, such financial statement schedule, when consideredin relation to the basic consolidated financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.

 

As discussed in Note 2, in 2002 the Company changed its methods ofaccounting for goodwill and trademarks to conform to Statement of FinancialAccounting Standard (“SFAS”) No. 142, and debt extinguishment costs to conformto SFAS No. 145.

 
| /s/  DELOITTE  & TOUCHE LLP |   |
|--------------------------------------|--------|
|                                 |
| Boston, Massachusetts                |
| February 21, 2003                    |

 

25

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

**CONSOLIDATED STATEMENTS OF INCOME**

## **YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002**

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

** **
|                                    |   | **2000**  |    | **2001**  |   | **2002**  |   |
|-----------------------------------------|--------|-----------|---------|-----------|--------|-----------|--------|
|                                    |   |      |    |      |   |      |   |   |   |   |
| Net  sales                              |   | $         | 331,698 |      | $      | 352,612   |   | $ | 332,297 |   |
| Cost  of sales                          |   | 226,740   |    | 245,114   |   | 235,146   |   |
|                                    |   |      |    |      |   |      |   |
| Gross  profit                           |   | 104,958   |    | 107,498   |   | 97,151    |   |
|                                    |   |      |    |      |   |      |   |
| Operating  expenses:                    |   |      |    |      |   |      |   |
| Sales  and marketing                    |   | 37,342    |    | 42,251    |   | 41,129    |   |
| General  and administrative             |   | 19,694    |    | 21,909    |   | 22,517    |   |
| Amortization                            |   | 3,856     |    | 4,255     |   | 1,154     |   |
| Other  operating expenses               |   | 887       |    | 611       |   | 952       |   |
| Non-recurring  charges                  |   | 1,490     |    | —    |   | —    |   |
| Total  operating expenses               |   | 63,269    |    | 69,026    |   | 65,752    |   |
|                                    |   |      |    |      |   |      |   |
| Income  from operations                 |   | 41,689    |    | 38,472    |   | 31,399    |   |
|                                    |   |      |    |      |   |      |   |
| Other  income, net                      |   | (1,825    | )       | (1,778    | )      | (3,939    | )      |
| Interest  income                        |   | (1,291    | )       | (2,306    | )      | (1,892    | )      |
| Interest  expense                       |   | 17,401    |    | 19,037    |   | 15,171    |   |
| Debt  extinguishment costs              |   | —    |    | 6,612     |   | —    |   |
|                                    |   |      |    |      |   |      |   |
| Income  before income taxes             |   | 27,404    |    | 16,907    |   | 22,059    |   |
|                                    |   |      |    |      |   |      |   |
| Provision  for income taxes             |   | 10,500    |    | 5,588     |   | 7,150     |   |
|                                    |   |      |    |      |   |      |   |
| Net  income                             |   | $         | 16,904  |      | $      | 11,319    |   | $ | 14,909 |   |
|                                    |   |      |    |      |   |      |   |
| Earnings  per share - basic and diluted |   | $         | 1.89    |      | $      | 1.27      |   | $ | 1.68 |   |
|                                    |   |      |    |      |   |      |   |
| Weighted  average shares:               |   |      |    |      |   |      |   |
| Basic                                   |   | 8,921,091 |    | 8,928,000 |   | 8,877,256 |   |
| Diluted                                 |   | 8,921,108 |    | 8,928,000 |   | 8,882,165 |   |

 

See notes to consolidatedfinancial statements.

 

26

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

**CONSOLIDATED BALANCE SHEETS**

**DECEMBER 31, 2001 AND 2002**

**(In Thousands Except Share Data)**

** **
|                                                                                                                                     |   | **December 31,  2001** |    | **December 31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|------------------------|--------|
| ASSETS                                                                                                                                   |   |                   |    |                   |   |
| Current assets:                                                                                                                          |   |                   |    |                   |   |
| Cash                                                                                                                                     |   | $                      | 5,545   |                   | $      | 19,099 |   |
| Accounts, notes and  leases receivable, net of allowance for  bad debts of $10,909 and $11,389 in 2001 and 2002, respectively            |   | 82,188                 |    | 77,421                 |   |
| Inventories                                                                                                                              |   | 161,124                |    | 163,090                |   |
| Prepaid expenses and  other current assets                                                                                               |   | 4,484                  |    | 5,227                  |   |
| Deferred tax assets                                                                                                                      |   | 5,636                  |    | 7,012                  |   |
| Total current assets                                                                                                                     |   | 258,977                |    | 271,849                |   |
|                                                                                                                                     |   |                   |    |                   |   |
| Property, plant and  equipment, net                                                                                                      |   | 104,011                |    | 102,567                |   |
| Trademarks                                                                                                                               |   | 9,142                  |    | 9,651                  |   |
| Goodwill                                                                                                                                 |   | 27,917                 |    | 29,539                 |   |
| Other intangibles, net                                                                                                                   |   | 8,086                  |    | 6,936                  |   |
| Other assets                                                                                                                             |   | 5,907                  |    | 7,692                  |   |
|                                                                                                                                     |   |                   |    |                   |   |
| TOTAL ASSETS                                                                                                                             |   | $                      | 414,040 |                   | $      | 428,234 |   |
|                                                                                                                                     |   |                   |    |                   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                               |   |                   |    |                   |   |
| Current liabilities:                                                                                                                     |   |                   |    |                   |   |
| Current portion of  long-term debt                                                                                                       |   | $                      | 7,446   |                   | $      | 8,055 |   |
| Accounts payable                                                                                                                         |   | 7,682                  |    | 9,888                  |   |
| Other current  liabilities                                                                                                               |   | 34,095                 |    | 35,264                 |   |
| Total current  liabilities                                                                                                               |   | 49,223                 |    | 53,207                 |   |
|                                                                                                                                     |   |                   |    |                   |   |
| Long-term debt                                                                                                                           |   | 203,757                |    | 192,581                |   |
| Deferred tax  liabilities                                                                                                                |   | 27,118                 |    | 22,709                 |   |
| Other non-current  liabilities                                                                                                           |   | 13,571                 |    | 23,931                 |   |
| Total liabilities                                                                                                                        |   | 293,669                |    | 292,428                |   |
|                                                                                                                                     |   |                   |    |                   |   |
| Commitments and  contingent liabilities                                                                                                  |   |                   |    |                   |   |
|                                                                                                                                     |   |                   |    |                   |   |
| Stockholders’ equity:                                                                                                               |   |                   |    |                   |   |
| Class A Common stock, $.001  par value, 5,000,000 shares authorized,  477,953 shares issued and outstanding                              |   | —                 |    | —                 |   |
| Common stock, $.001 par  value, 90,000,000 shares authorized, 8,368,496  and 8,428,285 shares outstanding in 2001 and 2002, respectively |   | 9                      |    | 9                      |   |
| Additional paid-in  capital                                                                                                              |   | 72,178                 |    | 73,172                 |   |
| Retained earnings                                                                                                                        |   | 76,711                 |    | 91,620                 |   |
| Accumulated other  comprehensive loss                                                                                                    |   | (12,674                | )       | (13,142                | )      |
| Treasury stock, at cost  (774,000 shares)                                                                                                |   | (15,853                | )       | (15,853                | )      |
| Total stockholders’  equity                                                                                                         |   | 120,371                |    | 135,806                |   |
|                                                                                                                                     |   |                   |    |                   |   |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                         |   | $                      | 414,040 |                   | $      | 428,234 |   |

 

See notes to consolidatedfinancial statements.

 

27

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**YEARS ENDED DECEMBER 31, 2000, 2001AND 2002**

**(In Thousands)**

 
|                                                                           |   | **2000** |   | **2001** |   | **2002** |   |
|--------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Cash flows from  operating activities:                                         |   |     |   |     |   |     |   |
| Net income                                                                     |   | $        | 16,904 |     | $      | 11,319   |   | $ | 14,909 |   |
| Adjustments to  reconcile net income to cash  flows from operating activities: |   |     |   |     |   |     |   |
| Depreciation and  amortization                                                 |   | 12,342   |   | 13,803   |   | 11,037   |   |
| Debt extinguishment  costs                                                     |   | —   |   | 6,612    |   | —   |   |
| Deferred tax benefit                                                           |   | (2,349   | )      | (1,421   | )      | (1,194   | )      |
| Other                                                                          |   | 240      |   | 431      |   | 334      |   |
| Changes in operating  assets and liabilities:                                  |   |     |   |     |   |     |   |
| Accounts, notes and  leases receivable                                         |   | 4,739    |   | 9,864    |   | 6,090    |   |
| Inventories                                                                    |   | (20,242  | )      | (3,520   | )      | 1,877    |   |
| Prepaid expenses and  other current assets                                     |   | 365      |   | (2,533   | )      | (755     | )      |
| Accounts payable                                                               |   | 2,161    |   | (3,440   | )      | 1,845    |   |
| Other current  liabilities                                                     |   | (895     | )      | (2,238   | )      | (3,095   | )      |
| Cash flows from  operating activities                                          |   | 13,265   |   | 28,877   |   | 31,048   |   |
|                                                                           |   |     |   |     |   |     |   |
| Cash flows from  investing activities:                                         |   |     |   |     |   |     |   |
| Capital expenditures                                                           |   | (7,890   | )      | (7,141   | )      | (5,604   | )      |
| Proceeds from disposals  of fixed assets                                       |   | 511      |   | 243      |   | 4        |   |
| Business acquisitions (net  of cash acquired)                                  |   | (86,567  | )      | —   |   | —   |   |
| Changes in other assets                                                        |   | 148      |   | (1,090   | )      | (2,149   | )      |
| Cash flows from  investing activities                                          |   | (93,798  | )      | (7,988   | )      | (7,749   | )      |
|                                                                           |   |     |   |     |   |     |   |
| Cash flows from  financing activities:                                         |   |     |   |     |   |     |   |
| Net borrowings  (repayments) under lines of credit                             |   | 41,297   |   | (45,601  | )      | 295      |   |
| Proceeds from long-term  debt                                                  |   | 45,000   |   | 150,000  |   | —   |   |
| Repayments of long-term  debt                                                  |   | (1,981   | )      | (118,847 | )      | (6,352   | )      |
| Repurchase of long-term  debt                                                  |   | —   |   | —   |   | (4,655   | )      |
| Debt issuance costs                                                            |   | (3,942   | )      | (4,516   | )      | —   |   |
| Proceeds from issuance  of stock                                               |   | 693      |   | 454      |   | 994      |   |
| Purchases of treasury  stock                                                   |   | (483     | )      | (1,901   | )      | —   |   |
| Cash flows from  financing activities                                          |   | 80,584   |   | (20,411  | )      | (9,718   | )      |
|                                                                           |   |     |   |     |   |     |   |
| Effects of foreign  exchange rate changes on cash                              |   | 274      |   | 78       |   | (27      | )      |
|                                                                           |   |     |   |     |   |     |   |
| Increase in cash                                                               |   | 325      |   | 556      |   | 13,554   |   |
| Cash, beginning of year                                                        |   | 4,664    |   | 4,989    |   | 5,545    |   |
|                                                                           |   |     |   |     |   |     |   |
| Cash, end of year                                                              |   | $        | 4,989  |     | $      | 5,545    |   | $ | 19,099 |   |
|                                                                           |   |     |   |     |   |     |   |
| Supplemental Cash Flow  Information                                            |   |     |   |     |   |     |   |
| Interest paid                                                                  |   | $        | 17,238 |     | $      | 19,120   |   | $ | 15,318 |   |
| Income taxes paid                                                              |   | $        | 14,990 |     | $      | 10,337   |   | $ | 11,363 |   |

 

See notes to consolidatedfinancial statements.

 

28

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

**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY**

**FOR THE YEARS ENDED DECEMBER 31,2000, 2001 AND 2002**

**(In Thousands Except Share Data)**

** **
|                                                    |   | **Common********Stock** |   | **Additional********Paid-In********Capital** |   | **Retained********Earnings** |   | **Accumulated********Other********Comprehensive********Loss** |   | **Treasury********Stock** |   | **Total********Stockholders’********Equity** |   |
|---------------------------------------------------------|--------|-------------------------|--------|----------------------------------------------|--------|------------------------------|--------|---------------------------------------------------------------|--------|---------------------------|--------|---------------------------------------------------|--------|
|                                                    |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Balance, January 1, 2000                                |   | $                       | 9      |                                         | $      | 71,031                       |   | $                                                             | 48,488 |                      | $      | (7,857                                            | )      | $ | (13,469 | ) | $ | 98,202 |   |
|                                                    |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Comprehensive  income:                                  |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Net  income                                             |   |                    |   |                                         |   | 16,904                       |   |                                                          |   |                      |   | 16,904                                            |   |
| Foreign  currency translation adjustment                |   |                    |   |                                         |   |                         |   | (1,988                                                        | )      |                      |   | (1,988                                            | )      |
| Additional  minimum pension liability, net              |   |                    |   |                                         |   |                         |   | (121                                                          | )      |                      |   | (121                                              | )      |
| Total  comprehensive income                             |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   | 14,795                                            |   |
|                                                    |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Issuance  of 42,173 shares  of common stock             |   |                    |   | 693                                          |   |                         |   |                                                          |   |                      |   | 693                                               |   |
|                                                    |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Purchase  of 26,700 shares  of common stock             |   |                    |   |                                         |   |                         |   |                                                          |   | (483                      | )      | (483                                              | )      |
|                                                    |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Balance,  December 31, 2000                             |   | 9                       |   | 71,724                                       |   | 65,392                       |   | (9,966                                                        | )      | (13,952                   | )      | 113,207                                           |   |
|                                                    |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Comprehensive  income:                                  |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Net  income                                             |   |                    |   |                                         |   | 11,319                       |   |                                                          |   |                      |   | 11,319                                            |   |
| Foreign  currency translation adjustment                |   |                    |   |                                         |   |                         |   | (1,852                                                        | )      |                      |   | (1,852                                            | )      |
| Additional  minimum pension liability, net              |   |                    |   |                                         |   |                         |   | (851                                                          | )      |                      |   | (851                                              | )      |
| Unrealized  loss on certain  long-term investments, net |   |                    |   |                                         |   |                         |   | (5                                                            | )      |                      |   | (5                                                | )      |
| Total  comprehensive income                             |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   | 8,611                                             |   |
|                                                    |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Issuance  of 29,549 shares  of common stock             |   |                    |   | 454                                          |   |                         |   |                                                          |   |                      |   | 454                                               |   |
|                                                    |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Purchase  of 114,600  shares of common stock            |   |                    |   |                                         |   |                         |   |                                                          |   | (1,901                    | )      | (1,901                                            | )      |
|                                                    |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Balance,  December 31, 2001                             |   | 9                       |   | 72,178                                       |   | 76,711                       |   | (12,674                                                       | )      | (15,853                   | )      | 120,371                                           |   |
| Comprehensive  income:                                  |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Net  income                                             |   |                    |   |                                         |   | 14,909                       |   |                                                          |   |                      |   | 14,909                                            |   |
| Foreign  currency translation adjustment                |   |                    |   |                                         |   |                         |   | 5,589                                                         |   |                      |   | 5,589                                             |   |
| Additional  minimum pension liability, net              |   |                    |   |                                         |   |                         |   | (5,986                                                        | )      |                      |   | (5,986                                            | )      |
| Unrealized  loss on certain  long-term investments, net |   |                    |   |                                         |   |                         |   | (71                                                           | )      |                      |   | (71                                               | )      |
| Total  comprehensive income                             |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   | 14,441                                            |   |
|                                                    |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Issuance  of 37,389 shares  of common stock             |   |                    |   | 994                                          |   |                         |   |                                                          |   |                      |   | 994                                               |   |
|                                                    |   |                    |   |                                         |   |                         |   |                                                          |   |                      |   |                                              |   |
| Balance,  December 31, 2002                             |   | $                       | 9      |                                         | $      | 73,172                       |   | $                                                             | 91,620 |                      | $      | (13,142                                           | )      | $ | (15,853 | ) | $ | 135,806 |   |

 

See notes to consolidatedfinancial statements.

 

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

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**YEARS ENDED DECEMBER 31, 2000, 2001AND 2002**

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

 

**(1)****      Natureof Business**

 

Steinway MusicalInstruments, Inc. and subsidiaries (the “Company”) is one of the world’sleading manufacturers of musical instruments. The Company, through its wholly-owned subsidiaries, The Steinway PianoCompany, Inc. (“Steinway”) and Conn-Selmer, Inc. (“Conn-Selmer”), manufacturesand distributes products within the musical instrument industry.  Steinway produces the highest quality pianoin the world and has one of the most highly recognized and prestigious brandnames.  Conn-Selmer is the leadingdomestic manufacturer of band and orchestral instruments and relatedaccessories, including complete lines of brasswind, woodwind, percussion andstringed instruments.  Selmer Parissaxophones, Bach Stradivarius trumpets, C.G. Conn French horns, King trombonesand Ludwig snare drums are considered by many to be the finest such instrumentsin the world.

 

Throughout this form “we”,“us”, and “our” refer to Steinway Musical Instruments, Inc. and subsidiariestaken as a whole.  During 2002 wecombined the operations of The Selmer Company (“Selmer”) and United MusicalInstruments, Inc. (“UMI”) into Conn-Selmer. The legal merger became effective on January 1, 2003. References to“Selmer” and “UMI” refer to events or circumstances prior to the merger.

 

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

 

*Principles of Consolidation* - Our consolidated financialstatements include the accounts of all of our direct and indirect wholly-ownedsubsidiaries.  Significant intercompanybalances have been eliminated in consolidation.

 

*Use of Estimates* - The preparation offinancial statements in conformity with accounting principles generally acceptedin the United States of America necessarily requires us to make estimates andassumptions that affect the reported amounts of assets and liabilities and thereported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

*Revenue Recognition* - Revenue is generallyrecognized upon shipment following receipt of a valid customer order. Weprovide for the estimated costs of warranties, discounts and returns at thetime of sale.

 

*Inventories*- Inventories are stated atthe lower of cost or market.  Cost hasbeen determined using the first-in, first-out (“FIFO”) method for approximately74% of our inventories at December 31, 2001 and 75% of our inventories at December31, 2002.  The cost of the remaining inventorieshas been determined by the last-in, first-out (“LIFO”) method.

 

*Goodwill,Trademarks and Other Intangible Assets*-**Intangible assets other than goodwill andtrademarks are amortized on a straight-line basis over their estimated usefullives.  Deferred financing costs areamortized over the repayment periods of the underlying debt, which approximatesthe effective interest method.  Prior to2002, goodwill was amortized on a straight-line basis over 40 years, andtrademarks acquired were recorded at appraised value and amortized on astraight-line basis over 10 years. However, effective January 1, 2002, we adopted Statement of FinancialAccounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,”which required that we cease to record

 

30

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amortization expense on our goodwill and trademark assets.  SFAS No. 142 also required that, uponadoption, we test our goodwill and trademark assets for impairment.  We are also required to test goodwill andtrademark assets 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 January 1, 2002 andDecember 31, 2002, we evaluated our goodwill and trademark assets anddetermined that the fair value had not decreased below the carrying value and,accordingly, no impairment adjustments have been made.

 

*Depreciation and Amortization* - Property,plant and equipment are recorded at cost or, in the case of assets acquiredthrough business combinations, at fair value. Depreciation is provided usingthe straight-line method over the estimated useful lives of the respectiveassets.  Leasehold improvements areamortized using the straight-line method over the estimated useful lives of theimprovements or the remaining term of the respective lease, whichever isshorter.  Estimated useful lives are asfollows:

 
| Buildings and  improvements           |   | 15-40 years |
|---------------------------------------|--------|-------------|
| Leasehold improvements                |   | 5-15 years  |
| Machinery, equipment  and tooling     |   | 3-10 years  |
| Office furniture and  fixtures        |   | 3-10 years  |
| Concert and artist and  rental pianos |   | 15 years    |

 

When conditions indicatea need to evaluate recoverability, we evaluate the recoverability of ourlong-lived assets by comparing the estimated future undiscounted cash flowsexpected to be generated by those assets to their carrying value.  To date, no impairment losses have beennoted or recorded as a result of this evaluation process.

 

*Advertising*- Advertising costs areexpensed as incurred.  Advertisingexpense was $7,684 for the year ended December 31, 2000, $8,344 for the yearended December 31, 2001, and $6,714 for the year ended December 31, 2002.

 

*Income Taxes-*We provide for income taxesusing an asset and liability approach to financial accounting and reporting forincome taxes.  We compute deferredincome tax assets and liabilities annually for differences between thefinancial statement and tax bases of assets and liabilities that will result intaxable or deductible amounts in the future based on enacted tax laws and ratesapplicable to the periods in which the differences are expected to affecttaxable income.  We establish valuationallowances when necessary to reduce deferred tax assets to the amount expectedto be realized.  Income tax expense isthe tax payable or refundable for the period plus or minus the change duringthe period in deferred tax assets and liabilities.

 

*Foreign Currency Translation* – Wetranslate assets and liabilities of non-U.S. operations into U.S. dollars at year-endrates, and revenues and expenses at average rates of exchange prevailing duringthe year.  We report the resultingtranslation adjustments as a separate component of comprehensive income.  We recognize foreign currency transactiongains and losses in the consolidated statements of income as incurred.

 

*Foreign Exchange Contracts* – We enter intoforeign exchange contracts as a hedge against risks inherent in foreigncurrency transactions.  These contractsare not used for trading or speculative purposes.  Gains and losses arising from fluctuations in exchange rates arerecognized at the end of each reporting period.  Such gains and losses directly offset the foreign exchange gainsor losses associated with the hedged receivable or payable.  Gains and losses on foreign exchangecontracts which exceed the related balance sheet or firm purchase commitmentexposure are included in foreign currency gain or loss

 

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in the consolidated statements of income.  We have credit risk to the extent the counterparties are unableto fulfill their obligations on the foreign exchange contracts.  However, we enter into these contracts withreputable institutions and we believe there is not a significant risk of loss.

 

*Stock-based Compensation* - We have an employee stock purchaseplan (“Purchase Plan”) and a stock plan (“Stock Plan”) which are described morefully in Note 12.  As permitted underaccounting principles generally accepted in the United States of America, we haveelected to continue to follow the intrinsic value method in accounting for ourstock-based employee compensation arrangement.

 

The following tableillustrates the effect on net income and earnings per share if we had appliedthe fair value method to measure stock-based employee compensation.
|                                                                                                                                           |   | **Years Ended December 31** |       |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|------------|
|                                                                                                                                           |   | **2000**                    |       | **2001** |   | **2002** |   |
|                                                                                                                                           |   |                        | ** ** |   | ** ** |   | ** ** |
| Net  income, as reported                                                                                                                       |   | $                           | 16,904     |   | $ | 11,319 |   | $ | 14,909 |   |
| Deduct:  Total stock-based employee compensation  expense determined under fair-value based method for  all awards, net of related tax effects |   | (971                        | )          | (715 | ) | (613 | ) |
| Pro  forma net income                                                                                                                          |   | $                           | 15,933     |   | $ | 10,604 |   | $ | 14,296 |   |
| Earnings  per share:                                                                                                                           |   |                        |       |   |   |   |   |
| As  reported Basic and Diluted                                                                                                                 |   | $                           | 1.89       |   | $ | 1.27 |   | $ | 1.68 |   |
| Pro  forma Basic and Diluted                                                                                                                   |   | $                           | 1.79       |   | $ | 1.19 |   | $ | 1.61 |   |

 

The fair value of optionson their grant date, including the valuation of the option feature implicit inour Purchase Plan, was measured using the Black-Scholes option-pricingmodel.  Key assumptions used to apply thispricing model are as follows:

 
|                                                |   | **2000**     |   | **2001** |   | **2002**     |   |
|-----------------------------------------------------|--------|--------------|--------|----------|--------|--------------|--------|
| Range  of risk-free interest rates                  |   | 6.05  - 6.41 | %      | 3.57     | %      | 1.86  - 3.56 | %      |
| Range  of expected life of option grants (in years) |   | 1  to 6      |   | 1  to 6  |   | 1  to 6      |   |
| Expected  volatility of underlying stock            |   | 26.0         | %      | 25.5     | %      | 25.6         | %      |

 

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

 
|           |   | **2000** |   | **2001** |   | **2002** |   |
|----------------|--------|----------|--------|----------|--------|----------|--------|
| Stock  Plan    |   | $        | 7.64   |     | $      | —   |   | $ | 6.27 |   |
| Purchase  Plan |   | $        | 4.79   |     | $      | 4.48     |   | $ | 4.78 |   |

 

It should be noted thatthe Black-Scholes option-pricing model was designed to value readily tradableoptions with relatively short lives and no vesting restrictions.  In addition, option valuation models requirethe input of highly subjective assumptions including the expected pricevolatility.  Because the options grantedare not tradable and have contractual lives of up to ten years, and becausechanges in the subjective input assumptions can materially affect the fairvalue estimate, in management’s opinion, the

 

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existing models do notprovide a reliable measure of the fair value of the options issued under eitherthe Stock Plan or Purchase Plan.

 

*Income per Common Share* - Basic income percommon share is computed using the weighted average number of common sharesoutstanding during each year.  Dilutedincome per common share reflects the effect of our outstanding options (usingthe treasury stock method), except when such items would be antidilutive.

 

A reconciliation of theweighted average shares used for the basic and diluted computations is asfollows for the years ended December 31:

 
|                                                  |   | **2000**  |   | **2001**  |   | **2002**  |   |
|-------------------------------------------------------|--------|-----------|--------|-----------|--------|-----------|--------|
|                                                  |   |      |   |      |   |      |   |
| Weighted  average shares for basic income per share   |   | 8,921,091 |   | 8,928,000 |   | 8,877,256 |   |
| Dilutive  effect of stock options                     |   | 17        |   | —    |   | 4,909     |   |
| Weighted  average shares for diluted income per share |   | 8,921,108 |   | 8,928,000 |   | 8,882,165 |   |

 

Options to purchase618,800, 612,400, and 1,098,300 shares of common stock at prices ranging from$18.55 to $21.94 per share were outstanding during the years ended December 31,2000, 2001 and 2002, respectively, but were not included in the computation ofdiluted net income per share because the options’ exercise prices were greaterthan the average market price of the common shares.

 

*Environmental Matters*- Potentialenvironmental liabilities are recorded when it is probable that a loss has beenincurred and its amount can reasonably be estimated (see Note 13).

 

*Segment Reporting* - We have two distinct reportable segments: the piano segmentand the band and orchestral instrument segment.  We consider these two segments reportable as they are managedseparately and the operating results of each segment are regularly reviewed andevaluated separately by our senior management.

 

C*omprehensive Income -*Comprehensiveincome is comprised of net income, foreign currency translation adjustments,additional minimum pension liabilities, and unrealized gains and losses oncertain long-term assets and is reported in the consolidated statements ofstockholders’ equity for all periods presented.

 

*New Accounting Pronouncements -*On April30, 2002 the Financial Accounting Standards Board (“FASB”) issued SFAS No. 145,“Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB StatementNo. 13, and Technical Corrections,” which addresses, among other things, thetreatment of gains and losses resulting from the early extinguishment ofdebt.  We adopted SFAS No. 145 in 2002and reclassified the components of the early extinguishment of debt recorded in2001 to an element of non-operating expenses and the income tax provision; thisreclassification does not change the amount of the loss recorded nor, otherthan the reclassification, does it have a material impact on our financialposition or results of operations.

 

On July 30, 2002 the FASBissued SFAS No. 146,  “Accounting forCosts Associated with Exit or Disposal Activities.”  SFAS No. 146 requires costs associated with exit or disposalactivities to be

 

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recognized when the costs are incurred, rather than at the date ofcommitment to an exit or disposal plan. The provisions of SFAS No. 146 are effective for disposal activitiesinitiated after December 31, 2002.

 

In December 2002, theFASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transitionand Disclosure-an Amendment of FASB Statement No. 123.”  SFAS No. 148 provides alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. We do not currently intend to adopt the fair value based method ofmeasuring compensation associated with stock awards and grants.  As a consequence of continuing to utilizethe intrinsic value method of measuring such compensation, we will be requiredin 2003 to provide additional disclosures in our quarterly financial statementswhich will reflect the impact on net income and earnings per share on a proforma basis as if we had applied the fair value method to stock-based employeecompensation.

 

*Reclassifications -*Certain prior year amountshave been reclassified to conform to the current year presentation.

 

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

 

During the year endedDecember 31, 2000, we completed two acquisitions, both of which were accountedfor as purchases.  The results of theacquired businesses have been included with our results from the dates ofacquisition.  The purchase prices paidwere allocated to the assets acquired and liabilities assumed based upon theirestimated fair values.

 

In January 2000, weacquired Pianohaus Karl Lang, located in Munich, Germany, for approximately$2.3 million.  The purchase price wasallocated primarily to fixed assets.

 

In September 2000, wecompleted the acquisition of UMI pursuant to a stock purchase agreement datedas of July 20, 2000.  The purchase priceaggregated $27.0 million in cash.  Inaddition, we assumed approximately $57.0 million of debt.

 

In connection with theacquisition of UMI, inventories were written up by $11.0 million to netrealizable value.  Prior to theacquisition, UMI had utilized the LIFO method of determining cost; the Companyhas continued to utilize this method for UMI inventories.  We recorded approximately $300 of trademarkamortization in 2001 relating to the UMI acquisition.

 

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

** **
|             |   | **December 31,** |    |
|------------------|--------|------------------|---------|
|             |   | **2001**         |    | **2002** |   |
| Raw  materials   |   | $                | 20,948  |   | $ | 21,568 |   |
| Work  in process |   | 52,967           |    | 56,019 |   |
| Finished  goods  |   | 87,209           |    | 85,503 |   |
| Total            |   | $                | 161,124 |   | $ | 163,090 |   |

 

Certain inventories heldby Conn-Selmer are accounted for using the LIFO method.  If the FIFO method of inventory valuationhad been used to value all inventories, inventory would have been $7,247 lowerthan reported at December 31, 2001 and 2002. As a result of using the LIFOvaluation method,

 

34

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net earnings were $2,581 higher in 2001.  There was no impact on earnings in 2002.  For financial reporting purposes, the fairvalue of UMI inventories as of the acquisition date constitutes the base layerfor purposes of applying the LIFO method. This layer includes the $11.0 million allocated to reflect opening UMIinventories at net realizable value.

 

**(5)****      Property, Plant and Equipment, Net**

** **
|                                            |   | **December 31,** |    |
|-------------------------------------------------|--------|------------------|---------|
|                                            |   | **2001**         |    | **2002** |   |
| Land                                            |   | $                | 18,101  |   | $ | 18,902 |   |
| Buildings  and improvements                     |   | 63,628           |    | 66,002 |   |
| Leasehold  improvements                         |   | 2,132            |    | 2,349 |   |
| Machinery,  equipment and tooling               |   | 43,281           |    | 47,229 |   |
| Office  furniture and fixtures                  |   | 8,185            |    | 8,702 |   |
| Concert  and artist and rental pianos           |   | 11,903           |    | 12,811 |   |
| Construction  in progress                       |   | 1,886            |    | 1,723 |   |
|                                            |   | 149,116          |    | 157,718 |   |
| Less  accumulated depreciation and amortization |   | 45,105           |    | 55,151 |   |
| Total                                           |   | $                | 104,011 |   | $ | 102,567 |   |

 

**(6) Goodwill and Other Intangible Assets**

 

Goodwilland other intangible assets as of December 31, 2001 and 2002 are as follows:

 
|                            |   | **2001** |   | **2002** |   |
|---------------------------------|--------|----------|--------|----------|--------|
| Amortized  intangible assets:   |   |     |   |     |   |
| Gross  deferred financing costs |   | $        | 10,747 |     | $      | 10,751 |   |
| Accumulated  amortization       |   | (2,846   | )      | (3,951   | )      |
| Deferred  financing costs, net  |   | $        | 7,901  |     | $      | 6,800 |   |
|                            |   |     |   |     |   |
| Gross  covenants not to compete |   | $        | 750    |     | $      | 750 |   |
| Accumulated  amortization       |   | (565     | )      | (614     | )      |
| Covenants  not to compete, net  |   | $        | 185    |     | $      | 136 |   |
|                            |   |     |   |     |   |
| Unamortized  intangible assets: |   |     |   |     |   |
| Gross  goodwill                 |   | $        | 33,916 |     | $      | 35,841 |   |
| Accumulated  amortization       |   | (5,999   | )      | (6,302   | )      |
| Goodwill,  net                  |   | $        | 27,917 |     | $      | 29,539 |   |
|                            |   |     |   |     |   |
| Gross  trademarks               |   | $        | 21,741 |     | $      | 23,176 |   |
| Accumulated  amortization       |   | (12,599  | )      | (13,525  | )      |
| Trademarks,  net                |   | $        | 9,142  |     | $      | 9,651 |   |

 

35

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Thechanges in the net carrying amounts of goodwill and trademarks for the yearended December 31, 2002 are as follows:

 
|                                 |   | **Piano Segment** |   | **Band & Orchestral  Segment** |   |
|--------------------------------------|--------|-------------------|--------|------------------------------------|--------|
| Goodwill:                            |   |              |   |                               |   |
| Balance  at December 31, 2001        |   | $                 | 19,362 |                               | $      | 8,555 |   |
| Foreign  currency translation impact |   | 1,622             |   | —                             |   |
| Balance  at December 31, 2002        |   | $                 | 20,984 |                               | $      | 8,555 |   |
|                                 |   |              |   |                               |   |
| Trademarks:                          |   |              |   |                               |   |
| Balance  at December 31, 2001        |   | $                 | 6,471  |                               | $      | 2,671 |   |
| Foreign  currency translation impact |   | 509               |   | —                             |   |
| Balance  at December 31, 2002        |   | $                 | 6,980  |                               | $      | 2,671 |   |

 

Thefollowing table summarizes amortization expense for the years ending December31:

 
|                            |   | **2000** |   | **2001** |   | **2002** |   |
|---------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                            |   |     |   |     |   |     |   |
| Aggregate  amortization expense |   | $        | 3,856  |     | $      | 4,255    |   | $ | 1,154 |   |
|                                 |        |          |        |          |        |          |        |  |  |  |

 

Theamortization periods for other intangible assets range from five to tenyears.  The following table shows theestimated amortization expense for these assets for each of the five succeedingfiscal years:

** **

**Estimated amortization expense:**

 

| 2003 |   | $     | 1,154  |   |
|------|--------|-------|--------|--------|
| 2004 |   | 1,043 |   |
| 2005 |   | 987   |   |
| 2006 |   | 952   |   |
| 2007 |   | 952   |   |

 

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Had SFAS No. 142 been ineffect prior to January 1, 2002, our reported net income and net income pershare would have been as follows: 

 
|                                   |   | **Years Ended December 31,** |   |
|----------------------------------------|--------|------------------------------|--------|
|                                   |   | **2000**                     |   | **2001** |   | **2002** |   |
|                                   |   |                         |   |   |   |   |   |
| Net  income                            |   | $                            | 16,904 |   | $ | 11,319 |   | $ | 14,909 |   |
| Goodwill  amortization                 |   | 864                          |   | 857 |   | — |   |
| Trademark  amortization, net of tax    |   | 1,204                        |   | 1,453 |   | — |   |
| Adjusted  net income                   |   | $                            | 18,972 |   | $ | 13,629 |   | $ | 14,909 |   |
|                                   |   |                         |   |   |   |   |   |
| Basic  and diluted earnings per share: |   |                         |   |   |   |   |   |
| Net  income                            |   | $                            | 1.89   |   | $ | 1.27 |   | $ | 1.68 |   |
| Goodwill  amortization                 |   | 0.10                         |   | 0.10 |   | — |   |
| Trademark  amortization                |   | 0.13                         |   | 0.16 |   | — |   |
| Adjusted  net income                   |   | $                            | 2.12   |   | $ | 1.53 |   | $ | 1.68 |   |

 

**(7) Other Assets**

** **
|              |   | **December 31,** |   |
|-------------------|--------|------------------|--------|
|              |   | **2001**         |   | **2002** |   |
| Pension  assets   |   | $                | 2,936  |   | $ | 2,526 |   |
| Notes  receivable |   | 2,037            |   | 3,967 |   |
| Other  assets     |   | 934              |   | 1,199 |   |
| Total             |   | $                | 5,907  |   | $ | 7,692 |   |

 

**(8) Other Current Liabilities**

** **
|                                  |   | **December 31,** |   |
|---------------------------------------|--------|------------------|--------|
|                                  |   | **2001**         |   | **2002** |   |
| Accrued  payroll and related benefits |   | $                | 14,516 |   | $ | 15,287 |   |
| Current  portion of pension liability |   | 3,051            |   | 4,111 |   |
| Accrued  warranty expense             |   | 2,221            |   | 2,357 |   |
| Accrued  interest                     |   | 2,811            |   | 2,720 |   |
| Deferred  income                      |   | 4,338            |   | 3,536 |   |
| Other  accrued expenses               |   | 7,158            |   | 7,253 |   |
| Total                                 |   | $                | 34,095 |   | $ | 35,264 |   |

 

Accrued warranty expense is generally recorded at thetime of sale for instruments which have a warranty period ranging from five toten years. The accrued expense recorded is based on a percentage

 

37

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of sales and is adjusted periodically following an analysis of warrantyactivity.  Accrued warranty expense forinstruments that have a warranty period of one year is recorded based onwarranty return trends.

 

The accrued warrantyexpense activity for the years ended December 31, 2000, 2001 and 2002 is asfollows:  

 
|                       |   | **2000** |   | **2001** |   | **2002** |   |
|----------------------------|--------|----------|--------|----------|--------|----------|--------|
| Accrued  warranty expense: |   |     |   |     |   |     |   |
| Beginning  balance         |   | $        | 2,330  |     | $      | 2,355    |   | $ | 2,221 |   |
| Additions                  |   | 841      |   | 932      |   | 950      |   |
| Claims  and reversals      |   | (816     | )      | (1,066   | )      | (814     | )      |
| Ending  balance            |   | $        | 2,355  |     | $      | 2,221    |   | $ | 2,357 |   |

 

**(9)****OtherIncome, Net**

 
|                               |   | **Years Ended December 31,** |   |
|------------------------------------|--------|------------------------------|--------|
|                               |   | **2000**                     |   | **2001** |   | **2002** |   |
|                               |   |                         |   |   |   |   |   |
| West  57th Building income         |   | $                            | (4,653 | ) | $ | (4,653 | ) | $ | (4,653 | ) |
| West  57th Building expenses       |   | 3,254                        |   | 3,254 |   | 3,254 |   |
| Foreign  exchange (gain) loss, net |   | 462                          |   | 791 |   | (691 | ) |
| Miscellaneous                      |   | (888                         | )      | (1,170 | ) | (1,849 | ) |
| Total                              |   | $                            | (1,825 | ) | $ | (1,778 | ) | $ | (3,939 | ) |

 

**(10) Income Taxes**

 

The components of the provision for income taxes areas follows:

 
|                   |   | **Years Ended December 31,** |   |
|------------------------|--------|------------------------------|--------|
|                   |   | **2000**                     |   | **2001** |   | **2002** |   |
| U.S.  Federal:         |   |                         |   |   |   |   |   |
| Current                |   | $                            | 7,097  |   | $ | 1,656 |   | $ | 3,896 |   |
| Deferred               |   | (780                         | )      | (535 | ) | 7 |   |
| U.S.  State and local: |   |                         |   |   |   |   |   |
| Current                |   | 1,310                        |   | 674 |   | 829 |   |
| Deferred               |   | (65                          | )      | (45 | ) | 76 |   |
| Foreign:               |   |                         |   |   |   |   |   |
| Current                |   | 4,442                        |   | 4,679 |   | 3,619 |   |
| Deferred               |   | (1,504                       | )      | (841 | ) | (1,277 | ) |
| Total                  |   | $                            | 10,500 |   | $ | 5,588 |   | $ | 7,150 |   |

 

38

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The components of incomebefore income taxes are as follows:

 
|                 |   | **Years Ended December 31,** |   |
|----------------------|--------|------------------------------|--------|
|                 |   | **2000**                     |   | **2001** |   | **2002** |   |
|                 |   |                         |   |   |   |   |   |
| U.S.  operations     |   | $                            | 20,075 |   | $ | 6,504 |   | $ | 12,839 |   |
| Non-U.S.  operations |   | 7,329                        |   | 10,403 |   | 9,220 |   |
| Total                |   | $                            | 27,404 |   | $ | 16,907 |   | $ | 22,059 |   |

 

Our provision for incometaxes differed from that using the statutory U.S. federal rate as follows:

 
|                                                             |   | **Years Ended December 31,** |   |
|------------------------------------------------------------------|--------|------------------------------|--------|
|                                                             |   | **2000**                     |   | **2001** |   | **2002** |   |
|                                                             |   |                         |   |   |   |   |   |
| Statutory  federal rate applied to earnings before  income taxes |   | $                            | 9,591  |   | $ | 5,917 |   | $ | 7,721 |   |
| Increase  (decrease) in income taxes resulting from:             |   |                         |   |   |   |   |   |
| Foreign  income taxes (net of federal benefit)                   |   | 1,280                        |   | (590 | ) | 21 |   |
| State  income taxes (net of federal benefit)                     |   | 802                          |   | 325 |   | 391 |   |
| Changes  in tax rate in Germany                                  |   | (570                         | )      | — |   | — |   |
| Other                                                            |   | (603                         | )      | (64 | ) | (983 | ) |
| Provision  for income taxes                                      |   | $                            | 10,500 |   | $ | 5,588 |   | $ | 7,150 |   |

 

In 2000, Germany passedlegislation that reduced the rate at which certain of our operations paytax.  Upon passage of the legislation,we recognized a reduction of $570 in deferred tax liabilities due to changes inthe rates. This legislation became effective in 2001, impacting taxes currentlypayable each year since.

 

At December 31, 2002,accumulated retained earnings of non-U.S. subsidiaries totaled $3,672.  No provision for U.S. income and foreignwithholding taxes has been made for these subsidiaries because it is currentlyexpected that such earnings will be reinvested indefinitely.

 

39

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The components of netdeferred taxes are as follows:

 
|                                                       |   | **December 31,** |    |
|------------------------------------------------------------|--------|------------------|---------|
|                                                       |   | **2001**         |    | **2002** |   |
| Deferred  tax assets:                                      |   |             |    |   |   |
| Uniform  capitalization adjustment to inventory            |   | $                | 2,992   |   | $ | 3,044 |   |
| Allowance  for doubtful accounts                           |   | 2,952            |    | 2,859 |   |
| Book  tax differences in LIFO reserves on inventory        |   | (6,306           | )       | (5,749 | ) |
| Accrued  expenses and other current assets and liabilities |   | 5165             |    | 6,831 |   |
| Additional  minimum pension liability                      |   | 648              |    | 4,638 |   |
| Foreign  tax credits                                       |   | 10,955           |    | 12,226 |   |
| Valuation  allowances                                      |   | (10,770          | )       | (11,709 | ) |
| Total  deferred tax assets                                 |   | 5,636            |    | 12,140 |   |
|                                                       |   |             |    |   |   |
| Deferred  tax liabilities:                                 |   |             |    |   |   |
| Pension  contributions                                     |   | (457             | )       | (1,040 | ) |
| Fixed  assets                                              |   | (20,243          | )       | (19,729 | ) |
| Intangibles                                                |   | (6,418           | )       | (7,068 | ) |
| Total  deferred tax liabilities                            |   | (27,118          | )       | (27,837 | ) |
|                                                       |   |             |    |   |   |
| Net  deferred taxes                                        |   | $                | (21,482 | ) | $ | (15,697 | ) |

 

Valuation allowancesprovided relate to excess foreign tax credits generated over expected creditabsorption.  Valuation allowancesrelating to the acquisition of Steinway totaled $3,301 as of December 31, 2001and $3,918 as of December 31, 2002. Should the related tax benefits be recognized in the future, the effectof removing the valuation allowances associated with the acquisition ofSteinway would generally be a decrease in goodwill.  During 2001, the valuation allowance decreased by $1,596 inconnection with the use and reduction of our foreign tax credits generated inprior years.  During 2002, the valuationallowance increased by $939 due to the generation of additional excess foreigntax credits.  Foreign tax creditcarryforwards expire in varying amounts through 2005.

 

**(11)     Long-Term Debt**

 

Long-term debt consistsof the following:

 
|                                                     |   | **December 31,** |    |
|----------------------------------------------------------|--------|------------------|---------|
|                                                     |   | **2001**         |    | **2002** |   |
|                                                     |   |             |    |   |   |
| Term  loans                                              |   | $                | 60,042  |   | $ | 53,690 |   |
| 8.75%  Senior Notes                                      |   | 150,000          |    | 145,345 |   |
| Note  payable to a foreign bank                          |   | —           |    | — |   |
| Open  account loans, payable on demand to a foreign bank |   | 1,161            |    | 1,601 |   |
| Total                                                    |   | 211,203          |    | 200,636 |   |
| Less  current portion                                    |   | 7,446            |    | 8,055 |   |
| Long-term  debt                                          |   | $                | 203,757 |   | $ | 192,581 |   |

 

40

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Scheduled maturities oflong-term debt as of December 31, 2002 are as follows:

 

|       |   | **Amount** |    |
|------------|--------|------------|---------|
|       |   |       |    |
| 2003       |   | $          | 8,055   |   |
| 2004       |   | 6,533      |    |
| 2005       |   | 6,578      |    |
| 2006       |   | 6,624      |    |
| 2007       |   | 6,671      |    |
| Thereafter |   | 166,175    |    |
| Total      |   | $          | 200,636 |   |

 

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, which was amended and restated to accommodate the $150.0million bond offering completed on April 19, 2001, provides us with a potentialborrowing capacity of $85.0 million in revolving credit loans, and expires onSeptember 14, 2008. Borrowings are collateralized by our domestic accountsreceivable, inventory and fixed assets. As of December 31, 2002, there were no revolving credit loansoutstanding, and availability based on eligible accounts receivable andinventory balances was approximately $80.5 million, net of letters of credit.The real estate term loan ($19.7 million at December 31, 2002) is payable inmonthly installments of $170 and includes interest at average 30-day LIBOR(1.38% at December 31, 2002) plus 1.5%. This term loan is secured by all of our interests in the Steinway Hallproperty.  The acquisition term loan($34.0 million at December 31, 2002) is repayable in monthly installments of$416 for the first five years and monthly installments of $556 in years sixthrough eight.  The acquisition termloan and revolving credit loans under the Credit Facility bear interest ataverage 30-day LIBOR plus 1.75%.

 

On April 19, 2001, wecompleted a $150.0 million 8.75% Senior Note offering.  The proceeds of this offering were used toredeem $110.0 million of previously outstanding Senior Subordinated Notes, withthe balance used to pay down the Credit Facility.  The early retirement of the Senior Subordinated Notes, which wereredeemed on June 1, 2001 at 102.75% of the principal amount, generated a debtextinguishment charge of approximately $6.6 million, and a related tax benefitof $2.7 million.  On December 18, 2002we repurchased $ 4.7 million of our Senior Notes.

 

The open account loansprovide for borrowings by foreign subsidiaries of up to €17,600  ($18,480 at the December 31, 2002 exchangerate) payable on demand.  A portion ofthe open account loan can be converted into a maximum of £500 ($805 at theDecember 31, 2002 exchange rate) for use by our UK branch and ¥350,000 ($2,947at the December 31, 2002 exchange rate) for use by our Japanesesubsidiary.  Demand borrowings bearinterest at rates of 6.95 — 7.60% for the Euro loans, 4.07% forEuromoney-market short-term loans (Euro based) and 1.35% for Japanese yenloans.  We have also purchased twointerest rate caps.  One cap limits thebase interest rate to 5% on  €1,534($1,611 at the December 31, 2002 exchange rate) declining to €511 ($537 at theDecember 31, 2002 exchange rate) in 2004. The other cap limits the base interest rate to 6.25% on €1,534 ($1,611at the December 31, 2002 exchange rate) and expires in 2005.  The unrealized gains or losses and carryingvalue of the caps are not material in any period presented.

 

All of the our debtagreements contain certain financial covenants which, among other things,require the maintenance of certain financial ratios and net worth, placecertain limitations on additional borrowings and capital expenditures, andprohibit the payment of cash dividends. We were in compliance with all such covenants as of December 31, 2002.

 

41

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**(12)     Stockholders’Equity and Stock Arrangements**

 

Our common stock iscomprised of two classes: Class A and Ordinary.  With the exception of disparate voting power, both classes aresubstantially identical.  Each share ofClass A common stock entitles the holder to 98 votes.  Holders of Ordinary common stock are entitled to one vote pershare.  Class A common stock shallautomatically convert to Ordinary common stock if, at any time, the Class Acommon stock is not owned by an original Class A holder.

 

*Employee Stock Purchase Plan* - We have anemployee stock purchase plan under which substantially all employees maypurchase common stock through payroll deductions at a purchase price equal to85% of the lower of the fair market values as of the beginning or end of eachtwelve-month offering period.  Stockpurchases under the Purchase Plan are limited to 5% of an employee’s annualbase earnings.  Shares issued under thePurchase Plan were 31,773 during 2000, 29,549 during 2001, and 37,389 during2002.  Of the 500,000 shares originallyreserved for issuance under the Purchase Plan, 311,799 shares remain reservedfor future issuance as of December 31, 2002.

 

*Stock Plan* - The 1996 stock plan, asamended, provides for the granting of 1,500,000 stock options (includingincentive stock options and non-qualified stock options), stock appreciationrights and other stock awards to certain of our key employees, consultants andadvisors.  As of December 31, 2002,Common stock reserved for issuance under the Stock Plan was 1,430,900 shares.

 

The following table setsforth information regarding both the Purchase Plan and the Stock Plan:

 
|                             |   | **2000**                |   | **2001**                               |   | **2002**                |    |
|----------------------------------|--------|-------------------------|--------|----------------------------------------|--------|-------------------------|---------|
|                             |   | **Number  of  Options** |   | **Weighted  Average  Exercise  Price** |   | **Number  of  Options** |    | **Weighted  Average  Exercise  Price** |   | **Number  of  Options** |   | **Weighted  Average  Exercise  Price** |   |
| Outstanding at beginning of year |   | 536,020                 |   | $                                      | 19.26  |                    | 632,398 |   | $ | 19.09 |   | 628,262 |   | $ | 19.07 |   |
| Granted                          |   | 152,851                 |   | 18.13                                  |   | 31,813                  |    | 15.30 |   | 561,174 |   | 18.80 |   |
| Exercised                        |   | (42,173                 | )      | 16.43                                  |   | (29,549                 | )       | 15.38 |   | (59,789 | ) | 16.63 |   |
| Canceled, forfeited or  expired  |   | (14,300                 | )      | 19.21                                  |   | (6,400                  | )       | 19.00 |   | (17,200 | ) | 19.01 |   |
| Outstanding at end of  year      |   | 632,398                 |   | 19.09                                  |   | 628,262                 |    | 19.07 |   | 1,112,447 |   | 19.07 |   |
|                             |   |                    |   |                                   |   |                    |    |   |   |   |   |   |   |
| Exercisable at end of  year      |   | 382,700                 |   | $                                      | 19.17  |                    | 502,300 |   | $ | 19.17 |   | 507,400 |   | $ | 19.21 |   |

 

42

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The following table setsforth information regarding outstanding and exercisable options at December 31,2002:

 
|                         |   | **Options Outstanding** |       | **Options Exercisable**                |   |
|------------------------------|--------|-------------------------|------------|----------------------------------------|--------|
| **Range of Exercise Prices** |   | **Number  of  Options** |       | **Weighted  Average  Remaining  Life** |   | **Weighted  Average  Exercise  Price** |   | **Number  of  Options** |   | **Weighted  Average  Exercise  Price** |   |
|                         |   |                    | ** ** |                                   |   |   | ** ** |   | ** ** |   | ** ** |
| $16.66                       |   | 14,147                  |       | .6years                                |   | $ | 16.66 |   | — |   | $ | — |   |
| $18.84 - $21.94              |   | 1,098,300               |       | 6.8                                    |   | $ | 19.10 |   | 507,400 |   | $ | 19.21 |   |
|                         |   | 1,112,447               |       | 6.7                                    |   | $ | 19.07 |   | 507,400 |   | $ | 19.21 |   |

 

**(13) Commitments and Contingent Liabilities**

 

*Lease Commitments* - We lease variousfacilities and equipment under non-cancelable operating leasearrangements.  These leases expire atvarious times through 2016 with various renewal options.  Rent expense was $3,979 for the year endedDecember 31, 2000, $4,013 for the year ended December 31, 2001, and $4,174 forthe year ended December 31, 2002.

 

In March 1999, weacquired the building that includes the Steinway Hall retail store on West 57thStreet in New York City for approximately $30.8 million.  We entered into a ninety-nine year landlease as part of the transaction. Annual rent payable under the land lease is $2,170 in the first tenyears, $2,790 for the subsequent ten-year period and will be adjusted everytwenty years thereafter to the greater of the existing rent or 4% of the fairmarket value of the land and building combined.  We also entered into a ten-year master lease whereby all of ourinterest in the land and building was leased back to the owner of theland.  Rental expense and rental incomeassociated with these leases was included, along with other real estate costs,in other income/expense (see Note 9).

 

Future minimum leasepayments for our non-cancelable operating leases, excluding the land leasediscussed above, and future rental income under the master lease for the yearsending December 31 are as follows:

 
|           |   | **Lease********Payments** |   | **Rental********Income** |   |
|----------------|--------|---------------------------|--------|--------------------------|--------|
| 2003           |   | $                         | 4,330  |                     | $      | 4,653 |   |
| 2004           |   | 4,049                     |   | 4,653                    |   |
| 2005           |   | 3,754                     |   | 4,653                    |   |
| 2006           |   | 3,275                     |   | 4,653                    |   |
| 2007           |   | 3,038                     |   | 4,653                    |   |
| Thereafter     |   | 3,556                     |   | 4,653                    |   |
| Minimum  Total |   | $                         | 22,002 |                     | $      | 27,918 |   |

 

*Notes Receivable Sold with Recourse* -Prior to August 2002, we sold notes receivable on a recourse basis to afinancing company.  The financingcompany had the option of purchasing up to $18.0 million of our notesreceivable.  We received proceeds fromthe sale of such notes of approximately $12.7 million during the year endedDecember 31, 2001 and $2.6 million during the year ended December 31,2002.  Other current liabilities includea recourse obligation of $849 as of December 31, 2001 for the

 

43

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notes sold with recourse. Outstanding balances on these notes were $6.7 million as of December 31,2001.  Subsequent to August 2002 we haveretained these notes receivable.

 

*Environmental Matters* - We are continuingenvironmental remediation projects at facilities acquired in 2000.  We believe that established reserves, whichapproximated $610 at December 31, 2002 and are included in other currentliabilities, are adequate to cover the remaining cost of these remediationprojects.  Other environmental mattersare pending against us which might result in monetary damages, the amount ofwhich, if any, cannot be determined at the present time.  Philips Electronics, one of our previousowners, has agreed to hold us harmless from any financial liability arisingfrom these environmental matters which were pending as of December 29, 1988.  We believe that these matters will not havea material adverse impact on our consolidated results of operations orfinancial position.

 

*Litigation* - In the ordinary course of ourbusiness, we are party to various legal actions that we believe are routine innature 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, the ultimate resolution of these matters will not have amaterial adverse impact on our consolidated results of operations or financialposition.

 

**(14)  Retirement Plans**

 

We have defined benefitpension plans covering the majority of our employees, including certainemployees in foreign countries.  Certainof our domestic hourly employees are covered by a multi-employer definedbenefit pension plan to which we make contributions.  The corresponding pension plan assets and liabilities belong to athird party and, accordingly, are not reflected herein.  Our plan assets are invested primarily in commonstocks and fixed income securities.  Wemake contributions generally equal to the minimum amounts required by federallaws and regulations.  Foreign plans arefunded in accordance with the requirements of regulatory bodies governing eachplan.

 

Effective December 31,2002 we amended the Selmer Salaried Pension Plan (the “Plan”) to eliminatefurther years of service credit under the Plan.  All distributions upon termination of employment will continue inthe normal course under the Plan.  Withrespect to the Plan amendment, no new participants will be added to the Planafter December 31, 2002.  We willcontinue to evaluate the Plan’s funded status and make any required minimumcontributions on an annual basis. The amendment resulted in a curtailment lossof  $10.

 

44

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The following table setsforth the funded status and amounts recognized as of December 31, 2001 and 2002for our defined benefit pension plans:

 
|                                                 |   | **Domestic Plans** |   | **Foreign Plans** |   |
|------------------------------------------------------|--------|--------------------|--------|-------------------|--------|
|                                                 |   | **2001**           |   | **2002**          |   | **2001** |   | **2002** |   |
| Change in benefit  obligation:                       |   |               |   |              |   |   |   |   |   |
| Benefit obligation,  beginning of year               |   | $                  | 30,968 |              | $      | 34,189 |   | $ | 15,923 |   | $ | 16,252 |   |
| Service cost                                         |   | 1,284              |   | 1,354             |   | 534 |   | 574 |   |
| Interest cost                                        |   | 2,342              |   | 2,508             |   | 930 |   | 1,054 |   |
| Plan participants’  contributions               |   | 25                 |   | 24                |   | — |   | — |   |
| Amendments                                           |   | 30                 |   | (1,392            | )      | — |   | 9 |   |
| Actuarial (gain) loss                                |   | 951                |   | 3,977             |   | 438 |   | (453 | ) |
| Foreign currency  exchange rate changes              |   | —             |   | —            |   | (732 | ) | 2,623 |   |
| Benefits paid                                        |   | (1,411             | )      | (1,802            | )      | (841 | ) | (819 | ) |
| Benefit obligation, end  of year                     |   | 34,189             |   | 38,858            |   | 16,252 |   | 19,240 |   |
|                                                 |   |               |   |              |   |   |   |   |   |
| Change in plan assets:                               |   |               |   |              |   |   |   |   |   |
| Fair value of plan  assets, beginning of year        |   | 30,915             |   | 29,987            |   | 3,384 |   | 3,013 |   |
| Return on plan assets                                |   | (1,741             | )      | (3,406            | )      | (229 | ) | (72 | ) |
| Employer contribution                                |   | 2,199              |   | 2,576             |   | 733 |   | 819 |   |
| Employee contributions                               |   | 25                 |   | 24                |   | 54 |   | 54 |   |
| Foreign currency  exchange rate changes              |   | —             |   | —            |   | (88 | ) | 318 |   |
| Benefits paid                                        |   | (1,411             | )      | (1,802            | )      | (841 | ) | (819 | ) |
| Fair value of plan  assets, end of year              |   | 29,987             |   | 27,379            |   | 3,013 |   | 3,313 |   |
|                                                 |   |               |   |              |   |   |   |   |   |
| Funded status                                        |   | (4,202             | )      | (11,479           | )      | (13,239 | ) | (15,927 | ) |
|                                                 |   |               |   |              |   |   |   |   |   |
| Unrecognized net  actuarial loss                     |   | 2,439              |   | 11,596            |   | 1,044 |   | 888 |   |
| Unrecognized prior  service cost                     |   | 2,946              |   | 2,526             |   | — |   | — |   |
| Net amount recognized                                |   | $                  | 1,183  |              | $      | 2,643 |   | $ | (12,195 | ) | $ | (15,039 | ) |
|                                                 |   |               |   |              |   |   |   |   |   |
| Amounts recognized in  the balance sheet consist of: |   |               |   |              |   |   |   |   |   |
| Accrued benefit cost                                 |   | $                  | (3,373 | )                 | $      | (11,479 | ) | $ | (12,195 | ) | $ | (15,039 | ) |
| Intangible asset                                     |   | 2,936              |   | 2,526             |   | — |   | — |   |
| Additional minimum  pension liability                |   | 1,620              |   | 11,596            |   | — |   | — |   |
| Net amount recognized                                |   | $                  | 1,183  |              | $      | 2,643 |   | $ | (12,195 | ) | $ | (15,039 | ) |

 
|                                              |   | **Domestic Plans** |   | **Foreign Plans** |   |
|---------------------------------------------------|--------|--------------------|--------|-------------------|--------|
|                                              |   | **2000**           |   | **2001**          |   | **2002** |   | **2000** |   | **2001** |   | **2002** |   |
| Weighted average  assumptions  as of December 31: |   |               |   |              |   |   |   |   |   |   |   |   |   |
| Discount rate                                     |   | 7.75               | %      | 7.50              | %      | 6.75 | % | 5.75-6.5 | % | 5.75-6.5 | % | 5.5-5.7 | % |
| Expected return on  assets                        |   | 9.0                |   | 9.0               |   | 9.0 |   | 6.75 |   | 6.75 |   | 6.75 |   |
| Rate of compensation  increase                    |   | 4.0                |   | 4.0               |   | 4.0 |   | 2.5-4.5 |   | 2.5-4.5 |   | 2.5-4.0 |   |

 

45

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The components of netpension expense for the years ended December 31 are as follows:

 
|                                |   | **2000** |   | **2001** |   | **2002** |   |
|-------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Domestic Plans:                     |   |     |   |     |   |     |   |
| Service cost                        |   | $        | 1,133  |     | $      | 1,284    |   | $ | 1,354 |   |
| Interest cost                       |   | 1,883    |   | 2,342    |   | 2,508    |   |
| Expected return on plan  assets     |   | (2,323   | )      | (2,897   | )      | (3,170   | )      |
| Amortization of prior  service cost |   | 362      |   | 407      |   | 410      |   |
| Recognized actuarial  (gain) loss   |   | (122     | )      | (142     | )      | 5        |   |
| Curtailment loss                    |   | —   |   | —   |   | 10       |   |
| Net pension expense                 |   | $        | 933    |     | $      | 994      |   | $ | 1,117 |   |
|                                |   |     |   |     |   |     |   |
| Foreign Plans:                      |   |     |   |     |   |     |   |
| Service cost                        |   | $        | 517    |     | $      | 534      |   | $ | 574 |   |
| Interest cost                       |   | 916      |   | 930      |   | 1,054    |   |
| Expected return on plan  assets     |   | (232     | )      | (177     | )      | (145     | )      |
| Net pension expense                 |   | $        | 1,201  |     | $      | 1,287    |   | $ | 1,483 |   |

 

The projected benefitobligation, accumulated benefit obligation, and fair value of plan assets forpension plans with accumulated benefit obligations in excess of plan assetswere as follows:

 
|                            |   | **2001** |   | **2002** |   |
|---------------------------------|--------|----------|--------|----------|--------|
| Projected  benefit obligation   |   | $        | 50,441 |     | $      | 58,098 |   |
| Accumulated  benefit obligation |   | 47,104   |   | 55,945   |   |
| Fair  value of plan assets      |   | 33,000   |   | 30,692   |   |
|                                 |        |          |        |          |        |  |  |

 

We provide postretirementhealth care and life insurance benefits to eligible hourly retirees and theirdependents.  The health care plan iscontributory, with retiree contributions adjusted every three years as part ofa union contract. The plans are unfunded and we pay part of the health carepremium and the full amount of the life insurance cost.

 

46

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The following table setsforth the funded status of our postretirement benefit plans and accruedpostretirement benefit cost reflected in our consolidated balance sheet as ofDecember 31:

 
|                                   |   | **2001** |   | **2002** |   |
|----------------------------------------|--------|----------|--------|----------|--------|
| Change  in benefit obligation:         |   |     |   |     |   |
| Benefit  obligation, beginning of year |   | $        | 1,488  |     | $      | 1,770 |   |
| Service  cost                          |   | 57       |   | 60       |   |
| Interest  cost                         |   | 124      |   | 129      |   |
| Plan  participants’ contribution  |   | 44       |   | 45       |   |
| Amendments                             |   | (58      | )      | —   |   |
| Actuarial  loss                        |   | 242      |   | 124      |   |
| Benefits  paid                         |   | (127     | )      | (114     | )      |
| Benefit  obligation, end of year       |   | 1,770    |   | 2,014    |   |
|                                   |   |     |   |     |   |
| Fair  value of plan assets             |   | —   |   | —   |   |
|                                   |   |     |   |     |   |
| Funded  status                         |   | (1,770   | )      | (2,014   | )      |
| Unrecognized  net actuarial loss       |   | 214      |   | 335      |   |
| Unrecognized  prior service cost       |   | 548      |   | 503      |   |
| Accrued  postretirement benefit cost   |   | $        | (1,008 | )        | $      | (1,176 | ) |
|                                        |        |          |        |          |        |  |  |  |  |

 

The assumed weightedaverage discount rate as of December 31 was 7.75% in 2000, 7.50% in 2001, and6.75% in 2002.  The annual assumed rateof increase in the per capita cost of covered health care benefits is 7.50% forretirees under age 65 in 2002 and is assumed to decrease gradually to 5.50% in2006, and remain at that level thereafter.

 

Net postretirementbenefit costs are as follows:

 
|                                   |   | **Years Ended December 31,** |   |
|----------------------------------------|--------|------------------------------|--------|
|                                   |   | **2000**                     |   | **2001** |   | **2002** |   |
| Service cost                           |   | $                            | 47     |   | $ | 57 |   | $ | 60 |   |
| Interest cost                          |   | 107                          |   | 124 |   | 129 |   |
| Net loss recognition                   |   | —                       |   | 1 |   | — |   |
| Amortization of  transition obligation |   | 50                           |   | 45 |   | 48 |   |
| Net postretirement  benefit cost       |   | $                            | 204    |   | $ | 227 |   | $ | 237 |   |

 

Assumed health care costtrend rates have a significant effect on the amounts reported for the healthcare plan.  A one-percentage-pointchange in assumed health care cost trend rates would have the followingeffects:

 
|                                                     |   | **1%  Increase** |   | **1%  Decrease** |   |
|----------------------------------------------------------|--------|------------------|--------|------------------|--------|
|                                                     |   |             |   |             |   |
| Effect on total of  service and interest cost components |   | $                | 12     |             | $      | (11 | ) |
| Effect on the  postretirement benefit obligation         |   | 99               |   | (89              | )      |
|                                                          |        |                  |        |                  |        |  |  |

 

We sponsor 401(k)retirement savings plans for eligible employees.  Discretionary employer contributions, as determined annually bythe Board of Directors, are made to two of these plans.  The contributions approximated $590 for2000, $550 for 2001, and $767 for 2002.

 

47

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We established asupplemental executive retirement plan (“SERP”) for a select group of ourexecutives who constitute a “top hat” group as defined by ERISA.  Discretionary employer contributions made tothis plan, as determined annually by the Board of Directors, are held in aRabbi Trust.  The SERP assets areincluded in our financial statements as available for sale investments withinother long-term assets since the Trust permits accessibility of the SERP assetsby our creditors in the event of our insolvency (see Notes 7 and 16).  We have no other claims to the assetscontained in the Trust.  Thecontributions approximated $203 in 2000, $283 in 2001, and $203 in 2002.

 

**(15) Foreign Exchange Contracts**

 

Our German divisions,whose functional currency is the Euro, secure options and forwards contractsfor Japanese yen and British pounds solely to manage currencyfluctuations.  At December 31, 2001,these divisions had options and forward contracts to sell  ¥230,000 and £2,150. These instruments hadvarious maturity dates through May 2003. At December 31, 2002, these divisions had forward contracts to sell£2,250. These instruments have various maturity dates through March 2004.

 

**(16) Fair Values of Financial Instruments**

 

Estimated fair values offinancial instruments have been developed using appropriate methodologies;however, considerable judgment is required to develop these estimates.  Accordingly, the estimates presented beloware not necessarily indicative of amounts that could be realized in a currentmarket exchange.  Use of differentassumptions or methodologies could have a significant effect on theseestimates.  The net carrying value andestimated fair value of our financial instruments are as follows at December31:

 
|                        |   | **2001**                      |    | **2002**                        |   |
|-----------------------------|--------|-------------------------------|---------|---------------------------------|--------|
|                        |   | **Net Carrying********Value** |    | **Estimated********Fair Value** |   | **Net Carrying********Value** |   | **Estimated********Fair Value** |   |
| Financial  liabilities:     |   |                          |    |                            |   |   |   |   |   |
| Long-term  debt             |   | $                             | 211,203 |                            | $      | 209,703 |   | $ | 200,636 |   | $ | 201,087 |   |
| Foreign  currency contracts |   | —                        |    | (73                             | )      | — |   | (106 | ) |
| Interest  rate caps         |   | —                        |    | (7                              | )      | — |   | — |   |
|                             |        |                               |         |                                 |        |  |  |  |  |  |  |  |  |

 

The estimated fair valueof existing long-term debt is based on rates currently available to us for debtwith similar terms and remaining maturities.

 

The estimated fair valueof foreign currency contracts (used for hedging purposes) has been determinedas the difference between the current spot rate and the contract ratemultiplied by the notional amount of the contract or upon the estimated fairvalue of purchased option contracts. The net carrying value of these contracts approximates zero as any gainsor losses on the contracts are generally offset by losses or gains on therelated hedged asset or liability.

 

The carrying amounts ofcash, marketable equity securities, accounts, notes and leases receivable, andaccounts payable approximate fair value because of the short maturity of theseinstruments.

 

Investments in marketableequity securities are categorized as trading, available-for-sale, orheld-to-maturity.  On December 31, 2001and 2002, we had only available-for-sale securities which are stated at

 

48

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fair value, with unrealized gains and losses, net of deferred taxes,reported in stockholders’ equity. Included in accumulated other comprehensive loss were unrealized netlosses of $5 at December 31, 2001 and unrealized net losses of $76 at December31, 2002.  Our marketable equitysecurities pertain to the SERP and are included as a component of other assets(see Notes 7 and 14).

 

**(17)     SegmentInformation**

 

As discussed in Note 2,we have identified two distinct and reportable segments: the piano segment andthe band and orchestral instrument segment. We consider these two segments reportable as they are managed separatelyand the operating results of each segment are regularly reviewed and evaluatedseparately by our senior management.

 

The accounting policiesof each segment are the same as those described in Note 2.  Intercompany transactions are generallyrecorded at cost plus a negotiated markup.

 

The following tablespresent information about our operating segments:

 
| **2000**                           |   | **Piano Segment** |    | **Band and Orchestral Segment** |   | **Other &** |   | **Consol** |   |
|------------------------------------|--------|-------------------|---------|---------------------------------|--------|-----------------|--------|------------|--------|
|                               |   | **U.S.**          |    | **Germany**                     |   | **Other**       |   | **Total**  |   | **U.S.** |   | **Other** |   | **Total** |   | **Elim** |   | **Total** |   |
| Revenues  from external  customers |   | $                 | 123,528 |                            | $      | 38,630          |   | $          | 20,686 |   | $ | 182,844 |   | $ | 143,904 |   | $ | 4,950 |   | $ | 148,854 |   | $ | — |   | $ | 331,698 |   |
| Operating  profit                  |   | 18,082            |    | 4,450                           |   | 3,372           |   | 25,904     |   | 18,237 |   | (268 | ) | 17,969 |   | (2,184 | ) | 41,689 |   |
| Interest  income                   |   | —            |    | 16                              |   | 25              |   | 41         |   | 1,250 |   | — |   | 1,250 |   | — |   | 1,291 |   |
| Interest  expense                  |   | 11,372            |    | 454                             |   | 219             |   | 12,045     |   | 23,020 |   | — |   | 23,020 |   | (17,664 | ) | 17,401 |   |
| Depreciation  and amortization     |   | 6,074             |    | 2,343                           |   | 218             |   | 8,635      |   | 3,659 |   | — |   | 3,659 |   | 48 |   | 12,342 |   |
| Income  tax expense (benefit)      |   | 3,972             |    | 1,735                           |   | 1,192           |   | 6,899      |   | (671 | ) | (132 | ) | (803 | ) | 4,404 |   | 10,500 |   |
| Net  income (loss)                 |   | 4,723             |    | 2,837                           |   | 1,514           |   | 9,074      |   | (3,076 | ) | (266 | ) | (3,342 | ) | 11,172 |   | 16,904 |   |
| Capital  expenditures              |   | 4,524             |    | 1,053                           |   | 39              |   | 5,616      |   | 2,184 |   | 55 |   | 2,239 |   | 35 |   | 7,890 |   |
| Total  assets                      |   | 144,014           |    | 54,008                          |   | 11,444          |   | 209,466    |   | 407,958 |   | 3,868 |   | 411,826 |   | (199,476 | ) | 421,816 |   |
|                                    |        |                   |         |                                 |        |                 |        |            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **2001**                           |   | **Piano Segment** |    | **Band and Orchestral Segment** |   | **Other &** |   | **Consol** |   |
|------------------------------------|--------|-------------------|---------|---------------------------------|--------|-----------------|--------|------------|--------|
|                               |   | **U.S.**          |    | **Germany**                     |   | **Other**       |   | **Total**  |   | **U.S.** |   | **Other** |   | **Total** |   | **Elim** |   | **Total** |   |
| Revenues  from external  customers |   | $                 | 105,726 |                            | $      | 41,144          |   | $          | 22,096 |   | $ | 168,966 |   | $ | 179,067 |   | $ | 4,579 |   | $ | 183,646 |   | $ | — |   | $ | 352,612 |   |
| Operating  profit                  |   | 10,190            |    | 6,124                           |   | 4,176           |   | 20,490     |   | 19,316 |   | 119 |   | 19,435 |   | (1,453 | ) | 38,472 |   |
| Interest  income                   |   | 38                |    | 44                              |   | 37              |   | 119        |   | 2,187 |   | — |   | 2,187 |   | — |   | 2,306 |   |
| Interest  expense                  |   | 10,767            |    | 273                             |   | 189             |   | 11,229     |   | 27,654 |   | — |   | 27,654 |   | (19,846 | ) | 19,037 |   |
| Depreciation  and amortization     |   | 5,872             |    | 2,366                           |   | 205             |   | 8,443      |   | 4,968 |   | 17 |   | 4,985 |   | 375 |   | 13,803 |   |
| Income  tax expense (benefit)      |   | (478              | )       | 2,246                           |   | 1,588           |   | 3,356      |   | (2,731 | ) | 3 |   | (2,728 | ) | 4,960 |   | 5,588 |   |
| Net  income (loss)                 |   | (1,434            | )       | 4,068                           |   | 2,435           |   | 5,069      |   | (6,177 | ) | 63 |   | (6,114 | ) | 12,364 |   | 11,319 |   |
| Capital  expenditures              |   | 2,566             |    | 651                             |   | 107             |   | 3,324      |   | 3,629 |   | 1 |   | 3,630 |   | 187 |   | 7,141 |   |
| Total  assets                      |   | 138,336           |    | 54,785                          |   | 10,499          |   | 203,620    |   | 399,817 |   | 3,214 |   | 403,031 |   | (192,611 | ) | 414,040 |   |
|                                    |        |                   |         |                                 |        |                 |        |            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **2002**                           |   | **Piano Segment** | ** ** | **Band and Orchestral Segment** | ** ** | **Other &** | ** ** | **Consol** | ** ** |
|------------------------------------|--------|-------------------|------------|---------------------------------|------------|-----------------|------------|------------|------------|
|                               |   | **U.S.**          |       | **Germany**                     |       | **Other**       |       | **Total**  |       | **U.S.** |   | **Other** |   | **Total** |   | **Elim** |   | **Total** |   |
|                               |   |              |       |                            |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Revenues  from external  customers |   | $                 | 105,842    |                            | $          | 38,431          |       | $          | 20,316     |   | $ | 164,589 |   | $ | 163,265 |   | $ | 4,443 |   | $ | 167,708 |   | $ | — |   | $ | 332,297 |   |
| Operating  profit                  |   | 13,392            |       | 5,294                           |       | 2,650           |       | 21,336     |       | 11,923 |   | 65 |   | 11,988 |   | (1,925 | ) | 31,399 |   |
| Interest  income                   |   | 37                |       | 34                              |       | 17              |       | 88         |       | 1,804 |   | — |   | 1,804 |   | — |   | 1,892 |   |
| Interest  expense                  |   | 9,417             |       | 179                             |       | 154             |       | 9,750      |       | 24,104 |   | — |   | 24,104 |   | (18,683 | ) | 15,171 |   |
| Depreciation  and amortization     |   | 4,495             |       | 1,295                           |       | 231             |       | 6,021      |       | 4,483 |   | 20 |   | 4,503 |   | 513 |   | 11,037 |   |
| Income  tax expense (benefit)      |   | 1,924             |       | 2,400                           |       | 1,009           |       | 5,333      |       | (2,568 | ) | 77 |   | (2,491 | ) | 4,308 |   | 7,150 |   |
| Net  income (loss)                 |   | 3,968             |       | 3,882                           |       | 1,691           |       | 9,541      |       | (7,566 | ) | 161 |   | (7,405 | ) | 12,773 |   | 14,909 |   |
| Capital  expenditures              |   | 2,095             |       | 665                             |       | 15              |       | 2,775      |       | 2,825 |   | — |   | 2,825 |   | 4 |   | 5,604 |   |
| Total  assets                      |   | 134,418           |       | 65,726                          |       | 13,334          |       | 213,478    |       | 393,383 |   | 3,192 |   | 396,575 |   | (181,819 | ) | 428,234 |   |
|                                    |        |                   |            |                                 |            |                 |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

49

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**(18)     Summary ofMerger and Guarantees**

 

On May 25, 1995, Selmeracquired Steinway pursuant to an Agreement and Plan of Merger dated as of April11, 1995.  The total purchase price ofapproximately $104.0 million, including fees and expenses, was funded by ouravailable cash balances and Selmer’s issuance of $105.0 million of 11% SeniorSubordinated Notes (the “Notes”) due 2005.

 

Selmer’s paymentobligations under the Notes were fully and unconditionally guaranteed on ajoint and several basis by us as Parent (the “Guarantor Parent”), and bySteinway, UMI and certain of our direct and indirect wholly-owned subsidiaries,each a “Guarantor” (the “Guarantor Subsidiaries”).  These subsidiaries, together with the operating divisions ofSelmer, represent all of our operations conducted in the United States.  The remaining subsidiaries, which did notguarantee the Notes, represent foreign operations (the “Non GuarantorSubsidiaries”).

 

OnApril 19, 2001, we completed a $150.0 million 8.75% Senior Note offering.  The proceeds of the offering were used toredeem all of the existing 11% Senior Subordinated Notes, with the balancepaying down the revolving credit facility.

 

Our payment obligationsunder the 8.75% Senior Notes are fully and conditionally guaranteed on a jointand several basis by Selmer, Steinway, UMI and certain other of our direct andindirect wholly-owned subsidiaries, each a “Guarantor” (the “GuarantorSubsidiaries”).  These subsidiariesrepresent all of our (the “Issuer”) operations conducted in the United States.

 

The following condensed consolidating supplementarydata illustrates the composition of the combined Guarantors.  Separate complete financial statements ofthe respective Guarantors would not provide additional material informationthat would be useful in assessing the financial composition of theGuarantors.  No single Guarantor has anysignificant legal restrictions on the ability of investors or creditors toobtain access to its assets in event of default on the Guarantee other than itssubordination to senior indebtedness.

 

We record investments insubsidiaries using the cost method for purposes of the supplementalconsolidating presentation.  Earnings ofsubsidiaries are therefore not reflected in our investment accounts andearnings.  The principal eliminationentries eliminate investments in subsidiaries and intercompany balances andtransactions.

 

50

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** **

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

**CONDENSED CONSOLIDATING STATEMENTS OFINCOME**

**YEAR ENDED DECEMBER 31, 2000**

**(In Thousands)**

** **
|                                     |   | **Guarantor  Parent** |   | **Issuer  of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |    | **Reclass/  Eliminations** |   | **Consolidated** |    |
|------------------------------------------|--------|-----------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|---------|----------------------------|--------|------------------|---------|
| Net sales                                |   | $                     | — |                 | $      | 122,848                     |   | $                                | 152,976 |                       | $      | 68,545           |    | $ | (12,671 | ) | $ | 331,698 |   |
| Cost of sales                            |   | —                |   | 89,758               |   | 104,911                     |   | 44,453                           |    | (12,382                    | )      | $                | 226,740 |   |
|                                     |   |                  |   |                 |   |                        |   |                             |    |                       |   |             |    |
| Gross profit                             |   | —                |   | 33,090               |   | 48,065                      |   | 24,092                           |    | (289                       | )      | 104,958          |    |
|                                     |   |                  |   |                 |   |                        |   |                             |    |                       |   |             |    |
| Operating expenses:                      |   |                  |   |                 |   |                        |   |                             |    |                       |   |             |    |
| Sales and marketing                      |   | —                |   | 10,790               |   | 16,873                      |   | 9,795                            |    | (116                       | )      | 37,342           |    |
| General and  administrative              |   | 3,409                 |   | 5,336                |   | 6,628                       |   | 4,321                            |    | —                     |   | 19,694           |    |
| Amortization                             |   | —                |   | 274                  |   | 2,470                       |   | 1,112                            |    | —                     |   | 3,856            |    |
| Other operating  (income) expense        |   | (2,717                | )      | 90                   |   | 2,352                       |   | 1,046                            |    | 116                        |   | 887              |    |
| Non-recurring charges                    |   | 1,290                 |   | —               |   | 200                         |   | —                           |    | —                     |   | 1,490            |    |
| Total operating  expenses                |   | 1,982                 |   | 16,490               |   | 28,523                      |   | 16,274                           |    | —                     |   | 63,269           |    |
|                                     |   |                  |   |                 |   |                        |   |                             |    |                       |   |             |    |
| Income (loss) from  operations           |   | (1,982                | )      | 16,600               |   | 19,542                      |   | 7,818                            |    | (289                       | )      | 41,689           |    |
|                                     |   |                  |   |                 |   |                        |   |                             |    |                       |   |             |    |
| Other income                             |   | —                |   | —               |   | (1,418                      | )      | (407                             | )       | —                     |   | (1,825           | )       |
| Interest income                          |   | —                |   | (764                 | )      | (18,150                     | )      | (41                              | )       | 17,664                     |   | (1,291           | )       |
| Interest expense                         |   | —                |   | 21,635               |   | 12,757                      |   | 673                              |    | (17,664                    | )      | 17,401           |    |
|                                     |   |                  |   |                 |   |                        |   |                             |    |                       |   |             |    |
| Income (loss) before  income taxes       |   | (1,982                | )      | (4,271               | )      | 26,353                      |   | 7,593                            |    | (289                       | )      | 27,404           |    |
|                                     |   |                  |   |                 |   |                        |   |                             |    |                       |   |             |    |
| Provision for (benefit  of) income taxes |   | (931                  | )      | (833                 | )      | 9,521                       |   | 2,917                            |    | (174                       | )      | 10,500           |    |
|                                     |   |                  |   |                 |   |                        |   |                             |    |                       |   |             |    |
| Net income (loss)                        |   | $                     | (1,051 | )                    | $      | (3,438                      | )      | $                                | 16,832  |                       | $      | 4,676            |    | $ | (115 | ) | $ | 16,904 |   |

 

51

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

**CONDENSED CONSOLIDATING STATEMENTS OFINCOME**

**YEAR ENDED DECEMBER 31, 2001**

**(In Thousands)**

 
|                                     |   | **Issuer  of Notes** |   | **Guarantor Subsidiaries** |   | **Non  Guarantor Subsidiaries** |   | **Reclass/ Eliminations** |   | **Consolidated** |    |
|------------------------------------------|--------|----------------------|--------|----------------------------|--------|---------------------------------|--------|---------------------------|--------|------------------|---------|
| Net sales                                |   | $                    | — |                       | $      | 292,168                         |   | $                         | 70,670 |             | $       | (10,226 | ) | $ | 352,612 |   |
| Cost of sales                            |   | —               |   | 212,028                    |   | 43,724                          |   | (10,638                   | )      | $                | 245,114 |   |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |    |
| Gross profit                             |   | —               |   | 80,140                     |   | 26,946                          |   | 412                       |   | 107,498          |    |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |    |
| Operating expenses:                      |   |                 |   |                       |   |                            |   |                      |   |             |    |
| Sales and marketing                      |   | —               |   | 32,186                     |   | 10,185                          |   | (120                      | )      | 42,251           |    |
| General and  administrative              |   | 4,299                |   | 13,210                     |   | 4,660                           |   | (260                      | )      | 21,909           |    |
| Amortization                             |   | 315                  |   | 2,862                      |   | 1,078                           |   | —                    |   | 4,255            |    |
| Other operating  (income) expense        |   | (3,163               | )      | 2,556                      |   | 838                             |   | 380                       |   | 611              |    |
| Total operating  expenses                |   | 1,451                |   | 50,814                     |   | 16,761                          |   | —                    |   | 69,026           |    |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |    |
| Income (loss) from  operations           |   | (1,451               | )      | 29,326                     |   | 10,185                          |   | 412                       |   | 38,472           |    |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |    |
| Other income                             |   | (229                 | )      | (1,184                     | )      | (365                            | )      | —                    |   | (1,778           | )       |
| Interest income                          |   | (9,929               | )      | (20,089                    | )      | (81                             | )      | 27,793                    |   | (2,306           | )       |
| Interest expense                         |   | 7,947                |   | 38,421                     |   | 462                             |   | (27,793                   | )      | 19,037           |    |
| Debt extinguishment  costs               |   | 1,216                |   | 5,396                      |   | —                          |   | —                    |   | 6,612            |    |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |    |
| Income (loss) before  income taxes       |   | (456                 | )      | 6,782                      |   | 10,169                          |   | 412                       |   | 16,907           |    |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |    |
| Provision for (benefit  of) income taxes |   | (250                 | )      | 1,873                      |   | 3,822                           |   | 143                       |   | 5,588            |    |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |    |
| Net income (loss)                        |   | $                    | (206   | )                          | $      | 4,909                           |   | $                         | 6,347  |             | $       | 269 |   | $ | 11,319 |   |

 

52

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

**CONDENSED CONSOLIDATING STATEMENTS OFINCOME**

**YEAR ENDED DECEMBER 31, 2002**

**(In Thousands)**

 

 
|                                     |   | **Issuer  of Notes** |   | **Guarantor Subsidiaries** |   | **Non  Guarantor Subsidiaries** |   | **Reclass/ Eliminations** |   | **Consolidated** |   |
|------------------------------------------|--------|----------------------|--------|----------------------------|--------|---------------------------------|--------|---------------------------|--------|------------------|--------|
| Net sales                                |   | $                    | — |                       | $      | 278,421                         |   | $                         | 65,065 |             | $      | (11,189 | ) | $ | 332,297 |   |
| Cost of sales                            |   | —               |   | 204,036                    |   | 42,205                          |   | (11,095                   | )      | 235,146          |   |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Gross profit                             |   | —               |   | 74,385                     |   | 22,860                          |   | (94                       | )      | 97,151           |   |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Operating expenses:                      |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Sales and marketing                      |   | —               |   | 31,136                     |   | 10,048                          |   | (55                       | )      | 41,129           |   |
| General and  administrative              |   | 4,677                |   | 13,373                     |   | 4,467                           |   | —                    |   | 22,517           |   |
| Amortization                             |   | 452                  |   | 698                        |   | 4                               |   | —                    |   | 1,154            |   |
| Other operating  (income) expense        |   | (3,204               | )      | 3,223                      |   | 878                             |   | 55                        |   | 952              |   |
| Total operating  expenses                |   | 1,925                |   | 48,430                     |   | 15,397                          |   | —                    |   | 65,752           |   |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Income (loss) from  operations           |   | (1,925               | )      | 25,955                     |   | 7,463                           |   | (94                       | )      | 31,399           |   |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Other income                             |   | (65                  | )      | (2,381                     | )      | (1,493                          | )      | —                    |   | (3,939           | )      |
| Interest income                          |   | (14,236              | )      | (19,413                    | )      | (51                             | )      | 31,808                    |   | (1,892           | )      |
| Interest expense                         |   | 13,125               |   | 33,521                     |   | 333                             |   | (31,808                   | )      | 15,171           |   |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Income (loss) before  income taxes       |   | (749                 | )      | 14,228                     |   | 8,674                           |   | (94                       | )      | 22,059           |   |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Provision for (benefit  of) income taxes |   | (185                 | )      | 4,033                      |   | 3,317                           |   | (15                       | )      | 7,150            |   |
|                                     |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Net income (loss)                        |   | $                    | (564   | )                          | $      | 10,195                          |   | $                         | 5,357  |             | $      | (79 | ) | $ | 14,909 |   |

 

53

----

 

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

**CONDENSED CONSOLIDATING BALANCE SHEETS**

**DECEMBER 31, 2001**

**(In Thousands)**

 
|                                             |   | **Issuer  Of Notes** |   | **Guarantor Subsidiaries** |   | **Non  Guarantor Subsidiaries** |   | **Reclass/ Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------|--------|----------------------|--------|----------------------------|--------|---------------------------------|--------|---------------------------|--------|------------------|--------|
| ASSETS                                           |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Current assets:                                  |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Cash                                             |   | $                    | — |                       | $      | 1,672                           |   | $                         | 3,229  |             | $      | 644 |   | $ | 5,545 |   |
| Accounts, notes and  leases receivable, net      |   | —               |   | 72,339                     |   | 9,971                           |   | (122                      | )      | 82,188           |   |
| Inventories                                      |   | —               |   | 136,832                    |   | 25,179                          |   | (887                      | )      | 161,124          |   |
| Prepaid expenses and  other current assets       |   | 391                  |   | 3,393                      |   | 700                             |   | —                    |   | 4,484            |   |
| Deferred tax assets                              |   | —               |   | 5,539                      |   | 4,639                           |   | (4,542                    | )      | 5,636            |   |
| Total current assets                             |   | 391                  |   | 219,775                    |   | 43,718                          |   | (4,907                    | )      | 258,977          |   |
|                                             |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Property, plant and  equipment, net              |   | 216                  |   | 90,844                     |   | 12,951                          |   | —                    |   | 104,011          |   |
| Investment in  subsidiaries                      |   | 71,143               |   | 254,961                    |   | —                          |   | (326,104                  | )      | —           |   |
| Trademarks                                       |   | —               |   | 6,280                      |   | 2,862                           |   | —                    |   | 9,142            |   |
| Goodwill                                         |   | —               |   | 18,795                     |   | 9,122                           |   | —                    |   | 27,917           |   |
| Other intangibles, net                           |   | 4,201                |   | 3,874                      |   | 11                              |   | —                    |   | 8,086            |   |
| Other assets                                     |   | 737                  |   | 4,836                      |   | 334                             |   |                      |   | 5,907            |   |
| TOTAL ASSETS                                     |   | $                    | 76,688 |                       | $      | 599,365                         |   | $                         | 68,998 |             | $      | (331,011 | ) | $ | 414,040 |   |
|                                             |   |                 |   |                       |   |                            |   |                      |   |             |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY       |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Current liabilities:                             |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Current portion of  long-term debt               |   | $                    | — |                       | $      | 6,285                           |   | $                         | 1,161  |             | $      | — |   | $ | 7,446 |   |
| Accounts payable                                 |   | 84                   |   | 6,080                      |   | 1,640                           |   | (122                      | )      | 7,682            |   |
| Other current liabilities                        |   | (15,592              | )      | 41,463                     |   | 13,625                          |   | (5,401                    | )      | 34,095           |   |
| Total current  liabilities                       |   | (15,508              | )      | 53,828                     |   | 16,426                          |   | (5,523                    | )      | 49,223           |   |
|                                             |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Long-term debt                                   |   | 150,020              |   | 53,093                     |   | —                          |   | 644                       |   | 203,757          |   |
| Intercompany                                     |   | (112,437             | )      | 108,035                    |   | 4,402                           |   | —                    |   | —           |   |
| Deferred tax  liabilities                        |   | —               |   | 20,882                     |   | 6,236                           |   | —                    |   | 27,118           |   |
| Other non current  liabilities                   |   | 125                  |   | 1,896                      |   | 11,550                          |   | —                    |   | 13,571           |   |
| Total liabilities                                |   | 22,200               |   | 237,734                    |   | 38,614                          |   | (4,879                    | )      | 293,669          |   |
|                                             |   |                 |   |                       |   |                            |   |                      |   |             |   |
| Stockholders’ equity                        |   | 54,488               |   | 361,631                    |   | 30,384                          |   | (326,132                  | )      | 120,371          |   |
|                                             |   |                 |   |                       |   |                            |   |                      |   |             |   |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY |   | $                    | 76,688 |                       | $      | 599,365                         |   | $                         | 68,998 |             | $      | (331,011 | ) | $ | 414,040 |   |

 

54

----

 

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

**CONDENSED CONSOLIDATING BALANCESHEETS**

**DECEMBER 31, 2002**

**(In Thousands)**

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

 

55

----

 

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

**CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS**

**YEAR ENDED DECEMBER 31, 2000**

**(In Thousands)**

 
|                                                                                 |   | **Guarantor  Parent** |   | **Issuer  Of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------------------------------------------|--------|-----------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
| Cash flows from  operating activities:                                               |   |                  |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net income  (loss)                                                                   |   | $                     | (1,051 | )                    | $      | (3,438                      | )      | $                                | 16,832 |                       | $      | 4,676            |   | $ | (115 | ) | $ | 16,904 |   |
| Adjustments to  reconcile net income (loss) to cash flows from operating activities: |   |                  |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Depreciation and  amortization                                                       |   | 46                    |   | 2,742                |   | 6,993                       |   | 2,561                            |   | —                     |   | 12,342           |   |
| Early  extinguishment of debt                                                        |   | —                |   | —               |   | —                      |   | —                           |   | —                     |   | —           |   |
| Deferred tax  expense (benefit)                                                      |   | —                |   | 527                  |   | (443                        | )      | (2,433                           | )      | —                     |   | (2,349           | )      |
| Other                                                                                |   | 1                     |   | 251                  |   | 14                          |   | (26                              | )      | —                     |   | 240              |   |
| Changes in operating  assets and liabilities:                                        |   |                  |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Accounts, notes  and leases receivable                                               |   | —                |   | 2,702                |   | 2,453                       |   | (416                             | )      | —                     |   | 4,739            |   |
| Inventories                                                                          |   | —                |   | (6,936               | )      | (12,257                     | )      | (1,338                           | )      | 289                        |   | (20,242          | )      |
| Prepaid expenses  and other current assets                                           |   | 270                   |   | (275                 | )      | 326                         |   | 44                               |   | —                     |   | 365              |   |
| Accounts payable                                                                     |   | (46                   | )      | 48                   |   | 1,532                       |   | 627                              |   | —                     |   | 2,161            |   |
| Other current  liabilities                                                           |   | (3,884                | )      | (5,932               | )      | 6,544                       |   | 2,551                            |   | (174                       | )      | (895             | )      |
| Cash flows from  operating activities                                                |   | (4,664                | )      | (10,311              | )      | 21,994                      |   | 6,246                            |   | —                     |   | 13,265           |   |
|                                                                                 |   |                  |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash flows from  investing activities:                                               |   |                  |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Capital  expenditures                                                                |   | (35                   | )      | (2,107               | )      | (4,601                      | )      | (1,147                           | )      | —                     |   | (7,890           | )      |
| Proceeds from  disposals of fixed assets                                             |   | —                |   | 14                   |   | 376                         |   | 121                              |   | —                     |   | 511              |   |
| Business  acquisition, net of cash acquired                                          |   | —                |   | (26,519              | )      | (57,708                     | )      | (2,340                           | )      | —                     |   | (86,567          | )      |
| Changes in other  assets                                                             |   | —                |   | 148                  |   | —                      |   | —                           |   | —                     |   | 148              |   |
| Cash flows from  investing activities                                                |   | (35                   | )      | (28,464              | )      | (61,933                     | )      | (3,366                           | )      | —                     |   | (93,798          | )      |
|                                                                                 |   |                  |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash flows from  financing activities:                                               |   |                  |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net borrowings  (repayments) under lines of credit                                   |   | (19                   | )      | 28,620               |   | 12,841                      |   | (1,099                           | )      | 954                        |   | 41,297           |   |
| Proceeds from  issuance of long-term debt                                            |   | —                |   | —               |   | 45,000                      |   | —                           |   | —                     |   | 45,000           |   |
| Repayment of  long-term debt                                                         |   | —                |   | —               |   | (1,261                      | )      | (720                             | )      | —                     |   | (1,981           | )      |
| Debt issuance  costs                                                                 |   | —                |   | —               |   | (3,920                      | )      | (22                              | )      | —                     |   | (3,942           | )      |
| Proceeds from  issuance of stock                                                     |   | 693                   |   | —               |   | —                      |   | —                           |   | —                     |   | 693              |   |
| Purchase of  treasury stock                                                          |   | (483                  | )      | —               |   | —                      |   | —                           |   | —                     |   | (483             | )      |
| Intercompany  dividends                                                              |   | —                |   | —               |   | 450                         |   | (450                             | )      | —                     |   | —           |   |
| Intercompany  transactions                                                           |   | 4,508                 |   | 8,544                |   | (13,364                     | )      | 312                              |   | —                     |   | —           |   |
| Cash flows from  financing activities                                                |   | 4,699                 |   | 37,164               |   | 39,746                      |   | (1,979                           | )      | 954                        |   | 80,584           |   |
|                                                                                 |   |                  |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Effect of  exchange rate changes on cash                                             |   | —                |   | —               |   | —                      |   | 274                              |   | —                     |   | 274              |   |
|                                                                                 |   |                  |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Increase  (decrease) in cash                                                         |   | —                |   | (1,611               | )      | (193                        | )      | 1,175                            |   | 954                        |   | 325              |   |
| Cash, beginning  of period                                                           |   | —                |   | 1,875                |   | 2,591                       |   | 1,152                            |   | (954                       | )      | 4,664            |   |
|                                                                                 |   |                  |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash, end of  period                                                                 |   | $                     | — |                 | $      | 264                         |   | $                                | 2,398  |                       | $      | 2,327            |   | $ | — |   | $ | 4,989 |   |

 

56

----

 

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

**CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS**

**YEAR ENDED DECEMBER 31, 2001**

**(In Thousands)**

 
|                                                                                   |   | **Issuer  Of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor  Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|----------------------------------------------------------------------------------------|--------|----------------------|--------|-----------------------------|--------|----------------------------------|--------|----------------------------|--------|------------------|--------|
| Cash flows from  operating activities:                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net income  (loss)                                                                     |   | $                    | (206   | )                           | $      | 4,828                            |   | $                          | 6,428  |             | $      | 269 |   | $ | 11,319 |   |
| Adjustments to  reconcile net income  (loss) to cash flows from operating  activities: |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Depreciation and  amortization                                                         |   | 373                  |   | 10,842                      |   | 2,588                            |   | —                     |   | 13,803           |   |
| Early  extinguishment of debt                                                          |   | 1,216                |   | 5,396                       |   | —                           |   | —                     |   | 6,612            |   |
| Deferred tax  expense (benefit)                                                        |   | —               |   | 1,879                       |   | (1,682                           | )      | (1,618                     | )      | (1,421           | )      |
| Other                                                                                  |   | 4                    |   | 216                         |   | 211                              |   | —                     |   | 431              |   |
| Changes in  operating assets and  liabilities:                                         |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Accounts, notes  and leases receivable                                                 |   | —               |   | 10,077                      |   | (335                             | )      | 122                        |   | 9,864            |   |
| Inventories                                                                            |   | —               |   | (1,415                      | )      | (1,693                           | )      | (412                       | )      | (3,520           | )      |
| Prepaid expenses  and other current  assets                                            |   | (298                 | )      | (1,214                      | )      | (370                             | )      | (651                       | )      | (2,533           | )      |
| Accounts payable                                                                       |   | (58                  | )      | (3,217                      | )      | (43                              | )      | (122                       | )      | (3,440           | )      |
| Other current  liabilities                                                             |   | 502                  |   | (8,763                      | )      | 3,614                            |   | 2,409                      |   | (2,238           | )      |
| Cash flows from  operating activities                                                  |   | 1,533                |   | 18,629                      |   | 8,718                            |   | (3                         | )      | 28,877           |   |
|                                                                                   |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash flows from  investing activities:                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Capital  expenditures                                                                  |   | (187                 | )      | (6,195                      | )      | (759                             | )      | —                     |   | (7,141           | )      |
| Proceeds from  disposals of fixed assets                                               |   | —               |   | 243                         |   | —                           |   | —                     |   | 243              |   |
| Changes in other  assets                                                               |   | (5                   | )      | (1,088                      | )      | —                           |   | 3                          |   | (1,090           | )      |
| Capital  contribution to subsidiary                                                    |   | —               |   | (419                        | )      | 419                              |   | —                     |   | —           |   |
| Cash flows from investing  activities                                                  |   | (192                 | )      | (7,459                      | )      | (340                             | )      | 3                          |   | (7,988           | )      |
|                                                                                   |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash flows from  financing activities:                                                 |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Net borrowings  (repayments) under lines  of credit                                    |   | (165                 | )      | (43,566                     | )      | (2,514                           | )      | 644                        |   | (45,601          | )      |
| Proceeds from  issuance of long-term debt                                              |   | 150,000              |   | —                      |   | —                           |   | —                     |   | 150,000          |   |
| Repayment of  long-term debt                                                           |   | —               |   | (118,497                    | )      | (350                             | )      | —                     |   | (118,847         | )      |
| Debt issuance  costs                                                                   |   | (4,516               | )      | —                      |   | —                           |   | —                     |   | (4,516           | )      |
| Proceeds from  issuance of stock                                                       |   | 454                  |   | —                      |   | —                           |   | —                     |   | 454              |   |
| Purchase of  treasury stock                                                            |   | (1,901               | )      | —                      |   | —                           |   | —                     |   | (1,901           | )      |
| Intercompany  dividends                                                                |   | —               |   | 3,801                       |   | (3,801                           | )      | —                     |   | —           |   |
| Intercompany  transactions                                                             |   | (145,213             | )      | 146,102                     |   | (889                             | )      | —                     |   | —           |   |
| Cash flows from  financing activities                                                  |   | (1,341               | )      | (12,160                     | )      | (7,554                           | )      | 644                        |   | (20,411          | )      |
|                                                                                   |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Effect of exchange  rate changes on cash                                               |   | —               |   | —                      |   | 78                               |   | —                     |   | 78               |   |
|                                                                                   |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Increase  (decrease) in cash                                                           |   | —               |   | (990                        | )      | 902                              |   | 644                        |   | 556              |   |
| Cash, beginning  of period                                                             |   | —               |   | 2,662                       |   | 2,327                            |   | —                     |   | 4,989            |   |
|                                                                                   |   |                 |   |                        |   |                             |   |                       |   |             |   |
| Cash, end of  period                                                                   |   | $                    | — |                        | $      | 1,672                            |   | $                          | 3,229  |             | $      | 644 |   | $ | 5,545 |   |

 

57

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** **

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

**CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS**

**YEAR ENDED DECEMBER 31, 2002**

**(In Thousands)**

 
|                                                                                   |   | **Issuer   Of Notes** |   | **Guarantor  Subsidiaries** |   | **Non  Guarantor Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|----------------------------------------------------------------------------------------|--------|-----------------------|--------|-----------------------------|--------|---------------------------------|--------|----------------------------|--------|------------------|--------|
| Cash flows from  operating activities:                                                 |   |                  |   |                        |   |                            |   |                       |   |             |   |
| Net income  (loss)                                                                     |   | $                     | (564   | )                           | $      | 10,195                          |   | $                          | 5,357  |             | $      | (79 | ) | $ | 14,909 |   |
| Adjustments to  reconcile net income  (loss) to cash flows from operating  activities: |   |                  |   |                        |   |                            |   |                       |   |             |   |
| Depreciation and  amortization                                                         |   | 513                   |   | 8,978                       |   | 1,546                           |   | —                     |   | 11,037           |   |
| Early  extinguishment of debt                                                          |   | —                |   | —                      |   | —                          |   | —                     |   | —           |   |
| Deferred tax  expense (benefit)                                                        |   | —                |   | (687                        | )      | (1,778                          | )      | 1,271                      |   | (1,194           | )      |
| Other                                                                                  |   | —                |   | 161                         |   | 173                             |   | —                     |   | 334              |   |
| Changes in  operating assets and  liabilities:                                         |   |                  |   |                        |   |                            |   |                       |   |             |   |
| Accounts, notes  and leases receivable                                                 |   | —                |   | 6,484                       |   | (350                            | )      | (44                        | )      | 6,090            |   |
| Inventories                                                                            |   | —                |   | 2,554                       |   | (771                            | )      | 94                         |   | 1,877            |   |
| Prepaid expenses  and other current  assets                                            |   | (380                  | )      | (226                        | )      | (149                            | )      | —                     |   | (755             | )      |
| Accounts payable                                                                       |   | 14                    |   | 850                         |   | 937                             |   | 44                         |   | 1,845            |   |
| Other current  liabilities                                                             |   | 1,524                 |   | (2,904                      | )      | (429                            | )      | (1,286                     | )      | (3,095           | )      |
| Cash flows from  operating activities                                                  |   | 1,107                 |   | 25,405                      |   | 4,536                           |   | —                     |   | 31,048           |   |
|                                                                                   |   |                  |   |                        |   |                            |   |                       |   |             |   |
| Cash flows from  investing activities:                                                 |   |                  |   |                        |   |                            |   |                       |   |             |   |
| Capital  expenditures                                                                  |   | (4                    | )      | (4,920                      | )      | (680                            | )      | —                     |   | (5,604           | )      |
| Proceeds from  disposals of fixed assets                                               |   | —                |   | 4                           |   | —                          |   | —                     |   | 4                |   |
| Changes in other  assets                                                               |   | (82                   | )      | (2,067                      | )      | —                          |   | —                     |   | (2,149           | )      |
| Capital  contribution to subsidiary                                                    |   | —                |   | (705                        | )      | 705                             |   | —                     |   | —           |   |
| Cash flows from  investing activities                                                  |   | (86                   | )      | (7,688                      | )      | 25                              |   | —                     |   | (7,749           | )      |
|                                                                                   |   |                  |   |                        |   |                            |   |                       |   |             |   |
| Cash flows from  financing activities:                                                 |   |                  |   |                        |   |                            |   |                       |   |             |   |
| Net borrowings  (repayments) under lines  of credit                                    |   | 33                    |   | (10,586                     | )      | 295                             |   | 10,553                     |   | 295              |   |
| Proceeds from  issuance of long-term debt                                              |   | —                |   | —                      |   | —                          |   | —                     |   | —           |   |
| Repayment of  long-term debt                                                           |   | —                |   | (6,352                      | )      | —                          |   | —                     |   | (6,352           | )      |
| Repurchase of  long-term debt                                                          |   | (4,655                | )      | —                      |   | —                          |   | —                     |   | (4,655           | )      |
| Debt issuance  costs                                                                   |   | —                |   | —                      |   | —                          |   | —                     |   | —           |   |
| Proceeds from  issuance of stock                                                       |   | 994                   |   | —                      |   | —                          |   | —                     |   | 994              |   |
| Intercompany  dividends                                                                |   | —                |   | 787                         |   | (787                            | )      | —                     |   | —           |   |
| Intercompany  transactions                                                             |   | 2,607                 |   | (2,072                      | )      | (535                            | )      | —                     |   | —           |   |
| Cash flows from  financing activities                                                  |   | (1,021                | )      | (18,223                     | )      | (1,027                          | )      | 10,553                     |   | (9,718           | )      |
|                                                                                   |   |                  |   |                        |   |                            |   |                       |   |             |   |
| Effect of  exchange rate changes on cash                                               |   | —                |   | —                      |   | (27                             | )      | —                     |   | (27              | )      |
|                                                                                   |   |                  |   |                        |   |                            |   |                       |   |             |   |
| Increase  (decrease) in cash                                                           |   | —                |   | (506                        | )      | 3,507                           |   | 10,553                     |   | 13,554           |   |
| Cash, beginning  of period                                                             |   | —                |   | 1,672                       |   | 3,229                           |   | 644                        |   | 5,545            |   |
|                                                                                   |   |                  |   |                        |   |                            |   |                       |   |             |   |
| Cash, end of  period                                                                   |   | $                     | — |                        | $      | 1,166                           |   | $                          | 6,736  |             | $      | 11,197 |   | $ | 19,099 |   |

 

58

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**(19)     Quarterly Financial Data (Unaudited)**

 

The following is a summary of unaudited results of operations (inthousands except share and per share data) for the years ended December 31,2001 and 2002.

 
|                             |   | **Year Ended  December 31, 2001** |    |
|----------------------------------|--------|-----------------------------------|---------|
|                             |   | **First  Quarter**                |    | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |   |
|                             |   |                              |    |   |   |   |   |   |   |
| Net sales                        |   | $                                 | 101,581 |   | $ | 83,661 |   | $ | 82,885 |   | $ | 84,485 |   |
| Gross profit                     |   | 31,709                            |    | 27,064 |   | 24,309 |   | 24,416 |   |
| Net income  (loss)               |   | 5,200                             |    | (249 | ) | 2,514 |   | 3,854 |   |
|                             |   |                              |    |   |   |   |   |   |   |
| Basic income  (loss) per share   |   | $                                 | 0.58    |   | $ | (0.03 | ) | $ | 0.28 |   | $ | 0.43 |   |
| Diluted income  (loss) per share |   | 0.58                              |    | (0.03 | ) | 0.28 |   | 0.43 |   |
|                             |   |                              |    |   |   |   |   |   |   |
| Weighted average  shares:        |   |                              |    |   |   |   |   |   |   |
| Basic                            |   | 8,931,500                         |    | 8,931,500 |   | 8,947,342 |   | 8,901,657 |   |
| Diluted                          |   | 8,931,500                         |    | 8,931,500 |   | 8,947,342 |   | 8,901,657 |   |

 
|                      |   | **Year Ended  December 31, 2002** |   |
|---------------------------|--------|-----------------------------------|--------|
|                      |   | **First  Quarter**                |   | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |   |
| Net sales                 |   | $                                 | 88,059 |   | $ | 78,349 |   | $ | 75,320 |   | $ | 90,569 |   |
| Gross profit              |   | 25,363                            |   | 24,385 |   | 21,301 |   | 26,102 |   |
| Net income                |   | 3,683                             |   | 4,084 |   | 2,191 |   | 4,951 |   |
|                      |   |                              |   |   |   |   |   |   |   |
| Basic income per  share   |   | $                                 | 0.42   |   | $ | 0.46 |   | $ | 0.25 |   | $ | 0.56 |   |
| Diluted income  per share |   | 0.42                              |   | 0.46 |   | 0.25 |   | 0.56 |   |
|                      |   |                              |   |   |   |   |   |   |   |
| Weighted average  shares: |   |                              |   |   |   |   |   |   |   |
| Basic                     |   | 8,847,372                         |   | 8,860,834 |   | 8,894,580 |   | 8,906,238 |   |
| Diluted                   |   | 8,853,917                         |   | 8,915,071 |   | 8,894,620 |   | 8,906,238 |   |

 

59

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

**SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS**

**(In Thousands)**

 
|                                                |   | **Balance at  Beginning  of Year** |   | **Additions**

**Charged to  Costs and  Expenses** |      | **Deductions  and Other  (see Note 1)** |      | **Balance at  End of Year** |   |
|-----------------------------------------------------|--------|------------------------------------|--------|----------------------------------------------------|-----------|-----------------------------------------|-----------|-----------------------------|--------|
|                                                |   |                               |   |                                               |      |                                    |      |                        |   |
| Reserves  deducted from assets to which they apply: |   |                               |   |                                               |      |                                    |      |                        |   |
| Allowance for  doubtful accounts:                   |   |                               |   |                                               |      |                                    |      |                        |   |
| Year ended  December 31, 2000                       |   | $                                  | 6,765  |                                               | $         | 4,394                                   | (3)       | $                           | 218    |  (2) | $ | 11,377 |   |
| Year ended  December 31, 2001                       |   | 11,377                             |   | 362                                                |      | (830                                    | )(2)      | 10,909                      |   |
| Year ended  December 31, 2002                       |   | 10,909                             |   | 242                                                |      | 238                                     |  (2) | 11,389                      |   |
|                                                |   |                               |   |                                               |      |                                    |      |                        |   |
| Inventory  obsolescence:                            |   |                               |   |                                               |      |                                    |      |                        |   |
| Year ended  December 31, 2000                       |   | 3,831                              |   | 171                                                |      | (259                                    | )         | 3,743                       |   |
| Year ended  December 31, 2001                       |   | 3,743                              |   | 1,086                                              |      | (301                                    | )         | 4,528                       |   |
| Year ended  December 31, 2002                       |   | 4,528                              |   | 1,644                                              |      | (892                                    | )         | 5,280                       |   |
|                                                |   |                               |   |                                               |      |                                    |      |                        |   |
| Reserves  included in other current liabilities:    |   |                               |   |                                               |      |                                    |      |                        |   |
| Accrued warranty  expense:                          |   |                               |   |                                               |      |                                    |      |                        |   |
| Year ended  December 31, 2000                       |   | 2,330                              |   | 841                                                | (4)  | (816                                    | )         | 2,355                       |   |
| Year ended  December 31, 2001                       |   | 2,355                              |   | 932                                                |      | (1,066                                  | )         | 2,221                       |   |
| Year ended  December 31, 2002                       |   | 2,221                              |   | 950                                                |      | (814                                    | )         | 2,357                       |   |
|                                                |   |                               |   |                                               |      |                                    |      |                        |   |
| Reserves for  notes sold with recourse:             |   |                               |   |                                               |      |                                    |      |                        |   |
| Year ended  December 31, 2000                       |   | 1,443                              |   | —                                             |      | (340                                    | )         | 1,103                       |   |
| Year ended  December 31, 2001                       |   | 1,103                              |   | —                                             |      | (254                                    | )         | 849                         |   |
| Year ended  December 31, 2002                       |   | 849                                |   | —                                             |      | (849                                    | )(2)      | —                      |   |
|                                                     |        |                                    |        |                                                    |           |                                         |           |                             |        |  |  |  |  |

 

----

| Note:  |   | (1) | Includes foreign currency translation adjustments                                                     |
|--------|--------|-----|-------------------------------------------------------------------------------------------------------|
|   |   | (2) | Represents accounts written off, net of recoveries;  and reclassifications to and from other accounts |
|   |   | (3) | Includes $4,200 related to acquisitions during the  year                                              |
|   |   | (4) | Includes $40 related to acquisitions during the year                                                  |

 

 

60

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**ITEM 9                   CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND**

** FINANCIAL DISCLOSURE**

 

Not applicable.

 

**PART III**

 

**ITEM 10                DIRECTORS AND EXECUTIVEOFFICERS OF THE REGISTRANT**

 

The information called for by this item is herebyincorporated by reference to the Registrant’s definitive Proxy Statement forthe fiscal year ended December 31, 2002, which Proxy Statement will be filedwith the Securities and Exchange Commission no later than 120 days after theend of the fiscal year covered by this report.

 

**ITEM 11                EXECUTIVE COMPENSATION**

 

The information called for by this item is herebyincorporated by reference to the Registrant’s definitive Proxy Statement forthe fiscal year ended December 31, 2002, which Proxy Statement will be filedwith the Securities and Exchange Commission no later than 120 days after theend of the fiscal year covered by this report.

 

 

**ITEM 12                SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT**

 

The information called for by this item is herebyincorporated by reference to the Registrant’s definitive Proxy Statement forthe fiscal year ended December 31, 2002, which Proxy Statement will be filedwith the Securities and Exchange Commission no later than 120 days after theend of the fiscal year covered by this report.

 

**ITEM 13                CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS**

 

The information called for by this item is herebyincorporated by reference to the Registrant’s definitive Proxy Statement forthe fiscal year ended December 31, 2002, which Proxy Statement will be filedwith the Securities and Exchange Commission no later than 120 days after theend of the fiscal year covered by this report.

 

61

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**PART IV**

** **

**ITEM 14****                                                 CONTROLSAND PROCEDURES**

 

(a)          Disclosure Controls andProcedures

 

Within 90 days beforefiling this report, we evaluated the effectiveness of the design and operationof our disclosure controls and procedures. Our disclosure controls andprocedures are the controls and other procedures that we designed to ensurethat we record, process, summarize and report in a timely manner theinformation we must disclose in reports that we file with or submit to the SEC.Mr. Messina, our President and Chief Executive Officer, and Mr. Hanson, ourSenior Executive Vice President and Chief Financial Officer, reviewed andparticipated in this evaluation. Based on this evaluation, Messrs. Messina andHanson concluded that, as of the date of their evaluation, our disclosurecontrols were effective.

 

(b)         Internal Controls

 

Since the date of theevaluation described above, there have not been any significant changes in ourinternal accounting controls or in other factors that could significantlyaffect those controls.

 

62

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**ITEM 15****                                                 EXHIBITS,FINANCIAL STATEMENT SCHEDULES AND REPORTS**

**ON FORM 8-K**

 

(a)           Thefollowing documents are filed as a part of this report:

 
| (1) Financial Statements                                                                                     |
|--------------------------------------------------------------------------------------------------------------|
|                                                                                                         |
| Independent Auditors’  Report                                                                           |
| Consolidated  Statements of Income for the Years Ended December 31, 2000, 2001, and 2002                     |
| Consolidated Balance Sheets  as of December 31, 2001 and 2002                                                |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2000, 2001, and  2002                |
| Consolidated  Statements of Stockholders’ Equity for the Years Ended December 31, 2000,  2001, and 2002 |
| Notes to  Consolidated Financial Statements                                                                  |
| Schedule  II - Valuation and Qualifying Accounts                                                             |

 

(3)           Exhibits:   The Exhibits listed below are filed as partof, or incorporated by reference into, this Report.

 
| **Exhibit  No.** |   | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1              |   | Stock Purchase Agreement dated as of July 20, 2000,  by and among Steinway Musical Instruments, Inc. and BIM Holding AG with  respect to all the capital stock of United Musical Instruments Holdings,  Inc.  (8)                                                                                                                                                                                                                                                      |
| 3.1              |   | Restated Certificate of Incorporation of  Registrant  (6)                                                                                                                                                                                                                                                                                                                                                                                                              |
| 3.2              |   | Bylaws of Registrant  (4)                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 3.3              |   | Amendment No. 1 to Bylaws of Registrant  (4)                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 4.1              |   | Second Amended and Restated Credit Agreement, dated  as of September 14, 2000, among The Selmer Company, Inc., Steinway, Inc., and  United Musical Instruments USA, Inc., as borrowers; certain wholly owned  subsidiaries of the borrowers (as may be amended from time to time), as  guarantors; the several lenders from time to time parties thereto; and GMAC  Commercial Credit LLC, as Administrative Agent  (9)                                                |
| 4.2              |   | First Amendment to Second Amended and Restated  Credit Agreement, dated as of March 2, 2001, to the Existing Credit  Agreement, by and among The Selmer Company, Inc., Steinway, Inc., United  Musical Instruments USA, Inc., as borrowers; certain wholly owned  subsidiaries of the borrowers (as may be amended from time to time), as  guarantors; the several lenders from time to time parties thereto; and GMAC  Commercial Credit LLC, as Administrative Agent (13) |
| 4.3              |   | Second Amendment to the Second Amended and Restated  Credit Agreement dated as of April 19, 2001 among The Selmer Company, Inc.,  Steinway, Inc. and United Musical Instruments USA, Inc., as borrowers:  certain wholly owned subsidiaries of the borrowers (as may be amended from  time to time), as guarantors; the several lenders from time to time parties  thereto; and GMAC Commercial Credit LLC, as Administrative Agent (10)                                    |
| 4.4              |   | Third Amendment to the Second Amended and Restated  Credit Agreement dated as of August 31, 2001 among The Selmer Company, Inc.,  Steinway, Inc. and United Musical Instruments USA, Inc., as borrowers;  certain wholly owned subsidiaries of the borrowers                                                                                                                                                                                                                |

 

63

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|   |   | (as may be amended from time to time), as  guarantors; the several lenders from time to time parties thereto; and GMAC  Commercial Credit LLC, as Administrative Agent (11)                                                                                                                                                                                                                                                                                                                                                                      |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.5    |   | Fourth Amendment to the Second Amended and Restated  Credit Agreement dated as of July 17, 2002 by and among The Selmer Company,  Inc., Steinway, Inc., United Musical Instruments USA, Inc., as borrowers;  certain wholly owned subsidiaries of the borrowers (as may be amended from  time to time), as guarantors; the lenders from time to time party to the  Agreement; and GMAC Commercial Credit, LLC, as Administrative Agent                                                                                                           |
| 4.6    |   | Fifth Amendment to the Second Amended and Restated  Credit Agreement dated as of January 14, 2003 by and among Conn-Selmer, Inc.  f/k/a The Selmer Company, Inc. and the surviving corporation of the merger of  United Musical Instruments USA, Inc. with and into Conn-Selmer, Inc.,  Steinway, Inc., as borrowers; certain wholly owned subsidiaries of the  borrowers (as may be amended from time to time), as guarantors; the lenders,  from time to time party to the Agreement; and GMAC Commercial Credit LLC, as  Administrative Agent |
| 4.7    |   | Registration Rights Agreement, dated as of August 9,  1993, among Selmer Industries, Inc. and the purchasers of certain equity  securities  (1)                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.8    |   | Indenture, dated as of April 19, 2001, among  Steinway Musical Instruments, Inc., the subsidiary guarantors named therein  and UBS Warburg, LLC, as the initial purchaser  (12)                                                                                                                                                                                                                                                                                                                                                             |
| 4.9    |   | Exchange Registration Rights agreement, dated as of  May 25, 1995, by and among The Selmer Company, Inc., Selmer Industries, Inc.,  Steinway Musical Properties, Inc., Steinway, Inc., Boston Piano Company, Inc.  and Donaldson, Lufkin  & Jenrette  Corporation  (2)                                                                                                                                                                                                                                                             |
| 10.1   |   | Employment Agreement, dated May 8, 1989, between  Steinway Musical Properties, Inc. and Thomas Kurrer  (3)                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.2   |   | Employment Agreement, dated as of May 1, 1995,  between Steinway Musical Properties, Inc. and Bruce Stevens  (3)                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.3   |   | Employment Agreement Renewal and Amendment dated  January 1, 1997 by and between Steinway Musical Instruments, Inc. and Bruce  Stevens  (6)                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.4   |   | Employment Agreement, dated as of May 1, 1995,  between Steinway Musical Properties, Inc. and Dennis Hanson  (3)                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.5   |   | Employment Agreement Renewal and Amendment dated  January 1, 1997 by and between Steinway Musical Instruments, Inc. and Dennis  Hanson  (6)                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.6   |   | Employment Agreement, dated as of January 4, 1999,  between the Registrant and Dana Messina   (7)                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.7   |   | Employment Agreement, dated as of January 4, 1999,  between the Registrant and Kyle Kirkland   (7)                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.8   |   | Environmental Indemnification and Non-Competition  Agreement, dated as of August 9, 1993, between The Selmer Company, Inc. and  Philips Electronics North American Corporation  (1)                                                                                                                                                                                                                                                                                                                                                         |
| 10.9   |   | Distribution Agreement, dated November 1, 1952, by  and between H. & A. Selmer, Inc. and Henri Selmer & Cie  (1)                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.10  |   | Amended and Restated 1996 Stock Plan of the  Registrant                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.11  |   | Form of Non-compete Agreement dated July 1996  between Steinway Musical Instruments, Inc. and each of Thomas Burzycki, Bruce  Stevens, Dennis Hanson and Michael Vickrey   (5)                                                                                                                                                                                                                                                                                                                                                              |
| 10.12  |   | Employment Agreement dated November 11, 2002 between  Conn-Selmer, Inc. and John M. Stoner, Jr.                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 21.1   |   | List of Subsidiaries of the Registrants                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 23.1   |   | Independent Auditors’ Consent - Deloitte &  Touche LLP                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |

 

64

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| 99.1 |   | Certification of the Chief Executive Officer  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|------|--------|---------------------------------------------------------------------------------------------------------|
| 99.2 |   | Certification of the Chief Financial Officer  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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(1)          Previously filed withthe Commission on February 8, 1994 as an exhibit to the Registrant’sRegistration Statement on Form S-1.

 

(2)          Previously filed withthe Commission on June 7, 1995 as an exhibit to the Registrant’s Current Reporton Form 8-K.

 

(3)          Previously filed withthe Commission on June 7, 1995 as an exhibit to the Registrant’s RegistrationStatement on Form S-4.

 

(4)          Previously filed withthe Commission on May 14, 1996 as an exhibit to the Registrant’s RegistrationStatement on Form S-1.

 

(5)          Previously filed withthe Commission on July 25, 1996 as an exhibit to the Registrant’s Amendment No.2 to Registration Statement on Form S-1.

 

(6)          Previously filed withthe Commission on March 27, 1997 as an exhibit to the Registrant’s Annual Reporton Form 10-K.

 

(7)          Previously filed withthe Commission on August 16, 1999 as an exhibit to the Registrant’s QuarterlyReport on Form 10-Q.

 

(8)          Previously filed withthe Commission on July 27, 2000 as an exhibit to the Registrant’s CurrentReport on Form 8-K.

 

(9)          Previously filed withthe Commission on September 29, 2000 as an exhibit to the Registrant’s CurrentReport on Form 8-K.

 

(10)    Previously filed with theCommission on August 14, 2001 as an exhibit to the Registrant’s QuarterlyReport on Form 10-Q.

 

(11)    Previously filed with theCommission on November 13, 2001 as an exhibit to the Registrant’s QuarterlyReport on Form 10-Q.

 

(12)    Previously filed with theCommission on June 12, 2001 as an exhibit to the Registrant’s RegistrationStatement on Form S-4.

 

(13)    Previously filed with theCommission on March 28, 2001 as an Exhibit to the Registrant’s Annual Report onForm 10-K.

 

(b)           Reportson Form 8-K

 

On November 18, 2002 the Company filed a CurrentReport on Form 8-K that included a press release issued on November 11, 2002announcing the resignation of Thomas T. Burzycki as an officer and director anda press release issued on November 11, 2002 announcing the appointment of JohnM. Stoner, Jr. as President of Conn-Selmer.

 

65

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
|           | STEINWAY MUSICAL INSTRUMENTS, INC. |
|----------------|------------------------------------|
|           |                               |   |
| March 14, 2003 |                               | By | /s/  Dana D.  Messina |   |
| (Date)         |                               |   | Dana D. Messina |   |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed by the following persons onbehalf of the registrant and in the capacities and on the dates indicated:

 
| **Signature**                  |   | **Title**                      |                                  |   |
|--------------------------------|--------|--------------------------------|---------------------------------------|--------|
|                           |   |                           |                                  |   |
| /s/  Dana D.  Messina     |   |                           | Director and Chief  Executive Officer |   | March 14, 2003 |
| Dana D. Messina                |   | (Principal Executive  Officer) |                                  |   |
|                           |   |                           |                                  |   |
| /s/  Dennis  M. Hanson    |   |                           | Chief Financial Officer               |   | March 14, 2003 |
| Dennis M. Hanson               |   | (Principal Financial  Officer) |                                  |   |
|                           |   |                           |                                  |   |
| /s/  Kyle R.  Kirkland    |   |                           | Chairman of the Board                 |   | March 14, 2003 |
| Kyle R. Kirkland               |   |                           |                                  |   |
|                           |   |                           |                                  |   |
| /s/  John M.  Stoner, Jr. |   |                           | Director                              |   | March 14, 2003 |
| John M. Stoner, Jr.            |   |                           |                                  |   |
|                           |   |                           |                                  |   |
| /s/  Bruce A.  Stevens    |   |                           | Director                              |   | March 14, 2003 |
| Bruce A. Stevens               |   |                           |                                  |   |
|                           |   |                           |                                  |   |
| /s/  Peter  McMillan      |   |                           | Director                              |   | March 14, 2003 |
| Peter McMillan                 |   |                           |                                  |   |
|                                |        |                                |                                       |        |  |  |  |  |

 

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| /s/  A.  Clinton Allen |   |   | Director |   | March 14, 2003 |
|-----------------------------|--------|--------|----------|--------|----------------|
| A. Clinton Allen            |   |   |     |   |
|                        |   |   |     |   |
| /s/ Rudolph K. Kluiber      |   |   | Director |   | March 14, 2003 |
| Rudolph K. Kluiber          |   |   |     |   |
|                             |        |        |          |        |                |  |

 

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I,  Dana D. Messina, certifythat:

 

1.  I have reviewed this annualreport on Form 10-K of Steinway Musical Instruments, Inc.;

 

2.  Based on my knowledge, thisannual report does not contain any untrue statement of a material fact or omitto state a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.  Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, theperiods presented in this annual report;

 

4.  The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

a)  designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisannual report is being prepared;

 

b)  evaluated the effectivenessof the registrant’s disclosure controls and procedures as of a date within 90days prior to the filing date of this annual report (the “Evaluation Date”);and

 

c)  presented in this annualreport our conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s othercertifying officers and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a)  all significant deficienciesin the design or operation of internal controls which could adversely affectthe registrant’s ability to record, process, summarize and report financialdata and have identified for the registrant’s auditors any material weaknessesin internal controls; and

 

b)  any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6.  The registrant’s othercertifying officers and I have indicated in this annual report whether or notthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date: March 14, 2003 |                                             |
|----------------------|--------------------------------------------------|
|                 |                                             |
|                 | /s/ Dana D. Messina                              |   |
|                 |                                             |   |
|                 | Dana D. Messina                                  |
|                 | Director, President and Chief  Executive Officer |

 

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I,  Dennis M. Hanson, certifythat:

 

1.  I have reviewed this annualreport on Form 10-K of Steinway Musical Instruments, Inc.;

 

2.  Based on my knowledge, thisannual report does not contain any untrue statement of a material fact or omitto state a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.  Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, theperiods presented in this annual report;

 

4.  The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

a)  designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisannual report is being prepared;

 

b)  evaluated the effectivenessof the registrant’s disclosure controls and procedures as of a date within 90days prior to the filing date of this annual report (the “Evaluation Date”);and

 

c)  presented in this annualreport our conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s othercertifying officers and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a)  all significant deficienciesin the design or operation of internal controls which could adversely affectthe registrant’s ability to record, process, summarize and report financialdata and have identified for the registrant’s auditors any material weaknessesin internal controls; and

 

b)  any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6.  The registrant’s othercertifying officers and I have indicated in this annual report whether or notthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date: March 14, 2003 |                                                         |
|----------------------|--------------------------------------------------------------|
|                 |                                                         |
|                 | /s/  Dennis  M. Hanson                                  |   |
|                 |                                                         |
|                 | Dennis M. Hanson                                             |
|                 | Senior Executive Vice President and  Chief Financial Officer |

 

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